An accountant's failure to timely e-file an income tax return extension for the taxpayers and their reliance on his erroneous advice about the accrual of late-filing penalties were not reasonable cause for the late filing of their tax return for purposes of the late-filing penalty.
Erik and Aspasia Oosterwijk built a highly successful meat wholesale business in Baltimore over 24 years, and, in 2017, they sold the business.
For the 2017 tax year, the Oosterwijks and their accountant, Ernie Paszkiewicz, decided to file for an extension on Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return. Paszkiewicz told the couple he would e-file the extension request before the individual return due date and have $1.8 million debited from their bank account to pay the balance of the tax due for 2017.
However, the $1.8 million payment was not debited from their bank account by the due date. The Oosterwijks, seeing that the money was still in their bank account, watched to see if it was transferred in the following days. On April 25, the couple e-mailed Paszkiewicz for his advice. Paszkiewicz advised them to wait until April 30 to see if the payment had been debited from their account and, if not, that he would contact the IRS.
On April 29, Aspasia emailed Paszkiewicz and told him that the payment remained in the couple's bank account. At this point, Paszkiewicz discovered that he had not e-filed the extension request. He told the Oosterwijks he had not filed the extension and (erroneously) advised them that if they filed the six-month extension request at that time, they would have until Oct. 15, 2018, to file their tax return, and the penalties for late filing would stop.
The Oosterwijks thus immediately mailed a paper Form 4868 and a check for $1.8 million to the IRS, and the payment posted to the Oosterwijks' 2017 Form 1040 account on May 4, 2018. Believing, based on Paszkiewicz's advice, that there was no rush to file their return, the couple did not e-file their 2017 return until June 29, 2018, after almost two months had passed. The IRS processed the return on Sept. 10, 2018.
Much to the Oosterwijks' dismay, on Oct. 15, 2018, in addition to assessing a failure-to-pay penalty for one month, the IRS assessed a failure-to-file penalty based on the date their return was filed, June 29, 2018, rather than on May 4, 2018, the date on which the couple mailed the $1.8 million payment. The failure-to-file penalty was over $250,000.
The Oosterwijks did not qualify for first-time penalty abatement because they had used it to have a $7 penalty abated in 2014. The couple filed for penalty relief, which was denied, but later, on appeal, the IRS agreed to abate half of the failure-to-pay and failure-to-file penalties.
The Oosterwijks afterward had several phone conversations about the issue with the IRS. On March 22, 2019, they also sent a letter to the IRS memorializing one of the phone conversations in which they raised the reasonable-cause defense for the late filing, citing Paszkiewicz's failure to e-file an extension request and his erroneous advice regarding the failure-to-file penalty accrual.
In June 2019, the Oosterwijks paid the penalties they owed and in July 2019, they filed Form 843, Claim for Refund and Request for Abatement, claiming a refund for the penalties sustained earlier by the IRS because, they said, they had reasonable cause for their late filing. Having received no response from the IRS, the Oosterwijks filed a refund suit in district court in May 2021.
In their suit, the Oosterwijks first asked for relief from all late-filing penalties (covering the period from the return due date to June 29, 2018) because Paszkiewicz's failure to e-file the extension and their limited access to e-filing gave them reasonable cause for filing their return late. The couple also argued that they separately had reasonable cause for relief from the penalties accruing in May and June because they would have filed a return immediately upon learning that the extension had not been filed but for Paszkiewicz's erroneous advice that filing an extension after the due date and paying the tax liability would stop the accrual of failure-to-file penalties.
The IRS countered that the Oosterwijks did have not reasonable cause for relief from the penalties under either argument. It also claimed that under the substantial-variance rule, the district court did not have jurisdiction over the case because the Oosterwijks' formal refund claim did not adequately cover the factual bases and legal arguments raised in their refund suit.
The district court's decision
The district court held that while the substantial-variance rule did not prevent it from ruling on the Oosterwijks' reasonable-cause claims, their accountant's failure to file an extension and his erroneous advice regarding the accrual of late-filing penalties did not give the Oosterwijks reasonable cause for failing to timely file their return. Therefore, it dismissed the case.
Jurisdiction: Under the substantial-variance rule, any legal theory that is not expressly or impliedly contained in an application for refund cannot be considered by a court in a refund suit. The reasons for this requirement are to prevent surprise and to give the IRS adequate notice of the taxpayer's claim and its underlying facts so that it can make an administrative investigation and determination regarding the claim.
The Oosterwijks' formal refund claim on Form 843, filed in July 2019, did not identify reliance on erroneous advice as a basis for reasonable cause, although they raised this theory with IRS Appeals on a phone call and in their March 22, 2019, letter. Instead, the Form 843 directly referred only to reasonable cause due to Paszkiewicz's failure to e-file their return. Because the formal refund claim did not include reliance on erroneous advice as a basis for reasonable cause, the IRS argued that the substantial-variance rule prevented the district court from having jurisdiction over the Ooster-wijks' case.
The court said it was a close question but that the substantial-variance rule did not bar it from ruling on the Oosterwijks' reasonable-cause claim. The court stated:
A refund claim need not provide a perfectly detailed explanation of the taxpayer's legal theory regarding reasonable cause or develop a complete factual background of the claim if it clearly states that the taxpayer seeks a refund for an improperly imposed penalty, calling for investigation into whether there truly existed reasonable cause for a late filing. [slip op. at 8]
The court found that the Oosterwijks' Form 843 was sufficient to "put the IRS on notice that the Oosterwijks alleged IRC § 6651(a) reasonable cause for their failure to file and to allow the IRS to focus its investigation" so that the IRS should have discovered the Oosterwijks' March 22, 2019, letter that discussed reliance on erroneous advice as one of the theories under which the couple claimed reasonable cause.
Reasonable cause due to failure to e-file the extension: Under Regs. Sec. 301.6651-1(c)(1), to demonstrate reasonable cause, a taxpayer filing a late return must show that he or she "exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time." The Supreme Court has held that to escape the failure-to-file penalty, a taxpayer must prove both that the failure did not result from willful neglect and that the failure was due to reasonable cause (Boyle, 469 U.S. 241 (1985)). The Supreme Court also drew "as 'bright' a line as can be drawn" that the taxpayer has an "unambiguous, precisely defined duty to file," and the expectation that a third-party agent will file on the taxpayer's behalf does not relieve the taxpayer of that duty.
In his concurring opinion in Boyle, Justice William Brennan stated that "a taxpayer cannot avoid the reach of § 6651(a)(1) merely by delegating this duty to an attorney, accountant, or other individual" but stressed that the "ordinary business care and prudence" standard applies only to the "ordinary person." Thus, the standard exempts individuals with disabilities or infirmities that render them physically or mentally incapable of knowing, remembering, and complying with a filing deadline.
The Oosterwijks argued that Boyle does not apply to e-filing, because a taxpayer cannot personally confirm that an accountant has e-filed as promised. In their view, e-filing interposes a third party between the taxpayer and the IRS, and their inability to e-file on their own or to confirm an e-filing's transmission put the filing beyond their control, making them incapable of complying with the filing deadline under the criteria in Brennan's Boyle concurrence.
The court concluded that Boyle did apply to the Oosterwijks and the couple did not have reasonable cause for filing their extension request late after relying on Paszkiewicz to file it for them. First, it noted that the same method of filing available to taxpayers at the time of the Boyle case, paper filing, was available to the Oosterwijks, who had been free to paper file their extension request rather than have Paszkiewicz e-file it, even if the IRS encourages e-filing — and, in fact, they did eventually file their extension request on paper. Thus, they could have avoided any barrier they claimed was presented by specialized technology and professionals-only availability of e-filing.
Second, the court found that the limits in Brennan's concurrence in Boyle on the bright-line rule of nondelegability did not apply. While the Oosterwijks claimed that e-filing's limitation to professional preparers and their inability to confirm electronic transmission put the filing out of their control, in his concurrence in Boyle, Brennan indicated that the limits on the bright-line rule only applied to taxpayers who are physically or mentally incapable of meeting a filing deadline. The Oosterwijks did not suffer such disabilities, so the exception did not apply to them.
Reasonable cause due to erroneous advice: The Oosterwijks asserted that if they had received correct advice from Paszkiewicz about the accrual of the late-filing penalty, they would have filed their return in April and avoided the late-filing penalty for May and June. Thus, they claimed they had reasonable cause for their late return filing for those two months based on Paszkiewicz's erroneous advice.
The IRS made two arguments in response to the Oosterwijks' claim. First, the Service argued that because reasonable cause is a one-time test evaluated at the due date of the return, the failure-to-file penalty was not divisible. Second, even if a reasonable-cause exception could be reevaluated after the return due date, the exception did not apply in the Oosterwijks' case because Paszkiewicz's advice contradicted the Form 4868 instructions that a taxpayer must file the form by the regular due date of the taxpayer's return. Thus, the advice was not based on a "reasonable factual or legal assumption," and the Oosterwijks would have acted unreasonably in relying on it.
Regarding divisibility, the court found that while the penalty could in some circumstances be divisible for reasonable-cause purposes, because the reasonable-cause exception is determined based on the facts as of the return's due date, it is divisible only where the taxpayer receives erroneous advice before the due date of the return. Since the Oosterwijks received the erroneous advice from Paszkiewicz after the due date of their tax return, they could not have reasonable cause for relief from their late filing of the return.
Because the court held that no reasonable cause could arise from Paszkiewicz's advice due to its timing, it did not have to determine whether the advice could have given rise to reasonable cause for the Oosterwijks. It nonetheless addressed the issue and found that because the advice was not reasonable, it could not be the basis for the reasonable-cause exception.
For tax advice to be reasonable, it cannot depend on legal assumptions that are unreasonable. In Baer, 150 Fed. Cl. 761 (Fed. Cl. 2020), the Court of Federal Claims held that the IRS's provision of explicit instructions on the face of a form renders any belief to the contrary unreasonable. Thus, advice contrary to such an instruction is unreasonable, and a taxpayer's reliance on the advice cannot constitute reasonable cause. In the Oosterwijks' case, Paszkiewicz's advice that paying their tax due and filing an extension request after the due date would stop the accrual of late-filing penalties contradicted the text of Form 4868, which states that the Form 4868 must be filed by the regular due date of the taxpayer's return for the taxpayer to receive an automatic extension. As a result, the court found that the advice was unreasonable, and the Oosterwijks' reliance on it could not establish that they had reasonable cause for failing to timely file their return.
The substantial-variance doctrine can be a relatively easy way out of a refund suit for the IRS, and the Service is not shy about asserting the doctrine. Consequently, practitioners assisting a taxpayer with a refund claim should carefully consider whether the claim includes all the arguments that could be made to support the refund requested and all the facts necessary to support those arguments.
Oosterwijk, No. CCB-21-1151 (D. Md. 1/27/22)