Reasonable Cause: Proving Reliance on a Tax Advisor

If you hire a competent tax advisor and end up having a late filed return, you may be able to avoid penalties for the late filing. But this is a defense. It is something that you, the taxpayer, have to prove. So how does a taxpayer prove that they relied on a tax advsior? The recent United States v. Ott, No. 18-cv-12174 (E.D. Mich 2019) case provides an opportunity to consider this issue.

Facts & Procedural History

This case involves penalties assessed under 31 U.S.C. § 5321(a)(5) for failing to report foreign accounts to the U.S. Treasury.

These penalties are commonly referred to as FBAR penalties, which is the acronym for Report of Foreign Bank and Financial Account. This is the title on the form the U.S. Treasury provides for reporting the foreign accounts.

The foreign accounts were apparently brokerage accounts with a Canadian investment firm. The account balances were sizable, but not large. The defendants had an obligation to report these accounts to the U.S. Treasury as they were both U.S. citizens.

The IRS assessed penalties for each account for each year, which totaled $60,000. When the penalties were not paid, the government sued the defendants to collect the penalties.

The government moved for summary judgment–which was the subject of the court opinion. In their brief, the defendants argued that they relied on a tax preparer and should not be liable for penalties. They also argued that additional evidence or facts would be presented at trial in support of this defense.

FBAR Penalties & Reasonable Cause

We provided an overview of the FBAR rules here. The short version is that U.S. citizens and residents have to report foreign financial accounts if the aggregate balance of the account(s) is over $10,000. The penalty is $10,000 if the failure to report is non-willful.

FBAR penalties cannot be imposed if the taxpayer had reasonable cause for the failure to file. There is no definition of what counts as “reasonable cause” in the FBAR statutes. Thus, the courts have applied the definition used for the failure to file tax returns, to pay tax, etc. penalties. The definition is found in several court cases, the leading case being 469 US 241 (1985).

One way to establish reasonable cause is reliance on a tax advisor. The leading case for this is Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 99 (2000); aff’d, 299 F.3d 221 (3d Cir. 2002). We have previously addressed this type of reasonable cause here in the context of an incompetent tax advisor. One of the elements that the taxpayer (or with FBAR collection cases like the present case, the defendant), has to establish is that all information was provided to the tax advisor. But how does the taxpayer (or defendant) do this?

Proving Up Reasonable Reliance

When it comes to tax litigation and reasonable cause, taxpayers have to establish that reasonable cause exists. To do so, they have to put on evidence of each element of the defense. With reliance on an advisor, this includes putting on evidence that the tax advisor was apprised of the facts necessary to provide advice on the matter.

According to the court in the present case, the defendants did not present any evidence or even allege any facts showing that the tax preparer they hired was apprised of the necessary facts. Rather, the defendants merely averred that they hired a tax preparer to prepare their tax returns. Because of this, the court concluded that reasonable cause was not established.

Bringing forth The Evidence and Facts

But what evidence or facts might have changed this outcome? Additional evidence or facts may have included (or proposed to have included):

1. testimony from the tax preparer,
2. testimony from the taxpayer as to conversations about the services to be provided (or emails or other correspondence saying the same),
3. the tax preparers engagement letter, or
4. even evidence that the tax preparer specialized in assisting clients with foreign accounts.

These are but a few items that may have helped.

According to the court, this type of evidence or facts were not included in the defendant’s brief filed with the court. The defendant’s brief merely said that additional evidence would be put on at the trial. The court noted that the defendant cannot rely on its pleadings alone–it has to actually present the evidence and facts.

This is a common example that repeats in many areas of the law, particularly in tax litigation. Facts and evidence that the parties presume to be known, are not taken as known by courts. They have to be established by identifying them and reducing them to writing.

One has to carefully develop the facts and evidence. This takes time and effort to do. It is often the reason why people hire tax attorneys, as it can often change the outcome of the court case.