Polish Lottery Winner’s Son Sues Over Penalties For Failing To Report Foreign Gifts

The other day I read in Tax Notes the complaint in Wrzesinski v US. I usually do not write about cases at this stage but it is a head scratcher.

Wrzesinski involves a refund suit for a hefty penalty under Section 6039F for failing to file Form 3520, the Annual Return To Report Transactions With Foreign Trusts and Receipt of Certain Foreign Gifts.

Krzysztof Wrzesinski emigrated to the US from Poland in 2005 at the age of 19. About five years later his mom, who still lived in Poland, won the Polish lottery. She took the proceeds and made gifts to Krzysztof of $830,000 over the course of 2010 and 2011.

read more...

According to the complaint, prior to receiving the gift, Krzysztof consulted an accountant who told him he did not need to file any forms with his tax returns and that the gift proceeds were exempt from gross income. 

Fast-forward about 8 years and Krzysztof, now a Philly cop, wants to make a gift to his godson. Searching the internet about consequences of that re-gift, he discovers that when he received the gift from his mom, he was supposed to file a Form 3520 to report the foreign sourced gifts.  In 2018, he contacts a Philly tax attorney for assistance with filing the forms and uses the “Delinquent International Information Return Submission Procedures.” As per those procedures, he explained in the submission his earlier reliance on an advisor and claimed that he had reasonable cause for failing to file the forms for both years. 

About a year later IRS assesses penalties anyway; $87,500.00 and $120,000.00 for 2010 and 2011. He files a protest, hoping to get the matter to Appeals. The protest gets lost in the system, and he gets TAS to intervene to get the matter before Appeals. 

About another year later Appeals abated $70,000 of the $87,000 penalty assessed for 2010 and $96,000 of the $120,000 penalty assessed for  2011. The Appeals write up indicated: “Case resolution based on ‘Hazards of Litigation’”; the remaining $41,500 in penalties was sustained.

Krzysztof paid the balance, and filed refund claims for both years. In denying one of the years’ claims the denial referred to the claim as “frivolous.”

Assuming the facts are as they are alleged (and they were properly before Appeals), and the taxpayer’s accountant was competent, I am struggling to see why Appeals did not fully concede.  The IRS had another chance to make this right when it considered the refund claim. Under Boyle and subsequent cases, reliance on an advisor that is premised on a mistake of law relating to the need to file a return at all differs from a nondelegable  duty as to when a taxpayer needs to file a return. And Appeals abated 80% of the penalty initially, an indication that it knew its position is shaky.

According to the IRS “[p]enalties exist to encourage voluntary compliance by supporting the standards of behavior required by the Internal Revenue Code.” I struggle to see how leaving thousands of dollars of penalties on the books for what seems like a good faith mistake based on what an advisor told makes any sense. Luckily for Wrzesinski, he was able to fully pay the balance of the penalties; otherwise Flora would have prevented him from bringing a refund suit. Of course, there is always the option of pursuing the initial advisor for malpractice, but that has costs.

Lamprecht v Comm’r: Statute of Limitations, Qualified Amended Returns And The Issuance Of A John Doe Summons

The recent case of Lamprecht v Commissioner highlights some interesting nuances in applying the statute of limitations on assessment when a taxpayer files an amended return and the IRS uses a John Doe summons to gather information about taxpayers.

The Lamprechts came to the IRS’s attention as part of the government’s efforts to detect US citizens and residents who had Swiss and other jurisdictions’ bank accounts and income associated with those accounts that went unreported.

read more...

In 2010 the Lamprechs, Swiss citizens who had green cards and a residence in Tiburon, California, filed amended 2006 and 2007 returns that reported previously omitted income from their Swiss UBS accounts. IRS examined the returns and proposed accuracy-related penalties for both years.  The taxpayers timely petitioned to Tax Court, challenging the penalties on multiple grounds, including that that their amended returns were “qualified amended returns”, that any proposed assessment of the accuracy-related penalties for 2006 and 2007 would be barred by the statute of limitations, and the IRS did not receive proper supervisory approval for the penalties under 6751(b) (note I will not discuss the 6751 issue in this post).

The procedural posture that triggered this opinion involved cross motions for summary judgment. The motions focused on the substantial understatement of income tax penalty (the government’s answer had also alleged a fraud penalty but the government later conceded the fraud penalty).

Lamprecht involves a John Doe summons (JDS), a topic I have been discussing here lately (see First Circuit Finds Anti-Injunction Act Does Not Bar Challenge to IRS’s Use of John Doe Summons That Gathered Taxpayer’s Virtual Currency Transactions and which also is discussed extensively Saltzman and Book IRS Practice and Procedure in Chapter 13). The Lamprechts’ 2006 and 2007 original 1040’s were short by about $6 million in interest, capital gains and commissions that flowed through their UBS accounts. The amended returns included the previously unreported income.

The Lamprechts’ amended returns in 2010 came after the ex parte IRS 2008 filing in federal district court to allow use of the JDS process to get identifying information about US taxpayers with accounts at UBS or its affiliates. After getting authorization, IRS issued the JDS to UBS in July of 2008. After the government initiated a February 2009 enforcement proceeding, the government of Switzerland joined in the enforcement suit as amicus curiae. In August of 2009 the enforcement suit was resolved by two agreements. The first agreement established a process for the exchange under the US –Swiss treaty that included the Swiss Federal Tax Administration and would in its terms “achieve the U.S. tax compliance goals of the UBS [John Doe] Summons while also respecting Swiss sovereignty.” The second agreement provided that “the IRS would “withdraw with prejudice” the UBS John Doe summons after receiving information concerning bank accounts from UBS pursuant to the treaty request for administrative assistance.”

In November of 2010, when IRS obtained the information it sought, the IRS formally withdrew the JDS (as we will see below, these different dates matter for SOL purposes).

Against this background, as most readers know under Section 6501(a)(1) the time period for assessing additional tax is generally three years from the filing of a return. For “substantial omissions” from gross income (greater than 25% of the amount of gross income stated in the return) that period is doubled to six years.  In addition, when IRS serves a summons, and that summons is not resolved within six months of service, then the period of limitations for assessment is suspended from the six-month anniversary of service of the summons until its final resolution. 

The Lamprechts agreed that the omission with respect to their original returns was substantial, though they and the IRS differed on the application of the SOL in light of their amended returns and the summons suspension issue.

Qualified Amended Returns

Section 6662 provides that a “substantial understatement” is determined by reference to “the amount of the tax imposed which is shown on the return”. Regulations provide that a taxpayer who files a qualified amended return can use the amount of tax shown on those returns for determining whether the understatement is substantial. The regs, however, provide that an amended return is not a qualified amended return if the amended return was filed after the service of a JDS relating to a tax liability of a group that includes the taxpayer if the “taxpayer claimed a direct or indirect tax benefit from the type of activity that is the subject of the summons…”

There was no question that the Lamprechts’ amended return filing was after the service of the JDS; the Lamprechts, however, argued that their omission of the overseas income did not constitute a direct or indirect tax benefit.

The opinion rejected the Lamprechts’ position on a few grounds, essentially concluding that:

[t]he Lamprechts omitted all foreign source income from their original 2006 and 2007 tax returns, thereby substantially understating their gross income and corresponding tax liabilities, and in doing so they received the benefit of understated tax liabilities. Furthermore, during the examination of their 2006 and 2007 income tax returns, when the Lamprechts filed amended returns for 2006 and 2007 to report foreign income previously unreported, their representative asserted that Mr. Lamprecht “did not report his foreign source income and earnings on his originally filed returns because he thought that ‘everything Swiss was not taxable in the U.S.’”

The opinion went on to discuss how the omission of income directly led to their affirmatively claiming itemized deductions that would otherwise have been phased out, thus also undercutting the Lamprechts’ position that they failed to claim a benefit.

Impact of the Summons on the SOL

Once concluding that the understatement was substantial and thus triggered the 6-year SOL, the opinion went on to discuss whether the proposed assessment was timely given that the 2006 and 2007 were filed in April of 2007 and 2008 respectively and the IRS issued the notice of deficiency for both years more than six year later, in January of 2015.  The timeliness of the potential assessment turned on whether and when the running of the six-year limitations period was suspended by the service and final resolution of the UBS JDS.

The Lamprechts argued initially that there should be no suspension of the SOL because in its view the JDS was issued without a valid purpose, just to extend the SOL. The opinion swiftly brushed that aside, noting that there was no precedent for the use of a collateral proceeding against a taxpayer in the John Doe class to raise that challenge. Alternatively the court reasoned that under the liberal Powell standard they had not shown that the summons was issued for an invalid purpose.

That still left open precisely when the SOL was suspended. Under Section 7609(e) the service of the summons suspended the period of limitations for assessment once the summons had remained unresolved after 6 months from service; that six-month date was January 21, 2009.  The suspension ends on when the summons is finally resolved; the parties disagreed on when the matter was finally resolved.

The regs provide that a summons proceeding is  finally resolved “when the summons or any order enforcing any part of the summons is fully complied with and all appeals or requests for further review are disposed of, the period in which an appeal may be taken has expired or the period in which a request for further review may be made has expired.”

The Lamprechts claimed that the final resolution occurred in August of 2009, when the district court ordered dismissal of the government’s summons enforcement suit.

The government argued that final resolution occurred when IRS formally withdrew the summons on November 15, 2010, after it received the documents pursuant to the treaty and the matter was dismissed with prejudice. That over one-year difference mattered, because under the government’s position the SOL was suspended from January 21, 2009, to November 15, 2010 (i.e., for 664 days), with the six-year SOL for assessment for the 2006 and 2007 years thus still open when the IRS mailed the notices of deficiency in January of 2015, which further suspends the SOL.

The Tax Court agreed with the government, stating that the Lamprechts did “not assert (nor make any showing of) an earlier date by which UBS had “fully complied” with the summons and “all appeals or requests for review” had been “disposed of”.

Conclusion

This is an important government victory. This opinion is significant as it explores SOL issues in the context of aggressive IRS pursuit of taxpayers who have failed to report income in overseas accounts. The intersection of the qualified amended return rules and the somewhat unusual posture by which the government obtained documents pertaining to the Lamprechts on the surface make this a somewhat novel opinion. I suspect, however, that practitioners representing similarly situated taxpayers with overseas accounts, unreported income, amended returns and hefty penalties will carefully study this opinion.

Late Filing Penalty Relief for 2019 and 2020 Returns to Generate Automatic Refunds

Today the IRS issued a press release announcing extremely broad late filing penalty relief for the 2019 and 2020 taxable years. Importantly, relief is being applied automatically, and taxpayers do not need to take any action to receive a refund of penalties they paid.

Notice 2022-36 details the specific tax returns and penalties for which relief is provided. Returns must be filed by September 30, 2022 to qualify for relief.

The notice also explains the government’s rationale for providing relief, citing the President’s coronavirus pandemic emergency declaration as well as the pandemic’s impact on IRS operations and return processing backlog. The notice states, “the Treasury Department and the IRS have determined that the penalty relief described in this notice will allow the IRS to focus its resources more effectively, as well as provide relief to taxpayers affected by the COVID-19 pandemic.”

Kudos to the IRS for making relief automatic. The press release indicates that most refunds will be issued by the end of September.

Edited to add: the National Taxpayer Advocate blog has a very good summary of the relief provided.

No Reasonable Cause For Failing To Include $238,000 From Information Return Sent To Old Address

Back in 2013, I wrote about Andersen v Comm’r, a summary opinion where a taxpayer failed to include $28,000 of W-2 income but was not subject to a 20% civil penalty for substantially understating income. In Andersen, the Tax Court held that there was reasonable cause for the omission and the taxpayer acted in good faith.

These types of cases are notoriously fact intensive. Whether the taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis. Courts, based on the regulations, examine the pertinent facts and circumstances, including the taxpayer’s knowledge, education, and experience, as well as the taxpayer’s reliance on professional advice.

In Andersen, the taxpayers were sympathetic, with a long history of tax compliance, a consistent recordkeeping practice, and a longtime competent tax preparer. The preparer testified about why he reasonably believed that his clients had retired and would not have had wage income. In finding that the taxpayers had established reasonable cause and good faith, the Tax Court acknowledged that it was an “exceptionally close case” but held that no penalties applied.

Contrast Andersen with last week’s LaRochelle v. Commissioner, another summary opinion involving a failure to include income reported on an information return.

read more...

The facts in LaRochelle were not nearly as sympathetic as Andersen. The amount at issue was $238,000 from an IRA distribution in 2017. In 2016, the taxpayers had moved from DC to Florida but still owned a DC residence. They set up US Postal Service mail forwarding. They recalled receiving the $238,000 IRA distribution but not the 1099-R, which had been sent to their DC address.

The husband was sophisticated; he was “professionally engaged in more than ten business partnerships”, including one where he was in charge of day to day operations, including recordkeeping.  The taxpayers used a tax return preparer ( I assume a lawyer, though not clear from the opinion), who also represented the taxpayers in Tax Court (uh oh, see below).

The opinion itself is fairly straightforward. After discussing why the substantial understatement penalty is “determined by an IRS computer program without human review” and “automatically calculated through electronic means” it held that under Tax Court precedent it is exempt from the Section 6751 written supervisory approval requirement (for a different view on that, see Caleb’s discussion in Walquist Harms The Poor: Revisiting Supervisory Approval For Accuracy Penalties.)

The summary opinion also concludes that the taxpayers had not established that they were entitled to a reasonable cause good/faith defense. Failure to receive an information return is not enough to insulate a taxpayer from a penalty, especially when, as here, the taxpayer admits to recalling having received the money, especially a lot of money.

The taxpayers also argued that their use of a preparer justified excusing the penalty. The use of a preparer alone is not enough to establish that the taxpayers’ reliance amounted to good faith/reasonable cause:

Mr. LaRochelle did not explain what was meant by petitioners’ relying upon Mr. Lander to handle their tax return

Moreover, as the opinion notes, a failure to provide necessary information is fatal to a good faith/reasonable cause defense predicated on reliance on a competent tax return professional.

Concluding Thoughts

Tax Court Rule 24(g)(2)(A) generally provides that “[c]ounsel may not represent a party at trial if the counsel is likely to be a necessary witness within the meaning of the ABA Model Rules of Professional Conduct.” The opinion notes that Judge Leyden apprised the parties of the rule, and that the taxpayers stated that their preparer was not likely to be a necessary witness.  While it would not have mattered in this case had the preparer testified, it is almost always a bad idea, and a conflict of interest, to have the taxpayers’ return preparer represent the taxpayer at trial.

For taxpayers with numerous information returns, it would be prudent to set up an online account with IRS. On extension, the preparer and taxpayer can easily access all of the information returns, even those that a taxpayer may not have physically received.

Of course, all of this nonsense could be avoided if the IRS provided taxpayers with a government sourced online filing platform that could access information that the IRS has received from third parties. That day may be coming, as I discussed this past May in Momentum Possibly Building for IRS To Provide Online Filing Options For Taxpayers, but for now we have a back end process where a taxpayer who omits an item has to go through a post filing automated underreporter program and possible disputes as to whether there is enough justification to avoid a penalty. Sad.

Hat tip on this case to Ed Zollars, whose post in Current Federal Tax Developments alerted me to this case. Ed’s work is terrific, and I recommend readers subscribe. As Ed notes, many taxpayers mistakenly believe that the hiring of a preparer means that taxpayers can avoid responsibility.

Ed notes the responsibility that preparers have to correct clients about that misperception:

But tax professionals need to be aware of this belief on the part of their clients that merely hiring the professional and dropping off the documents they decided were relevant means the return they get back will contain no errors. It is important to remind clients that it is their responsibility to provide all relevant information for their return and to make use of tools the professional may provide…

Honest Mistakes Happen, But a Two Million Dollar Difference in Mortgage Interest Will Likely Trigger An Accuracy-Related Penalty

Busch v Commissioner, a small tax case issued as a bench opinion, involves a couple who claimed to have made an honest mistake on their self-prepared tax return.  According to the Busches, when using their tax return prep software, the software did not allow them to enter cents when recording the mortgage interest paid in a year. The Busches paid $21,201.25 in deductible mortgage interest and entered $21,201.25 line for their mortgage interest, but the software, kicking out the cents, recorded the deduction as $2,120,125 instead. The couple of million dollar difference led IRS to likely discover the error automatically via document matching.

What followed was likely mismatch virtual audit, a notice of deficiency that adjusted for the underpaid tax, and for good measure, a proposed 20 per cent substantial understatement accuracy related penalty under Section 6662(a). The Busches filed a petition, conceding the extra tax but challenging the penalty.

read more...

The issue in the case was whether the taxpayers could establish that they acted with reasonable cause and in good faith under Section 6664(c) and thus be excused from the penalty.

The brief opinion notes that the taxpayers urged the court to find that the error was an “honest” mistake, and, as such, they should not be penalized for that mistake. The opinion shows some sympathy for the taxpayers and more generally to how it is possible that taxpayers may foot fault when using software:

[The taxpayers] ask the Court to recognize, as they point out that honest mistakes are sometimes made. As a general proposition of life, we agree with petitioners on the point, and we further agree with petitioners’ suggestion that not every mistake made on a Federal income tax return should result in the imposition of an accuracy-related penalty. A person preparing a return might understandably get distracted while doing so and enter the wrong amount for an item, or if not distracted, when transferring numbers from one document to another, transpositions often occur. If a computer-based software program is being used in the process, the limitations and requirements of a software program might not be fully appreciated by the user. Any number of situations could cause an “honest” mistake to be made when amounts are incorrectly reported on a Federal income tax return. 

The problem with the taxpayers’ argument though was that the taxpayers had an obligation to review the return. The two-million dollar difference between the deduction on the return and interest actually paid should have triggered greater inquiry into the matter:

But petitioners’ focus on the erroneous entry as the “mistake”, and their explanation describing how the mistake occurred, misses the point. The mistaken entry is not the real problem. Their mistake was failing to review the return carefully enough to have recognized the erroneous entry before the return was filed. After all, it should go without saying, that a taxpayer’s obligation to prepare and file a Federal income tax return includes the duty to review that return to ensure that the information reported or shown on the return is accurate before the return is filed.

The opinion notes that the “deduction for mortgage interest shown on the return occupies at least two additional columns” on the same page as where the deduction appears on the return:

Looking up and down the columns showing other items reported on the return, the mortgage interest deduction sticks out, as the saying goes, “like a sore thumb”. A careful review of the return after it was prepared would most certainly have caught the error; actually, even as little as a quick glance at the return probably would have done so.

Conclusion

This is another in the line of cases that holds that the use of tax software by itself is not sufficient to establish a defense to an accuracy-related penalty. As Bryan Camp noted in Lesson From The Tax Court: The Turbo-Tax Defense in Tax Prof a few years ago, there is dicta in a Tax Court opinion that suggests that the use of software can help establish reasonable cause/good faith. But hiding behind “the software made me do it” is not enough to insulate all taxpayers from penalties.

To succeed in blaming the software, taxpayers will generally achieve better results if the software issue involves a question of the proper tax treatment of the item as opposed to a clerical type mistake any taxpayer could pick up by reviewing the return.  The taxpayers discussed in post by Bryan Camp were sophisticated yet the Tax Court, in dicta, expressed sympathy with their plight.  Similarly, former Treasury Secretary Timothy Geithner had a problem reporting his income from the World Bank that he blamed on the tax prep program.  His excuse worked to get him out of a confirmation pickle.  Where the defense of the computer made me do it fails is in cases in which any reasonable taxpayer should recognize the mistake if they took care.

Taxpayers can generally rely on a paid preparer to insulate them from the penalty when taxpayers give the paid preparer all of the information necessary and the preparer makes a mistake; however, just having a paid preparer doesn’t necessarily insulate a taxpayer from the duty to review the return and catch obvious mistakes.  Taxpayers could not easily escape penalty where a return contained an obvious mistake just by saying they relied on the accountant to add the numbers properly and if the accountant said 1 + 1 + 3 the taxpayer had no duty to correct the mistake. 

Courts seek to build on decades of case law involving human paid preparers as they analyze situations in order to decide the appropriateness of penalizing someone relying on digital paid preparers.  Taxpayers choosing the do it yourself route can put some blame on their digital preparer but must assume some responsibility to check to make sure the resulting return makes sense.  Had the taxpayers here checked, they would have concluded the return did not reflect the correct tax result.  The Busches bore responsibility to at least check for a return that made sense.

No Reasonable Cause When Tax Return Preparer Fails to E-file Extension

A recent district court opinion addresses the inability to establish reasonable cause for a late filing penalty even if a longtime preparer promised but failed to e-file an extension of time to file a 1040.  The case, Oosterwijk v United States, brings in interesting reasonable cause issues and highlights the limits of the IRS First Time Penalty Abatement policy.

In 2017, taxpayers Erik and Aspasia Oosterwijk sold for many millions of dollars a Baltimore based wholesale meat business that they had run for decades. When it came time to file their 2017 tax return on Tuesday April 17, 2018 (Monday April 16, 2018 was Emancipation Day in DC), the taxpayers expected their longtime preparer to e-file an extension and instruct IRS to apply a payment of about $1.8 million in taxes.  The taxpayers made sure they transferred money to their checking account, and kept looking to see when the tax payment would hit the account.

By April 25, when the money was still not debited from their account, the taxpayers emailed their longtime CPA tax return preparer, who told them to wait until April 30, and if the money were still in their checking account at that date he would follow up with the IRS.

On April 29 the now concerned taxpayers emailed their CPA again saying that the money was still in their account. The preparer checked his records and……

read more...


You guessed it. The preparer realized that that he failed to e-file the extension and had not given instructions to IRS to debit the payment.

What happens next compounds the original problem.

The preparer advised the Oosterwijks that if they immediately filed a six-month Extension Request on Form 4868, they would have until October 15, 2018, to file their tax return, and the penalties for late filing would stop accruing..
The taxpayers followed the advice and immediately mailed in the Form 4868 and a check for $1.8 million, which IRS processed on May 4, 2018.

On June 29, 2018 the Oosterwijks’ CPA e-filed their 2017 return. Upon processing the return, IRS assessed failure to pay penalties of about $8,860 for the one month non payment delinquency period that ran April 17 to May 4, 2018. IRS assessed failure to file (FTF) penalties of about $259,000 for the three month late filing period that ran from April 17 to June 29th 2018, the date that Oosterwijks’ CPA e-filed their return on their behalf.

The Oosterwijks (and their CPA) were surprised that the IRS assessed a FTF penalty for the two-month period that ran from May 15 to June 29th. Based on their CPA’s advice, the taxpayers had incorrectly believed that by paying their taxes, submitting the Extension Request on May 4 (during the first month), and filing the return before October 15, they would halt the accrual of any FTF penalties beyond the first monthly delinquency.
Well, as you likely know, the CPA and his clients were mistaken. A late filed extension to file does not excuse FTF penalties for any subsequent filing.

In November 2018, after the IRS assessed both delinquency penalties, the taxpayers’ CPA requested penalty relief based on reasonable cause. The IRS denied the relief, and the CPA appealed administratively on behalf of his clients. The Appeals Officer agreed to abate about 50% of both delinquency penalties.
Despite the 50% abatement, the taxpayers were not happy with the result. By March of 2019, the taxpayers sent in another letter to IRS stating that they believed they should be relieved of all the penalties, raising the issue of their reasonable cause for late filing due to their CPA’s failure to e-file the extension and his incorrect substantive advice about how to halt the FTF penalty’s accrual.

IRS did not respond, and the taxpayers paid the balance due and filed a refund claim. After six months passed they then filed a refund suit in federal district court, claiming that they had reasonable cause for the delinquency due to both the mistaken belief that the extension were filed and the reliance on substantive advice that a late filed extension excused a portion of the FTF penalties.

Following the complaint, the government filed a motion to dismiss, which the court treated as a motion for summary judgment.

As a threshold matter, why didn’t the taxpayers avoid having to file a suit and request administrative relief under the IRS’s First Time Abatement policy? To add insult to injury the Oosterwijks were not eligible, because their decades long history of tax compliance was tainted by a $7 late payment penalty from the 2014 tax year and the first time abatement for delinquency penalties requires a clean past three years of tax compliance.

With that out of the way the opinion first addressed a variance issue because the formal refund claim addressed reasonable cause relating to the mistaken belief that the extension was filed and did not mention the advice the CPA gave about limiting penalty accrual by filing a 4868 after the due date of the return. The opinion concluded that the claim and communications with IRS were sufficient to put IRS on notice about the full extent of the reasonable cause argument. (as an aside the opinion also seems to mix up the SOL issues in 6511 and 6532).

That gets to the merits of the reasonable cause defense. The taxpayers argued that the FTF penalties should be completely excused because they had reasonable cause for filing late, specifically that their accountant failed to e-file their extension request and their personal e-filing access was limited.

Boyle and Non Delegable Duties

This of course brings in the Boyle case and its applicability to failures to e-file, which we have discussed in Delinquency Penalties: Boyle in the Age of E-Filing and more recently in Possible Opening in Defending Against Late Filing Penalty When Preparer Fails to E-file Timely. To date, even when a taxpayer is relying on an agent to e-file, courts have been unwilling to distinguish Boyle and have held that reliance on a third party 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.”

The Oosterwijk opinion cites to the opinion in Boyle, and also to Justice Brennan’s concurring opinion, where he “stressed that the ‘ordinary business care and prudence’ standard applies only to the “ordinary person.” That is, the standard exempts individuals with disabilities or infirmities that render them physically or mentally incapable of knowing, remembering, and complying with a filing deadline.”

The Oosterwijks argued that “Boyle does not apply to electronic filing, because a taxpayer cannot personally confirm that an accountant has e-filed as promised.”

The Oosterwijks essentially argued that the placement of a third party (the preparer) “between the taxpayer and the IRS, and the Oosterwijks’ inability either to e-file on their own or to confirm the e-filing’s transmission put the filing beyond their control according to Justice Brennan’s concurrence.”

The opinion disagreed, noting that the taxpayers were free to paper file an extension (and in fact did so):

The specialized technology and professionals-only availability of e-filing need not have been a barrier to the filing of an Extension Request; the same means available to the Boyle taxpayer in 1979 were available to the Oosterwijks in 2017, even if the IRS encourages e-filing.

Moreover, the opinion notes that Justice Brennan’s Boyle concurrence “contemplates differently abled taxpayers who are physically or mentally incapable of meeting filing deadline. The Oosterwijks do not fall under this exception.”

What About The CPA’s Substantive Advice?

Boyle does not prevent a finding of reasonable cause when a taxpayer’s non or late filing was due to erroneous substantive legal advice as compared to just an agent’s failure to file a return or extension. To that end, the Oosterwijks argued that the penalty period after the first month should be excused because their preparer mistakenly believed and advised them that if they mailed an extension after the due date of the return so long as they paid any balance due and filed the 2017 return by October 15, 2018 they would only be subjected to one-month FTF penalty. This, they argued, amounted to substantive legal advice.

A. Is The Penalty Divisible

As I mentioned above, that advice was wrong; the FTF penalty is based on the net tax due as of the due date of the return, and the delinquent extension provided no benefit. But should the taxpayer be expected to second-guess their preparer?

The court’s inquiry focused on timing. Does it matter if the substantive advice arises after the due date of the return? The opinion notes that the reasonable cause inquiry looks to the due date, and while the due date (and thus inquiry time) could be extended if the taxpayer timely filed an extension, actions beyond the due date are not determinative.

To be sure, the opinion notes that reasonable cause at the due date does not mean that there is reasonable cause for the entire delinquency period, citing to the Federal Circuit Court of Appeals case from 2013, Estate of Liftin v US.

The government argued that any advice that the Oosterwijks’ preparer gave after the April 17 due date was irrelevant if as of the original due date the taxpayer did not establish that it had reasonable cause (and as discussed above there was no reasonable cause as of April 17).

The taxpayers essentially argued that the FTF penalty was divisible, or that whether a taxpayer has reasonable cause should be evaluated on a monthly basis given that the penalty amount is triggered by each monthly delinquency period:

To the Oosterwijks, the core issue is whether reasonable cause arose as to parts of the penalty incurred in later months when, after the deadline had already passed, they relied on their tax professional’s bad substantive advice about what actions would stop the accrual of a tax penalty. They say that this would leave intact the April 2018 penalty but would require removal of the penalties for May and June 2018, the months after [the CPA’s] incorrect April 30 advice. The Oosterwijks focus on the distinction between relying on a tax professional to perform the ministerial (and non-delegable, under Boyle) duty of filing an extension return, as compared to the tax professional’s erroneous substantive advice about what actions would halt the penalty’s accrual.

On divisibility, the court examined case law which suggested that the FTF penalty was divisible but distinguished those circumstances. Those cases mostly involved erroneous “legal advice about the availability of second extensions after the taxpayer had already timely filed and obtained a first extension.”

In those cases there was reasonable cause at the original due date but not later:

These second-extension cases are distinct from the Oosterwijks’. The taxpayers in these cases were erroneously advised by their attorneys before their (first extended) deadlines had passed, meaning they could still have had reasonable cause under § 6651. The fact that they received erroneous advice after their original deadlines is immaterial, because their reasonable cause evaluation was governed by their first extended deadline. In contrast, the Oosterwijks received their erroneous advice after the deadline had passed and therefore after the door had closed on reasonable cause for late filing.

Similarly, the opinion distinguished Estate of Liftin, where a taxpayer had reasonable cause at the date of filing based on erroneous advice about not needing  to file an estate tax return until after the taxpayer’s spouse had become a citizen.  In Liftin, the reasonable cause defense did not apply to the FTF penalty when circumstances changed and the spouse became a citizen, but there was still an additional 9-month delinquency prior to filing:

Liftin shows that although the penalty is not entirely indivisible for the purposes of the reasonable cause exception, it is not divisible in the way the Oosterwijks hope. They, unlike the Liftin taxpayer, failed to meet the initial requirements of reasonable cause. The purpose of encouraging timely filing is best served by reading the statute to allow reasonable cause to expire based on a change in circumstances at some point in the delinquency but not allowing it to materialize where the taxpayer had none at the time of filing.

B. Even if the Penalty Were Divisible the Advice Was Not Reasonable

For good measure, the opinion notes that even if the penalty were divisible in the way the Oostwerwijks argued they still would not qualify for relief because the advice they received was not reasonable given the explicit text of Form 4868. In so concluding the opinion cites to Baer v US, a 2020 Court of Federal Claims opinion that considered a CPA’s failure to file a 4868 because he believed that any extension had to be accompanied by a taxpayer payment. While Baer held that the CPA’s actions were not advice and thus could not justify a taxpayer’s reliance, it also held that if it did amount to advice it was not based on a “reasonable factual or legal assumption.” That was because the text of the extension form directly contradicted the CPA’s mistaken belief, that it could not file a 4868 a scenario analogous to the Oosterwijk’s situation where the form itself stated that the taxpayer must file the 4868 by the due date to receive the extension.

In contrast in La Meres v Commissioner, one case where a taxpayer was able to establish that mistaken advice as to an extension was reasonable cause, the opinion notes that the advice concerned the advisor’s mistaken belief that the taxpayer was entitled to two extensions of time to file an estate tax return, an issue not addressed in the form itself but only  “toward the end of the relevant estate tax regulation” and one in which the IRS actions misled the taxpayer into thinking a second extension was valid.

Concluding Thoughts

The court signs off by acknowledging that it is “sympathetic to the Oosterwijks, who were not willfully neglectful but rather appear to have relied on the advice of a trusted professional, intending to fulfill their obligations under the tax laws.”

Yet the court also acknowledges that the government was not at fault and did in fact abate about half of the penalties. 

I am not sure I accept that there is no government fault here.  Even though I suspect the taxpayers’ longtime preparer will likely reimburse the taxpayers in light of a possible malpractice suit (though maybe Congress should consider directly penalizing the preparer rather than forcing the taxpayer to seek reimbursement from the preparer), the case leaves a bad taste in my mouth.

Apart from my belief that courts (and the IRS) should distinguish Boyle when e-filing makes it difficult to monitor an agent’s actions, the policy underlying the imposition of civil penalties and the first time abatement policy itself suggest that the IRS should have exercised discretion and abated the FTF penalty in full.

Recall that the taxpayers had a long history of tax compliance, save for a 2014 $7 delinquency penalty. Under the First Time Abatement policy, the IRS will abate a delinquency penalty if a taxpayer

  • Didn’t previously have to file a return or have no penalties for the 3 tax years prior to the tax year in which the taxpayer received a penalty;
  • Filed all currently required returns or filed an extension of time to file; and
  • Has paid, or arranged to pay, any tax due.

As the IRS acknowledges, “penalties should relate to the standards of behavior they encourage. Penalties best aid voluntary compliance if they support belief in the fairness and effectiveness of the tax system.” IRM 20.1.1.2.1 (11-25-2011) Encouraging Voluntary Compliance.

While perhaps the IRS has the power to penalize taxpayers like the Oosterwijks, the taxpayers’ de minimis $7 delinquency penalty is all that stood in the way of a full abatement. The IRS should apply the First Time Abatement policy by ignoring a de mininimis assessment during the three-year period. Even if the policy were not changed to have a deminimis carveout, when a taxpayer has a long history of compliance and the delinquency is directly attributable to preparer error, perhaps the government should show mercy. After all, as Shakespeare wrote, mercy can have an effect that is “twice blest.” It is needed more so these days as trust in our public institutions and IRS in particular seems to be eroding.

Sometimes doing the right thing means the IRS looking the other way. Even if the law is on its side.

The Fifth Circuit Parts Ways with the Ninth Circuit Regarding the Non-Willful FBAR Penalty

We welcome guest blogger Andy Weiner today to provide insight on a very important case decided last year.  Professor Weiner teaches at Temple Law School where he directs their LLM program in Tax and, starting this fall, also directs their low income taxpayer clinic.  Prior to arriving at Temple, Professor Weiner spent more than a decade as an attorney in the Tax Division of the Department of Justice, initially in the Appellate Section, where he briefed and argued approximately 50 cases throughout the United States Courts of Appeals, and then at the trial level in the Court of Federal Claims Section. He received numerous distinguished service awards during his tenure.  Keith

In United States v. Bittner, the Fifth Circuit reckons with the crack down on hiding wealth offshore. At issue is the non-willful penalty in 31 U.S.C. § 5321(a)(5)(A) for failing to report interest in foreign financial accounts on an annual Report of Foreign Bank and Financial Accounts known as an FBAR. The statute provides the Secretary of the Treasury “may impose a civil monetary penalty on any person who violates, or causes any violation of, any provision of section 5314 . . . not [to] exceed $10,000.” As explained by the Fifth Circuit, the case “hinges on what constitutes a ‘violation’ of section 5314: the failure to file an FBAR (as urged by Bittner) or the failure to report an account (as urged by the government).” Slip Op. at 13. On the surface, it’s a straightforward question of statutory interpretation, and not a particularly close one at that. It becomes more complicated, however, when you consider questions of purpose and fairness, which may help to explain why the Fifth Circuit and the Ninth Circuit split on the issue.

read more...

Bittner has spent most of his life in Romania. Between 1982 and 1990, he lived in the United States and became a citizen. He then returned to Romania and made a fortune as an investor. Through holding companies, Bittner controlled dozens of bank accounts in Romania, Switzerland and Liechtenstein. He did not file timely FBARs for 2007 to 2011 disclosing these accounts. The IRS imposed the maximum non-willful penalty of $10,000 regarding each account for each year. Bittner’s total penalty liability came to $1.77 million.

Bittner argued his liability should be capped at $50,000 based on his failure to file an FBAR for each of five years. As mentioned, that depends on what qualifies as a violation of 31 U.S.C. § 5314 subject to a penalty. Section 5314 states that the Secretary “shall require a resident or citizen of the United States . . . to keep records, file reports, or keep records and file reports, when the . . . person makes a transaction or maintains a relation for any person with a foreign financial agency.” By the Fifth Circuit’s reading, a person violates the statute according when he or she fails to report “a relation . . . with a foreign financial agency.” Bittner pointed out that the statute is not self-effectuating and that the implementing regulations require filing one FBAR that reports all applicable accounts. But that does not affect the meaning of the statute, as the Fifth Circuit explained: “Streamlining the process in this way, . . . cannot redefine the underlying reporting requirement imposed by section 5314.” Slip Op. at 17.

The Fifth Circuit also looked to the surrounding penalty provisions. Section 5321(a)(5) includes both a non-willful and a willful penalty, and the latter unquestionably treats each failure to report an account as a violation. Specifically, 31 U.S.C. § 5321(a)(5)(C) provides that “any person willfully violating, or willfully causing any violation of, any provision of section 5314” is subject to a maximum penalty equal to the greater of $100,000 or 50% of “the balance in the account at the time of the violation.” The reasonable cause exception to the non-willful penalty at 31 U.S.C. § 5321(a)(5)(B)(ii) likewise treats each failure to report an account as a violation, excusing “such violation” if “due to reasonable cause” and “the balance in the account at the time of the transaction was properly reported.” The same word in the definition of the non-willful penalty presumably bears the same meaning as it does in these related provisions.

The Fifth Circuit presents a compelling case based on the text of the statute that each failure to report a foreign bank account is a violation subject to a non-willful FBAR penalty. But why should Bittner, who maintained many foreign accounts ostensibly for legitimate business reasons and who did not willfully fail to report them on an FBAR, owe $1.77 million? Given the unintentional nature of the conduct, there’s little, if any, deterrence value to be gained. What then is the point of such significant penalty liability? The history of the non-willful penalty raises the prospect that it has outlived some of its usefulness.

The original FBAR reporting requirement in the Bank Secrecy Act of 1970 was enforced only by a willful penalty up to $100,000. In 2004, following a report by Treasury that perhaps hundreds of thousands of taxpayers were hiding wealth offshore and not filing FBARs, Congress increased the maximum willful penalty to 50% of the balance in an account not properly reported and added a non-willful penalty up to $10,000. Congress sought to make getting caught prohibitively expense and installed the non-willful penalty as a floor on the cost of non-compliance. Then, in 2010, Congress enacted the Foreign Account Tax Compliance Act, which required foreign banks to report account information of U.S. taxpayers. Bank reporting has proven much more efficient and effective at enforcing FBAR compliance and weakened the justification for the maximum non-willful penalty.

Still, the maximum penalty has its place, for example, as a proxy for taxes that the account holder avoided. Finding the appropriate balance is a matter of IRS discretion and the penalty mitigation guidelines at IRM 4.26.16-2. A person must cooperate with the examination and have a clean record in terms of prior FBAR penalty assessments, criminal activities, and civil tax fraud in any year of a non-willful FBAR violation. If these criteria are met, examiners are instructed to “limit the total mitigated penalties for each year to the statutory maximum for a single non-willful violation,” unless “in the examiner’s discretion . . . , the facts and circumstances of a case warrant a different penalty amount.” IRM 4.26.16.5.4.1 (06-24-2021). Among the factors an examiner should consider is “the harm caused by the FBAR violation,” i.e., lost tax revenue. IRM 4.26.16.5.2.1 (06-24-2021).

There is no indication why the IRS sought the maximum penalty liability against Bittner. The Fifth Circuit seemed to assume that Bittner’s liability was justified by “Congress’s central goal in enacting the BSA . . . to crack down on the use of foreign financial accounts to evade tax.” Slip Op. at 22. The Ninth Circuit in United States v. Boyd, 991 F.3d 1077 (2021), on the other hand, observed that Boyd amended her return to include income from her foreign bank accounts and proceeded to conclude that her non-willful penalty liability from failing to report 13 accounts in one year could not exceed $10,000. Tax avoidance (or the lack thereof) weighs heavily on courts notwithstanding that the relevant information is not necessarily disclosed in FBAR cases.

The lesson here for foreign account holders is to cooperate with an examination and pay the tax owed on income from foreign bank accounts. If the IRS does not mitigate the non-willful penalty liability, the account holder is in position to seize the higher equitable ground in court. The lesson for the IRS is to follow the mitigation guidelines and consider any departures from those rules carefully. The Supreme Court may take up Bittner to resolve the conflict with the Ninth Circuit, in which case I would expect it to affirm that each failure to report a foreign bank account is a violation of section 5314. But that will not end the debate over the appropriate level of non-willful penalty liability. To the contrary, the more the IRS has discretion, the more likely those disputes will endure.

2021 Year in Review – Graev

Maybe it’s too much to devote one year in review post to a single issue, but Graev has dominated case decisions the past few years and maybe, maybe not, is on its way out.  As we reported and blogged about here, the now stalled Build Back Better legislation has a provision that will eliminate Graev, not just going forward, but going back over 20 years.  Not since the retroactive elimination of the telephone excise tax has Congress tried to undo itself in such a grand way.  Since this may be the last hurrah for Graev, why not send it out in style or, if it remains, why not remind ourselves how a poorly worded piece of legislation can cause so much havoc.

read more...

Since the IRS has noticed the existence of IRC 6751(b), it seems now to have procedures in place to ensure that the immediate supervisor of the employee imposing the penalty actually approves the penalty imposition.  If the IRS has finally figured this out, why then repeal the legislation now and why does it receive a relatively high score from Congress for repealing it?  One suggestion concerns a whole bunch of old shelter cases that exist out there in pre-notice of deficiency status in which the IRS failed to follow the now more clearly defined rules of IRC 6751(b).  If true, it becomes easier to see why the administration would push for retroactive repeal and why certain groups of taxpayers would push back.  While we contemplate what might happen in the future, let’s look at the more important Graev decisions of 2021.

Graev and the Fraud Penalty

I posted on a decision that troubled me because when the IRS pursues a taxpayer criminally, the case goes through a myriad set of approvals.  Yet in Minemyer v. Commissioner, T.C. Memo 2020-99 – a case that took 10 years to decide – the Court found that the IRS did not follow IRC 6751(b) and stripped off the civil fraud penalty following a criminal tax case.  I wrote about the Minemyer case here and expressed surprise that IRC 6751(b) would stop the application of the fraud penalty in a case that involved a prior prosecution of the taxpayer, since the assertion of the fraud penalty following prosecution occurred automatically, with the hands of the agent and the agent’s supervisor essentially tied.  Of course, the statute does not specifically address prior criminal cases or create any special exception for them.

The Tax Court followed up the Minemyer case with a precedential decision in Beland v. Commissioner, 156 T.C. No. 5 (2021), where the Tax Court determined that the fraud penalty the IRS sought to assert failed the requirements of IRC 6751(b) allowing the taxpayers to avoid the 75% penalty proposed by the IRS without getting to the merits.  The Court issued this opinion granting partial summary judgment on the fraud issue five years after the case was filed. 

When a revenue agent seeks to impose the fraud penalty, the agent must send the case from exam over to obtain approval from the fraud technical advisor (FTA).  The FTA is a Small Business/Self Employed revenue agent specially trained on tax fraud issues. The IRS set up the system of having agents refer cases to FTAs so that an investigator trained specifically in fraud detection could determine if the revenue agent had gathered enough information to support the fraud penalty and to allow the FTA to determine if this case should chart a path toward criminal prosecution prior to imposition of the civil fraud penalty. See IRM 25.1.2.2 (08-12-2016).

Requiring that the imposition of the fraud penalty first go through an FTA seems to provide even better protection against the use of the fraud penalty as a bargaining chip than having the immediate supervisor sign off on the penalty, but the statute has a specific structure applicable to all penalties.  Striking the fraud penalty in this situation may be part of what’s causing Congress to rethink its passage of IRC 6751(b), but for the reasons discussed in a post by Nina Olson, that seems too radical a fix to a problem that it could resolve with better statutory language.

Graev and the Early Withdrawal Excise Tax

Pulling money out of a retirement account before reaching 59 and ½ and without meeting one of the statutory exceptions in IRC 72(t) triggers a 10% excise tax usually referred to as a penalty and determined by bankruptcy courts to be a penalty for purposes of priority classification.  In Grajales v. Commissioner, 156 T.C. No. 3 (2021), the Tax Court determined that the 10% exaction imposed under IRC 72(t) is not a penalty for purposes of whether the IRS must obtain supervisory approval prior to its imposition.  The amount at issue in this precedential opinion was $90.86 and the case was litigated by Frank Agostino, the godfather of IRC 6751(b) litigation. See Frank’s brief here, and the government’s here.  Frank lost this one but given the way that most people look at this exaction, his arguments were not illogical.

Conservation Easement Cases

In Oconee Landing Property LLC et al v. Commissioner, Dk. No. 11814-19, the Tax Court entered a very substantive order granting partial summary judgment to the IRS on the issue of penalty approval.  If the Court still designated orders, I suspect it would have designated this one.

The taxpayer does not argue in this case that the IRS did not obtain the penalty approvals prior to the communication with it that the IRS had asserted a penalty.  Although the prior approval issue exists in most IRC 6751(b) cases, here the issue focuses on the form and manner of the approval, particularly as it relates to summary judgment.  It asserts that the penalty lead sheet in the file “does not identify Ms. Smithson’s [the immediate supervisor] role … or even a date of signature.”

In this case, the approval occurred through email rather than by a signing of the same paper by the agent and the immediate supervisor.  This type of approval has no doubt become quite common during the pandemic while many employees and managers have been working remotely.  It could also be common in situations where the employee and the manager work out of different offices.  Obtaining acceptance of this type of approval is important for the IRS.  One hurdle it has here and in many other cases involves proving that the person signing the approval is, in fact, the immediate supervisor of the employee imposing the penalty.

When is Supervisory Approval Necessary

In Walquist v. Commissioner, 152 T.C. No. 3 (2021), the issue focused on the IRS’s Automated Correspondence Exam (ACE) software. ACE automatically processes taxpayer returns. In many cases, ACE handles returns from receipt to closing with “minimal to no tax examiner involvement.” In Walquist, ACE processed the taxpayer’s 2014 tax return, assessed a §6662 penalty, and issued the notice of deficiency automatically and without any human interaction. The Tax Court found that because the penalty was determined mathematically by a computer software program without the involvement of a human IRS examiner, the penalty was “automatically calculated through electronic means.”

This decision creates a dichotomy between low-income taxpayers whose cases are regularly handled by somewhat automated processes and higher income taxpayers whose cases are not.  The Court did not need to issue a precedential opinion in a case in which the taxpayers were unrepresented tax protestors, yet decided to do so despite the inability of the adversarial process to work effectively.  The Court heard only from the government and clearly expressed displeasure at the unfounded arguments advanced by these taxpayers.  The decision leaves a bad taste in my mouth for the way it casually treats an issue involving many low-income taxpayers without giving lawyers for low-income taxpayers the opportunity to present arguments explaining why this result should not attach.  I have a working paper on the topic of precedential opinions in pro se cases and possible solutions to the creation of precedent where only the government has a real voice.