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Reasonable cause for abating penalties.

IRS penalty notices usually create frustration and anxiety for both taxpayers and their tax advisers. From the practitioner's perspective, penalty notices may be embarrassing and often become a time-consuming project to resolve.

The Internal Revenue Code allows the Service to abate late filing and payment penalties if reasonable cause exists. The regulations and most courts require a taxpayer to show that the failure was not due to willful neglect and that ordinary business care and prudence were exercised even though the required actions was unable to be performed timely; see, for instance, Regs. Sec. 301.6651-1(c)(1).

The key to successful abatement of penalties is preparing a reasonable cause statement that satisfies the IRS's criteria (described in Section 4562.2 of the Internal Revenue Audit Manual (IRM). Reasonable cause as described in the IRM generally deals with events and casualties beyond the taxpayer's control. In addition, the IRM also recognize that reliance on a competent adviser may be reasonable cause:

Taxpayer contacts a tax advisor who is competent on the specific tax matter, furnishes necessary and relevant information, and is then incorrectly advised that the filing of a return is not required. Further the taxpayer exercises ordinary business care and prudence based on the taxpayer's own information and knowledge in determining whether to secure further advice; then the taxpayer may have reasonable cause. Note: Reliance on a tax advisor to prepare a return is not reasonable cause for failure to file, the duty to file is upon the taxpayer.

In Boyle, 469 US 241 (1985), the Supreme Court unanimously (but with a four-justice concurring opinion) attempted to draw a "bright line" for reasonable cause. The taxpayer, a businessman who was appointed executor of his mother's estate engaged an attorney to prepare the estate tax return. The taxpayer did not know the return's due date, but relied on the attorney's assurances that the return would be prepared "in plenty of time." Despite the taxpayer's numerous inquiries, the return was filed three months late. The Supreme Court recognized that reliance on a tax professional is reasonable cause when an issue involves a matter of tax law. However, in Boyle, the taxpayer did not rely on his attorney's legal advice. Rather, he delegated his filing responsibility:

When an attorney or accountant advises a taxpayer on a matter of tax law, it is reasonable for the taxpayer to rely on that advice. Most taxpayers are not competent to discern error in the substantive advice of an accountant or attorney. To require the taxpayer to challenge the attorney, to seek a "second opinion," or to try to monitor counsel on the provisions of the Code himself would nullify the very purpose of seeking the advice of a presumed expert in the first place. "Ordinary business care and prudence" does not demand such actions. (Emphasis added by the Court.)

On the other hand:

This case is not one in which a taxpayer has relied on the erroneous advice of counsel concerning a question of law. Courts have frequently held that "reasonable cause" is established when a taxpayer shows that he reasonably relied on the advice of an accountant or attorney that it was unnecessary to file a return, even when such advice turned out to have been mistaken. . . This Court also has implied that, in such a situation, reliance on the opinion of a tax advisor may constitute reasonable cause for failure to file a return. See Commissioner v. Lane-Wells Co., 321 U.S. 219 (1944) (remanding for determination whether failure to file return was due to reasonable cause, when taxpayer was advised that filing was not required).

Therefore, the Supreme Court concluded:

It requires no special training or effort to ascertain a deadline and make sure that it is met. The failure to make a timely filing of a tax return is not excused by the taxpayer's reliance on an agent, and such reliance is not "reasonable cause" for a late filing under [section] 6651(a)(1).

Where did Mr. Boyle go wrong? Apparently, his failure to take steps to ascertain the return's due date was a breach of his duty to exercise ordinary business care and prudence. The Court did not discuss the lengths to which taxpayers must go to ascertain the correct due date of their returns.

In La Meres, 98 TC No. 24 (1992), an estate's late filing and payment was excused for reasonable cause when an attorney advised the estate's personal representative of the wrong due date. The Service argued that reliance on counsel regarding a due date cannot be reasonable cause.

The Tax Court addressed this issue as follows:

The second subcategory of cases involves taxpayers whose late filing was caused by erroneous expert advice as to the date that the law required the taxpayer to file its return. The Supreme Court acknowledged that courts are split on whether reliance on this type of advice can constitute reasonable cause for purposes of section 6651(a)(1).

However, the Tax Court stated that it "has consistently held that erroneous legal advice with respect to the date on which a return must be filed can constitute reasonable cause for failure to file a timely return if such reliance was reasonable under the circumstances."

The court further stated:

In Estate of Rapelje, . . ., we commented on our opinion in Estate of DiPalma and noted that reasonable reliance on an attorney's advice as to when a return is due falls into the same category of cases as those in which taxpayers relied on an attorney's advice that no return at all need be filed. Both situations require someone to ascertain the duties imposed by law, and in both situations, lay persons typically rely on the advice of experts. These cases are distinguishable from those in which the taxpayer simply delegates all responsibility for filing to an agent.

Therefore, the Tax Court concluded:

In Boyle, the Supreme Court made clear that a taxpayer's reliance on an agent to perform a nondelegable duty is different from a taxpayer's reliance on an expert's advice. We hold that reasonable reliance on the erroneous advice of an attorney with respect to the due date of a return can constitute "reasonable cause" within the meaning of section 6651(a)(1).

Tax advisers and taxpayers also should be cognizant of how the IRS evaluates reasonable cause. The IRM directs Services personnel to consider the following questions:

* Do the taxpayer's reasons address the penalty that was assessed?

* Is the length of time between the event cited as cause and the filing or payment date reasonable?

* Does the continued operation of a business after such event indicate that the late filing or payment could have been avoided?

* Should that event have been reasonably anticipated?

* Was the penalty the result of carelessness, or did the taxpayer appear to have made an honest mistake? (Carelessness and forgetfulness are the same as civil willful neglect and are not examples of ordinary business care and prudence.)

* Has the taxpayer provided sufficient detail to determine if ordinary business care and prudence were exercised?

* If a nonliable individuals is blamed for the taxpayer's noncompliance, what is that person's relationship to the taxpayer?

* Has the taxpayer documented all pertinent facts?

* Does the taxpayer have a history of being assessed the same penalty?

* Could the taxpayer have requested an extension or filed an amended return?

Most notable among these questions is the one dealing with an apparently honest mistake. Practitioners should not overlook this factor in determining whether clients have reasonable cause to avoid late filing penalties.

Note: Taxpayers may appeal the Service's initial rejection of reasonable cause in the same manner as they appeal adjustments proposed by revenue agents.
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Title Annotation:examples of effective methods for abating IRS penalties
Author:Taylor, David E.
Publication:The Tax Adviser
Date:May 1, 1993
Previous Article:Accounting method change for depreciation attributable prior misclassification of property.
Next Article:Treatment of COD income under secs. 704 and 752.

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