IRS: shoot first, let the Tax Court sort it out later. One of the most annoying features of exams in recent years is the IRS habit of imposing penalties on almost every underpayment, regardless of the cause or the taxpayers’ history of good compliance. It’s nice to see a case like one in the Tax Court yesterday that held the IRS went too far.
The taxpayer were a married couple with a 50-year unblemished compliance history. The wife’s employer switched from issuing paper W-2s to downloadable versions for 2010. She didn’t get the memo, if there was one, and left her wage income off the couple’s 1040. The IRS computers noticed and issued a notice and penalty; the taxpayers double-checked with their preparer and immediately paid the extra taxes, but they balked at the 20% underpayment penalty.
The Tax Court pointed out (all emphasis mine):
Petitioners regard their tax situation as fairly complex, as they receive income from multiple sources, including two subchapter S corporations that lease farmland out of State. Petitioners worry about their ability to prepare accurate tax returns; accordingly, for many years, including 2010, petitioners have hired a certified public accountant (C.P.A.) to assist them in the preparation of their returns.
Petitioners are aware of the importance of recordkeeping, and for many years they have maintained a system for keeping track of documents that will be needed to prepare their returns. Thus, when petitioners received in the mail a tax document such as a Form W-2, Wage and Tax Statement, Form 1098, Mortgage Interest Statement, Form 1099-R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., or Schedule K-1, Beneficiary’s Share of Income, Deductions, Credits, etc., they would briefly review it and then place it in a dedicated tax file, along with other tax-relevant documents that they collected throughout the year. In February or March petitioners would meet with their C.P.A. and furnish him with their tax file. Once the return had been prepared, petitioners would again meet with the C.P.A. to review the return.
So the taxpayers had a pretty good system in place to ensure compliance. Yet the missing W-2 fell through the cracks — partly because their preparer thought the wife had retired.
Petitioners’ failure to notice the absence of a Form W-2 for Mrs. Andersen was an oversight on their part. However, the oversight was at least partially understandable given both the number of petitioners’ tax documents and the fact that Mrs. Andersen never received from either her employer or her employer’s payroll agent a paper copy of a Form W-2, something that she had previously received throughout her career. Nor had Mrs. Andersen received notification from either of those parties that the payroll agent had discontinued issuing Forms W-2 in paper form in favor of making electronic copies available on the Internet.
Petitioners also failed to notice, when they reviewed their return with Mr. Trader, that Mrs. Andersen’s wages were not included on line 7. But when, as part of the review process, petitioners and Mr. Trader compared the 2010 return with the 2009 return, the parties noted the similarity of the amounts of income and the absence of any anomaly, thereby suggesting that no error had occurred. Indeed, the difference between the amounts of income reported on petitioners’ 2010 and 2009 returns was less than $1,000, or two-thirds of one percent of their 2009 income, a difference that would not ordinarily give rise to any suspicion that income had not been fully reported.
So the mistake was one a reasonable human would make. But the IRS thinks no mistake is reasonable, apparently. Fortunately the Tax Court held otherwise:
Clearly, petitioners made a mistake. But we think it was an honest mistake and not of a type that should justify the imposition of the accuracy-related penalty. In short, we think that petitioners’ diligent efforts to keep track of their tax information, hiring a C.P.A. to prepare their tax return, reviewing their return with the C.P.A. when it was completed, and prompt payment of the deficiency upon receipt of the notice of deficiency, together with the other facts and circumstances discussed above, represent a good-faith attempt to assess their proper tax liability. Accordingly, we hold that petitioners have carried their burden with respect to the reasonable cause and good faith exception under section 6664(c)(1) and that petitioners are therefore not liable for the accuracy-related penalty under section 6662(a).
So: good records, full cooperation with a reliable preparer, and prompt payment of any underpaid taxes on discovery of the underpayment were key. It’s ridiculous that it took a trip to Tax Court to get what seems like the only appropriate and fair result. The IRS should stop being so trigger-happy with penalties. Maybe a sauce for the gander rule, where the IRS and IRS personnel are as liable for penalties on incorrect assessments as taxpayers are for those on underpayments, would get them to see reason.
Cite: Andersen, T.C. Summ. Op. 2013-100
Kyle Pomerleau, CBO Report Confirms that the Federal Government Redistributes a Substantial Amount of Income (Tax Policy Blog, my emphasis):
They also break down taxes paid and spending received by income quintile. When looked at this way, the redistribution becomes very clear. According to their analysis, those in the lowest quintile received $22,000 in spending minus taxes. In contrast, taxes exceeded spending by $56,000 in the highest quintile.
When private think tanks like the Tax Foundation issue this sort of report, people favoring higher taxes on “the rich” dismiss it. CBO numbers are harder to credibly attack as partisan.
But we can always find a dark side. CBO Finds Growing U.S. Income Inequality (Roberton Williams, TaxVox)
William Perez, Selling Losing Investments as Part of a Year-End Tax Strategy.
Tony Nitti, IRS Addresses Deductibility Of Organizational And Startup Costs Upon Partnership Technical Termination. By saying no.
TaxGrrrl, Tax Scammers Continue To Dial Up Trouble For America’s Seniors. This is a big problem. Unless they have contacted you by mail first, the tax folks aren’t going to phone you. Just hang up.
Paul Neiffer, How $12,000 Becomes $6,000 or less. By putting it in farmland, if crop prices stay where they are.
Stephen Olsen, IRS says Hom Gonna Getcha on FBAR too. “The Swiss government and banks are folding like a bunch of cheap patio chairs.”
Phil Hodgen, Voluntary Disclosure and Frozen Swiss Bank Accounts
Jeremy Scott, Will FATCA Ever Go Into Effect? (Tax Analysts Blog) “FATCA should be put into effect as soon as possible, and the administration should stop bending separation of powers rules by using delays to functionally repeal unpleasant parts of statutes.”
Nah, just repeal the whole mess.
Winter Carnival! Tax Carnival #123: It’s Beginning to Look a Lot Like Tax Time (Kay Bell)
TaxProf, The IRS Scandal, Day 215
Um, no, was there one? Remember the Tax Reform Act of 1995? (Clint Stretch, Tax Analysts Blog) “What is certain is that the 1995 hope of creating a tax system that genuinely favors savings and investment is dead.”
It’s always a good Tuesday for a Robert D. Flach Buzz!
We hardly knew ye. Farewell to Feel-Good Tax Reform (Martin Sullivan, Tax Analysts Blog)
Tags: Anthony Nitti, Clint Stretch, Jeremy Scott, Judge Armen, Kay Bell, Kyle Pomerleau, Martin Sullivan, Paul Neiffer, Phil Hodgen, Roberton Williams, sauce for the gander, Stephen Olsen, tax administration, tax court, TaxGrrrl, TaxProf, William Perez