Tax Court Finds no “reasonable cause” for income omission where taxpayer provided information to and relied on tax return preparer

Oct 24, 2011   

In Woodsum v. Commission, 136 T.C. No. 129 (June 13, 2011), Judge Gustafson addressed the taxpayers’ petition for redetermination of accuracy-related penalty of $104,295 that the Internal Revenue Service (IRS) determined against the taxpayers for tax year 2006, pursuant to section 6662(a). The issue for decision was whether the petitioners had “reasonable cause” under section 6664(c)(1) for omitting $3.4 million of income from their joint 2006 Federal income tax return.

In 1998 the taxpayers participated in a financial transaction described as a “ten year total return limited partnership linked swap.” In entering into this transaction, the taxpayers were advised by an attorney who supervised the preparation of the tax return for the year at issue. The taxpayers provided to their tax return preparer 160-plus information returns, including the Form 1099-MISC reporting $3.4 million from the termination of the swap and Form 1099-INT reporting $60,291.69 of interest income from the swap.  The Form 1040 prepared for the taxpayers was 115 pages long. The return did report the $60,291.69 of interest income that the taxpayers received from the swap. Likewise, the return did not include the $3.4 million from the swap.

The IRS received a Form 1099-MISC reporting the $3.4 million for the swap, compared with taxpayers’ return, and determined a deficiency in tax of $521,473 and an accuracy related penalty under section 6662(a) of $104,295.  The taxpayers agreed to the assessment of tax in the amount determined by the IRS. As a result, their tax due, which they reported as $3,719,454, was actually $4,240,927.  The taxpayers paid the tax deficiency plus interest. However, the taxpayers petitioned the Tax Court disputing the accuracy-related penalty.

The Tax Court held that the taxpayers did not receive advice from tax professionals that would justify the omission of income.  In so holding, the Court held that because the taxpayers knew that their Form 1099 should have been included, they lacked reasonable cause for their return preparer’s failure to include the income.  The Court also held that the taxpayers failed to show that they were entitled to the “computational or transcription error” exception.  The Tax Court’s decision requires taxpayers to perform more than a cursory review of the return to ensure of its accuracy. 

The full decision can be found here.

The attorneys at Fuerst Ittleman, PL have extensive experience litigating tax issues against the U.S. Government.  You can reach an attorney by emailing us at:  contact@fidjlaw.com.