Reasonable Cause Tax Procedure

Wife Can Rely on Husband (to Avoid a Tax Penalty)

Marriage can be challenging.  This is particularly true when it comes to finances.  And it is even more so when it comes to taxes.  But what if a spouse reports something wrong?  Can the other spouse get out of penalties for the wrong doing?  The court answers this in Miller v. Commissioner, T.C. Summary Opinion 2014-74,

The Facts & Procedural History

Mrs. Miller was in the advertising industry.  She worked for a public relations, marketing, and advertising services firm.  She operated their New York office out of her personal New York apartment.

She incurred various expenses for the office, including rent and cable/internet services.  She also incurred several other expenses on behalf of her employer and/or as an employee.  Her employer generally did not reimburse these expenses.

The court described Mrs. Miller’s tax preparation as follows:

Petitioner provided her tax records, including original receipts and invoices of her business expenses for 2009, to Michael Letta. Mr. Letta used TurboTax software to prepare and electronically file petitioner’s tax return.

Mr. Letta earned a bachelor’s degree from Ohio State University and is a certified public accountant. At the time of trial, Mr. Letta was working as the chief financial officer for Charity Water in New York. He testified that he reviewed petitioner’s tax records, considered them to be complete and accurate, and discussed the return with her before filing it. When he learned that many of petitioner’s original tax records had been lost, Mr. Letta contacted TurboTax in what turned out to be an unsuccessful attempt to retrieve worksheets that he completed while preparing the return for electronic filing.

The IRS conducted and audit and disallowed many of Mrs. Miller’s expenses and assessed accuracy-related penalties. The substantive question for the court was whether Mrs Miller was entitled to the deductions despite the the lack of records.

Reasonable Cause for Abating Penalties

The IRS has the authority to abate or remove most penalties.  There are a number of court cases that provide guidance as to when it is permissible for the IRS to do so.  Many of these cases focus on “reasonable cause” as a defense to penalties.  

The court cases provide a number of examples of what counts as reasonable cause.  Reliance on a tax advisor for tax advice is one example.  Failure to have or to keep records is not.  This brings us back to the Miller case.  

Tax Deductions and the Missing Records

Mrs. Miller claimed that she maintained complete and accurate records for her business expenses for 2009, including meeting logs, receipts and invoices for various expenditures, and reimbursements from her employer, but that she lost most of her business records when she moved to a new apartment in 2011.

Mrs. Miller presented summary spreadsheets created during the time her 2009 tax return was prepared and her checking account statements. She also presented her testimony and the testimony of her tax-return-preparer husband.

The court considered this evidence and each category of expenses. The expenses included several expenses that are subject to heightened substantiation requirements, including business use of her cell phone, travel, and clothing expenses. The court allowed the expenses that were not subject to this higher standard, but did not allow the others.

Reliance on a Tax Return Preparer

Regarding the accuracy related penalty, Mrs. Miller argued that she relied on her husband as a tax return preparer and should not be liable for accuracy related penalties. Reliance on a tax attorney can be one way of establishing reasonable case and good faith as a defense to penalties and is one way to get tax penalties abated.

In considering the penalty and the facts, the court noted that:

Petitioner provided her tax records to Mr. Letta, a certified public accountant, and she consulted with him regarding deductions for her business expenses. Mr. Letta reviewed petitioner’s tax records, considered them to be complete and accurate, and discussed the return with her before filing it. When he earned that many of petitioner’s original tax records had been lost, Mr. Letta contacted TurboTax in an ultimately unsuccessful attempt to retrieve worksheets that he completed while preparing the return for electronic filing.

It is somewhat unusual for the court to conclude that a tax return preparer’s views on whether records are complete is sufficient or even a factor to be considered.

The court did not even question whether the tax return preparer had the requisite experience to be competent in preparing individual income tax returns. Most return preparers would have noted that many of the expenses were of a type that would be subject to higher substantiation requirements and are not deductible absent these records.

The court also did not seem concerned about the tax return preparer’s relationship as the taxpayers husband, before relying on his assessment of the records.  In the end, the U.S. Tax Court concluded that the wife was not liable for accuracy-related penalties under Section 6662(a) for relying on her husband as the tax preparer.