The tax filing deadline has arrived, May 17, 2021.

Taxpayers are advised to request an extension to October 15, 2021 if they cannot file on time. Compound interest on tax due starts on May 18, 2021.

Taxpayers are liable for the accuracy of their tax return. Unfortunately, many taxpayers do not know the content of their personal or business tax return. The Internal Revenue Service will not process a return until the taxpayer declares and signs that “Under penalties of perjury, I declare that I have examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and complete. Declaration of preparer (other than taxpayer) is based on all information of which preparer has knowledge.

The tax return could be multiple pages for some taxpayers and many items are not easy to understand. However, there are some basic steps that taxpayers could take to ensure that their return is accurate. Taxpayers should know in advance how much the return would cost. Taxpayers should turn the pages to search for any fraudulent Schedule A, Schedule C, and Form 8863. The Recovery Rebate Credit (stimulus payment), a new line in the Form 1040 in 2020, could be a target for fraud. Taxpayers should make sure the correct amount is reported. Taxpayers could review and ask questions relating to:

  • Line 1 (Wages),
  • Line 8 (Other Income),
  • Line 10b (Charitable Contribution),
  • Line 12 (Standard Deduction or Itemized Deductions),
  • Line 15 (Taxable Income),
  • Line 30 (Recovery Rebate Credit),
  • Lines 34-36 (Refund).

The recent Bruneaus’ case is another application of the Internal Revenue Code and regulations that reflects the views of the Internal Revenue Service and the Courts.

In Paul B . Bruneau and Karen L. Bruneau v. Commissioner of Internal Revenue Service (T.C. Summary Opinion 2021-1), the Tax Court ruled in favor of the Commissioner relating to the determination of tax deficiencies of $66,250 and penalties of $13,249 for taxable years 2014 and 2015.

Petitioners did not provide enough evidence to the Court to successfully dispute the IRS determination of tax deficiencies for the tax years at issue. They did not have adequate records to substantiate their claims of business income, expenses, and deductions. The Bruneaus conceded to the disallowance of deductions for “Other” expenses; vehicle expenses; utility expenses; and meals and entertainment expenses. However, they disputed several other issues: 1) the amounts of petitioners’ gross receipts; 2) whether petitioners are entitled to their amount of depreciation deductions; 3) whether petitioners are entitled to deductions for travel expenses while away from home; 4) whether petitioners are liable for accuracy-related penalties under section 6662(a). We focus on the penalties dispute.

The Internal Revenue Code in Section 6662(a) and (b)(1) imposes an accuracy-related penalty equal to 20% of the amount of any underpayment of tax that is due to the taxpayer’s negligence or disregard of rules or regulations. An underpayment is generally defined as the difference between the tax imposed on the taxpayer and the tax reported on the tax return. Section 6662(a) imposes an accuracy-related penalty on taxpayers on the theory that the petitioners’ underpayment of tax were due to negligence. Petitioners stated that their tax returns for the relevant years were prepared by a tax return preparer. They acknowledged that they did not review the completed returns for accuracy and completeness before signing them.

The Internal Revenue Code provides an exception in Section 6664(c)(1) to the imposition of a penalty, if it is shown that there was reasonable cause for the underpayment and the taxpayer acted in good faith.

The IRS and the Courts apply a three parts test established by the Third Circuit Court of Appeals in Neonatology Assocs. P.A. v. Commissioner to prove reasonable cause and good faith. For reliance on the advice of a professional tax adviser to constitute reasonable cause and good faith, a taxpayer must prove that:

1) the adviser was a competent professional who had sufficient expertise to justify reliance,
2) the taxpayer gave the adviser the necessary and accurate information, and
3) the taxpayer actually relied in good faith on the adviser’s judgment

The Third Circuit Court of Appeals in Neonatology stated in the closing of their decision: “Moreover, they should have been apprehensive when they examined the scheme, for experience shows that when something seems too good to be true that probably is the case.” Taxpayers should inquire about large refund and deductions, especially when their financial situation has not changed.

The Tax Court concluded that petitioners did not offer a meaningful defense to the imposition of the accuracy-related penalties. Even though Mr. Bruneau asserted that they relied on their tax return preparer to properly prepare their tax returns, he acknowledged that they did not review the returns for accuracy and completeness before signing them. Thus, they have failed to show that they reasonably attempted to ascertain the correctness of the disallowed deductions or to comply with the provisions of the Internal Revenue Code. 

Further readings:

  • Rule 142(a)
  • Welch v. Helvering, 290. U.S. 111, 115 (1933)
  • Internal Revenue Code Section 6662(c)
  • Income Tax Regs. section 1.6662-3(b)(1)
  • Higbee v. Commissioner, 116 T.C. 438,446-447 (2001)
  • Neonatology Assocs. P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).

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