August 21, 2017

“Good Faith” Abates Tax Penalties

By Joseph Molloy, Director, Tax & Business Services

“Good Faith” Abates Tax Penalties Tax & Business

The Internal Revenue Code imposes a 20% penalty on any portion of a tax underpayment that is attributable to negligence or disregard of rules and regulations. Negligence is defined as “any failure to make a reasonable attempt to comply.” Taxpayers bear the burden with respect to such liabilities. Such penalties can be avoided if a taxpayer can show reasonable cause and good faith. This can be demonstrated by the taxpayer exercising ordinary business care. Good faith means, an intent to perform all lawful obligations. Taxpayers may demonstrate good faith by showing reliance on the advice of a tax professional.

The United States Tax Court recently decided to drop accuracy-related penalties for a taxpayer who acted with “good faith” reliance on her preparer.

Carolyn F. Whitsett V Commissioner of IRS involved a taxpayer who, in early 2013, received Form 1099-B, Proceeds from Broker and Barter Exchange Transactions, related to a sale of stock transaction. The Form 1099-B reported a transaction date of January 4, 2012. The initial judgment of the tax advisor was to not report the transaction for tax year 2012 because it was originally reported on the taxpayer’s tax return for 2011, when the shares were actually tendered. The IRS determined a deficiency in 2012 because of the omission and imposed a 20% penalty for negligence or disregard of rules or regulations.

A taxpayer may avoid this 20% penalty if evidence of reasonable cause and good faith can be shown, such as reliance on a tax professional. The taxpayer used the defense of”good faith” reliance on her tax preparer to request the penalties to be removed. To use on the “good faith” defense, the taxpayer must prove the following:

  • The advisor that she relied on was a knowledgeable professional who had adequate experience and knowledge to support the reliance;
  • All the required information was provided to the advisor; and
  • The taxpayer relied on the advice given by the advisor.

While the taxpayer tendered the shares in 2011, she incorrectly believed that the gain was required to be picked up in that tax year. The Court found that she requested advice on the matter from her long- term tax preparer, who had prepared returns for her without any material errors in the past, giving her a reason to believe he was a knowledgeable professional. The Court also decided that all the required information was provided to the tax preparer. The Court established that Whitsett had no reason to question her advisor’s advice and dropped the penalties, concluding that she had reasonable cause and acted in “good faith.”

A word of warning that this defense is not as simple as it sounds and has several requirements before the Court will approve.

Should you receive a notice imposing a penalty, consult your Marcum tax professional to discuss appropriate next steps.