Handout # 6
Live Appeals Ethics/Reasonable Cause Case
Issue: Ethics of Representative during Appeal of Delinquency
Penalties, sec. 6651(a)(1) & (2) & Reasonable Cause
SUMMARY AND CONCLUSION
Is the taxpayer entitled to an abatement of the delinquency penalties based on reasonable cause?
No, the taxpayer, Mr. Important, (via the representatives) has not presented any facts or circumstances that are recognized by any court as forming a basis for finding reasonable cause for the delinquency.
Primarily, the taxpayer’s explanation of reasonable cause is that his individual return, and the flow through entity returns that are reported on the individual return were so extremely complex, time consuming and difficult to prepare that reasonable cause for lateness is established. Further, it was argued that a loss of up to five tax professionals working at Big & Four, CPA’s on the return information at the time the information was being gathered, analyzed, assembled, etc. caused delays as well.
Finally, the taxpayer argued that imposing the delinquency penalties in this case is contrary to the IRS’ policy of only imposing such penalties if they enhance voluntary compliance. The taxpayer has at least a ten year history of non-compliant behavior in filing his individual returns. Virtually every year back to 2000 shows estimated tax penalties. Some of those years were filed late, like the year 2007 now before Appeals e.g., 2002 and 2005. Further, at the time the taxpayers’ case was in Appeals on the subject penalties for 2007, the 2008 and 2009 individual returns were on extension, and at some point became delinquent; both were filed in January of 2011. This means the 2008 return was delinquent by thirteen months, and the 2009 by almost two months. The taxpayers incurred the delinquency and estimated tax payment penalties for both years and as of June 28, 2011 both of those accounts reflect large balances due. No estimated tax payments were made on the 2008 and 2009 returns.
The taxpayer, via the representative, conceded that approximately 90% of the tax information for 2007 was on hand in November of 2008. There are several Court cases that hold that it is more important to file a return timely with the majority of income, deductions, etc. than file a return late with 100% of the income, deductions, etc. reported thereon.
The taxpayer faces enormous hazards of litigation in this case by not filing a return timely with the tax information on hand in November of 2008 and amending that return thereafter when the remaining 10% of the tax information was secured.
Additionally, there is no precedent in the current tax law that concludes Big & Four,CPA firm staff turnover amounts to reasonable cause. The taxpayers face enormous hazards of litigation on that argument as well.
When I use “hazards of litigation” above, I mean the taxpayers have not borne their burden of proof on reasonable cause, not in the sense that I settled this case based on the hazards of litigation.
BACKGROUND
This is a case involving late filing and late paying penalties on the1040 of high income taxpayers living in London which total a bit over $800,000. The penalties are partially paid in the amount of $150,000. The Philadelphia Service Center penalty appeals coordinator received the request for abatement of the delinquency penalties and rejected the argument that the taxpayers had reasonable cause for late filing and late payment of taxes on their 2007 Form 1040. The penalty abatement rejection letter stated that timely filing would have to be prevented by circumstances beyond the taxpayer's control, and did not find that this was the case.
The reasonable cause arguments presented by the taxpayers via their representative are as follows:
· 2007 return was very complicated because of the 'widespread footprint of investment by Mr. Important throughout Europe and the U.S., particularly Benson Hedges, (a flow-through entity) of which taxpayer is founder and Managing Partner.”
· Mrs. Important's wage documentation was not secured from her employer, the Big European Company, until after 12/15/2008, the extended filing deadline for these joint taxpayers. No explanation was given as to why this information was not available. NOTE: Logic would dictate that Mrs. Important knew what she was paid in terms of an annual salary, as negotiated with her employer. Further, as she was paid periodically through the tax year, she would have known what the gross pay was and most likely, would have received detailed statements showing the gross pay and any/all deductions, withholdings, etc. Finally, at some point between January 1, 2008 and December 15, 2008 one would expect that Mrs. Important could have expended sufficient effort to request and secure her wage reporting document from the payroll office.
· Mr. Important's Berlin LLC financial statements/tax return was not complete and the tax return flow-through information was not complete until approximately a month after the final extended filing deadline on 12/15/2008.
· The financial turmoil of 2008 negatively impacted the efficiency of gathering and submitting large amounts of information to Big & Four, making it more onerous than usual.
· Compounding the delay were several changes to the Big & Four team responsible for assisting with Mr. Important's 2007 individual income tax return due to illness and some staff departures. The representative, Mr. Mike Snooty insisted that this factor is extremely important in establishing reasonable cause, since it was beyond the taxpayers’ control.
He argued that even though they might have had 90% of the information on hand in November of 2008, there was no one available to prepare the return at that time. NOTE: I dismissed the argument that there was no one to prepare the return as not credible, given we are talking about a Form 1040, with sophisticated software available, and Big & Four, one of the largest international CPA firms in the world.
· The taxpayer’s penalty abatement request letter, written in December of 2009 stated that corrective action (after 2007) was taken and the taxpayer and Big & Four were poised to timely file the 2008 before December 15, 2009. Regarding the 2008 return, the letter also stated that estimated payments (plural) had been made. Further, the letter states the 2009 return would be timely filed.
NOTE: these two returns were finally filed in February of 2011 and no estimated payments were actually made. This misstatement of the facts in the abatement request letter, among others, causes this Appeals Officer to find the representatives lacking in credibility in terms of many of their explanations that have no supporting evidence to prove them as true; e.g., that Big & Four had no one to prepare the taxpayers’ return in November of 2008, as mentioned above.
As noted above, the final information that was needed; i.e., asserted to be Mrs. Important’s wage information, the flow through from the Berlin LLC and another flow-through entity were alleged to have been received in January 2009. The total income from these two sources was approximately 10% of the total of income on the return. Further, the return was then filed in July of 2009, seven months after the last information was secured.
After analyzing the taxpayer’s Appeals protest, apparently drafted by Mike Snooty, Big & Four, CPA’s, the Appeals Officer conducted an in-depth review of taxpayers' filing and paying compliance history since 2000, as well as reviewed the transcript of returns to compare 2006 (timely filed) to 2007 (late filed/now subject of this case).
The review of the 2006 return shows that it was exactly similar to the 2007 in terms of the various entities and sources of income. The major difference was the amount of the long term capital gain flow through amount, which was around $5 million vs. $25 million on the 2007 return. It was confirmed with the representatives that each of those long term capital gain amounts was generated by one transaction each year and the gains were known to the taxpayer and Big & Four upon completion of the transactions.
The in-depth review of the taxpayers’ filing and paying compliance history since 2000 determined that the taxpayer consistently fails to pay and/or underpays ES tax payments and is subject to the ES penalty year after year from at least 2000 to 2007. The 2008 and 2009 were delinquent at the time the AO first researched the compliance history, they were both finally filed in January of 2011.
The transcripts of account for both years show that there were no timely estimated tax payments. Rather, a payment was paid at some point months after the end of the tax years and the next payment was made with the returns when filed.
After completing all of the steps mentioned above, the AO prepared a letter and “Preliminary Determination” based on the protest letter, evidence in the administrative file, IDRS filing and compliance history, etc. suggesting that based on the information on hand, the AO would be compelled to deny in full the abatement of all penalties because the taxpayer lacked reasonable cause. This document presented a detailed discussion of the applicable tax law, with references to case law, regulations, etc.
Additional information eventually provided by the representatives, including spreadsheets reflecting all entries made by Big & Four employees into the billable hours data base, shows that there were long periods during 2008 when there was no work being done by Big & Four. This indicates their efforts as stated in the Appeals protest were not all that diligent.
LAW
The IRS imposes mandatory penalties for failure to (1) file payroll tax returns, (2) pay payroll taxes, unless the taxpayer can demonstrate that such failure was occasioned by “reasonable cause and not due to willful neglect.” 26 U.S.C. §§ 6651(a)(1), (a)(2).
Thus, to obtain abatement of employment tax penalties imposed under §§ 6651, the taxpayer must bear the heavy burden of proving that (1) the failure did not result from “willful neglect;” and (2) the failure was occasioned by “reasonable cause.” Boyle, 469 U.S. at 245, 105 S.Ct. 687.
Neither “willful neglect,” nor “reasonable cause,” is defined in the IRC. In United States v. Boyle, the Supreme Court defined “willful neglect,” as used in § 6651(a)(1), as “a conscious, intentional failure or reckless indifference.”
Stated differently, the taxpayer must show that the failure to file a return was the result “neither of carelessness, reckless indifference, nor intentional failure.” Boyle, 469 U.S. at 246 n. 4, 105 S.Ct. 687.
The analysis in Boyle only concerned failure-to-file penalties under § 6651(a)(1) and not failure-to-pay penalty under § 6651(a)(2). The language concerning the relevant standard is identical in both provisions.
Thus, the court in Boyle found no reason to treat the language in § 6651(a)(1) differently from that in § 6651(a)(2). E. Wind, 196 F.3d at 504 n. 5.
There is no jurisprudential definition of “reasonable cause;” however, the Treasury Regulations shed some light on its meaning, see Exceptions to the Section 6651(a)(1) and (2) Additions to Tax, below.
Section 6651(a)(1) Addition to Tax
Section 6651(a)(1) imposes an addition to tax for failure to file a return on the date prescribed unless the taxpayer can establish that the failure is due to reasonable cause and not due to willful neglect.
Section 6651(a)(2) Addition to Tax
Section 6651(a)(2) imposes an addition to tax for failure to pay the amount shown as tax on the taxpayer's return on or before the date prescribed unless the taxpayer can establish that the failure is due to reasonable cause and not due to willful neglect.
For purposes of computing the section 6651(a)(2) addition for any month, the amount of tax shown on the return is reduced by the amount of any part of the tax paid before the beginning of the month and by the amount of any credit against the tax which may be claimed on the return. Sec. 6651(b)(2).
The amount of the addition to tax under sec. 6651(a)(2) reduces the amount of the addition to tax under sec. 6651(a)(1) for any month for which an addition to tax applies under both paragraphs. Sec. 6651(c)(1).
Exceptions to the Section 6651(a)(1) and (2) Additions to Tax
A delay is due to reasonable cause if the taxpayer exercised ordinary business care and prudence but was, nevertheless, unable to file the return within the prescribed period. Regs. § 301.6651-1(c)(1).
To claim a reasonable cause exception, the taxpayer must file a written statement, signed under penalties of perjury that affirmatively shows facts sufficient to indicate the existence of a reasonable cause for failing to timely file the return. Regs. § 301.6651-1(c)(1).
Reasonable cause is a defense to the section 6651(a)(1) and (2) additions to tax. To prove reasonable cause for a failure to timely file, the taxpayer must show that he exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time. Crocker v. Commissioner, 92 T.C. 899, 913 (1989).
To prove reasonable cause for a failure to pay the amount shown as tax on a return, the taxpayer must show that he exercised ordinary business care and prudence in providing for payment of her tax liability and nevertheless was either unable to pay the tax or would suffer undue hardship if he paid the tax on the due date per Regs. sec. 301 .6651-1(c)(1).
The determination of whether reasonable cause exists is based on all the facts and circumstances. Estate of Hartsell v. Commissioner, T.C. Memo.2004-211; Merriam v. Commissioner, T.C. Memo.1995-432, affd. without published opinion 107 F.3d 877 (9th Cir.1997).