Recent U.S. Tax Court Case Finds Taxpayers’ Reliance on Accountant was Unreasonable and Denies Request for Penalty Abatement

US Tax Court

    As tax attorneys in Columbus, Ohio, Nardone Limited routinely assists taxpayers with representation and tax examinations, tax audits, appeals, and civil litigation with the Internal Revenue Service and the Ohio Department of Taxation. As part of that representation, our tax attorneys routinely advise taxpayers regarding potential penalty abatement requests relating to penalties assessed by the IRS and the Ohio Department of Taxation. Many times when a taxpayer’s return is examined by an IRS Revenue Agent, the IRS will assess accuracy-related penalties under Internal Revenue Code Section 6662 on any underpayment of income tax attributable to a taxpayer’s negligence or disregard of rules and regulations, or to a substantial understatement of income tax. Generally, the IRS will abate these penalties if the taxpayer can show that the taxpayer’s failure to file an accurate return was based upon reasonable cause and not willful neglect.

IRS Assesses Accuracy-Related Penalties for Improper Deductions Regarding Life Insurance Plan Payments

    In a recent U.S. court tax case, Jerry L. Keenan, et ux v. Commissioner, the taxpayers participated in a Benistar 419 plan. Further, the taxpayers deducted the Benistar 419 plan payments, totaling over $3 million, on their federal income tax return. But, the accountants listed the deductions as cost of goods sold, rather than reporting as an employee benefits on their return. After the IRS’s examination of the taxpayers’ 2003 Form 1040, U.S. Individual Income Tax Return, the IRS issued a Notice of Deficiency for $882,936.00, and assessed an Internal Revenue Code Section 6662(a) penalty of $176,587.20. Ultimately, the IRS disallowed the deductions claimed by the taxpayers as a pass through loss from their S corporation. In Keenan, the U.S. Tax Court found that contributions made by the participating company were not ordinary necessary business expenses deductible under Internal Revenue Code Section 162(a). Further, in cases regarding the same issue of improper deductions relating to Benistar 419 plan payments, the IRS has held that the taxpayers are liable for the Section 6662(a), accuracy-related penalties.

            Taxpayers Argue They Relied Upon Accountants in Good Faith

    Here, the taxpayers argued that they relied, in good faith, on the advice of their accountants. But, the U.S. Tax Court held that reliance on a professional advisor is, not by itself, an absolute to negligence. Further, the U.S. Tax Court confirmed that there was little reason for the taxpayers to believe that their accountants were authorities on the tax treatment of welfare benefit plan contributions, or that they had sufficiently researched the issue. In fact, according to the U.S. Tax Court, the accountants advised the taxpayers that the accountants had solely relied on a letter that was included in promotional materials for the Benistar 419 plan. The letter included in the promotional materials specifically stated that the IRS may disallow taxpayer deductions based upon a finding that the contributions is not necessary and ordinary expenses. The U.S. Tax Court found that the taxpayers did not conduct the necessary investigations sufficient to avail themselves of a good faith defense.

    The taxpayers argued that they did not graduate high school or attend college, and had no tax background. Further, the taxpayers discussed the plan with their estate planning lawyer and licensed insurance sales man. Ultimately, the taxpayers relied on their accountant, as well as their lawyer, in making a decision to adopt a Section 419 plan and to deduct the contributions regarding the same on their tax return. The accountants deducted the payments relating to the 419 plan as cost of goods sold, rather than the employee benefit on the return. Further, the accountant acknowledged that they deducted the payments as cost of goods sold to lessen the chance of an audit by an IRS revenue agent.

    Ultimately, the U.S. Tax Court found that the taxpayers’ arguments failed to demonstrate that they acted with reasonable cause and in good faith. According to the U.S. Tax Court, the most important factor is the extent of the taxpayer’s effort to assess his proper tax liability in light of all the circumstances. See Brinkly v. Commissioner, 838 F.3d 657,669. The U.S. Tax Court held that the taxpayers blindly delegated their responsibility relating their 419 plan, including the deductions regarding the same, to their accountants and lawyers. The taxpayers did not review the 419 plan, promotional materials, and did not review their tax returns. At the end of the day, the U.S. Tax Court held that the taxpayers did not show any genuine attempt to assess their proper federal tax liabilities for the year at issue. Thus, the U.S. Tax Court upheld the IRS’s assessment of the Section 6662, Accuracy-related Penalties against the taxpayers.

Nardone Limited Recommendation

    In light of the Keenan case, taxpayers should ensure that the professionals they hire are experienced in the subject area that the taxpayers are hiring the tax professionals for. Thus, if the taxpayer is seeking guidance relating to employee benefit plans, it is important that the taxpayers hire professionals who have experience in employee benefit plans. At the end of the day, reliance on professional advice is not, in and of itself, an absolute defense to negligence. If there is little reason for the taxpayers to believe that the tax professionals are authorities in a particular subject area, or that the tax professionals have not sufficiently researched the issue, then—according to the U.S. Tax Court—the taxpayers have not relied in good faith on the advice of their tax professionals. And, if the taxpayers did not act with reasonable cause and in good faith, then the IRS, and the U.S. Tax Court, will likely deny the taxpayer’s request for a penalty abatement.

    In sum, it is important for taxpayers to hire knowledgeable and experienced tax professionals, when doing any type of tax planning, as well as for preparing their tax returns. Further, it is important that the taxpayers rely on their tax professionals in good faith. Generally, all taxpayers are not required to understand complicated tax issues, when it comes to preparing their tax returns; however, taxpayers are required to conduct the necessary due diligence in hiring qualified professionals and asking the necessary questions. At the end of the day, it is the taxpayer’s responsibility to file an accurate tax return to avoid further scrutiny by Revenue Agents during IRS examinations.