Tax Court rules against corporate taxpayers who relied on advice from in-house professional

Oct 26, 2011   

On June 7, 2011, Judge Foley in writing for the Tax Court held that corporate taxpayers cannot rely on the advice of a tax professional as a reasonable cause defense to penalties when the tax professional is an employee of the taxpayer.  The case was decided on a consolidated basis with the cases captions of Seven W. Enterprises, Inc. & Subsidiaries, v. Commissioner, and Highland Supply Corp. & Subsidiaries, v. Commissioner.

The facts are relatively straight-forward.  From February 2001 until March 2002, the tax professional worked as an outside consultant for the taxpayers.  During this period, the tax professional prepared Sevens 2000 tax return and Highlands 2001 tax return. In March 2002, both taxpayers hired the tax professional as their vice president of taxes. As  the taxpayers vice president of taxes, the tax professional prepared and signed, on behalf of the taxpayers, Sevens 2001, 2002, and 2003 tax returns and Highlands 2002, 2003, and 2004 tax returns. In 2000 through 2004, the taxpayers incorrectly concluded that they were not liable for personal holding company taxes and, as a result, understated their tax liabilities relating to those years.  The IRS  issued Seven a notice of deficiency relating to 2000 through 2003 and Highland a notice of deficiency relating to 2003 and 2004. In the notices, the IRS determined that the taxpayers were liable for accuracy-related penalties.

The taxpayers contend that they had reasonable cause for their underpayments and acted in good faith. Alternatively, the taxpayers contend that they reasonably relied on the advice of the tax professional in 2000 when the tax professional served as an outside consultant and in 2001 through 2004 when he served as vice president of taxes.

The Tax Court explicitly held that pursuant to sec. 1.6664-4(b)(1) and (c)(1), Income Tax Regs., Seven is not liable for an accuracy-related penalty relating to 2000 because it reasonably relied on the then outside consultant/tax professional to prepare its tax return.  The Tax Court further held that the then in-house tax professional does not qualify as “a person, other than the taxpayer”, pursuant to sec. 1.6664-4(c)(2), Income Tax Regs., with respect to the returns which he signed on behalf of taxpayers, and therefore the aforementioned regulation is not applicable to the taxpayers underpayments of taxes relating to 2001 through 2004.  The Tax Court finally held that the taxpayers were liable for accuracy related penalties relating to 2001 through 2004.

Treas. Reg. 1.6664-4 provides that:  (a) In general. No penalty may be imposed under section 6662 with respect to any portion of an underpayment upon a showing by the taxpayer that there was reasonable cause for, and the taxpayer acted in good faith with respect to, such portion.  The full text of the regulation can be found here.

In general, a penalty defense is a factually intensive analysis and will be unique to each individual taxpayer.  However, the over-riding principle is the extent that a taxpayer attempted to properly report and calculate the taxes due for each taxable year will determine if penalty relief is applicable. 

The full decision can be found here.

The implication of this decision is that reliance on in-house professionals is not a defense to penalties, and as a result, taxpayers need to consult with outside professionals on tax treatment as reflected on their income tax returns.  The attorneys at Fuerst Ittleman have extensive experience advising individuals, partnerships, and corporations on all aspects of the Internal Revenue Code and have extensive experience litigating against the IRS.  You can reach an attorney by emailing us at:  contact@fidjlaw.com.