Accuracy-Related Penalty Section 6662(a) and (b)(2) imposes a 20% accuracy-related penalty on any portion of an underpayment attributable to a substantial understatement of income tax. Section 7491(c) provides that the Commissioner bears the burden of production with regard to penalties and must come forward with sufficient evidence indicating that it is appropriate to impose the penalty. See Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once the Commissioner meets his burden of production, however, the burden of proof remains with the taxpayer, including the burden of proving that the penalty is inappropriate because of reasonable cause under section 6664. See Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446-447.
M. Blackwood, et ux. v. Commissioner, TC Memo 2012-190 ,
Code Sec(s) 61; 104; 6662; 7491.
M. BLACKWOOD AND J. WEIKLE BLACKWOOD, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent .
Case Information:
Code Sec(s): 61;
104; 6662; 7491
Docket: Docket
No. 23530-10.
Date Issued:
07/11/2012
HEADNOTE
XX.
Reference(s): Code Sec. 61; Code Sec. 104; Code Sec. 6662;
Code Sec. 7491
Syllabus
Official Tax Court Syllabus
Counsel
Michael D. Weikle, for petitioners.
Diana N. Wells, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
RUWE, Judge: Respondent determined a $34,970 deficiency in
petitioners' 2008 Federal income tax and a $6,994 accuracy-related penalty
under section 6662(a). 1 After concessions by the parties, 2 the issues for
decision are: (1) whether the $100,000 settlement payment received by Julie W.
Blackwood (petitioner) during 2008 is excludable from gross income under
section 104(a)(2); (2) whether a portion of the $100,000 settlement is
excludable from gross income under the flush language of section 104(a); and
(3) whether petitioners are liable for an accuracy-related penalty under
section 6662(a) for substantial understatement of income tax.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The
stipulation of facts and the attached exhibits are incorporated herein by this
reference.
At the time the petition was filed, petitioners resided in
West Virginia. Before January 3, 2008, petitioner worked for Siemens as a
trainer assigned to Siemens' client, the Charleston Area Medical Center
(hospital). Petitioner's job duties included training hospital personnel in the
use of a Siemens-developed computer program for the collection of patient
information at the time of the patient's admission to the hospital. The
information collected by the Siemens system would then be used by other medical
personnel when making decisions regarding the patient's subsequent medical care
at the hospital. The Siemens system required hospital personnel to consult with
the patient and simultaneously enter the patient's responses to prompted
questions.
Following the admission of her son to the hospital in
December 2007, petitioner observed the hospital nurse taking her son's medical
history without using the Siemens data entry program. Having trained hospital
personnel in the use of the Siemens program, petitioner was immediately aware
that the hospital nurse failed to ask all the questions required by the
program.
Following the release of her son from the hospital,
petitioner used her Siemens access to view her son's electronically stored
medical records. Upon review petitioner learned that the hospital nurse had
input information regarding questions she failed to ask petitioner's son during
the admissions process. Petitioner reported her observation of the hospital
nurse's use of the Siemens system to her superiors at work and requested
guidance as to how to report the hospital nurse's actions. Petitioner's
supervisor informed her that petitioner would be advised of the action she
should take upon returning to work from a previously scheduled vacation. Upon
returning to work on January 3, 2008, petitioner was informed that her
employment had been terminated by Siemens because she had accessed her son's
hospital medical records without permission and in violation of the Health
Insurance Portability and Accountability Act (HIPAA).
Before January 3, 2008, petitioner suffered from depression.
As a result of her termination, petitioner's depression relapsed, causing her
to suffer symptoms such as insomnia, sleeping too much, migraines, nausea,
vomiting, weight gain, acne, and pain in her back, shoulder and neck.
Petitioner resumed counseling sessions with her counselor, D. Lynn Lewis, who
has a master of arts degree and is a licensed professional counselor and a
licensed clinical social worker.
Petitioner requested that her counsel, Michael D. Weikle,
present her claim of wrongful termination to Siemens. Michael D. Weikle is
petitioner's father. Petitioner's counsel advised Siemens' counsel of
petitioner's intent to file a claim for wrongful termination by sending to
Siemens' counsel a copy of his draft complaint for their review. On August 21,
2008, petitioner signed a confidential settlement agreement and general release
(settlement agreement) in which Siemens agreed to pay petitioner $100,000 for
“alleged damages for illness and medical expenses allegedly exacerbated by, and
allegedly otherwise attributable to, *** [petitioner's] alleged wrongful
discharge”.
The settlement agreement states that petitioner “agrees that
she is responsible for all applicable taxes, if any, as a result of the receipt
of these monies.” Petitioner was issued a Form 1099-MISC, Miscellaneous Income,
reporting the $100,000 Siemens paid to her in 2008. On advice of counsel,
petitioners did not report the $100,000 as income on their joint Federal income
tax return for 2008, nor did they disclose on the return that they considered
the settlement payment to be nontaxable.
On July 26, 2010, respondent issued to petitioners a notice
of deficiency for 2008. Petitioners timely filed a petition disputing the
determinations in the notice of deficiency.
OPINION
Respondent's determinations in the notice of deficiency are
presumed correct, and the taxpayer bears the burden of proving that the
determinations are in error. See Rule 142(a); Welch v. Helvering, 290 U.S. 111,
115 [12 AFTR 1456] (1933). Petitioners argue, for the first time on brief, that
respondent bears the burden of proof pursuant to section 7491(a) for the issue
of Siemens' intent with respect to the $100,000 settlement payment. 3 Our
conclusions, however, are based on a preponderance of the evidence, and thus
the allocation of the burden of proof is immaterial.See McGowen v.
Commissioner, T.C. Memo. 2011-186 [TC Memo 2011-186], 2011 Tax Ct. Memo LEXIS
185, at *5-6 n.3; Tamberella v. Commissioner T.C. Memo. 2004-47 [TC Memo
2004-47], 2004 Tax Ct. , Memo LEXIS 47, at *4, aff'd, 139 Fed. Appx. 319 [96
AFTR 2d 2005-5311] (2d Cir. 2005). Section 104(a)(2) Exclusion From Income
Section 61(a) generally provides: “gross income means all income from whatever
source derived” unless excluded by a specific provision of the Code. This
section is construed broadly, whereas exclusions from gross income are
construed narrowly. Commissioner v. Schleier, 515 U.S. 323, 327-328 [75 AFTR 2d
95-2675] (1995); Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430 [47 AFTR
162] (1955). Section 104(a)(2) provides an exclusion from gross income for “the
amount of any damages (other than punitive damages) received (whether by suit
or agreement and whether as lump sums or as periodic payments) on account of
personal physical injuries or physical sickness”. 4 “The term `damages received
(whether by suit or agreement)' means an amount received *** through
prosecution of a legal suit or action based upon tort or tort type rights, or
through a settlement agreement entered into in lieu of such prosecution.” Sec.
1.104-1(c), Income Tax Regs.
In order for damages to be excludable from gross income
under section 104(a)(2), the taxpayer must demonstrate that: (1) the underlying
cause of action is based upon tort or tort type rights and (2) the damages were
received on account of personal injuries that are physical or a sickness that
is physical. See sec. 104(a)(2); Commissioner v. Schleier, 515 U.S. at 337. The
flush language of section 104(a) provides that emotional distress shall not be
treated as a physical injury or physical sickness.
Respondent concedes that the underlying cause of action, a wrongful
termination claim, which gave rise to Siemens' settlement payment, is based
upon a tort or tort type right. Therefore, the first prong of the section
104(a)(2) test is satisfied. We will then consider whether petitioners satisfy
the second prong of the test. Petitioners argue that the exacerbation of
petitioner's depression symptoms as a result of her termination is a physical
injury or physical sickness under section 104(a)(2). Respondent contends that
any of the depression symptoms petitioner suffered are properly classified as
emotional distress under the flush language of section 104(a). The main issue
we must decide is whether petitioner's symptoms qualify as a physical injury or
physical sickness under section 104(a)(2) or rather as emotional distress under
the flush language of section 104(a).
Petitioner's counselor, D. Lynn Lewis, did not testify at
trial. Petitioners offered into evidence a two-page letter (counselor's letter)
from D. Lynn Lewis to petitioner. The counselor's letter, dated March 10, 2010,
was written at petitioner's request and summarizes the counselor's interactions
with petitioner during their counseling sessions in 2008. In the letter D. Lynn
Lewis states that petitioner suffered from “increased levels of anxiety and depressive
symptoms that seemed directly related to the termination from ***
[petitioner's] job.” The counselor's letter also noted that petitioner was
receiving psychiatric services and medications from a psychiatrist. Notably,
the counselor's letter did not mention that petitioner suffered from any
physical injuries or specific physical symptoms of depression.
At trial petitioners testified that she suffered from
insomnia, sleeping too much, migraines, nausea, vomiting, weight gain, acne,
and pain in her back, shoulder, and neck. Petitioner testified that these
symptoms were a result of her depression. Aside from the summary testimony of
petitioners, no other evidence was submitted to prove that petitioner suffered
from any physical injuries.
The flush language of section 104(a) provides: “For purposes
of paragraph (2), emotional distress shall not be treated as a physical injury
or physical sickness.” The legislative history of section 104(a) states it “is
intended that the term emotional distress includes symptoms (e.g., insomnia,
headaches, stomach disorders) which may result from such emotional distress.”
H.R. Conf. Rept. No. 104-737, at 301 n.56 (1996), 1996-3 C.B. 741, 1041. The
legislative history of section 104 specifically contemplates that emotional distress
may manifest itself in physical symptoms by explicitly listing physical
symptoms as symptoms that may result from emotional distress. See id. Congress'
listing of physical symptoms of emotional distress is evidence of Congress'
intent to establish that not every physical symptom will qualify as a physical
injury or physical sickness under section 104(a)(2). Therefore, the fact that a
taxpayer suffers physical symptoms from emotional distress does not
automatically qualify the taxpayer for an exclusion from gross income under
section 104(a)(2). See Wells v. Commissioner, T.C. Memo. 2010-5 [TC Memo
2010-5], 2010 Tax Ct. Memo LEXIS 4, at *9 (”[A]ny amounts paid in such
circumstances for physical symptoms of emotional distress are similarly
includable in income.”).
Petitioners rely on Domeny v. Commissioner, T.C. Memo.
2010-9 [TC Memo 2010-9], 2010 Tax Ct. Memo LEXIS 9, to support their argument
that the flareup of petitioner's depression symptoms is a physical injury or
physical sickness under section 104(a)(2). In Domeny, the taxpayer suffered
from multiple sclerosis 5 (MS). Id. at *2. Due to a hostile and stressful work
environment, the taxpayer's MS symptoms began to “flare up”. Id. at *3. The
taxpayer experienced MS symptoms such as vertigo, spinning head, extreme
fatigue, shooting pain in her legs, and difficulty walking due to numbness in
her feet. Id. at *4-5. The taxpayer's primary care physician determined the
taxpayer was too ill, because of her MS symptoms, to return to work. Id. at *4.
After giving the physician's instructions to her supervisor, the taxpayer was
terminated from her job. Id. After her termination, the taxpayer's MS symptoms
began “spiking”. Id. at *5.
The instant case is distinguishable fromDomeny. The evidence
of petitioner's symptoms does not show the level of physical injury or physical
sickness in Domeny. Of the eight symptoms 6 that petitioners testified to at
trial, five of the symptoms 7 are very similar to the nonexclusive list of
emotional distress symptoms in the legislative history of section 104(a). See
H.R. Conf. Rept. No. 104-737, supra at 301 n.56, 1996-3 C.B. at 1041 (emotional
distress includes symptoms such as “e.g., insomnia, headaches, stomach
disorders”). Petitioner testified that her symptoms were a result of her
depression. However, petitioners did not provide evidence that petitioner's
physical symptoms of depression were severe enough to rise to the level of a physical
injury or physical sickness. See Wells v. Commissioner, 2010 Tax Ct. Memo LEXIS
4, at *9 (money paid for emotional distress due to depression is includable in
income);Sanford v. Commissioner, T.C. Memo. 2008-158 [TC Memo 2008-158], 2008
Tax Ct. Memo LEXIS 159, at *9 (emotional distress can be manifested in physical
symptoms such as depression, skin irritation, appetite loss, asthma, sleep
deprivation, and severe headaches); Lindsey v. Commissioner, T.C. Memo.
2004-113 [TC Memo 2004-113], 2004 Tax Ct. Memo LEXIS 113, at *14 (fatigability,
occasional indigestion, and difficulty sleeping are encompassed within the
definition of emotional distress),aff'd, 422 F.3d 684 [96 AFTR 2d 2005-5959]
(8th Cir. 2005). Unlike the taxpayer in Domeny, a medical doctor did not
determine that petitioner was too ill to work. In fact, the counselor's letter
stated that petitioner suffered only from “increased levels of anxiety and
depressive symptoms”. See McGowen v. Commissioner, 2011 Tax Ct. Memo LEXIS 185,
at *2 (anxiety is a symptom of emotional distress); Moulton v. Commissioner,
T.C. Memo. 2009-38 [TC Memo 2009-38], 2009 Tax Ct. Memo LEXIS 40, at *18
(depression falls within the category of emotional distress under the flush
language of section 104(a)).
We conclude on the basis of the preponderance of the
evidence that petitioner's depression and corresponding physical symptoms do
not qualify as physical injuries or physical sickness under section 104(a)(2).
Therefore, we find that the $100,000 settlement payment from Siemens is not
excludable under section 104(a)(2). Flush Language of Section 104(a) The flush
language of section 104(a) permits a taxpayer to exclude from gross income the
amount of damages received on account of emotional distress to the extent of
the amount paid for medical care. 8 We note that the depression and (continued...) physical symptoms of
depression that petitioner suffered from qualify as emotional distress under
the flush language of section 104(a). See Moulton v. Commissioner, 2009 Tax Ct.
Memo LEXIS 40, at *18 (depression falls within the category of emotional
distress under the flush language of section 104(a)); H.R. Conf. Rept. No.
104-737, supra at 301 n.56, 1996-3 C.B. at 1041 (emotional distress includes
symptoms such as “e.g., insomnia, headaches, stomach disorders”). We further
note petitioners would have been able to exclude from income a portion of the
settlement payment equal to the amount spent on petitioner's medical care.
However, there is no substantiation in the record of any of petitioner's actual
expenditures for medical care. Therefore, we find that petitioners are not
entitled to any exclusion from gross income under the flush language of section
104(a).
There is a substantial understatement of income tax for any
taxable year if the amount of the understatement for the taxable year exceeds
the greater of 10% of the tax required to be shown on the return for the
taxable year or $5,000. Sec. 6662(d)(1)(A). The understatement of income tax on
petitioners' joint Federal income tax return is substantial. Respondent has met
his burden of production in that he has shown that petitioners improperly
excluded the $100,000 settlement payment from gross income on their joint
Federal income tax return for 2008.See Longoria v. Commissioner T.C. Memo.
2009-162 [TC Memo 2009-162], 2009 Tax Ct. Memo LEXIS , 162, at *31. Reasonable
Cause Petitioners argue that they had reasonable cause for excluding the
$100,000 settlement payment from gross income on their joint Federal income tax
return for 2008. “Reasonable cause requires that the taxpayer have exercised
ordinary business care and prudence as to the disputed item.” Neonatology
Assocs., P.A. v. Commissioner, 115 T.C. 43, 98 (2000), aff'd, 299 F.3d 221 [90
AFTR 2d 2002-5442] (3d Cir. 2002). The good-faith reliance on the advice of an
independent, competent professional as to the tax treatment of an item may meet
this requirement. Id. (citing United States v. Boyle, 469 U.S. 241 [55 AFTR 2d
85-1535] (1985)); sec. 1.6664-4(b), Income Tax Regs. Whether a taxpayer relies
on the advice and whether such reliance is reasonable hinge on the facts and
circumstances of the case and the law that applies to those facts and
circumstances. Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 98; sec.
1.6664-4(c)(1), Income Tax Regs. For reliance to be reasonable, “the taxpayer
must prove by a preponderance of the evidence that the taxpayer meets each
requirement of the following three-prong test: (1) The adviser was a competent
professional who had sufficient expertise to justify reliance, (2) the taxpayer
provided necessary and accurate information to the adviser, and (3) the
taxpayer actually relied in good faith on the adviser's judgment.” Neonatology
Assocs., P.A. v. Commissioner, 115 T.C. at 99; see Sanford v. Commissioner,
2008 Tax Ct. Memo LEXIS 159, at *17.
At trial petitioner testified that she was advised by her
counsel that the settlement payment was not taxable. Petitioners' counsel is a
certified public accountant (C.P.A.) and lawyer. The professional
qualifications of petitioners' counsel justified their reliance on his advice.
We note there is a level of uncertainty regarding when physical manifestations
of emotional distress give rise to a physical injury or physical sickness under
section 104(a)(2). Compare Moulton v. Commissioner, 2009 Tax Ct. Memo LEXIS 40,
at *18 (”depression, sleep disorders, or elevated blood sugar levels *** fall
within the category of `emotional distress”), with Domeny v. Commissioner, T.C.
Memo. 2010-9 [TC Memo 2010-9] (physical symptoms of multiple sclerosis that
were exacerbated by emotional distress qualified as a physical injury or
physical sickness). Although we note petitioner's symptoms do not qualify as a
physical injury or physical sickness under section 104(a)(2), petitioners'
counsel's advice was not so unreasonable as to not justify petitioners'
reliance on it. See Longoria v. Commissioner 2009 Tax Ct. Memo , LEXIS 162, at
*33 (taxpayer who received advice from C.P.A. to exclude settlement under
section 104(a)(2) was not liable for the section 6662(a) penalty when the Court
determined injuries were result of emotional distress).
Petitioners' counsel represented petitioner in the
settlement agreement with Siemens. This satisfies the second prong of the test
as petitioner's counsel knew all the necessary facts concerning the settlement
agreement. The third prong of the test was satisfied by petitioner's testimony
that she relied on counsel's advice that the $100,000 settlement payment was
excludable from gross income in filing petitioners' 2008 joint Federal income
tax return.
We conclude that petitioners acted with reasonable cause and
in good faith as to excluding the settlement payment from gross income.
Accordingly, we hold that petitioners are not liable for the accuracy-related
penalty under section 6662(a).
In reaching our decision, we have considered all arguments
made by the parties, and to the extent not mentioned or addressed, they are
irrelevant or without merit.
To reflect the foregoing, Decision will be entered under
Rule 155.
1
Unless otherwise
indicated, all section references are to the Internal Revenue Code (Code) in
effect for the year in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
2
Petitioners concede
they failed to report $11 of interest income for 2008. Respondent concedes
petitioners are not liable for the self-employment tax for 2008.
3
“This Court
generally will not consider issues that are raised for the first time on brief,
particularly where the belated claim would prejudice a party.” Han v.
Commissioner, T.C. Memo. 2002-148, 2002 Tax Ct. Memo LEXIS 155, at *111; see
Rules 34(b)(4), 41(a) and (b); Foil v. Commissioner, 92 T.C. 376, 418 (1989),
aff'd, 920 F.2d 1196 (5th Cir. 1990); Gibson v. Commissioner, T.C. Memo. 2007-
224, 2007 Tax Ct. Memo LEXIS 224, at *8 n.5.
4
The Small Business
Job Protection Act of 1996, Pub. L. No. 104-188, sec. 1605(a), 110 Stat. at
1838, amended sec. 104(a)(2) to limit the exclusion, inter alia, to “personal
physical injuries or physical sickness”. (Emphasis added.)
5
Multiple sclerosis
is a “demyelinating disease marked by patches of hardened tissue in the brain
or the spinal cord and associated esp[ecially] with partial or complete
paralysis and jerking muscle tremor.” Webster's Collegiate Dictionary 764 (10th
ed. 1997).
6
At trial petitioners
testified that petitioner suffered from insomnia, sleeping too much, migraines,
nausea, vomiting, weight gain, acne, and pain in her back, shoulder, and neck.
7
Insomnia, sleeping
too much, migraines, nausea, and vomiting.
8
The flush language
of sec. 104(a) provides: “For purposes of paragraph (2), emotional distress
shall not be treated as a physical injury or physical sickness. The preceding
sentence shall not apply to an amount of damages not in excess of the amount
paid for medical care (described in subparagraph (A) or (B) of section
213(d)(1)) attributable to emotional distress.”
Reg §1.6664-4. Reasonable cause and good faith exception to
section 6662 penalties.
Caution: The Treasury has not yet amended Reg § 1.6664-4 to
reflect changes made by P.L. 111-152, P.L. 109-280
Effective: December
30, 2003. These regulations apply to returns filed after December 31, 2002,
with respect to transactions entered into on or after January 1, 2003.
(a) In general. No penalty may be imposed under section 6662
with respect to any portion of an underpayment upon a showing by the taxpayer
that there was reasonable cause for, and the taxpayer acted in good faith with
respect to, such portion. Rules for determining whether the reasonable cause
and good faith exception applies are set forth in paragraphs (b) through (h) of
this section.
(b) Facts and circumstances taken into account.
(1) In general. The determination of whether a taxpayer
acted with reasonable cause and in good faith is made on a case-by-case basis,
taking into account all pertinent facts and circumstances. (See paragraph (e)
of this section for certain rules relating to a substantial understatement
penalty attributable to tax shelter items of corporations.) Generally, the most
important factor is the extent of the taxpayer's effort to assess the
taxpayer's proper tax liability. Circumstances that may indicate reasonable
cause and good faith include an honest misunderstanding of fact or law that is
reasonable in light of all the facts and circumstances, including the
experience, knowledge and education of the taxpayer. An isolated computational
or transcriptional error generally is not inconsistent with reasonable cause
and good faith. Reliance on an information return or on the advice of a
professional tax advisor or an appraiser does not necessarily demonstrate
reasonable cause and good faith. Similarly, reasonable cause and good faith is
not necessarily indicated by reliance on facts that, unknown to the taxpayer,
are incorrect. Reliance on an information return, professional advice or other
facts, however, constitutes reasonable cause and good faith if, under all the
circumstances, such reliance was reasonable and the taxpayer acted in good
faith. (See paragraph (c) of this section for certain rules relating to
reliance on the advice of others.) For example, reliance on erroneous
information (such as an error relating to the cost or adjusted basis of
property, the date property was placed in service, or the amount of opening or
closing inventory) inadvertently included in data compiled by the various
divisions of a multidivisional corporation or in financial books and records
prepared by those divisions generally indicates reasonable cause and good
faith, provided the corporation employed internal controls and procedures,
reasonable under the circumstances, that were designed to identify such factual
errors. Reasonable cause and good faith ordinarily is not indicated by the mere
fact that there is an appraisal of the value of property. Other factors to
consider include the methodology and assumptions underlying the appraisal, the
appraised value, the relationship between appraised value and purchase price,
the circumstances under which the appraisal was obtained, and the appraiser's
relationship to the taxpayer or to the activity in which the property is used.
(See paragraph (g) of this section for special rules relating to appraisals for
charitable deduction property.) A taxpayer's reliance on erroneous information
reported on a Form W-2, Form 1099 or other information return indicates
reasonable cause and good faith, provided the taxpayer did not know or have
reason to know that the information was incorrect. Generally, a taxpayer knows,
or has reason to know, that the information on an information return is
incorrect if such information is inconsistent with other information reported
or otherwise furnished to the taxpayer, or with the taxpayer's knowledge of the
transaction. This knowledge includes, for example, the taxpayer's knowledge of
the terms of his employment relationship or of the rate of return on a payor's
obligation.
(2) Examples. The following examples illustrate this
paragraph (b). They do not involve tax shelter items. (See paragraph (e) of
this section for certain rules relating to the substantial understatement
penalty attributable to the tax shelter items of corporations.)
Example (1). A, an individual calendar year taxpayer,
engages B, a professional tax advisor, to give A advice concerning the
deductibility of certain state and local taxes. A provides B with full details
concerning the taxes at issue. B advises A that the taxes are fully deductible.
A, in preparing his own tax return, claims a deduction for the taxes. Absent
other facts, and assuming the facts and circumstances surrounding B's advice
and A's reliance on such advice satisfy the requirements of paragraph (c) of
this section, A is considered to have demonstrated good faith by seeking the
advice of a professional tax advisor, and to have shown reasonable cause for
any underpayment attributable to the deduction claimed for the taxes. However,
if A had sought advice from someone that he knew, or should have known, lacked
knowledge in the relevant aspects of Federal tax law, or if other facts
demonstrate that A failed to act reasonably or in good faith, A would not be
considered to have shown reasonable cause or to have acted in good faith.
Example (2). C, an individual, sought advice from D, a
friend who was not a tax professional, as to how C might reduce his Federal tax
obligations. D advised C that, for a nominal investment in Corporation X, D had
received certain tax benefits which virtually eliminated D's Federal tax
liability. D also named other investors who had received similar benefits.
Without further inquiry, C invested in X and claimed the benefits that he had
been assured by D were due him. In this case, C did not make any good faith
attempt to ascertain the correctness of what D had advised him concerning his
tax matters, and is not considered to have reasonable cause for the
underpayment attributable to the benefits claimed.
Example (3). E, an individual, worked for Company X doing
odd jobs and filling in for other employees when necessary. E worked irregular
hours and was paid by the hour. The amount of E's pay check differed from week
to week. The Form W-2 furnished to E reflected wages for 1990 in the amount of
$29,729. It did not, however, include compensation of $1,467 paid for some
hours E worked. Relying on the Form W-2, E filed a return reporting wages of
$29,729. E had no reason to know that the amount reported on the Form W-2 was
incorrect. Under the circumstances, E is considered to have acted in good faith
in relying on the Form W-2 and to have reasonable cause for the underpayment
attributable to the unreported wages.
Example (4). H, an individual, did not enjoy preparing his
tax returns and procrastinated in doing so until April 15th. On April 15th, H
hurriedly gathered together his tax records and materials, prepared a return,
and mailed it before midnight. The return contained numerous errors, some of
which were in H's favor and some of which were not. The net result of all the
adjustments, however, was an underpayment of tax by H. Under these
circumstances, H is not considered to have reasonable cause for the
underpayment or to have acted in good faith in attempting to file an accurate
return.
(c) Reliance on opinion or advice.
(1) Facts and circumstances; minimum and requirements. All
facts and circumstances must be taken into account in determining whether a
taxpayer has reasonably relied in good faith on advice (including the opinion
of a professional tax advisor) as to the treatment of the taxpayer (or any
entity, plan, or arrangement) under Federal tax law. For example, the
taxpayer's education, sophistication and business experience will be relevant
in determining whether the taxpayer's reliance on tax advice was reasonable and
made in good faith. In no event will a taxpayer be considered to have
reasonably relied in good faith on advice (including an opinion) unless the requirements
of this paragraph (c)(1) are satisfied. The fact that these requirements are
satisfied, however, will not necessarily establish that the taxpayer reasonably
relied on the advice (including the opinion of a tax advisor) in good faith.
For example, reliance may not be reasonable or in good faith if the taxpayer
knew, or reasonably should have known, that the advisor lacked knowledge in the
relevant aspects of Federal tax law.
(i) All facts and circumstances considered. The advice must
be based upon all pertinent facts and circumstances and the law as it relates
to those facts and circumstances. For example, the advice must take into
account the taxpayer's purposes (and the relative weight of such purposes) for
entering into a transaction and for structuring a transaction in a particular
manner. In addition, the requirements of this paragraph (c)(1) are not
satisfied if the taxpayer fails to disclose a fact that it knows, or reasonably
should know, to be relevant to the proper tax treatment of an item.
(ii) No unreasonable assumptions. The advice must not be
based on unreasonable factual or legal assumptions (including assumptions as to
future events) and must not unreasonably rely on the representations,
statements, findings, or agreements of the taxpayer or any other person. For
example, the advice must not be based upon a representation or assumption which
the taxpayer knows, or has reason to know, is unlikely to be true, such as an
inaccurate representation or assumption as to the taxpayer's purposes for
entering into a transaction or for structuring a transaction in a particular
manner.
(iii) Reliance on the invalidity of a regulation. A taxpayer
may not rely on an opinion or advice that a regulation is invalid to establish
that the taxpayer acted with reasonable cause and good faith unless the
taxpayer adequately disclosed, in accordance with §1.6662-3(c)(2), the position
that the regulation in question is invalid.
(2) Advice defined. Advice is any communication, including
the opinion of a professional tax advisor, setting forth the analysis or
conclusion of a person, other than the taxpayer, provided to (or for the
benefit of) the taxpayer and on which the taxpayer relies, directly or
indirectly, with respect to the imposition of the section 6662 accuracy-related
penalty. Advice does not have to be in any particular form.
(3) Cross-reference. For rules applicable to advisors, see
e.g., §§1.6694-1 through 1.6694-3 (regarding preparer penalties), 31 CFR 10.22
(regarding diligence as to accuracy), 31 CFR 10.33 (regarding tax shelter
opinions), and 31 CFR 10.34 (regarding standards for advising with respect to
tax return positions and for preparing or signing returns).
(d) Underpayments attributable to reportable transactions.
If any portion of an underpayment is attributable to a reportable transaction,
as defined in §1.6011-4(b) (or §1.6011-4T(b), as applicable), then failure by
the taxpayer to disclose the transaction in accordance with §1.6011-4 (or
§1.6011-4T, as applicable) is a strong indication that the taxpayer did not act
in good faith with respect to the portion of the underpayment attributable to
the reportable transaction.
(e) Pass-through items. The determination of whether a
taxpayer acted with reasonable cause and in good faith with respect to an
underpayment that is related to an item reflected on the return of a
pass-through entity is made on the basis of all pertinent facts and
circumstances, including the taxpayer's own actions, as well as the actions of
the pass-through entity.
(f) Special rules for substantial understatement penalty
attributable to tax shelter items of corporations.
(1) In general; facts and circumstances. The determination
of whether a corporation acted with reasonable cause and in good faith in its
treatment of a tax shelter item (as defined in §1.6662-4(g)(3)) is based on all
pertinent facts and circumstances. Paragraphs (f)(2), (3), and (4) of this
section set forth rules that apply, in the case of a penalty attributable to a
substantial understatement of income tax (within the meaning of section
6662(d)), in determining whether a corporation acted with reasonable cause and
in good faith with respect to a tax shelter item.
(2) Reasonable cause based on legal justification.
(i) Minimum requirements. A corporation's legal
justification (as defined in paragraph (e)(2)(ii) of this section) may be taken
into account, as appropriate, in establishing that the corporation acted with
reasonable cause and in good faith in its treatment of a tax shelter item only
if the authority requirement of paragraph (f)(2)(i)(A) of this section and the
belief requirement of paragraph (f)(2)(i)(B) of this section are satisfied (the
minimum requirements). Thus, a failure to satisfy the minimum requirements will
preclude a finding of reasonable cause and good faith based (in whole or in
part) on the corporation's legal justification.
(A) Authority requirement. The authority requirement is
satisfied only if there is substantial authority (within the meaning of
§1.6662-4(d)) for the tax treatment of the item.
(B) Belief requirement. The belief requirement is satisfied
only if, based on all facts and circumstances, the corporation reasonably
believed, at the time the return was filed, that the tax treatment of the item
was more likely than not the proper treatment. For purposes of the preceding
sentence, a corporation is considered reasonably to believe that the tax
treatment of an item is more likely than not the proper tax treatment if
(without taking into account the possibility that a return will not be audited,
that an issue will not be raised on audit, or that an issue will be settled)—
(1) The corporation
analyzes the pertinent facts and authorities in the manner described in
§1.6662-4(d)(3)(ii), and in reliance upon that analysis, reasonably concludes
in good faith that there is a greater than 50-percent likelihood that the tax
treatment of the item will be upheld if challenged by the Internal Revenue
Service; or
(2) The corporation
reasonably relies in good faith on the opinion of a professional tax advisor,
if the opinion is based on the tax advisor's analysis of the pertinent facts
and authorities in the manner described in §1.6662-4(d)(3)(ii) and
unambiguously states that the tax advisor concludes that there is a greater than
50-percent likelihood that the tax treatment of the item will be upheld if
challenged by the Internal Revenue Service. (For this purpose, the requirements
of paragraph (c) of this section must be met with respect to the opinion of a
professional tax advisor.)
(ii) Legal justification defined. For purposes of this
paragraph (f), legal justification includes any justification relating to the
treatment or characterization under the Federal tax law of the tax shelter item
or of the entity, plan, or arrangement that gave rise to the item. Thus, a
taxpayer's belief (whether independently formed or based on the advice of
others) as to the merits of the taxpayer's underlying position is a legal
justification.
(3) Minimum requirements not dispositive. Satisfaction of
the minimum requirements of paragraph (f)(2) of this section is an important
factor to be considered in determining whether a corporate taxpayer acted with
reasonable cause and in good faith, but is not necessarily dispositive. For
example, depending on the circumstances, satisfaction of the minimum
requirements may not be dispositive if the taxpayer's participation in the tax
shelter lacked significant business purpose, if the taxpayer claimed tax
benefits that are unreasonable in comparison to the taxpayer's investment in
the tax shelter, or if the taxpayer agreed with the organizer or promoter of
the tax shelter that the taxpayer would protect the confidentiality of the tax
aspects of the structure of the tax shelter.
(4) Other factors. Facts and circumstances other than a
corporation's legal justification may be taken into account, as appropriate, in
determining whether the corporation acted with reasonable cause and in good
faith with respect to a tax shelter item regardless of whether the minimum
requirements of paragraph (f)(2) of this section are satisfied.
(g) Transactions between persons described in section 482
and net section 482 transfer price adjustments. [Reserved]
(h) Valuation misstatements of charitable deduction
property.
(1) In general. There may be reasonable cause and good faith
with respect to a portion of an underpayment that is attributable to a
substantial (or gross) valuation misstatement of charitable deduction property
(as defined in paragraph (h)(2) of this section) only if—
(i) The claimed value of the property was based on a
qualified appraisal (as defined in paragraph (h)(2) of this section) by a
qualified appraiser (as defined in paragraph (h)(2) of this section); and
(ii) In addition to obtaining a qualified appraisal, the
taxpayer made a good faith investigation of the value of the contributed
property.
(2) Definitions. For purposes of this paragraph (h):
Charitable deduction property means any property (other than money or publicly
traded securities, as defined in §1.170A-13(c)(7)(xi)) contributed by the
taxpayer in a contribution for which a deduction was claimed under section 170.
Qualified appraisal means a qualified appraisal as defined in §1.170A-13(c)(3).
Qualified appraiser means a qualified appraiser as defined in §1.170A-13(c)(5).
(3) Special rules. The rules of this paragraph (h) apply
regardless of whether §1.170A-13 permits a taxpayer to claim a charitable
contribution deduction for the property without obtaining a qualified
appraisal. The rules of this paragraph (h) apply in addition to the generally
applicable rules concerning reasonable cause and good faith.
T.D. 8381, 12/30/91, amendT.D. 8617, 8/31/95 ,T.D. 8790,
12/01/98 ,T.D. 9109, 12/29/2003 .
www.irstaxattorney.com (212) 588-1113 ab@irstaxattorney.com
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