Can a client rely on his preparer to file an extension?

Who is ultimately responsible for filing extension requests for clients' tax returns, and what kind of liability do accountants have by not filing these extension requests? This issue was raised in the recent case of McMahan, 2d Cir., 5/23/97.

The taxpayer, a lawyer and partner in a law firm, relied on his business partner, an attorney with tax expertise who had prepared the taxpayer's return in prior years and who had filed for the taxpayer's automatic extension, to file an additional extension of time to file his individual return. Both the taxpayer and the taxpayer's assistant reminded the business partner several times about the approaching deadline and filing of the extension request. (The taxpayer knew that this additional extension request was not automatic.) The business partner assured the two that the second extension request had been filed, when in fact it had not. The taxpayer was subsequently assessed with late filing penalties of $141,000 under Sec. 6651. The taxpayer claimed that the late filing penalties should not be assessed based on reasonable cause. Regs. Sec. 301.6651-1(c)(1) defines reasonable cause as the inability to timely file a tax return, provided the taxpayer exercised ordinary business care and prudence. The taxpayer claimed that his reliance on his business partner to file the extension constituted the exercise of due care. The court disagreed. The court ruled that it is the taxpayer, and not the taxpayer's tax practitioner, who is responsible for ensuring that all appropriate tax forms, including extension requests, are filed. The court distinguished the act of filing an extension form, which requires no special training or knowledge, from reliance on a practitioner for substantive tax advice. In issuing this ruling, the court relied on Boyle, 469 US 241 (1985), in which the Supreme Court ruled that a taxpayer cannot avoid a penalty by relying on an adviser to file a return. This reliance could be relevant in situations in which there is a question of substantive law; even in that situation, however, the taxpayer must furnish the adviser with all relevant information to make a decision, the advice must be obtained timely and the advice must directly address the issue in question. Obviously, the more complex the issue on which the taxpayer relies on the practitioner's advice, the better the chances that a reasonable cause exception could apply.

What constitutes reasonable cause? Reliance on the advice of a tax practitioner usually qualifies for the reasonable cause exception for accuracy-related penalties. Predominately, however, reasonable cause has been accepted in late filing penalty situations only when the reasonable cause is beyond the taxpayer's control. Examples include death or illness of the taxpayer or a member of the immediate family; destruction of tax records due to a casualty, such as a flood or fire; unavoidable postal delays; timely filing of a return with an incorrect IRS office; and erroneous advice furnished to the taxpayer, in writing, by the IRS, if relied on by the taxpayer. The facts and circumstances of each particular situation will dictate whether or not reasonable cause exists.

Ultimately, the burden of timely filing or proving reasonable cause rests with the taxpayer in nearly all situations. However, the taxpayer could seek recourse from the practitioner and his firm by suing for malpractice or breach of fiduciary duty under state law.

A practical way for both practitioners and clients to avoid this situation is with an in-house tracking system, to ensure that all clients have been accounted for, and by using written correspondence when requesting information needed to' accurately and timely file the return or extension. This should provide both the practitioner and his clients with peace of mind at deadline time.