Reliance on an agent held not to constitute reasonable cause.

In McMahan, 114 F3d 366 (1997), the Second Circuit found that reliance on an agent to file an application for an extension of time to file a Federal income tax return did not constitute reasonable cause for purposes of the failure to file penalty imposed by Sec. 6651(a)(1). As a result of this finding, the taxpayer (and quite probably, in turn, his agent) was liable for a penalty of $141,028.

On April 14, 1983, McMahan's attorney, who prepared and filed his 1978-1981 Federal income tax returns, prepared and filed Form 4868, Application for Automatic Extension of Time To File U.S. Individual Income Tax Return, extending the deadline to file McMahan's 1982 tax return until Aug. 15, 1983. Several weeks prior to the extended due date, both McMahan and his executive secretary questioned the attorney about the status of the return, and were assured that the attorney would file a request for a second extension of time to file (which he believed the IRS would grant). During the week prior to August 15, the attorney told both McMahan and his secretary that the second extension request had been filed; after this, McMahan went on vacation. When he returned, he learned that the second extension request had actually not been filed. McMahan ultimately filed his 1982 tax return in March 1984, and subsequently received a notice of deficiency for additional tax (as well as a late filing penalty).

Sec. 6651(a)(1) imposes a failure to file penalty of 5% per month of the late tax liability up to a maximum of 25%, unless the taxpayer can show that such failure was due to reasonable cause and not willful neglect. The burden of proving reasonable cause and lack of willful neglect rests on the taxpayer. Regs. Sec. 301.6651-1(c)(1) provides that, "If the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time, then the delay is due to reasonable cause." McMahan argued that he had reasonable cause for failing to file a timely request for extension; he relied on his tax agent's assurances that the agent filed the extension and that this reliance was an exercise of ordinary business care and prudence. The courts disagreed.

The Second Circuit based its opinion in McMahan on Boyle, 469 US 241 (1985). In Boyle, the Supreme Court held that reliance on an agent to file an estate tax return by its statutory deadline did not constitute reasonable cause, even though the filing deadline was missed as the result of a clerical error in the attorney's office.

Although the taxpayer in Boyle relied on an adviser to file an actual return, while McMahan relied on his adviser to file an extension request (which the attorney was authorized to sign), the Second Circuit refused to differentiate between these responsibilities. Quoting the Tax Court, the court stated, "[I]t would be anomalous to excuse a late return where the taxpayer asked his agent to file an extension request but not excuse a late return where the taxpayer asked his agent to file a return." Thus, the Supreme Court's holding in Boyle and the Second Circuit's holding in McMahan consistently conclude that the duty to file a return and to pay taxes on time is clearly placed on the taxpayer, and it is unreasonable for a taxpayer to simply rely on an agent to file either an actual return or a request for an extension of time to file.

Tax practitioners should take special note of McMahan. As noted by the court, "McMahan may well be able to recover the amount of the penalty he must pay from his attorney through a malpractice action or a claim for breach of fiduciary duty under state law. But, the attorney's alleged misrepresentations and negligence are state law issues to be resolved between the parties, not on the basis of federal tax law by the IRS or by this Court." To the extent that neither the Service nor the courts will abate late filing penalties in situations such as those presented in this case, clients may well be justified in expecting their tax advisers to make them whole.