Procedure & Administration
Taxpayers and their representatives often argue that a failure to timely file a tax or information return or to timely pay any tax owed was due to reasonable reliance on the advice of a professional tax adviser. The IRS, U.S. Department of Justice, and even some courts take a hardline view on when a taxpayer, to avoid failure-to-file and failure-to-pay penalties, may establish reasonable cause by relying on a tax adviser, pointing to the Supreme Court's opinion in Boyle, 469 U.S. 241 (1985), as support for denying a reasonable-cause claim. Tax advisers, therefore, should take heed to ensure that they adequately explain, in any reasonable-cause request, why Boyle does not preclude penalty relief in appropriate cases, as demonstrated by the recent Third Circuit opinion in Estate of Thouron, 752 F.3d 311 (3d Cir. 2014).
Sec. 6651(a)(1) imposes a civil penalty for late filing of a tax return of 5% per month of the net amount due, up to a maximum of 25%, unless the failure to timely file is shown to be "due to reasonable cause and not due to willful neglect." Similarly, Sec. 6651(a)(2) provides a civil penalty for late payments of tax of 0.5% per month of the unpaid balance, up to a maximum of 25%, unless the failure to timely pay is shown to be "due to reasonable cause and not due to willful neglect." The IRS also frequently assesses various information return penalties for late filings, including late Forms 5471, Information Return of U.S. Persons With Respect to Certain Foreign Corporations, and 5472, Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business.
In these situations, the IRS considers a delay to be due to reasonable cause if the taxpayer exercised ordinary business care and prudence and was nevertheless unable to timely file or pay (Regs. Sec. 301.6651-1(c)). The penalty handbook in the Internal Revenue Manual (IRM) (§20.1) provides the primary reference source for IRS employees working on penalty issues, including reasonable-cause determinations. The IRM provides that ordinary business care and prudence is generally the level of care that a reasonably prudent person would use in conducting business (seeIRM §220.127.116.11.1.2(1)). In determining whether the taxpayer exercised ordinary business care and prudence, IRS employees are instructed to review the following available information: (1) the taxpayer's reason for the noncompliance; (2) the taxpayer's compliance history; (3) the length of time between the event cited as a reason for the noncompliance and subsequent compliance; and (4) whether there are circumstances beyond the taxpayer's control (IRM §18.104.22.168.1.2(2)). Willful neglect is generally thought of as a conscious, intentional failure to comply with the Code, or reckless indifference to the Code (seeIRM §22.214.171.124.4.1(2); IRM Exhibit 20.1.1-8).
Boyle and Estate of Thouron
In Boyle, an estate relied on its attorney to file a return, and, due to an oversight, the attorney filed three months late. The Supreme Court held that there was no reasonable cause to allow for abatement of the Sec. 6651(a)(1) failure-to-file penalty, even though the taxpayer relied on an adviser to prepare and file the estate tax return by the filing due date (Boyle, 469 U.S. at 252). The main proposition in the case is that taxpayers cannot shift or delegate to an agent the ministerial duty to timely file tax returns. The holding in Boyle is often cited by the government in arguing that, as a matter of law, reliance on a tax adviser is not sufficient to establish reasonable cause for failure to timely file returns or pay taxes.
A recent example of the government taking this stance is the case of Estate of Thouron, where the Third Circuit held that a district court erroneously concluded that a taxpayer cannot establish reasonable cause for the failure-to-pay penalty by relying on substantive tax advice of a qualified tax professional (Estate of Thouron,752 F.3d at 316). In asking the district court to set aside the assessed penalty, the estate claimed that it did not pay its full tax liability by the original due date of the return or request an extension of time to pay, in part because it was relying on the advice of its tax attorney relating to the possibility of deferring a portion of the estate's tax liabilities under Sec. 6166. After it received an automatic six-month extension of time to file the return, the estate concluded that Sec. 6166 did not apply.
The IRS treated the estate's subsequent payment on the extended return due date as delinquent and imposed a failure-to-pay penalty for the six-month period. The government moved for summary judgment in the district court, which the court granted, concluding that, as a matter of law, the Supreme Court's decision in Boyle precluded reliance on a tax professional as grounds for reasonable cause for failure to timely file returns or pay taxes. The estate appealed the district court's ruling to the Third Circuit.
The Third Circuit took a different view of the opinion in Boyle. Although Boyle was a late-filing case, the court agreed that Boyle applied equally to late-payment penalty cases. However, the court read Boyle as differentiating among three types of reliance on an agent: (1) reliance related to the ministerial task of filing returns and paying taxes; (2) reliance under which a taxpayer files or pays after the actual due date, but within the time erroneously advised by a tax professional; and (3) reliance on a tax professional's advice about a matter of tax law (Estate of Thouron,752 F.3d at 316). This reading is supported directly by language in Boyle that distinguishes between situations involving mere administrative failures to file and situations involving reliance on the advice of an attorney or accountant. In other words, Boyle was not a situation in which a taxpayer relied on erroneous substantive tax advice, such as whether it was necessary for a taxpayer to file a return, even when the advice turned out to have been wrong (Boyle, 469 U.S. at 250—251).
Having concluded that Boyle's per se holding applied only to the first type of reliance, the Third Circuit in Estate of Thouron concluded that reliance on the advice of a tax professional may still support a reasonable-cause defense for failure to pay—if the taxpayer can also show inability to pay or undue hardship, as the regulations require. As the circumstances of that case appeared to involve reliance on a tax professional's substantive tax advice, the Third Circuit remanded the case to the district court to apply the reasonable-cause standard after further fact finding.
The Third Circuit's thoughtful analysis of Boyle creates a framework for distinguishing between the three types of reliance on a tax adviser, and, by confining the holding of Boyle to the first type, the Third Circuit appropriately held that reliance on the substantive advice of a qualified tax adviser may constitute reasonable cause for failure-to-file and failure-to-pay penalties.
The IRS routinely denies penalty abatement requests based on a broad reading of Boyle,without a full analysis of the nuances discussed by both the Supreme Court and the Third Circuit. Taxpayers raising a reasonable-cause and good-faith defense to failure-to-file and failure-to-pay penalties, including penalties for failing to file Forms 5471 and 5472, should affirmatively explain to the IRS the type of reliance present in their particular case and why Boyle is distinguishable to the extent possible.
The views expressed are those of the authors and do not necessarily reflect the views of Ernst & Young LLP.
|Valrie Chambers is an associate professor of accounting at Stetson University in Celebration, Fla. Matthew Cooper is a senior manager in the Ernst & Young LLP Tax Controversy and Risk Management Services group, advising on tax controversy matters, and was previously special counsel to the associate chief counsel (Procedure & Administration) in the IRS Office of Chief Counsel. Frank Ng is an executive director in the Ernst & Young LLP Tax Controversy and Risk Management Services group, advising on tax controversy matters, and was previously the commissioner of the IRS’s Large and Mid-Size Business Division. Mr. Ng is a member of the AICPA IRS Advocacy & Relations Committee. For more information about this column, contact Prof. Chambers at email@example.com.|