Opinion ID: 14441
Heading Depth: 2
Heading Rank: 2

Heading: substantial understatement penalty

Text: 35 The second issue before this court is whether the Tax Court abused its discretion when it held appellants liable for the addition to tax for substantial understatement, pursuant to I.R.C. § 6661(a). See Heasley v. Commissioner, 902 F.2d 380, 385 (5th Cir.1990). Section 6661 provides for an addition to tax equal to twenty-five percent of the amount of any underpayment attributable to a substantial understatement of tax. If a taxpayer is able to show that there was a reasonable cause for the understatement and good faith, which may stem from reasonable reliance on the advice of professional, the I.R.S. may waive the understatement penalty. See Heasley, 902 F.2d at 384-85; see also Reser v. Commissioner, 112 F.3d 1258, 1271-72 (5th Cir.1997). 36 First, as has been noted, the appellants reasonably relied on the advice they received from their attorney. IRS acknowledges that the extent of the taxpayer's effort to assess her proper tax liability under the law is the most important factor in determining reasonable cause and good faith. Heasley, 902 F.2d at 385. Because of appellants' youth and inexperience in business, reliance on counsel, and proof of good faith in their position by reporting the transaction to the Service as to their father's potential liability, the conclusions this court reached in Heasley are controlling: 37 Applying the I.R.S.'s own regulatory standards, we find that the I.R.S. abused its discretion by failing to waive the penalty in this case. We are at a loss to determine just what the I.R.S. would find to be a reasonable cause given the Heasleys' experience, knowledge, and education. First, the Heasleys attempted to assess their proper tax liability by taking their taxes to a C.P.A., something they never did before. The accountant found no problem with the plan. While Danner suggested that the Heasleys use Smith, nothing else in the record connects the two. Therefore, considering this most important factor, the Heasleys showed reasonable cause and good faith. Second, the Heasleys read the portions of the prospectus and other O.E.C. materials and relied on Danner to explain the rest. If neither Danner nor their C.P.A. found anything wrong with the investment, how could the Heasleys? Certainly, their failure to out-guess their financial advisor and accountant is not negligence. Finally, the Heasleys believed that they legitimately claimed the deduction and investment tax credit. Given the Heasleys' inexperience and limited knowledge about investing, and their level of education, their misunderstanding is reasonable. The I.R.S. abused its discretion by failing to waive the penalty and the tax court erred by upholding the I.R.S.'s decision. 38 Id. 39 Second, I.R.S. too narrowly interprets the meaning of the substantial authority defense on which appellants rely to defeat this penalty. 13 This case turned on one factual issue: when Parker made the gift to his daughters. If the gift was made before 1985, Tracy and Teresa are liable for the income they received in 1985; if it was effectively made in 1985, Parker is liable. The subsidiary facts relating to this transaction were complex, largely undisputed, and not materially affected by the Tax Court's assessment of the sisters' lack of credibility. In a recent decision, the Eleventh Circuit explained that where the substantial authority issue turns on evidence going both ways, there is substantial authority from a factual standpoint for the taxpayer's position. Only if there was a record upon which the Government could obtain a reversal under the clearly erroneous standard could it be argued that from an evidentiary standpoint, there was not substantial authority.... Osteen v. Commissioner, 62 F.3d 356, 359 (11th Cir.1995). Apart from trying to confine Osteen to its facts, an untenable position, I.R.S. does not demonstrate how its principle is inapt here. The government makes no effort to assert that the only rational tax treatment of the transaction was as a gift made before 1985. 14 40 For these reasons, the I.R.S. abused its discretion in failing to waive the penalty and the Tax Court erred in upholding the I.R.S.'s decision. See Heasley, 902 F.2d at 385. It is clear upon review of the record that the appellants had substantial factual authority for the tax position they asserted and reasonably relied on the advice of their attorney.