How to Establish Professional Reliance for IRS Penalty Waivers

How to Establish Professional Reliance for IRS Penalty Waivers

How to Establish Professional Reliance for IRS Penalty Waivers

When a U.S. taxpayer has been penalized by the Internal Revenue Service, they have a limited time to contest the penalty without going to court and paying the amount due first. One of the first lines of defense for the taxpayer is to show that they acted with reasonable cause and not willful neglect. When a taxpayer can show they had reasonable cause, then they have an opportunity to have the entire penalty waived (or possibly reduced) — depending on the specific facts and circumstances.  One of the biggest hurdles that taxpayers have to overcome when it comes to reasonable cause and professional reliace is the Supreme Court’s ruling in Boyle — as well as meet the requirements outlined in Neonatalogy  Let’s look at Boyle, Neonataology, and Treas Reg 1.6664 to get an understanding of what may and may not qualify for reasonable cause.

26 CFR § 1.6664-4

• • • “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 of 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 certain 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.”

What does this mean?

Reasonable cause is established on a case-by-case basis. To establish reasonable cause, the taxpayer must convince the IRS agent that, based on the totality of the circumstances and specific facts of his case, he can show reasonable cause and good faith as the basis for failing to report a form, such as filing Form 3520. There is not one specific fact that establishes reasonable cause, but the IRS does prioritize certain behaviors, such as what actions the taxpayer took to assess their proper tax liability or filing requirements.

Boyle (Supreme Court)

When it comes to professional reliance, Boyle is crucial in how it distinguishes between relying on an advisor for legal advice as opposed to relying on an advisor to meet a deadline. While relying on an attorney can be considered professional reliance, it is not an all-inclusive defense. In Boyle, the question was not whether the advice was improper, but rather that the attorney the client hired failed to meet a deadline. Here, the Supreme Court makes the distinction that if Boyle relied on his attorney to meet the deadline and the attorney did not meet the deadline, then that is not ‘professional reliance.’ In other words, the court distinguishes between relying on legal advice as opposed to relying on the attorney — that the attorney essentially gets the job done. The fact that the attorney did not get the job done is not a basis for professional reliance. As provided by the Court in Boyle:

• • • “When an accountant or attorney advisesa taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on that advice. Most taxpayers are not competent to discern error in the substantive advice of an accountant or attorney. To require the taxpayer to challenge the attorney, to seek a “second opinion,” or to try to monitor counsel on the provisions of the Code himself would nullify the very purpose of seeking the advice of a presumed expert in the first place. See Haywood Lumber, supra, at 771. “Ordinary business care and prudence” do not demand such actions.

    • By contrast, one does not have to be a tax expert to know that tax returns have fixed filing dates and that taxes must be paid when they are due. In short, tax returns imply deadlines. Reliance by a lay person on a lawyer is of course common; but that reliance cannot function as a substitute for compliance with an unambiguous statute. Among the first duties of the representative of a decedent’s estate is to identify and assemble the assets of the decedent and to ascertain tax obligations

    • Although it is common practice for an executor to engage a professional to prepare and file an estate tax return, a person experienced in business matters can perform that task personally. It is not unknown for an executor to prepare tax returns, take inventories, and carry out other significant steps in the probate of an estate. It is even not uncommon for an executor to conduct probate proceedings without counsel.

    • It requires no special training or effort to ascertain a deadline and make sure that it is met. The failure to make a timely filing of a tax return is not excused by the taxpayer’s reliance on an agent, and such reliance is not “reasonable cause” for a late filing under § 6651(a)(1). The judgment of the Court of Appeals is reversed.”

Neonatology (Third Circuit, Court of Appeals)

In Neonatology, while the court rejected the taxpayer’s claim for professional reliance and a reasonable cause wherever penalties, they also set forth the three-prong test that helps determine whether a taxpayer meets the requirements to establish reasonable cause to abate penalties. As provided in Neonatology

• • • “Taxpayers argue that their negligence should have been excused because they relied on the advice of professionals. While it is true that actual reliance on the tax advice of an independent, competent professional may negate a finding of negligence, see, e.g., United States v. Boyle, 469 U.S. 241, 250, 105 S.Ct. 687, 692, 83 L.Ed.2d 622 (1985), the reliance itself must be objectively reasonable in the sense that the taxpayer supplied the professional with all the necessary information to assess the tax matter and that the professional himself does not suffer from a conflict of interest or lack of expertise that the taxpayer knew of or should have known about. ? See Treas. ? §?1.6664-4(c); ?Ellwest Stereo Theatres, Inc. v. Comm’r, T.C. Memo.1995-610, 70 T.C.M. (C.C.H.) 1655; ?see also Zfass v. Comm’r, 118 F.3d 184, 189 (4th Cir.1997).

    • The Tax Court concluded that taxpayers could not prevail on a reliance-on-professional defense because they received advice only from Cohen, an insurance agent who stood to profit considerably from the participation of Neonatology and Lakewood in the VEBA program, rather than from a competent, independent tax professional with sufficient expertise to warrant reliance. ?

    • The circumstances here, including the facts that certified public accountants prepared taxpayers’ returns, the New Jersey Medical Society-a group with dubious tax code proficiency which in fact received royalties to endorse the SC VEBA?20-purportedly endorsed the program, and the engagement agreement between PES and the employers stated that PES would submit the trust to the IRS for qualification,21 do not suffice for us to disturb the Tax Court’s negligence finding on a clear error basis. ? See Merino v. Comm’r, 196 F.3d 147, 154 (3d Cir.1999).”

Neonatology ‘Professional Reliance’ 3-Prong Test

As summarized by the Taxpayer Advocate Service: 

• • • Reasonable Cause and Good Faith The accuracy-related penalty does not apply to any portion of an underpayment where the taxpayer acted with reasonable cause and in good faith.18 A reasonable cause determination considers all the pertinent facts and circumstances.19 Generally, the most important factor is the extent to which the taxpayer made an effort to determine the proper tax liability.20 Reliance on a return preparer may constitute reasonable cause and good faith if the reliance was reasonable and the taxpayer acted in good faith.21 Neonatology Associates v. Commissioner establishes the three-part test for reasonable reliance on a tax professional in accuracy-related penalty cases:

      • • (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.

What does this mean?

In Neonatology, the Court of Apeals lays out a three-pronged test that taxpayers should follow when seeking to establish professional reliance as a means to the reasonable cause exception to penalties. It is important to note that the advisor that the taxpayer relies upon must be someone who is knowledgeable in the specific area — the taxpayer must be able to show the advisor had sufficient expertise in this area of law to establish professional reliance. Likewise, it is important that the taxpayer provided sufficient information to the advisor so that the advisor could issue competent advice, and finally that the taxpayer relied in good faith on the adviser’s judgment. For example, if the taxpayer provided sufficient information and the tax professional had sufficient expertise, the taxpayer must still show that they relied in good faith on the advisors judgment — so that if they do not believe that the advice provided was accurate, then they would not be able to rely on it — because it would not have been in good faith even if the tax professional has sufficient expertise and was provided necessary information to reach his conclusion.

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Late-Filing Disclosure Options

If a Taxpayer is out of compliance, there are various international offshore tax amnesty programs that they can apply to safely get into compliance. Depending on the specific facts and circumstances of the Taxpayers’ noncompliance, they can determine which program will work best for them.

*Below please find separate links to each program with extensive details about the reporting requirements and examples.

Streamlined Filing Compliance Procedures (SFCP, Non-Willful)

The Streamlined Filing Compliance Procedures is one of the most common programs used by Taxpayers who are non-willful and qualify for either the Streamlined Domestic Offshore Procedures or Streamlined Foreign Offshore Procedures.

Streamlined Domestic Offshore Procedures (SDOP, Non-Willful)

Taxpayers who are considered U.S. residents and file timely tax returns each year but fail to report foreign income and/or assets may consider the Streamlined Domestic Offshore Procedures.

Streamlined Foreign Offshore Procedures (SFOP, Non-Willful)

Taxpayers who are foreign residents may consider the Streamlined Foreign Offshore Procedures which is typically the preferred program of the two streamlined procedures. That is because under this program Taxpayers can file original returns and the 5% title 26 miscellaneous offshore penalty is waived.

Delinquent FBAR Submission Procedures (DFSP, Non-Willful/Reasonable Cause)

Taxpayers who only missed the FBAR reporting and do not have any unreported income or other international information reporting forms to file may consider the Delinquent FBAR Submission Procedures — which may include a penalty waiver.

Delinquent International Information Returns Submission Procedures (DIIRSP, Reasonable Cause)

Taxpayers who have undisclosed foreign accounts and assets beyond just the FBAR — but have no unreported income — may consider the Delinquent International Information Return Submission Procedures. Before November 2020, the IRS was more inclined to issue a penalty waiver, but since then this type of delinquency procedure submission has morphed into a reasonable cause request to waive or abate penalties.

IRS Voluntary Disclosure Procedures (VDP, Willful)

For Taxpayers who are considered willful, the IRS offers a separate program referred to as the IRS Voluntary Disclosure Program (VDP). This program is used by Taxpayers to disclose both unreported domestic and offshore assets and income (before 2018, there was a separate program that only dealt with offshore assets (OVDP), but that program merged back into the traditional voluntary disclosure program (VDP).

Quiet Disclosure

Quiet disclosure is when a Taxpayer submits information to the IRS regarding the undisclosed foreign accounts, assets, and income but they do not go through one of the approved offshore disclosure programs. This is illegal and the IRS has indicated they have every intention of investigating Taxpayers who they discover intentionally sought to file delinquent forms to avoid the penalty instead of submitting to one of the approved methods identified above.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure.

Contact our firm today for assistance.