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

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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……

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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.

About Leslie Book

Professor Book is a Professor of Law at the Villanova University Charles Widger School of Law.

Comments

  1. A. Lavar Taylor says

    The “ordinary business care and prudence” standard does not require “extraordinary” business care and prudence. When a taxpayer is aware of the deadline and gets assurance from a trusted tax professional that the deadline has been met (which was not the fact pattern in Boyle), in many, if not most, cases the taxpayer should meet the “ordinary care an prudence” standard.

    Fact patterns like the one in Oosterwijk should at least raise triable issues of fact as to whether the standard was met, i.e., the question of whether they met the applicable standard should be decided by a jury or judicial fact finder. For “ordinary” persons, there should not be strict liability for penalties where taxpayers are aware of the deadline, their trusted tax professional is aware of the deadline, and their trusted tax professional screws up.

    Of course, if it is a jury question, taxpayers can still end up losing on the factual issue. Don’t conflate the argument that there is a legitimate issue of fact with the argument that the taxpayer has actually demonstrated reasonable cause. They are two separate issues.

  2. Bob Kamman says

    If my client is going to owe nearly $2 million and we already know it, I’m not going to put off filing a 4868 until April 15. The extension form for 2021 returns is available now. If clients at the deadline want to delegate filing it and making a payment, online or by mailed check, I will tell them to delegate it to someone else. The taxpayers probably have a history of requesting last-minute extensions – they may have been waiting for a Schedule K-1, perhaps for their own business, with a return due on March 15 that had already been extended.

    We don’t know the net worth of these taxpayers. If it’s $100 million, should that make a difference in how much mercy IRS shows? Taxpayers with negative net worth might find even greater hardship in paying a $2,000 penalty under similar circumstances. The solution here is to bifurcate the First Time Abatement Policy: If you had to pay FTP in the last three years, another FTP won’t be abated. If you had to pay FTF in the last three years, another FTF won’t be abated. But we won’t penalize you for both if you only messed up on one.

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