Failure to File Penalty When Return Not Filed-What is Reasonable Cause to Avoid the Penalty? (11/24/23)

In Lee v. United States, 84 F.4^th 1271, (11^th Cir. 8/24/23) (GS here), the Court held that reliance upon a return preparer to e-file a tax return is not reasonable cause for the failure to file penalty. This is a logical and probably necessary holding from Boyle’s bright line holding for those penalties applying for failure to file and pay by mail. United States v. Boyle, 469 U.S. 241 (1985), here.

Lee serves as a reminder that taxpayers assume the risk of their preparer’s failure to file (whether in hard copy format or by e-file). Of course the taxpayer has to sign the hard copy manually and should be able to know at least whether that essential act was done in time. So, if signing the return occurs in time, the taxpayer should simply mail the return in one of the § 7502 guaranteed timely mailed, timely filed way.

In this regard, readers may want to review Judge Lagoa’s “specially concurring” opinion warning of the risks in this process for manually mailed and efiled returns.

I posit one hypothetical as a possible reasonable cause defense for failure to file timely. Assume an individual taxpayer with an extended filing date of 10/15/XX. He engages with a competent preparer to whom he timely delivers all documents and data required to prepare the return and offer it to the taxpayer for filing and mailing in early October. The expectation is that the taxpayer will do the guaranteed timely mailing-timely filing method under § 7502. During the preparation phase, the taxpayer and the preparer correspond as necessary to make sure the preparer has the information sufficiently to prepare the return competently and timely and is progressing in a timely manner to meet the early October time to deliver to the client for filing. On October 13/XX, the taxpayer goes to the preparer’s office to sign, physically signs, and takes possession of the return, bringing a properly addressed envelope with a postage-paid envelope for one of the guaranteed timely mailing -timely filing methods. The taxpayer finds at the preparers office that for some reason the return has not been prepared and the underlying documents and data are in such a mess that the mess cannot be resolved in time to file the return timely. Would that be reasonable cause? Surely this is a different case than Boyle where the problem resulted from the adviser giving incorrect legal advice as to the filing date so that, apparently no attempt was made to prepare a return in time for timely filing. Also, assume that the failure to file penalty is $1,000,000. Would you take the case on a contingency fee?

Of course, taxpayers who can prove that they reasonably relied upon the preparer under state law have a likely cause of action under state law. But pursuing that right might be expensive, timely, and perhaps fruitless.

Tax Procedure Book Errata - Base to Which the Failure to File and Fraudulent Failure to File Penalty Rates Apply (9/1/16)

I did not state the penalty base for the failure to file penalty which comes in two flavors -- the fraudulent failure to file penalty and the general failure to file penalty.  See § 6651(a)(1) and (f).  (Actually, it is buried in the discussion of the fraudulent failure to file penalty, but being buried is not good enough.)  The respective failure to file penalty rates are 15% per month up to 75% for fraudulent failure to file and 5% per month up to 25% for the general nonfraudulent failure to file.  The base to which the respective rates apply is the same -- the tax due "reduced by the amount of any part of the tax which is paid on or before the date prescribed for payment of the tax and by the amount of any credit against the tax which may be claimed on the return."  § 6651(b)(1).

The penalty base is important and needs to be stated explicitly.  I have made that addition as follows:

In the Student edition p. 233 and the Practitioner edition p. 331, I have added the following sentence immediately after the first sentence in the section under D. Fraudulent Failure to File Return - § 6651(f).:

The base to which the 15% per month fraudulent failure to file penalty rate applies is the same base as the general failure to file 5% per month penalty – the tax due “reduced by the amount of any part of the tax which is paid on or before the date prescribed for payment of the tax and by the amount of any credit against the tax which may be claimed on the return.” fn
  fn § 6651(b)(1).

In the Student edition p. 248 and the Practitioner edition p. 352, I have added the following sentence immediately after the fourth sentence in the section under F.1. Most Returns with Tax Due:

The base to which the 5% per month penalty rate applies is the tax due “reduced by the amount of any part of the tax which is paid on or before the date prescribed for payment of the tax and by the amount of any credit against the tax which may be claimed on the return.” fn
   fn § 6651(b)(1).

Remember that the indicated footnotes are not contained in the Student edition.

Estate Did Not Have Reasonable Cause For Failure to Timely File Estate Tax Return (4/11/13)

My immediately preceding blog entry is titled Estate Had Reasonable Cause for Failure to Timely File Estate Tax Return Based on Attorney's Advice (4/6/13), here.  I now present a new decision with the opposite result.  In Knappe v. United States, 713 F.3d 1164 (9th Cir. 2013), here, the executor received erroneous advice from his expert accountant regarding the extended due date for filing the estate tax return.  The case appears closer to the leading decision in the Supreme Court's Boyle case (United States v. Boyle, 469 U.S. 241 (1985)) than the Estate of Liftin decision discussed in the preceding blog.  Hence, in Knappe, the Ninth Circuit applied the Boyle result -- i.e., no relief from the penalties.  Why?

In Knappe, the executor was advised by a tax accountant with whom he had dealt previously that the estate could file for an extension of time to file the estate tax return and pay the tax.  The executor authorized the accountant to file the extension.  The extension requested was for six-months additional time to file the return and one year discretionary additional time to pay.  The IRS granted the extensions as requested -- 6 months and one year respectively.  However, for some reason, the accountant believed he had requested a one-year extension for both.  The return was then filed after the 6-month extended due date but before the one-year period.  The IRS imposed the late filing penalty.

The Ninth Circuit first laid out the Code's background (footnote omitted):

An estate-tax return, Form 706, must be filed within nine months of the decedent's death. 26 U.S.C. § 6075(a); 26 C.F.R. § 20.6075-1. An executor may apply for an automatic six-month extension of time to file Form 706 by filing Form 4768 on or before the due date of the return and checking the appropriate box. 26 C.F.R. § 20.6081-1(b). While the IRS "may grant a reasonable extension of time for filing any return," "no such extension shall be for more than 6 months" except in the case of taxpayers who are abroad. 26 U.S.C. § 6081(a). 

Extensions of the deadline to pay the estate tax operate differently. Treasury Department regulations specify that the IRS may grant an extension of time to pay estate taxes, at the written request of the executor, "for a reasonable period of time, not to exceed 12 months." 26 C.F.R. § 20.6161-1(a)(1).

Estate Had Reasonable Cause for Failure to Timely File Estate Tax Return Based on Attorney's Advice (4/6/13)

In Estate of Morton Liftin v. United States, 110 Fed. Cl. 119 (2013), here, the Court of Federal Claims, Judge Miller, held that the estate's failure to timely file the estate tax return because it was waiting for the surviving spouse to obtain citizenship, thus qualifying  bequests to her for the marital deduction, constituted reasonable cause sufficient to prevent the application of the late filing penalty.  Readers who have only a passing familiarity with the Supreme Court's holding in United States v. Boyle, 469 U.S. 241 (1985) may think the holding inconsistent.  It is not, as the Judge Miller explained.  I quote the relevant portion of the opinion (some case, page citations and quotation marks omitted for readability):

To avoid a penalty for a late-filed return, the taxpayer bears the "heavy burden" of proving its failure to file timely was due to reasonable cause and not willful neglect. Boyle, 469 U.S. at 245 (citing I.R.C. § 6651(a)(1)). In order to prove "reasonable cause," a taxpayer must show that it "exercised 'ordinary business care and prudence' but nevertheless was 'unable to file the return within the prescribed time.'" "Willful neglect" requires a "conscious, intentional failure or reckless indifference." 

In Boyle, the Supreme Court observed that "[c]ourts have differed over whether a taxpayer demonstrates 'reasonable cause' when, in reliance on the advice of his accountant or attorney, the taxpayer files a return after the actual due date but within the time the adviser erroneously told him was available." The Court's decision in Boyle did not resolve those differences. The Court did state, however, that: 

When an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, 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" do not demand such actions. 

By contrast, one does not have to be a tax expert to know that tax returns have fixed filing dates and that taxes must be paid when they are due. In short, tax returns imply deadlines. Reliance by a lay person on a lawyer is of course common; but that reliance cannot function as a substitute for compliance with an unambiguous statute. Among the first duties of the representative of a decedent's estate is to identify and assemble the assets of the decedent and to ascertain tax obligations. Although it is common practice for an executor to engage a professional to prepare and file an estate tax return, a person experienced in business matters can perform that task personally. It is not unknown for an executor to prepare tax returns, take inventories, and carry out other significant steps in the probate of an estate. It is even not uncommon for an executor to conduct probate proceedings without counsel.

First Time Abatement for FTF and FTP Penalties (10/17/12)

TIGTA issued a report on the First Time Abate Penalty waiver of failure to file (FTF) and failure to pay penalties under Section 6651(a)(1) and (2).  TIGTA, Penalty Abatement Procedures Should be Applied Consistently to All Taxpayers and Should Encourage Volulntary Compliance, Treasury Inspector General for Tax Administration (Ref. No. 2012-40-113 9/19/12), here.

The FTF penalty is usually 5 percent of the unpaid taxes for each month or part of a month that a tax return is late.  This penalty will not exceed 25 percent of the unpaid taxes.  If a taxpayer files his or her tax return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.    

If a taxpayer does not pay all taxes owed by the due date, he or she will generally have to pay an FTP penalty of one-half of one percent of the unpaid taxes for each month or part of a month after the due date that the taxes are not paid.  This penalty can be as much as 25 percent of the unpaid taxes.  The FTP penalty will continue to accrue after the initial assessment if the taxpayer fails to pay the total tax due when the tax return was due. 

The IRS can abate both penalties under certain circumstances.  Relief from these penalties is generally granted to taxpayers who show they exercised ordinary care and prudence, and failure to file or pay was due to reasonable cause and not due to willful neglect.  However, beginning in Calendar Year 2001, the IRS began granting penalty relief under an Administrative Waiver known as the First-Time Abate (FTA).  Using the FTA waiver, the IRS grants relief to taxpayers who receive an FTF or FTP penalty but have a compliant tax history for the prior three years.  The FTA waiver applies only to a single tax year.

For further background, see IRM 20.1.1.3.6.1  (11-25-2011), titled First Time Abate (FTA), here.

Render Unto Caesar -- Another Intersection of Alleged Religion and Tax (10/9/12)

In Hovind v. Commissioner, T.C. Memo. 2012-281, here, the Tax Court decided decided that the taxpayer had "had unreported Schedule C income and expenses (collectively, net profit) attributable to Creation Science Evangelism (CSE) and Dinosaur Adventure Land (DAL) for each of the years at issue; " (ii) that the taxpayer whether petitioner is liable for additions to tax under section 6651(a)(1) for failing to timely file her income tax return for each of the years at issue; and (3) and that the taxpayer is liable for the fraud penalty under section 6663(a) for each of the years at issue.

The following is from the opinion and gives a good introduction (footnotes omitted):\

Mr. Hovind established CSE in 1989. CSE purported to be a nondenominational religious organization that advocated the message of creation science and opposed the theory of evolution. CSE promoted its message through live lectures by Mr. Hovind and Eric Hovind. Mr. Hovind frequently traveled, domestically and internationally, for speaking engagements, and petitioner occasionally accompanied Mr. Hovind on these trips.

The Ministry then somehow developed, with various revenue generating projects.  The Court then continued (some footnotes omitted):