Penalty Abatement for Reliance on Tax Advisor Who Made Obvious Errors
The IRS often willing to abate or remove tax penalties. To do so, taxpayers usually have to show that they acted with reasonable cause and in good faith. Relying on a competent tax professional can be one way taxpayers can make this showing. But what exactly is a competent tax professional? The court addressed this in Whitsett v. Commissioner, T.C. Memo. 2017-100.
The Facts & Procedural History
The facts and procedural history in the court case are as follows: The taxpayer is a 70-year-old doctor. She made a stock investment in 1982 for $11,000. She sold the shares in 2012 for $1,717,038. The taxpayer asked her accountant how to report the gain. The accountant determined, incorrectly, that the gain should be reported in 2011. The accountant then filed an extension of time to file the 2011 return. He prepared the return late, after the extended due date. He then failed to file the return, even though he told the taxpayer he had electronically filed the return.
The IRS received the Form 1099 from the brokerage company for 2012 and assessed the tax for 2012. The IRS also sent the taxpayer notices that she had a large balance on account from 2011. The taxpayer hired her accountant to try to resolve the issue with the IRS. It wasn’t until 2015 that the accountant told the taxpayer that the stock sale should have been reported in 2012. The IRS assessed a $107,995 penalty for the 2012 tax year. The penalty was the subject of the court’s opinion.
The Accuracy-Related Penalty
The IRS assesses accuracy-related penalties if there is a substantial understatement on a tax return. The penalty is 20% of the portion of the underpayment. The penalty does not apply if the taxpayer acted with reasonable cause and in good faith. There are a number of ways a taxpayer can show that they acted with reasonable cause and in good faith. This includes, as relevant here, showing that the taxpayer reasonably relied on the advice of a tax advisor.
Reliance on a Tax Advisor
To rely in good faith on the advice of a tax advisor, the taxpayer must show that:
- The tax adviser was a competent professional who had sufficient expertise to justify reliance,
- The taxpayer provided necessary and accurate information to the tax adviser, and
- the taxpayer actually relied in good faith on the adviser’s judgment.
Here, the court easily found that the second and third elements were met. The first element as to whether the accountant was a competent professional was the real issue in dispute.
What is a Competent Tax Professional?
What exactly is a “competent tax professional?” Is the standard one of experience and education, history of preparing accurate tax returns, both, or some other factors? What if the tax advisor made very obvious and substantial errors?
Here, the court opinion does not address the tax advisor’s education or training and it only addresses the tax advisor’s work history briefly. The court opinion merely says that the accountant had over 25 years of experience, cited facts that may suggest that he apparently had a moderately successful tax return preparation business, and he was not a CPA.
The court noted the accountant had prepared the taxpayer’s ex-husband’s tax returns for years without significant issues. It also noted that the accountant made several of the errors on the taxpayer’s returns. This included picking the wrong year for reporting the stock gain and not filing various tax returns, even though he had told the taxpayer that he filed the tax returns.
The court found that the taxpayer did not know of the accountant’s errors at the time. Given this finding, the court concluded that the evidence was sufficient to show that the taxpayer had hired a competent tax professional to justify reliance on the advisor’s advice.
The court case is helpful for penalty abatement cases in that it provides authority for the position that the taxpayer’s first-hand knowledge that the tax advisor has a long track record of preparing mostly accurate tax returns can overcome the fact that the tax advisor does not have the best credentials or experience and has made several more recent and obvious and substantial errors.