Today’s guest blogger is Joseph Cole, LL.M. He is an Senior Associate Attorney at RJS Law in San Diego, California. His practice includes federal and state tax controversy. Taxpayers often argue their accuracy relate penalties should be excused because their accountant made an error while preparing their tax return. Today’s post discusses how taxpayers must first show they relied on actual professional advice involving professional judgment from an accountant or tax advisor (as opposed to the tax return error being attributed to a clerical-type error) in order to obtain relief from accuracy related penalties.
The post struck a special cord with me since I recently lost a penalty case, Mulu v. Commissioner, TC Summary Opinion 2023-2 in which the taxpayer did not review the return prepared by a paid but ghosting preparer. Had my client reviewed the return he could have corrected the incorrect job title placed on the return but would not have been able to understand and fix the incorrect depreciation and business expense claims which caused the liability giving rise to the additional tax, to which he agreed, and the penalty with which he did not agree. I did not view job title as an important facet of the return but the court did creating a result that surprised me. Keith
The Tax Court’s recent Patacsil (Patacsil v. Comm’r, TC Memo 2023-8) illustrates a threshold inquiry a taxpayer may need to overcome when he or she seeks relief from penalties. The taxpayers in Patacsil sought relief from accuracy related penalties claiming they relied on the advice of their tax advisor. Judge Holmes’ opinion illustrates that taxpayers may only be eligible for relief when they rely an actual advice from a tax advisor, i.e. professional judgment or analysis of a tax advisor, as opposed to “tax preparation” or clerical tasks associated with a tax advisor’s duties.
read more...To briefly summarize the Patacsil case, the taxpayers owned several group homes. Some of the properties they owned were lost in foreclosure. Among other things, the taxpayers claimed NOL carry-forwards, claimed Cancellation of Indebtedness Income (COI) was excluded from income because of insolvency exception, and various Schedule C losses. (There were some procedural issues raised like implied consent in pleadings I would be remiss if I did not briefly mention).
The Court ruled against the taxpayers on most of the issues that were in dispute. Among other things, the taxpayers could not exclude COI income for one of the years in question, they could not claim NOL carry-forwards, and could not claim many of their Schedule C deductions. Like many tax court opinions, the Patacsil opinion ends with a discussion of penalties.
Like many other taxpayers, the Patacsils sought professional help in preparing their returns. The Patacsils argued that they should be entitled to relief from accuracy related penalties because they relied on the advice of their tax advisor. The Tax Court looked to whether the taxpayers received advice from their tax preparer in determining whether they were eligible for relief from accuracy related penalties.
Tax Accounting, for lack of a better term, comprises of tax advice (i.e., tasks that involve judgment or analysis) and tax preparation (i.e., tasks that are clerical in nature.). The case law differentiates between tax advice and tax preparation. (See Woodsum v. Comm’r, 136 TC 585 (2011)). Advice requires special training.
In Patacsil, the court determined reporting business expenses on a Schedule C may not constitute tax advice because the accountant in the case simply transcribed figures provided by the taxpayers and did not exercise any judgments or perform any analysis regarding the deductions. The Patacsil decision did grant the Taxpayers relief for accuracy related penalties related to claimed NOL’s because it considered the treatment of NOL’s “tax-law arcana.” The court did not apply the three part Neonatology Associates test for the Schedule C deductions because the taxpayers did not rely on advice, and the Neonatology Associates test only applies to advice. (Some Procedurally Taxing posts touching on Neonatology Associates can be found here and here).
The case law provides lists other tasks that do not constitute advice for penalty relief purposes. To give some examples, a tax preparer’s failure to report income on a tax return may not constitute advice. (See Woodsum and Viola v. Comm’r, TC Memo 2013-213). The failure to report income in these cases was deemed to be based on some clerical error rather than specific advice from the tax preparer. These failures to report income were attributed in part to the taxpayers neglecting to carefully review their return. A tax preparer is not providing advice when the preparer is merely inputting data into software. (See Pankratz v. Comm’r, TC Memo 2021-26).
Seeking the services of a professional tax preparer does not make a taxpayer completely immune to potential penalties. While a taxpayer may rely on their tax preparer’s professional judgment, they may not necessarily rely on their tax preparer’s clerical work if they wish to avoid penalties.
“In Patacsil, the court determined reporting business expenses on a Schedule C may not constitute tax advice because the accountant in the case simply transcribed figures provided by the taxpayers and did not exercise any judgments or perform any analysis regarding the deductions.”
Did the taxpayers instruct the accountant to transcribe every figure onto Schedule C? Or did the taxpayers give the accountant a list of figures and rely on the accountant’s advice as to which form, if any, each figure should be transcribed onto?
The Patacsil Opinion does not give much detail as to the exact process the accountant went through in preparing the tax return other than the accountant’s staff inputting figures based on documents provided to the accountant’s staff by the taxpayers. This does seem potentially troubling because the preparation of a Schedule C often requires professional judgment. The account needs to decide which expenditures get expensed, which expenditures need to be depreciated (and how to calculate depreciation), and whether an expenditure should even be considered a business expense at all.
I see no error in the decisions in Mulu or Patacsil.
I think a taxpayer who pays a preparer who doesn’t identify as preparer on the tax return is on notice something may be amiss. Reasonable reliance should is defeated in such cases for anything on the return. And of course, there is Boyle and its body of caselaw. It is unreasonable to rely on a preparer you might (or should) suspect isn’t qualified or law-abiding.