Court Opinion

ID: 4635936
Source: CourtListenerOpinion
Date Created: 2020-11-24 21:50:03.677403+00
Date Added: 2024-06-11T07:58:27.549819
License: Public Domain

T.C. Memo. 2020-154

                         UNITED STATES TAX COURT

        GURPREET S. PADDA AND PAMELA B. KANE, Petitioners v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent

      Docket No. 17338-16.                          Filed November 16, 2020.

      James A. Kutten, for petitioners.

      Teri L. Jackson and William R. Peck, for respondent.

            MEMORANDUM FINDINGS OF FACT AND OPINION

      MORRISON, Judge: The petitioners, Gurpreet S. Padda and Pamela B.

Kane, filed joint returns for 2010, 2011, and 2012. The respondent (referred to

here as the IRS) issued a notice of deficiency determining the following

deficiencies in income tax, additions to tax, and penalties:
                                             -2-

[*2]                                               Addition to tax     Penalty
           Year              Deficiency            sec. 6651(a)(1)   sec. 6662(a)

           2010               $380,934              $94,579.75        $76,186.80
           2011                270,479                  -0-            54,095.80
           2012                424,963               20,931.85         84,992.60

       Padda and Kane filed a timely petition. We have jurisdiction under section

6213(a).1

       Padda and Kane have conceded the section 6651(a)(1) addition to tax for

late filing for the 2010 year. Taking this concession into account, here are the

remaining issues for decision:

       (1)      Did Padda meet the material-participation requirements of section

                469 for the activities of five restaurants and a brewery? We hold he

                did meet the requirements.

       (2)      Did Padda receive a constructive dividend in 2010 because his wholly

                owned medical corporation2 paid $81,828 of his expenses? We hold

                he did receive a constructive dividend.

       1
      Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
       2
           Interventional Center for Pain Management, Inc. (Interventional Center).
                                        -3-

[*3] (3)     Are Padda and Kane liable for a section 6651(a)(1) addition to tax for

             failing to timely file their 2012 return? We hold they are liable.

      (4)    Are Padda and Kane liable for accuracy-related penalties under

             section 6662(a) for 2010, 2011, and 2012? We hold they are liable

             for the penalty under section 6662(a) for 2010 for the portion of the

             underpayment related to the constructive dividend.

                               FINDINGS OF FACT

      The parties have stipulated some of the facts. These facts are adopted by the

Court as findings of fact.

      Padda and Kane resided in Missouri when they filed their petition.

      Padda and Kane are both medical doctors. Kane practices medicine at a

pediatric clinic.

      Padda practices medicine through his wholly owned C corporation,

Interventional Center, a pain-management clinic in St. Louis, Missouri, that he

incorporated in the late 1990s. Padda is the president of Interventional Center and

has primary responsibility for its operations. Interventional Center employed a

number of physicians, nurse practitioners, chiropractors, and physical therapists

during the years at issue.
                                        -4-

[*4] During 2010 and 2011, Interventional Center’s hours of operation were

8 a.m. to 5 p.m., Monday through Friday, and 10 a.m. to 1 p.m. on Saturday. In

2012, Interventional Center shortened its Friday hours to 8 a.m. to 1 p.m. Padda

would typically work at Interventional Center for approximately three eight-hour

workdays and two four-hour workdays, Monday through Friday. Once every few

months he worked a few hours on a Saturday.

        In 2006, Ami Grimes became the chief financial officer of Interventional

Center. She maintained Interventional Center’s books of accounts using the

QuickBooks program. She entered Interventional Center’s expenses and checks

into the program.

        During the years at issue, Padda was the sole shareholder and corporate

president of Masala, Inc., an S corporation that operated a medical billing service

for Interventional Center under the names eProBill and eProCollect. eProBill

handled all of the medical billing for Interventional Center, and eProCollect

handled the collection of overdue payments. Padda and other Interventional

Center employees performed all of Masala’s functions. Padda spent between 210

and 220 hours per year exclusively on work for Masala during 2010, 2011, and

2012.
                                        -5-

[*5] Padda also operated another clinic called the Padda Institute Center for

Aesthetic and Laser Medicine (Padda Institute). The Padda Institute was a

medical spa specializing in skincare and laser hair removal treatments. It was

open for business Monday through Saturday. Padda did not spend significant

hours working on the business of the Padda Institute in 2010, 2011, or 2012. The

corporate form under which the Padda Institute operated is not revealed by the

record.

      Between 2008 and 2012, Padda and Grimes opened five restaurants in the

St. Louis area.

      Each of the five restaurants was operated by a separate partnership. Thus:

      !      CA Group, LLC,3 operated a full-service restaurant and bar under the
             name Chuy Arzolas. It opened in 2009 and closed in 2013.

      !      Cafe Ventana, LLC, operated a cafe serving food and beverages. It
             opened in 2008.

      !      Agave STL, LLC, operated a full-service restaurant and bar called
             Sanctuaria. It opened in 2009.

      !      Hendricks BBQ, LLC, operated a full-service restaurant and bar. It
             opened in August 2012 although planning for its operations occurred
             in 2010 and 2011.

      3
        All limited liability corporations, or LLCs, mentioned in this opinion are
entities treated as partnerships for federal tax purposes.
                                           -6-

[*6] !        Diatina, LLC, operated a full-service restaurant and bar called
              Diablitos Cantina. It opened in 2011 and closed in 2017.

      During the relevant years, Padda owned a 50% interest in each of the five

restaurant partnerships; Grimes owned the other 50%. Grimes did not contribute

cash or other property to acquire her interests in the partnerships. Although Padda

owned only 50% of each of the five restaurant partnerships, he was allocated

100% of the losses. Grimes was not allocated any losses. The IRS does not

challenge this loss allocation.

      Padda also invested in a brewery operated by Ninkasi, LLC. During the

years at issue, Padda owned a 90% interest in Ninkasi; Grimes owned 5% and

Padda’s brother (who was also his attorney) owned the remaining 5%. Ninkasi

opened for business in 2008 and operated under the name Cathedral Square

Brewery. Although Padda owned 90% of Ninkasi, he was allocated 100% of the

losses. Grimes and Padda’s brother were not allocated any of the losses. The IRS

does not challenge this loss allocation.

      Padda was the sole shareholder of Padda Equipment Co., an S corporation

through which he purchased the furniture, fixtures, decor, and machinery for the

five restaurants and the brewery. Padda spent some time exclusively on its

operations.
                                        -7-

[*7] During 2010, Padda used Interventional Center’s corporate credit card to

pay for $81,828 of expenses for travel, meals, and event tickets.

      On their 2010, 2011, and 2012 tax returns, Padda and Kane reported the

following losses from the restaurants and the brewery as nonpassive (and they

netted the losses against their nonpassive income):

  Company name               2010                 2011                2012

 CA Group                 $375,390              $186,298              $49,418
 Cafe Ventana               323,776              210,848              323,763
 Hendricks BBQ               25,344               72,192              211,470
 Ninkasi                    149,657               38,692              214,019
 Agave STL                  278,739               47,677              100,665
 Diatina                      n/a                317,394              329,002
  Total                   1,152,906              873,101            1,228,337

      Padda and Kane hired a certified public accountant, Sylvia A. Ehrenreich, to

prepare their 2010, 2011, and 2012 federal income tax returns. She had prepared

Padda and Kane’s returns since at least 2006.

      Ehrenreich also prepared the corporate federal income tax returns for

Interventional Center for 2010, 2011, and 2012. Ehrenreich relied on the trial

balance shown in Quickbooks for the amounts of meals and entertainment and

travel expenses that were deducted on Interventional Center’s 2010 return. She

was not asked to review any documentation related to these expenses, nor was she
                                        -8-

[*8] asked to determine whether any of the expenses paid were personal or were

properly substantiated.

      Ehrenreich also prepared the federal income tax returns for the five

restaurant partnerships and the brewery partnership for the years at issue.

      On their 2010 return, Padda and Kane filed an “Election to Group

Activities”. They elected to group the following activities: (1) Ninkasi with 3914

Lindell, LLC; and (2) Cafe Ventana with 3919 West Pine, LLC. The business

activities of 3914 Lindell and 3919 West Pine are not reflected in the record.4

      For tax years 2006 through 2012, with the exception of 2011, Padda and

Kane’s federal income tax returns were filed with the IRS after the prescribed due

dates (including extensions).

      Padda and Kane’s 2012 federal individual income tax return was due

October 15, 2013. On October 15, 2013, Padda and Kane signed IRS Form 8879,

“IRS e-file Signature Authorization” to authorize Ehrenreich’s accounting firm to

electronically file their 2012 Form 1040, “U.S. Individual Income Tax Return”.

On October 15, 2013, Ehrenreich’s accounting firm was electronically filing

several tax returns just before midnight. Ehrenreich’s accounting firm created an

      4
      Both 3914 Lindell and 3919 West Pine are listed on Schedule E,
Supplemental Income and Loss, of Padda and Kane’s 2010 return in Part 1,
Income or Loss From Rental Real Estate and Royalties.
                                        -9-

[*9] electronic version of Padda and Kane’s return on October 15, 2013, at

11:59 p.m. It transmitted the electronic version to the IRS on October 16, 2013, at

12 a.m. On October 16, 2013, the IRS rejected the return as a duplicate

submission. Ehrenreich’s accounting firm electronically resent the return on

October 25, 2013, and it was received and accepted by the IRS the same day.

      On May 2, 2016, the IRS issued a notice of deficiency to Padda and Kane

for the 2010, 2011, and 2012 taxable years. The notice determined deficiencies

for all three years based on the following determinations: (1) the restaurants and

the brewery were passive activities for all three years and (2) Padda and Kane

failed to report constructive-dividend income for 2010. As indicated at the

beginning of the opinion, the notice of deficiency determined section 6662(a)

penalties for all three years. Before the IRS issued the notice of deficiency, the

group manager responsible for the examination of Padda and Kane’s returns for

the three years approved in writing the determination of the section 6662(a)

penalties for those years.

                                     OPINION

      The IRS’s determinations in the notice of deficiency are generally presumed

correct, and taxpayers generally bear the burden of proving otherwise. Rule
                                        - 10 -

[*10] 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933). Padda and Kane

concede in their opening brief that they bear the burden of proof.

1.    Padda materially participated in the business operations of the five
      restaurants and the brewery during 2010, 2011, and 2012.

      a.     The relevant legal tests

      Taxpayers are allowed deductions for certain business and investment

expenses under sections 162 and 212. However, a taxpayer may not deduct losses

from passive activities to the extent the losses exceed the taxpayer’s income from

passive activities. Sec. 469(a)(1), (d)(1); sec. 1.469-1T(a)(1)(i), Temporary

Income Tax Regs., 53 Fed. Reg. 5700-5701 (Feb. 25, 1988). A passive activity is

generally an activity involving the conduct of a trade or business in which the

taxpayer does not materially participate. Sec. 469(c)(1).

      Generally, taxpayers materially participate in an activity if they are involved

in the operations of the activity on a regular, continuous, and substantial basis.

Sec. 469(h)(1). Material participation in an activity may be established by any

reasonable means. Sec. 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed.

Reg. 5727 (Feb. 25, 1988). Generally, “reasonable means” include the

“identification of services performed over a period of time and the approximate

number of hours spent performing such services during such period, based on
                                          - 11 -

[*11] appointment books, calendars, or narrative summaries.” Id. While daily

time reports, logs, or similar documentation are not required, a taxpayer must

provide other reasonable means to establish participation in the activity. Id.

      A taxpayer can establish material participation in an activity by satisfying

any one of seven tests set forth in section 1.469-5T(a), Temporary Income Tax

Regs., 53 Fed. Reg. 5725-5726 (Feb. 25, 1988). Paragraph (a)(4) provides that the

fourth test is met if the “activity is a significant participation activity * * * for the

taxable year, and the individual’s aggregate participation in all significant

participation activities during such year exceeds 500 hours”. A significant

participation activity is a trade or business activity in which the individual

participates for more than 100 hours during the year. Id. para. (c), 53 Fed.

Reg. 5726.

      For the purposes of determining whether the five restaurants and the

brewery were passive activities, we assume without deciding that the five

restaurants and the brewery each count as separate activities. A taxpayer may treat

one or more trade or business activities as a single activity if the activities

constitute an appropriate economic unit for the measurement of gain or loss for

purposes of the passive-activity rules. Sec. 1.469-4(c)(1), Income Tax Regs.

Once a taxpayer has grouped activities, the taxpayer may not regroup the activities
                                        - 12 -

[*12] in later taxable years unless the taxpayer complies with disclosure

requirements prescribed by the IRS. Id. para. (e)(1). On their 2010 return Padda

and Kane elected to group Ninkasi with 3914 Lindell (an entity not at issue), and

Café Ventana with 3919 West Pine (an entity not at issue). They did not elect to

treat as a single activity any combination of the five restaurants and the brewery.

The IRS argues that Padda and Kane cannot, for the purposes of this litigation,

make a retrospective election to regroup their activities for the years at issue.

Because (as we explain below) the time spent by Padda on each of the six

activities exceeded 100 hours for each year without grouping any of the activities

together, we need not determine whether Padda and Kane are entitled to regroup

the activities.5

       b.     Padda’s nontravel hours

       Padda presented testimony to establish his hours spent on the restaurant and

the brewery activities. He personally testified for an entire day of trial, explaining

in detail his nontravel involvement in each restaurant and the brewery. Padda

stated the nontravel hours he spent working on the restaurants and the brewery

each year.

       5
       For all hours calculations, we exclude the year 2010 for Diatina because no
losses were claimed for Diatina for 2010.
                                       - 13 -

[*13] Following Padda’s testimony, 12 individuals testified regarding Padda’s

nontravel involvement in the restaurants and the brewery. They explained how

Padda was involved in every aspect of the restaurants and the brewery. This

included hands-on work and onsite instruction.

      Padda’s testimony was also directed to how many hours he spent on each

activity for each year. For example, Padda testified that he spent 400 hours in

2011 on Cafe Ventana, of which 200 hours were spent on renovations.

      On the basis of the testimony we described from Padda and the

corroborating witnesses, we find that the nontravel time Padda spent on each

activity exceeded 100 hours for each year at issue.

      Because there are six activities involved in this calculation, our finding

means that Padda annually devoted more than 600 hours (i.e., 6 × 100 ' 600) of

nontravel time to the five restaurants and the brewery. This conclusion is valid

despite the IRS’s skepticism that Padda could have spent significant time on the

restaurants and the brewery given the demands of his work at his medical practice

(which was highly successful) and the lack of documentary evidence of his

personal involvement in the restaurants and the brewery. These reasons for

skepticism might be well placed in another case. But the record in this case is

consistent with our conclusions about Padda’s hours. Padda did not use
                                        - 14 -

[*14] correspondence or emails with respect to the restaurants and the brewery.

Instead he used the telephone and face-to-face meetings. Using these means of

communications, Padda exercised tight control of many aspects of the restaurants

and the brewery. In particular, he paid close attention to the quality and

ingredients of the food and beverages. He also rigorously controlled the decor and

appearance of the establishments. His employees confirmed his heavy

involvement. They complained in their testimony about his micromanagement.

Perhaps as a result of Padda’s efforts, the restaurants and the brewery were

lavishly appointed. The food and beverages were of the highest quality. The

restaurants and the brewery were also costly to operate. Year after year, they

produced massive financial losses that largely wiped out Padda’s profits from his

medical practice. Thus it was that Padda was a successful doctor and at the same

time spent significant time on the restaurants and the brewery.

      c.     Padda’s travel hours

      In addition to the nontravel time he spent working on the five restaurants

and the brewery, Padda spent time traveling. Grimes accompanied Padda on most

of his trips. Grimes testified at length about the business nature of the trips using

her personal knowledge. Credible testimony by Padda and by Grimes established

that the trips were factfinding trips for the five restaurants and the brewery. They
                                        - 15 -

[*15] testified about how visits to particular establishments were related to

particular Padda-owned restaurants or the brewery.

      Furthermore, Grimes created three spreadsheets before trial to summarize

Padda’s travel during 2010, 2011, and 2012, respectively. The spreadsheets

showed dates of travel, destination cities, and the names of bars, restaurants, and

breweries visited. Grimes testified extensively about the spreadsheets. Padda and

Kane exchanged with IRS counsel the documentation on which the spreadsheets

were based (credit-card receipts and invoices). The parties stipulated the

admissibility of the spreadsheets, and they were admitted.

      According to the spreadsheets and Grimes’s testimony, Padda’s traveltime

related to the five restaurants and the brewery was 1,900 hours in 2010, 1,900

hours in 2011, and 1,100 hours in 2012. These hourly amounts are based on a

24-hour day, meaning that for a particular trip, every hour of each day of the trip

was counted, including time Padda spent not working (i.e., sleeping). If one were

to divide the annual traveltime totals by three to account for a typical eight-hour

work day, Padda’s restaurant and brewery traveltime becomes 633 hours in 2010;

633 hours in 2011; and 366 hours in 2012. We find these traveltime totals reliable

when adjusted as described.
                                        - 16 -

[*16] The preponderance of evidence, which includes the spreadsheets, Padda’s

testimony regarding his travel, and Grimes’ testimony regarding Padda’s travel,

shows that Padda spent at least 25 hours of travel time during each year at issue on

each of the five restaurants and the brewery. This is in addition to more than 100

hours of nontravel time that we find Padda spent each year at issue on each of the

five restaurants and the brewery.

      d.     Padda’s total hours, travel and nontravel

      For each activity for each year (i.e., for each of the restaurants and the

brewery), Padda’s hours exceeded the 100-hour threshold required for an activity

to be a significant participation activity.6 This is because for each activity and for

each year his nontravel hours exceeded 100 hours and his travel hours exceeded

      6
        Not all time spent on a business activity counts as participation for the
purposes of these rules. Work performed in an individual’s capacity as an investor
does not qualify as participation unless the individual is directly involved in the
day-to-day management or operations. Sec. 1.469-5T(f)(2)(ii)(A), Temporary
Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988). Sec. 1.469-5T(f)(2)(ii)(B),
Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988), enumerates the
types of investor activities excluded from material participation. Investor-type
work includes studying and reviewing financial statements or reports on
operations of the activity; preparing or compiling summaries or analyses of the
finances or operations for the individual’s own use; and monitoring the finances or
operations in a nonmanagerial capacity. Id. None of Padda’s activities are those
listed in subdiv. (ii)(B). Therefore, we find that Padda’s participation in the five
restaurants and the brewery is not excluded as investor-type work as the IRS
alleges.
                                         - 17 -

[*17] 25 hours. Each activity was therefore a significant participation activity for

each year. See sec. 1.469-5T(c), Temporary Income Tax Regs., supra. Because

for each year Padda had at least these six significant participation activities,7 his

aggregate participation in all significant participation activities during the year

exceeded the 500-hour threshold of section 1.469-5T(a)(4), Temporary Income

Tax Regs., supra. The five restaurants and the brewery were not passive activities.

2.    Padda and Kane failed to report dividend income in 2010 for expenses paid
      by Interventional Center.

      A distribution of property made by a corporation to a shareholder with

respect to its stock is governed by section 301(c). Sec. 301(a). Under section

301(c)(1), a distribution that is a “dividend” is includable in the shareholder’s

income. See also sec. 61(a)(7). A dividend is any distribution a corporation

makes to its shareholders out of earnings and profits. Sec. 316(a).

      One type of distribution governed by section 301(c) is a constructive

distribution. United States v. Smith, 418 F.2d 589, 593 (5th Cir. 1969). To

determine whether a shareholder received a constructive distribution, this Court

looks to whether the distribution was primarily for the shareholder’s benefit rather

than for the corporation’s benefit. Hood v. Commissioner, 115 T.C. 172, 179-180

      7
        For 2010, Padda had no activities for Diatina, and therefore there were five
significant participation activities rather than six.
                                         - 18 -

[*18] (2000). The determination of whether the shareholder or the corporation

primarily benefits is a question of fact. Id. at 180.

      During 2010, Padda (Interventional Center’s sole shareholder) used

Interventional Center’s corporate credit card to pay $81,828 of travel, dining, and

entertainment expenses for himself, his family, and his friends. Padda and Kane

do not dispute that Interventional Center had sufficient earnings and profits to

cause the $81,828 of expenses in 2010, if characterized as a distribution, to be

dividends.

      Interventional Center reported deductions of these amounts on its corporate

return. Padda and Kane argue that the IRS entered into an agreement with

Interventional Center whereby it was allowed a business expense deduction for all

or some of the $81,828. Padda and Kane contend that the IRS is legally barred

from taking the position in this proceeding that the $81,828 in payments is a

constructive distribution to the extent the same payments were allowed as a

deduction to Interventional Center as part of the settlement agreement between the

IRS and Interventional Center.

      It is undisputed that the IRS examined Interventional Center’s corporate

income tax return for 2010 and that the IRS reached an agreement with

Interventional Center about its income tax liability for that year. But that
                                       - 19 -

[*19] settlement has no effect on the determination of Padda and Kane’s income.

First, the settlement expressly governed only the question of whether

Interventional Center was entitled to deductions. The settlement did not purport to

address the question of what amounts are includable in Padda and Kane’s income.

Second, Interventional Center was a party to the settlement agreement, and Padda

and Kane were not.

      At trial, Padda and Kane attempted to introduce into the record documents

marked as Exhibits 20-P, 49-P, 50-P, 51-P, and 52-P and related testimony (Tr.

250-256, 758-761) to prove which payments were governed by the settlement.

The IRS objected. The Court reserved ruling on the objection. We need not rule

on the objection. The evidence would have no effect on the outcome of this case.

The settlement has no effect on Padda and Kane’s income, as explained above.8

      The question of whether Interventional Center’s payment of the $81,828 of

Padda’s expenses is a constructive dividend depends on whether Interventional

      8
        Padda and Kane also argue that the IRS is bound by a duty of consistency
to treat the reimbursements as other than distributions. The duty of consistency is
an obligation by which a representation made by a taxpayer to the IRS may be
binding on the taxpayer if the IRS relies on the representation to its detriment.
See, e.g., Beltzer v. United States, 495 F.2d 211, 212 (8th Cir. 1974). Even if the
duty of consistency governs the IRS (as opposed to taxpayers), the record does not
show that the IRS made a representation to Padda and Kane on which they
detrimentally relied.
                                        - 20 -

[*20] Center primarily benefited from paying the expenses. If it did primarily

benefit, then the payment is not a constructive dividend. If it did not, then the

payment is a constructive dividend.

      Padda testified that as a general matter there was a business purpose for the

$81,828 in expenses. In our view, the testimony suggested that the business

purpose of the $81,828 in expenses was related to the five restaurants and the

brewery, not Interventional Center. We also observe that a portion of the $81,828

in expenses corresponds to the travel activities conducted by Padda for the five

restaurants and the brewery during 2010. See supra Part 1.c. Grimes and Padda

both testified about these travel activities, and Grimes created a spreadsheet for

each year about them. We concluded supra Part 1.c that the travel activities were

related to the five restaurants and the brewery.

      The evidence we described in the paragraph above is the only evidence

regarding the $81,828 in expenses. The preponderance of the evidence shows that

the $81,828 did not benefit Interventional Center.

      Therefore, we conclude that Padda and Kane received an $81,828

constructive dividend in 2010 for the travel, dining, and entertainment expenses

paid by Interventional Center.
                                        - 21 -

[*21] 3.     Padda and Kane are liable for a section 6651(a)(1) addition to tax for
             failing to timely file their 2012 return.

      Section 6651(a)(1) imposes an addition to tax for failure to file a tax return

by its filing deadline (as extended) unless the taxpayer can establish that the

failure to timely file is due to reasonable cause and not due to willful neglect. The

section 6651(a)(1) addition to tax is 5% of the amount required to be shown on the

return if the failure is for not more than one month. Sec. 6651(b)(1).

      The IRS bears the burden of production for additions to tax determined

under section 6651(a)(1). See sec. 7491(c); Higbee v. Commissioner, 116 T.C.

438, 446-447 (2001). The IRS satisfies its burden by producing sufficient

evidence to establish that the taxpayer failed to timely file a required return. See

Wheeler v. Commissioner, 127 T.C. 200, 207-208 (2006), aff’d, 521 F.3d 1289

(10th Cir. 2008); Higbee v. Commissioner, 116 T.C. at 447. Once the IRS has

satisfied its burden of production, the taxpayer has the burden of proving that the

lateness was due to reasonable cause and not willful neglect. Higbee v.

Commissioner, 116 T.C. at 447. Reasonable cause excusing a failure to timely file

exists if the taxpayer exercised ordinary business care and prudence but

nevertheless was unable to file the return by the deadline. See sec. 301.6651-

1(c)(1), Proced. & Admin. Regs. Willful neglect means a conscious,
                                        - 22 -

[*22] intentional failure, or reckless indifference. United States v. Boyle, 469 U.S.

241, 245 (1985).

      Padda and Kane’s 2012 return was due on October 15, 2013. The parties

have stipulated that the return was filed on October 25, 2013. Padda and Kane

seek to avoid the addition to tax because they claim that Ehrenreich’s accounting

firm was responsible for the untimeliness.

      In considering whether a taxpayer has exercised reasonable care and

prudence, courts have held that the taxpayer’s duty to file a timely return cannot be

avoided by delegating to another party, including an accountant, the responsibility

for preparing and filing the return. Mauldin v. Commissioner, 60 T.C. 749, 762

(1973); see also Boyle, 469 U.S. at 251-252 (holding that reliance on an agent to

file a return does not establish reasonable cause because “[i]t requires no special

training or effort to ascertain a deadline and make sure that it is met”).9 Padda and

Kane argue that the reason that their 2012 return was filed late was that

      9
        As explained in the text, reliance on an accountant to file a return is not
reasonable cause for the failure to file on time. Reasonable cause for failure to file
may be established when a taxpayer relies on a competent adviser who advises that
the taxpayer is not required to file a return. Evans v. Commissioner, T.C. Memo.
2016-7, at *43. There is no evidence that Padda and Kane received this type of
advice. See United States v. Boyle, 469 U.S. 241, 251-252 (1985); Mauldin v.
Commissioner, 60 T.C. 749, 762 (1973); Niv v. Commissioner, T.C. Memo. 2013-
82, at *24; Owusu v. Commissioner, T.C. Memo. 2010-186, slip op. at 13.
                                         - 23 -

[*23] (1) Ehrenreich’s accounting firm pressed a button only a few seconds late,

(2) they relied on Ehrenreich’s accounting firm to timely file the return, and

(3) they themselves could not have pressed the button to timely file the return.

Even if sometimes it might be reasonable for a taxpayer to rely on his or her

accountant to timely file his or her returns (contrary to the caselaw), it was not

reasonable in this particular case for Padda and Kane to rely on Ehrenreich’s firm

to timely file their return. Padda and Kane have relied on Ehrenreich’s firm to file

their returns every year since at least 2006. And every year since then, except for

2011, their return was filed late. Yet they have continued to use Ehrenreich’s firm

to file their return year after year. Padda and Kane’s failure to ensure that

Ehrenreich’s firm timely filed their 2012 return demonstrates a lack of ordinary

business care, particularly in the light of the firm’s history of delinquent filings.

      We find that Padda and Kane do not have reasonable cause, on the basis of

any reliance on Ehrenreich’s firm for their untimely 2012 return, and we hold that

Padda and Kane are liable for the section 6651(a)(1) addition to tax for failing to

timely file their 2012 return.
                                       - 24 -

[*24] 4.     Padda and Kane are liable for a section 6662 penalty for 2010, but not
             2011 and 2012.

      Section 6662(a) and (b)(1) and (2) imposes a penalty equal to 20% of any

portion of an underpayment of tax that is attributable to negligence or to a

substantial understatement of income tax. An underpayment is the difference

between the correct tax and the tax reported on the return, with exceptions not

relevant here. Sec. 6664(a). Negligence includes any failure to make a reasonable

attempt to comply with the provisions of the internal revenue laws or to exercise

ordinary and reasonable care in the preparation of a tax return. Sec. 6662(c);

sec. 1.6662-3(b)(1), Income Tax Regs. Negligence may also include the failure to

properly substantiate an item. Higbee v. Commissioner, 116 T.C. at 449;

sec. 1.6662-3(b)(1), Income Tax Regs. A substantial understatement of income

tax exists if (1) the understatement exceeds 10% of the tax required to be shown

on the return and (2) the understatement exceeds $5,000. Sec. 6662(d)(1)(A). An

understatement is the difference between the correct tax and the tax reported on

the return, with exceptions not relevant here. Sec. 6662(d)(2)(A).

      For any penalty the IRS determines applies to an individual, section 7491(c)

imposes the burden of production on the IRS. Higbee v. Commissioner, 116 T.C.

at 446. This means that the IRS is required to come forward with sufficient
                                        - 25 -

[*25] evidence that it is appropriate to impose the penalty. Sec. 7491(c); Higbee

v. Commissioner, 116 T.C. at 446.

      No section 6662 penalty is imposed with respect to any portion of an

underpayment if it is shown that there was a reasonable cause for such portion and

that the taxpayer acted in good faith with respect to such portion. Circumstances

that indicate reasonable cause and good faith include reliance on the advice of a

tax professional. Sec. 1.6664-4(b), Income Tax Regs. The taxpayer has the

burden of proving that he or she acted with reasonable cause and in good faith.

Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446-447.

      The notice of deficiency determined that Padda and Kane were liable for

penalties under section 6662(a) for 2010, 2011, and 2012. The underpayments for

all three years, as calculated in the notice of deficiency, were due to Padda’s

failure to meet the material-participation requirements. The underpayment for

2010 was due also to Padda and Kane’s failure to report as their income the

$81,128 in Padda’s credit-card expenses that Interventional Center paid.

      However, we have concluded supra Part 1 that Padda met the material-

participation requirements. Therefore, Padda and Kane’s potential penalty under

section 6662 is limited to the tax year 2010. And the underpayment for that year
                                       - 26 -

[*26] relates to Padda and Kane’s failure to report the $81,828 of Padda’s credit-

card expenses paid by Interventional Center.

      The IRS satisfied its burden of producing evidence that Padda and Kane

acted negligently in failing to report the $81,828. Padda and Kane failed to

provide their accountant, Ehrenreich, with the information necessary to ascertain

whether Interventional Center’s $81,828 payment of credit-card expenses was

includable in their income as a constructive dividend. They did not solicit or

receive advice from Ehrenreich on the tax consequences of paying the expenses

with Interventional Center funds.

      Padda and Kane, who bear the burden of persuasion, have not adduced

sufficient evidence that the IRS’s negligence determination was incorrect. Nor

have they argued that the negligence determination was incorrect.10

      We conclude that the underpayment for 2010 is due to negligence.

Therefore, Padda and Kane are liable for the section 6662 penalty for 2010,

although in a lesser amount than the amount computed in the notice of

      10
        For example, Padda and Kane do not argue that they had reasonable cause
and good faith with respect to the $81,828 because they relied on Ehrenreich.
Such a defense would be without merit anyway because, as we explain in the text,
they failed to supply Ehrenreich with necessary information about the credit-card
expenses and received no advice from her regarding the tax consequences of
payment of the expenses by Interventional Center.
                                         - 27 -

[*27] deficiency.11 Computations under Rule 155 will determine the amount of

the underpayment and the amount of the penalty. Computations under Rule 155

will also determine whether there is a substantial understatement for 2010. If there

is a substantial understatement, that will serve as an alternative basis for liability

for the penalty.

      To reflect the foregoing,

                                                  Decision will be entered under

                                        Rule 155.

      11
       The parties stipulated that the IRS satisfied the penalty-approval
requirement in sec. 6751(b) with respect to the penalties under sec. 6662.