Taxing Lessons Case Summaries

Case — Penalty Abatement due to Reliance on Professional Advice

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TL Case Summ

THE QUESTION

Does reliance on a professional tax return preparer allow a taxpayer to avoid a penalty for errors involving depreciation deductions?

THE DISPUTE

Taxpayer Says: Ordinary business care and prudence were exercised in the reliance on a professional preparer to properly compute depreciation, and the reasonable cause exception to the penalty applies.

Internal Revenue Service Says: The penalty was assessed due to substantial understatement of income tax and/or negligence. The taxpayer was aware of the rules and did not reasonably rely on the preparer.

THE LAW

From Internal Revenue Code Section 6662(a) and (b)(1): Authorizes a 20% penalty on the portion of an underpayment of income tax attributable to negligence or disregard of rules or regulations.

From Internal Revenue Code Section 6664(c)(1): Provides an exception to the Section 6662(a) accuracy-related penalty with respect to any portion of an underpayment if the taxpayer shows that there was reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion.

From Federal Tax Regulation 1.6662-3(b)(2): Disregard of rules or regulations is careless if “the taxpayer does not exercise reasonable diligence to determine the correctness of a return position” and is reckless if “the taxpayer makes little or no effort to determine whether a rule or regulation exists, under circumstances which demonstrate a substantial deviation from the standard of conduct that a reasonable person would observe.”

From United States v. Boyle, 469 U.S. 241, 250 (1985): Reliance upon the advice of a tax  professional may establish reasonable cause and good faith for the purpose of avoiding liability for the section 6662(a) penalty.

THE CAUSE OF THE DISPUTE

The IRS can waive penalties in certain circumstances. Examples include having reasonable cause for your position, or when your situation involves a statutory exception, administrative waiver or correction of an IRS error. You can request partial or full elimination of penalties by calling the IRS or sending a letter, or by working with the employee who is assigned your case.

To qualify for a penalty waiver under the reasonable cause exception, you must have a legitimate reason as to why the situation occurred that led to the penalty. Reasonable cause is based on all the facts and circumstances, such as if you exercised ordinary business care and prudence in determining your tax obligations. Good faith reliance on your tax preparer is a factor that can be considered when determining whether you have reasonable cause.

This case involves three depreciation-related issues: 1) bonus depreciation erroneously claimed on a used airplane; 2) depreciation erroneously claimed on non-business use of an asset; and 3) depreciation errors due to use of incorrect asset lives and depreciation methods.

The taxpayer’s certified public accountant prepared financial statements and tax returns, both of which included deductions for depreciation, based on records and information provided by the taxpayer. The taxpayer did not inquire about amounts deducted on the tax return even though the taxpayer and the accountant discussed new rules involving bonus depreciation.

The taxpayer agrees the depreciation claimed on the tax return was overstated, but believes reliance on the certified public accountant qualifies for the reasonable cause exception to the penalty. The IRS contends the taxpayer failed to act prudently by neglecting to review the tax return.

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

Download (PDF, 33KB)

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Split. The taxpayer owes the portion of the penalty attributable to bonus depreciation erroneously claimed because the taxpayer knew the rules and did not reasonably rely on the return preparer in good faith. In addition, the penalty was properly assessed for the depreciation claimed on non-business use of an asset because the taxpayer did not provide the accountant with necessary and accurate information. The penalty is waived for the third issue because the errors were not readily apparent to the taxpayer and were not caused by negligence on his part.
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