If you have an ongoing dispute with the IRS for one or more years and the outcome of that dispute will impact the current year, can you take a wait-and-see approach for filing the current year’s tax return?
Or should you wait to file an amended tax return after the audit?
The Namakain v. Commissioner, T.C. Memo. 2018-200, case provides an opportunity to consider this question.
Facts & Procedural History
The taxpayer was in the financial industry. The taxpayer had a running dispute with the IRS for his 2008 tax period. The dispute turned on whether he was an investor or a trader with respect to his stock sales. This classification dictates how income and expense are reported on personal tax returns. The 2008 tax court case was resolved in 2013.
The current dispute was for the 2007-2013 tax years and it focused on whether penalties were appropriate for these years.
The taxpayer argued that failure to file penalties should not be imposed as he was precluded from filing his later year returns given the uncertainty from the 2008 tax litigation.
Late Filing & Accuracy-Related Penalties
Our tax laws provide for a late filing penalty. This penalty applies if an income tax return is required to be filed and it is not filed timely. The penalty is five percent of the unpaid tax required to be reported and is charged each month or part of a month the return is late, up to five months. Our tax laws also provide for accuracy-related penalties for incorrect tax returns. The penalty is twenty percent of any understatement attributable to negligence, disregard of our tax laws, etc.
Given that the accuracy-related penalty may be higher in amount than the late filing penalty, one may infer that Congress and the courts would say that it is more important to file accurate returns rather than timely returns.
This was essentially the taxpayer’s argument in the case.
What Do the Courts Say About it?
The court, in this case, cites Thomas v. Commissioner, T.C. Memo. 2001-225, for the general rule. Thomas involved a late-filed estate tax return. The estate tax return was filed ten years late. The CPA advised the taxpayer that it should file the estate tax return late given that there was pending litigation that impacted the information that would be reported on the estate tax return and impact the amount of the estate tax due.
The court in Thomas summarized the case law as follows:
As a general matter, the unavailability of information is not reasonable cause for failing to file a timely return. Unless a taxpayer applies for and obtains a timely extension of time to file, a taxpayer is expected to file a timely return based on the best information available and then file an amended return if necessary. Moreover, pending litigation, even if the outcome affects the estate’s final tax liability, is not reasonable cause for failing to file an estate tax return timely.
This brings us back to the present case. Given the law, the court concluded that “the pendency of litigation, even where the decision for an earlier year may affect the determination of a taxpayer’s liability for a later year, is not reasonable cause for failure to timely file.”
Inaccurate But Timely-Filed Tax Return
But what if a taxpayer makes an estimate and files a timely, but incorrect, tax return? Is this always the right answer?
In Cocker v. Commissioner, the taxpayer did just that. The IRS argued that the taxpayer’s estimates were not sufficient, such that its request for an extension of time to file was invalid. The court agreed. Because the extensions were invalid, the tax return was filed late and the taxpayer was subject to the same late-filing penalty.
Sometimes you just can’t win.