Taxpayer Prevails in Substantial Understatement Penalty

It is somewhat rare for taxpayers to prevail in penalty abatement cases, so it is always good to read cases where taxpayers do prevail. Thrane v. Commissioner is one of those cases.

Thrane was in the mortgage business. He was the sole owner of a Subchapter S corporation. Thrane employed an accountant to prepare his business tax return and a business bookkeeper and he had his individual tax return prepared by an accountant. An accountant error on the business tax return resulted in Thrane underreporting income received on his personal tax return to the tune of $173,093.

The IRS imposed a Section 6662 substantial understatement penalty, because the amount of the tax that was not reported exceeded $5,000. Thrane argued that he had reasonable cause for the understatement and that he acted in good faith; however, it appears that the IRS rejected this argument. The parties made the same arguments in court.

The tax court held that Thrane did in fact have reasonable case and he did act in good faith. The court’s logic was that the error was one that was not obvious from the front of the tax return, it was an error that would require a thorough examination of the taxpayer’s Schedule E. Thus, because Thrane employed accountants he was entitled to rely on the accountant’s faulty work.

Good for Thrane. My problem with this type of case is that the IRS did not concede the case at the administrative level or in court. It is this type of denial at all cost stance of the IRS that results in a number of taxpayers simply paying the tax – especially if they cannot afford to take the IRS to court. I suppose the lesson is that taxpayers should not let the IRS bully them, especially when the IRS takes a frivolous position.