Source: https://taxlaw.typepad.com/tax_law/penalties/
Timestamp: 2019-04-23 22:13:48+00:00

Document:
Estate of Angle v. Commissioner, T.C. Memo. 2009-227 (T.C. 2009).
Ever been on an airplane? If yes, then you are probably familiar with SkyMall, the mail-order catalog easily found in the pouch behind every airplane seat. But I bet you never knew you could find tax advice in those catalogs did you? Let me introduce Cloyd Angle and his son Tyler.
Cloyd was the founder and sole owner of Cal-Almond, Inc. He started the Company in 1979, and by the mid-90's was one of the top four almond processors in the country. (2). During the 1990's Cloyd transferred both ownership, approximately 51%, and management of the Company to his son Tyler. (2).
Interested in selling his remaining 49% ownership interest for a hefty price tag, Cloyd came upon Morven Partners. (3). Morven had a large presence in the nutmeat industry, but not much in the way of almonds. Cloyd told Morven he would sell the whole business for $20 million, a number he thought they would refuse. To his delight they accepted. After convincing his son Tyler to sell his 51%, Morven signed a letter of intent.
Of course, Cloyd would have to pay taxes on the sale of his stock to Morven. Cloyd's taxable gain would be the sale price of his stock less his cost basis, which appears to be zero. (3). That means Cloyd's taxable gain would be 49% x $20,000,000 minus $-0-, or $9,800,000. The sale was supposed to take place in 1995. At that time capital gains rates were approximately 28% (see table here). Multiplying 28% by Cloyd's share of the sale ($9,800,000) equals $2,744,000 in federal income taxes. The idea of paying $2.7 million in income taxes was too much for Cloyd to bear.
Fortunately, Cloyd came across a copy of SkyMall. While perusing through the myriad of wonderful gifts and gadgets, "he spotted an advertisement for books and tapes on offshore tax planning." Thrilled about the prospect of avoiding income taxes he contacted Jerome Schneider, the man who was selling the books and tapes.
It was not long after meeting Mr. Schneider that Cloyd began setting up offshore business, renouncing his U.S. citizenship, and transferring his stock to companies set up in beautiful places like Turks and Caicos and the British Virgin Islands. When all was said and done there were six different entities. I beg you to go to page 10 of the opinion and view the exquisite picture provided by the Tax Court depicting all the moving parts; it is truly a work of art.
Unfortunately, poor Cloyd dies before he can realize his dream of avoiding federal income taxes. (15). The Tax Court, however, showed no mercy on his estate, and found Cloyd's web of transactions served little to avoid the imposition of federal income taxes on the sale of his stock. (15). The Tax Court also imposed a 20% accuracy-related penalty because Cloyd did not "act with reasonable cause and in good faith by relying on the professional advice of [SkyMall]. (22).
In the end, Cloyd's estate will pay 48% tax (28% plus the 20% penalty) on the $9,800,000. He will also have to pay interest on the tax from 1995 until the tax is paid, presumably sometime in the near future.
Woodard v. Commissioner, T.C. Summary Opinion 2009-150 (T.C. 2009).
Does Mr. Woodard's reliance on unknown internet resources constitute reasonable cause for purposes of avoiding the accuracy-related penalty under section 6662(a)?
Mr. Woodard received $100,000 from his IRA and deposited that amount into his personal checking account in 2004. (3). In February 2005, Mr. Woodard wired funds to Amanda M. Mahn pursuant to demand notes and statutory mortgage documents . . . [naming] Ms. Mahn as debtor and Hunter Financial, LLC as lender. (3). Mr. Woodard established Hunter Financial, LLC (Hunter) almost six months later in September 2005. (4).
The IRS determined that Mr. Woodard failed to include in income the $100,000 in distributions from his IRA and issued a notice of deficiency as well as assessed an accuracy-related penalty pursuant to section 6662(a). (2).
Mr. Woodard concedes the distributions are taxable but challenges the section 6662(a) accuracy-related penalty. (5).
In a separate action the Minnesota Court of Appeals voided the mortgage that granted Hunter a property interest because Hunter was not registered until September 2005, therefore it could not have taken delivery [of the mortgage] in February 2005. (5).
Section 6662(a) and (b)(1) and (2) imposes a penalty equal to 20 percent of any underpayment of tax that is attributable to negligence or disregard of rules or regulations or to a substantial understatement of income tax. (6). The term “negligence” includes any failure to make a reasonable attempt to comply with the provisions of the internal revenue laws. (6). The term “disregard” includes any careless, reckless, or intentional disregard. (6). An understatement of income tax is “substantial” if it exceeds the greater of 10 percent of the tax required to be shown on the return or $5,000. (6).
Section 6664 provides a defense to the penalty if a taxpayer establishes that there was reasonable cause for the underpayment and that he acted in good faith. (7). The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all the pertinent facts and circumstances. (7).
Generally, the most important factor is the extent of the taxpayer’s effort to assess the proper tax liability, including reliance on the advice of a tax return preparer. (7). An honest misunderstanding of fact or law that is reasonable considering the taxpayer’s education, experience, and knowledge may indicate reasonable cause and good faith. (7).
Mr. Woodard explained that he thought he had a self-directed IRA and that he intended to reinvest the $100,000 in private mortgages. He searched the Internet for information about self-directed IRAs, and he followed advice he found on line. He deposited the $100,000 into his personal checking account and wired the funds from that account to Ms. Mahn as mortgagor. (8).
Good-faith reliance on advice from an independent, competent professional as to the tax treatment of an item may meet the reasonable cause requirement. (9). A taxpayer must act with ordinary business care and prudence to claim reasonable cause. (9).
Mr. Woodard claims that he relied on information found on unspecified Web sites written by unidentified individuals or organizations. (9). From the record, it is not clear that he questioned the provenance or accuracy of the information he found through the Google search engine. (10). Mr. Woodard has not provided the Court with any information about the sources of the information he found on the Internet. (9). Without knowing the sources of the information, it is impossible for the Court to determine that those sources were competent to provide tax advice. (10).
Accordingly, we cannot conclude that Mr. Woodard exercised ordinary business care and prudence in selecting and relying upon the information he found on line. (10).
The court's recitation of the facts was poorly written. On the other hand their statement of the law and their analysis was well done.
This case is interesting because the court does not actually say Mr. Woodard could not meet his burden by using an internet source, rather Mr. Woodard did not provide the internet source he relied on therefore they could not continue their analysis. Had he done that, the court presumably would need to visit the internet source and determine if the advice on the website met the "independent, competent professional" requirement.
Given the proliferation of tax advice on the internet in the form of newspaper articles, magazine articles, finance website, blogs, etc., I believe this is an area of concern for taxpayers. My advice is to not use websites or blogs for tax advice, but if you do, this case should make clear that the taxpayer should document where the advice came from and inquire about the writer's competence to give advice.
Additionally, most websites and blogs (like mine) have disclaimers regarding the use of information to avoid penalties imposed by the IRS. I am not sure how this would effect the analysis for the taxpayer, but it probably would not be helpful to the taxpayer's argument.
Finally, the tax court footnotes on the last page of the opinion that credible information is on the internet; "such as, for example, the Internal Revenue Code and the income tax regulations." Good Luck With That!
Powell v. Comm'r, T.C. Memo. 2009-174 (T.C. 2009).
I blogged previously about section 6673(a)(1) penalties assessed against taxpayers (here). But this is the first case I have seen - albeit I have only been blogging for two months - where the Court assessed section 6673(a)(2) costs against a taxpayer's attorney for "unreasonably and vexatiously" delaying proceedings before the Court.
The taxpayer, Mr. Powell, conducted research of the Internal Revenue Code, case law, etc., which led him to the conclusion that he was not required to file a tax return or pay taxes. This false conclusion resulted in his failure to file tax returns from 1999 through 2002 and his failure to pay some $434,796 in outstanding liabilities.
In October 2005, the IRS sent Mr. Powell a Notice of Intent to Levy and Notice of Your Right to a Hearing. Mr. Powell, however, persisted in his ways even after reading the IRS's publication, "The Truth About Frivolous Tax Arguments." In response to Mr. Powell's belligerence, the IRS sent him a Notice of Determination Concerning Collection Action(s) Under Section 6320 and/or 6330, dated August 11, 2006, sustaining the levy and warning him of potential 6673 sanctions. In September 2006, Mr. Powell filed a petition with Tax Court challenging the levy notice.
Almost a year later, the IRS filed its first Motion for Summary Judgment. The Court denied the IRS’s motion stating, “satisfaction of the requirements of section 6330 [Notice and Opportunity for Hearing Before Levy] should be demonstrated at trial rather than in a summary adjudication,” (as we will see, this comes back to haunt the IRS.) In November 2008, the IRS filed its second Motion for Summary Judgment and a Motion to Impose a Penalty Under section 6673.
In the interim, Mr. Powell retained the services of an attorney, Mr. Barringer, to represent him in the proceedings before the Tax Court. Mr. Barringer responded the IRS’s second motion for summary judgment by seeking more time for discovery and requesting the Court deny the IRS’s motion until Mr. Powell receives satisfactory answers to his questions regarding the meaning of “taxpayer” and “individual” under the Internal Revenue Code.
The Court grants the IRS's second motion for summary judgment. In addition, the Court set an April 20, 2009 hearing for Mr. Barringer to Show Cause why he should not be required to pay attorney’s fees under section 6673(a)(2). In its Order to Show Cause, the Court points out that Mr. Barringer employed the discovery process to delay trial.
Petitioner’s argument [i.e. Mr. Barringer] that respondent’s motions [i.e. IRS] should be denied because they are premature until petitioner secures responses to his various inquiries is patently for the purpose of delay. Petitioner’s interrogatories [interrogatories are written questionnaires] indirectly assert stale tax defiance arguments about terms such as “taxpayer”, “person”, “non-resident alien”, “income”, and other non-meritorious arguments about delegated authority.
The Court rejects the IRS’s request for time and costs for the second motion for summary judgment because it was a choice by the IRS to file the first motion, which the Court warned against. Accordingly, Mr. Barringer – though not completely blameless – is not required to pay time and costs for the IRS’s attorneys in the second motion for summary judgment.
Mr. Barringer protests the abuse of discovery charge, stating that he was simply representing his client based on his client’s directive, and that it would have been futile to try and convince his client, Mr. Powell, otherwise.
Mr. Barringer’s reasoning is rejected by the Court because section 3.1 of the Model Rules of Professional Conduct, incorporated into proceedings before the Tax Court by Rule 201(a) of the Tax Court Rules of Procedure, prevent an attorney from “defending a proceeding…unless there is a basis in law and fact for doing so that is not frivolous, which includes a good faith argument for an extension, modification or reversal of existing law.” Under these Model Rules, Mr. Barringer was prohibited from defending Mr. Powell's frivolous claims. Consequently, the Court grants the IRS’s motion for time and costs for abuse of the discovery process, and awards the IRS $4,725 under section 6673(a)(2).
The Court's decision here imposes section 6673 costs because the attorney abused the discovery process by advancing Mr. Powell's position. The implication of this particular decision is that an attorney is effectively barred, by both the Model Rules and section 6673, from even representing a taxpayer whose only grounds for challenging his or her tax liability are frivolous.
Samples v. Comm’r, T.C. Memo. 2009-167 (T.C. 2009).
Mr. Samples asserts the income tax is an indirect excise tax improperly imposed upon the labor of a natural person. That is, he believes wages received in exchange for labor become property, and it is therefore improper to impose an income tax on his property.
Mr. Samples’s theory is rejected by the Tax Court. His argument is frivolous for several reasons but mostly because “gross income means all income from whatever source derived.” 26 U.S.C. sections 61(a) and 61(a)(1).
Mr. Samples’s argument sounds like a very twisted application of John Locke’s Theory of Labor. Locke theorized that when a person “mixes his labor with” the land, their labor becomes part of the land, and thus imparts land ownership to the laborer. But, as pointed out by the Tax Court, whether a person receives money or property in exchange for his labor, he has received income.
The Tax Court provides a thorough explanation of the section 274(d) substantiation requirements for vehicle expenses otherwise deductible under section 162(a).
The taxpayer is self-employed in the promotions and marketing business. She regularly travels to client sites changing out displays and advertising signs. She did not file a tax return for 2003, as a result the IRS prepared one for her pursuant to section 6020(b).
The are two issues for the Tax Court. First, is the taxpayer allowed a mileage deduction for vehicle expenses. Second, is she liable for penalties under 6651(a)(1) and (2), and 6654(a).
Section 162(a) allows a deduction for ordinary and necessary expenses incurred or paid in carrying on a trade or business. Section 274(d) disallows all travel expenses, including vehicle expenses, otherwise allowed under section 162(a), unless the taxpayer substantiates the expenses with adequate records. The taxpayer's records must include the amount, time and place, business purpose of the expense, and business relationship between the taxpayer and the person entertained, etc.
Acceptable forms of records include "an account book, a diary, a log, a statement of expense, a trip sheet, or a similar record and documentary evidence that in combination are sufficient to establish each element of expenditure or use." see Temp. Reg. 1.274-5T(c)(2)(i). Records should be made at or near the time of the actual expenditure or use. As elapsed time increases, the record's credibility decreases. see Temp. Reg. 1.274-5T(c)(2)(ii).
Here, the taxpayer testified that she kept a mileage booklet but unfortunately she could not find it for trial. She also provided a mileage trip list for 2003, but she stated at trial that she prepared the list in 2007 - after the IRS sent her the notice of deficiency at issue in the case. She also produced several different reports showing client names and the dates she serviced their accounts.
The Court holds for the Service because the taxpayer’s records were not made "at or near the time" she incurred the vehicle expense. Thus she did not meet the substantiation requirements. As such, she is not allowed a mileage deduction. There is nothing in the opinion regarding actual vehicle expenses.
The IRS also assessed penalties for failure to file her 2003 tax return, failure to pay the tax shown on the return, and failure to pay estimated taxes. The Tax Court (in fact the same Judge) dealt with this identical topic here. As was the case with Ms. Humes, the IRS did not produce evidence of the taxpayer's 2002 return, thus the Court abated the 6654(a) failure to pay estimated tax penalties. The failure to file and failure to pay penalties under 6651(a) were sustained.
This opinion is subject to section 7463 and may not be used as precedent for any other case.
This opinion is subject to section 7463(b), which means the opinion may not be treated as precedent for any other case (even though this information is in the opinion, I will provide this disclosure going forward if applicable). This, however, does not diminish its usefulness. Private letter rulings, for example, may not be used as precedent either under section 6110(k)(3), however, many practitioners use them as guidance in analyzing particular fact and law scenarios.
There are three penalty sections at play in this case: 6651(a)(1), 6651(a)(2), and 6654(a). The taxpayer concedes she is liable for a deficiency for her 2003 and 2004 tax returns. But she contests penalties imposed under 6651(a)(1) & (2), and 6654(a).
Section 6651(a)(1) imposes a penalty for failure to file a tax return. Section 6651(a)(2) imposes a penalty for failure to pay tax shown on a tax return. And Section 6654(a) imposes a penalty for failure to pay estimated income tax. To overcome a section 6651(a) penalty the taxpayer must show the failure was due to reasonable cause and not due to willful neglect – see language in same section.
To overcome a section 6654(a) penalty, in addition to reasonable cause, the taxpayer must either be disabled, or 62 and retired – see section 6654(e)(3)(B) . For the section 6654(a) penalty there is also a provision under 6654(e)(3)(A) that gives the Secretary discretion to waive the penalty because of casualty or disaster, and under circumstances which would be against equity and good conscience.
The taxpayer, Ms. Humes, was experiencing emotional problems during the years at issue. The only evidence offered by Ms. Humes at trial regarding her illness was her own testimony. She testified that she stopped working in August 2004, was hospitalized the same month, and was one year in arrears on her mortgage payments. Her house was foreclosed on in 2005. The Tax Court acknowledges that there are circumstances in which a taxpayer's illness may constitute reasonable cause for all three penalties imposed here.
The Tax Court disposes of the 2003 section 6654(a) penalty without any reference to Ms. Humes’s illness. Under 6654(c) & (d), estimated tax payments equal to 25% of the “required annual payment” are due in four equal installments. The required annual payment is the lesser of 90% of the current year’s tax, or 100% of the prior year’s tax. The 100% prior year tax clause does not apply in cases where the tax return was not filed in the prior year.
The IRS did not introduce any evidence that Ms. Humes failed to file her 2002 tax return. If she did file it, they did not introduce evidence of the 2002 tax shown on the return. Without any indication as to Ms. Humes’s 2002 tax return, the Court must apply the formula as written without exception. Consequently, under the 6654(d) formula Ms. Humes’s required annual payment for 2003 is $0.00 (100% of the prior year = $0.00; which is always going to be less than 90% of the current year’s tax). Either the IRS was not prepared for trial, or they did not understand the law.
Since the IRS was auditing both 2003 and 2004, there was ample evidence on the record that Ms. Humes was liable for 2004 estimated tax payments. Using the 6654(d) formula for the 2004 tax year, the 100% clause applies to the 2003 tax return admitted at trial. The Court, nonetheless, agrees with Ms. Humes that her illness met the definition of a disability under 6654(e)(3)(B)(i)(II) and abates the failure to pay estimated tax penalty.
The Tax Court sustains both penalties for 2004, but finds Ms. Humes established reasonable cause for 2003 and abates the penalties for that year.
In April 2004, Ms. Humes filed for an extension, thus the 2003 tax return’s due date was August 15, 2004. She testified at trial that her illness prevented her from working after August 2004 and that she was hospitalized in the same month. The Tax Court agrees this is enough to show reasonable cause under 6651(a)(1) for failure to file a tax return. Ms. Humes also testified that she was not able to manage her finances in 2004, she was one year in arrears on her mortgage payments, and the mortgage was foreclosed in 2005. The Court agrees here as well, Ms. Humes established reasonable cause for failure to pay the tax shown on her 2003 return.
Ms. Humes loses here because she failed to introduce evidence of her illness in 2005 and its impact on her ability to file her 2004 tax return and pay the tax shown on the return. In contrast to April 2004 where Ms. Humes at least filed for an extension, there is nothing in the opinion regarding her efforts to comply with the 2004 filing requirement in April 2005. She also provided no evidence regarding her ability to pay the tax shown on her 2004 tax return. Such evidence could include her income, assets, and liabilities in 2005.
It seems the Tax Court was more than willing to help Ms. Humes, but they were not going to make her case for her. Producing evidence at trial is critical. In this case both sides lost an issue simply because they failed to produce evidence.
Mr. Florance appears to be making a name for himself in the halls of the U.S. Tax Court. He was the recipient of not one, but two decisions from the Tax Court yesterday.
The facts are almost identical in each case, the only real difference is the year at issue. In the first case Mr. Florance failed to file his tax return for 2003, and in the second case he failed to file for 2005. The IRS assessed a deficiency, to which Mr. Florance asserts he is not liable for because "he did not consent to becoming a taxpayer and therefore is not subject to the income tax laws of the United States." This might be my favorite frivolous argument yet.
In response to Mr. Florance's assertion, the IRS filed a motion to dismiss and asked the Court to impose section 6673 penalties. Section 6673 penalties are reserved for frivolous arguments and "proceedings instituted primarily for delay." The Tax Court can impose up to $25,000 in penalties.
The best part is at the motion to dismiss hearing for the 2003 tax return. Mr. Florance did not show up. The IRS wins right? Well, not here because the IRS asked the Court to dismiss its own motion. Turns out, the IRS found more of Mr. Florance's unreported income and they needed additional time to assess higher deficiencies.
"Mr. Florance is no stranger to this Court, In Florance v. Commissioner, T.C. Memo. 2005-60, affd. 174 Fed. Appx. 200 (5th Cir. 2006) and Florance v. Commissioner, T.C. Memo. 2005-61, affd. 174 Fed. Appx. 200 (5th Cir. 2006). Florance asserted similar tax defier arguments for the 1994 through 1997 tax years and was sanctioned by this Court under section 6673 in the respective amounts of $10,000 and $12,500. In this case he asks us to consider his frivolous arguments once again."
Mr. Florance loses. The Tax Court imposes a $15,000 section 6673 penalty for the 2003 tax year, and a $17,500 section 6673 penalty for the 2005 tax year.
There is more to this opinion than just the regular run-of-the-mill taxpayer penalty. I encourage you to read on.
In the early 80’s, Mr. Pack, at the advice of his CPA, invested $25k in a limited partnership called Platte Leasing Associates. A $25k investment in 1981 equates to about a $60k investment today (per the calculator on The Federal Reserve Bank of Minn.'s website). Prior to Mr. Pack’s investment, he was informed via several documents that Platte was taking significant tax risks, and would most likely be challenged by the IRS. Within those documents was a section that stated Platte’s general partners were involved in other partnerships that were currently under IRS audit. As a result of those audits, the partnerships deductions were disallowed.
In 1983, Platte passed-through ordinary losses and interest expense, which Mr. Pack reported on his 1983 tax return. Similarly, in 1985, Platted passed-through ordinary income and interest expense, which Mr. Pack reported on his 1985 tax return.
In the early 90’s, the IRS adjusted Platte’s 1983 & 1985 tax returns. In 2006, the Tax Court upheld those adjustments. Shortly thereafter, the IRS sent Mr. Pack a notice of deficiency relating to his 1983 and 1985 tax returns.
The issue for the Tax Court is whether penalties imposed by section 6653(a) and 6661(a) apply to Mr. Pack. Don’t go looking for section 6661(a); it is not part of the current tax code, it was repealed in 1989. Section 6653(a) – under the 1954 tax code - imposes a 5% penalty for underpayments “due to negligence or intentional disregard of rules or regulations.” Section 6653(a)(2) imposes an additional tax “equal to 50 percent of the interest payable under section 6601.” This means, that whatever interest penalty the Pack’s have to pay because of underpayment, increase it by 50%.
Here, the Tax Court has to determine if the Pack’s acted negligently. The Tax Court points out that in the Ninth Circuit (where this appeal would lie), “[in] cases involving a deduction for loss that results from an investment [a determination as to negligence] depends on both the legitimacy of the underlying investment, and due care in claiming the deduction."
(3) the taxpayer actually relied in good faith on the adviser's judgment.
As to the first prong, The Tax Court cites the CPA’s lack of investment experience to show Mr. Pack’s reliance was unjustified. The second prong was not an issue. The Tax Court also agrees with the IRS’s on the third prong; Mr. Pack knew of his CPA's conflict of interest. Lastly, the documents that accompanied the Platte investment contained several warnings regarding the tax risks that should have resounded loudly in Mr. Pack’s head.
Mr. Pack loses because the document he received in connection with the Platte investment was a clear warning, and he ignored it.
At first glance, the Tax Court’s application of Neonatology’s first prong appears incorrect. Based on the context of the Third Circuit's opinion, the first prong refers to the professional’s expertise as a tax adviser not as an investment adviser. In Neonatology, the taxpayer received tax advice from their insurance agent, “rather than from a competent, independent tax professional.” Neonatology, 299 F.3d at 234. Here, the IRS attacked the CPA’s expertise as an investment adviser and said nothing of his expertise as a tax adviser.
But as stated above, the standard for negligence here is defined by the Ninth Circuit. The Ninth Circuit requires a showing that the underlying investment was legitimate to avoid the negligence penalty. This has the impact of turning Neonatoloty's three-prong test into a six-prong test. Now, Mr. Pack has to show he acted reasonably not only with respect to taking the deduction, but also with respect to investing in Platte in the first place. Since Mr. Pack did not seek independent investment advice he fails the test.
My only policy argument against the Ninth Circuit's negligence test is that it is different than the test used in the Fifth Circuit. The Tax Court cites the Ninth Circuit's opinion in Saks v. Commissioner, 82 F.3d 918 (9th Cir. 1996). The Saks Court rejects the Fifth Circuit's opinion in Chamberlain v. Commissioner, 66 F.3d 729, (5th Cir. 1995). In Chamberlain, the issue of negligence is based solely on whether the taxpayer acted negligently in claiming the loss.
While I think the Fifth Circuit is the better approach, it seems wholly unfair that taxpayers in the ninth circuit should be subjected to a more stringent negligence test than taxpayers in the fifth circuit.

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