Corporation's and Shareholder's Reasonable Reliance on Tax Adviser Precluded Negligence Penalty.

S owns all the stock of S-M, a C corporation. S-M retails and wholesales optical merchandise and its business requires that its salespeople travel frequently. S-M generally requires that these salespeople pay their own business expenses and get reimbursed from S-M.

S-M and S use the same accounting firm, and have for the past 52 years. The firm reviews S-M's records and prepares its financial statements and tax returns; it also prepares S's personal returns.

For 1993-1995, S-M claimed deductions totaling approximately $4.5 million. The IRS disallowed approximately $180,000 of this amount for lack of substantiation. This disallowance meant that S received constructive dividends for this amount.

In addition, in 1993, when he was diagnosed with cancer, S stopped keeping an expense log for his auto travel. However, S-M continued to pay S an expense allowance after he stopped traveling.

The Service determined that S's underpayments stemming from all these income adjustments were due to negligence and assessed accuracy-related penalties under Sec. 6662(a). S challenged these penalties. The Tax Court holds for S, ruling that he reasonably relied on his tax adviser and was therefore not negligent.

We believe that both S-M and S have disproved the IRS's determination of negligence. A taxpayer is not negligent when he relies reasonably on a tax adviser for tax advice.

Reasonable reliance occurs when (1) the adviser has sufficient expertise to justify reliance, (2) the taxpayer provides necessary and accurate information to the adviser and (3) the taxpayer actually relies in good faith on the adviser's judgment. Such is the case here. S is an elderly man, and both he and S-M relied reasonably on their longtime accounting firm to prepare their tax returns correctly. Although the Service ultimately disallowed a small portion of S-M's deductions as unsubstantiated, we do not believe that S-M was negligent in claiming those deductions. Nor do we believe that $ was negligent when he failed to report the dividends that resulted from the-IRS's disallowance of those deductions, or the interest that S received from S-M.

SHANE MICHAEL OPTICAL, CO., TC MEMO 1999-267