TAX NEWS - January 2010

Reliance on preparer was not reasonable, accuracy-related penalty upheld

In a recent decision, the Tax Court upheld an accuracy-related penalty against the taxpayers because the taxpayers did not act in good faith and with reasonable cause when relying on their accountant to prepare their individual income tax return. Estate of Stiel v. Commissioner, T.C. Memo 2009-278 (12/01/09).


Background

In this case, the estate and surviving spouse (the "taxpayers"), went to a tax preparer, who had prepared the spouses' income tax returns for more than thirty years, to prepare the 2005 Form 1040, U.S. Individual Income Tax Return. The taxpayers provided Form SSA-1099, Social Security Benefit Statement, to the tax preparer indicating that they received $21,445 of Social Security benefits in 2005. The taxpayers, however, failed to provide the tax preparer with the 2005 Form 1099-DIV, Dividends and Distributions, and Form 1099-INT, Interest Income, indicating that they received $216 and $24, respectively.

The tax preparer did not include the Social Security benefits, as well as the dividends and interest, when he prepared the taxpayers' 2005 federal income tax return. The preparer provided the taxpayers a summary of items that would be included on the return prior to filing. Additionally, he provided a copy of the 2005 return after it was timely e-filed and accepted by the Internal Revenue Service (IRS). The surviving spouse did not detect the omission of the Social Security benefits or the other two items. The IRS assessed a deficiency and imposed Section 6662(d) accuracy-related penalty for the substantial understatement of tax.


Reasonable cause defense – Reliance on advice of a tax professional

The taxpayers asserted the reasonable cause and good faith defense under Section 6664(c)(1). The IRS, however, contended that the taxpayers did not satisfy the reasonable cause and good faith exception simply by relying on the advice of a tax professional. Treas. Reg. Section 1.6664-4(b) provides that the determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances.

The Court stated that in order for a taxpayer to establish the reasonable cause and good faith defense by relying on advice of a tax professional to avoid a liability for a Section 6662(d) penalty, three requirements must be met: the adviser must be competent and have sufficient expertise to justify reliance, the taxpayer must have provided the adviser complete and accurate information, and the taxpayer must have relied in good faith on the adviser's judgment. The Court further clarified that "unconditional reliance on a preparer or adviser does not always, by itself, constitute reasonable reliance."


Conclusion

The Tax Court, in this case, found that the taxpayers did not rely in good faith on the tax preparer by not reviewing the return prior to its submission to the IRS. A cursory review of the return by the taxpayers would have likely revealed the tax preparer's error. Thus, the Court upheld the accuracy-related penalty for substantial understatement against the taxpayers.

This case demonstrates that reliance on a tax preparer does not guarantee reasonable cause relief from penalties. Instead, the availability of such relief depends on various factors. Taxpayers have a duty to ensure all items of income are included on their return, and they should review their returns before signing or authorizing e-filing.