By David I. Kempler, Esq., and Elizabeth Carrott
Buchanan Ingersoll & Rooney PC, Washington, DC
In Sampson v. Commissioner, T.C. Memo 2013-212, the Tax
Court sustained §6662 accuracy-related penalties assessed against
taxpayers because there was no substantial authority for their
position and they did not act with reasonable cause or in good
faith when they failed to properly estimate or report income
derived from the two S corporations the husband controlled.
This case serves as important reminder to taxpayers that if
taxpayers are missing information needed to complete their federal
income tax return (and no additional extensions are available), the
taxpayer should file the return on time with the best information
available, adequately disclose the missing information and file an
amendment as soon as the missing information becomes available.
Section 6662 imposes an accuracy-related penalty equal to 20% of
the portion of an underpayment of tax attributable to, among other
things, negligence or disregard of rules or regulations, or any
substantial understatement of income tax. Section
6662(d)(1)(A) defines a "substantial understatement of income
tax" as an understatement in an amount exceeding the greater of 10%
of the tax required to be shown on the return or $5,000. Section
6662(d)(2)(B), however, reduces the amount of an understatement by
the portion of the understatement for which (i) there is
substantial authority for the taxpayer's tax treatment of the item
or (ii) there is adequate disclosure of the relevant facts
affecting the item's tax treatment and there is a reasonable basis
for the taxpayer's treatment of the item.
Husband was the sole shareholder of two S corporations. Wife
served as a part-time employee of one of the S corporations.
For the 2008 and 2009 tax years, Taxpayers' accountant was
delinquent in filing Forms 1120S, U.S. Income Tax Return for an
S Corporation, because on both years the S corporations were
delinquent in providing source documents to the accountant. As a
result of not filing the Forms 1120S, the accountant lacked the
Schedules K-1, Shareholder's Share of Income, Deductions,
Credits, etc., from which to enter pass-through items from the
corporations on Taxpayers' personal federal tax returns.
Accordingly, the accountant prepared the returns omitting any
income or losses passed through to Taxpayers from the S
corporations, and attached a statement that the returns would be
amended once the delinquent Schedules K-1 were received. Taxpayers
failed to file amended returns for 2008 and 2009 until after the
IRS notified them they were being audited. The amended returns
reported increases in Taxpayers' total tax liabilities from $34,330
to $69,408 for 2008 and from $34,246 to $121,564 for 2009.
On June 23, 2011, the IRS made positive adjustments of $41,449
and $91,882 (in both cases, including interest) to Taxpayers' 2008
and 2009 tax liabilities, respectively. The IRS also assessed §6662
accuracy-related penalties, to which the Taxpayers objected.
Taxpayers agreed to the assessed deficiencies and paid them, but
challenged the issuance of §6662 accuracy-related penalties.
The Tax Court first addressed the issue of whether Regs.
§1.6664-2(a)(1) provided substantial authority for Taxpayers'
omission of the pass-through items on their returns. Substantial
authority is an objective standard that is less stringent than the
more-likely-than-not standard but more stringent than the
reasonable-basis standard defined in Regs. §1.6662-3(b)(3). Regs.
§1.6664-2(a)(1) provides that, for purposes of §6662, the term
"underpayment" means the amount of tax imposed over the amount of
tax shown by the taxpayer on his return. Under Regs. §1.6664-
2(c)(2), the amount shown by the taxpayer on his return includes
"an amount shown as additional tax on a qualified amended return."
Under Regs. §1.6664-2(c)(3), a "qualified amended return" is an
amended return filed before the taxpayer is first contacted by the
IRS regarding an audit.
Taxpayers argued that there was substantial authority for their
omitting pass-through items on the original returns since Regs.
§1.6664-2(c)(2) provides that an amount shown on a qualified
amended return can reduce or eliminate an underpayment. Taxpayers
argued, in the alternative, that even if the Tax Court found there
was no substantial authority for their treatment of the corporate
income, their understatements should be reduced or even eliminated
because, pursuant to Regs. §1.6664-2(c)(2) the overall tax amounts
shown on what they consider to be their returns include the
additional corporate income shown on their qualified amended
return. The IRS, conversely, argued that Regs. §1.6664- 2(c)(2)
does not excuse a taxpayer from the §6662(a) accuracy-related
penalty if the taxpayer merely promises to file an amended return
in the future; but rather provides a safe harbor for a taxpayer who
actually does file a qualified amended return. Further, the IRS
argued that Taxpayers' amended returns are not qualified amended
returns because they were filed after the date the IRS contacted
them in connection with the examination of the original
The Tax Court agreed with the IRS that Regs. §1.6664-2(a)(1) did
not provide substantial authority for Taxpayer's omission of the
pass-through income, finding that Regs. §1.6664-2(a)(1) only
provides a safe harbor for taxpayers who in fact file a qualified
amended return, not taxpayers who merely promise to file an amended
return in the future. Moreover, the Tax Court agreed that
Taxpayers' underpayments of tax were not reduced on account of the
amended returns, because neither amended return is a "qualified"
The Tax Court then turned to the issue of adequate disclosure.
For purposes of §6662, Regs. §1.6662-4(f) provides that a
disclosure is adequate if either the disclosure is (i) made on a
properly completed form attached to the taxpayer's original return
or qualified amended return or (ii) permitted by the annual revenue
procedure or otherwise to be made on the tax return itself and is
made in accordance with the applicable instructions. If the annual
revenue procedure does not permit the disclosure of an item on the
face of the return, disclosure is adequate only if the disclosure
is made on a properly completed Form 8275, Disclosure Statement, or
Form 8275-R, Regulation Disclosure Statement, attached to the
taxpayer's return for the year the disclosure applies. The Tax
Court concluded that the written statement was not an adequate
disclosure of pass-through items on Taxpayer's returns.
The Tax Court then turned to the question of whether, under
§6664(c)(1), Taxpayers could avoid the penalty by showing that they
acted with reasonable cause and in good faith. Reasonable
cause requires that the taxpayer exercise "ordinary business care
and prudence" as to the disputed item.1 Under
Regs. §1.6664-4(b)(1), the term "good faith" has no precise
definition, and a determination of good faith must be made on a
case-by-case basis, taking into account all pertinent facts and
circumstances, including a taxpayer's knowledge and experience.
The duty of filing accurate returns generally cannot be avoided
by placing the responsibility on an employee or tax return
preparer.2 A taxpayer,
however, may demonstrate reasonable cause through good-faith
reliance on the advice of an independent tax professional, such as
a tax adviser, a lawyer, or an accountant, as to the item's tax
treatment.3 To prevail, the
taxpayer must demonstrate: (i) the tax professional was competent
and had sufficient expertise to justify reliance, (2) the taxpayer
supplied the tax professional with the necessary and accurate
information, and (3) the taxpayer actually relied in good faith on
the tax professional's judgment.4
Agreeing with the IRS, the Tax Court concluded that Taxpayers
did not satisfy the reasonable cause exception. Firstly, the Tax
Court noted that Taxpayers failed to provide their accountant with
all the necessary available documentation about the pass-through
items from the corporations. Secondly, the Tax Court noted that
Taxpayers were sophisticated taxpayers who, on the basis of S
corporations' electronic data as well as past experience, knew that
the original returns underreported their income but signed the
returns anyway. Finally, the Tax Court noted that it was not
clear that in failing to estimate and in underpaying their tax
Taxpayers were acting on actual advice of their accountant.
Accordingly, the Tax Court concluded that Taxpayers had failed to
show " that, even if they understood [their accountant] to have
been telling them that it was okay to omit income from the original
returns, they had a reasonable basis to do so and that they acted
in good faith in failing to estimate and report income from the
Based on the foregoing, the Tax Court sustained all
accuracy-related penalties assessed against Taxpayers.
As a general rule, if taxpayers are missing information needed
to complete federal income tax return (and no additional extensions
are available), the taxpayer should file the return on time with
the best information available, adequately disclose the missing
information and file an amendment as soon as the missing
information becomes available. In some cases, this disclosure can
relieve the taxpayers of penalties that would otherwise be assessed
for failing to file a complete and accurate return. Form 8275,
Disclosure Statement, or Form 8082, Notice of
Inconsistent Treatment or Administrative Adjustment Request
(AAR), may be used to satisfy the requirements for disclosure
and penalty relief. Additionally, filing an amended return that
satisfies the requirements for a qualified amended return (i.e., an
amended return that is filed before the IRS initiates an audit) can
reduce or eliminate accuracy-related penalties.
For more information, in the Tax Management Portfolios, see
Tarr and Drucker, 634 T.M., Civil Tax Penalties, and
in Tax Practice Series, see ¶3830, Penalties.
2 See Metra Chem Corp. v.
Commissioner, 88 T.C. 654, 662 (1987).; Slawek v.
Commissioner, T.C. Memo 1991-338 (finding no reasonable cause
defense where taxpayers blamed their employees and accountants for
erroneous returns), aff'd without published opinion, 972 F.2d 1332
(3d Cir. 1992).
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