Friday, June 10, 2011

Corporations Couldn't Rely On Employee-Tax Professional To Avoid The Accuracy-Related Penalty

Seven W. Enterprises, Inc. & Subsidiaries and Highland Supply Corporation & Subsidiaries, (2011) 136 TC No. 26

The Tax Court has concluded that corporations that engaged an independent consultant to prepare their returns could rely on his advice as a tax professional to avoid the accuracy-related penalty under Code Sec. 6662(a) and Code Sec. 6662(b)(2). However, when those corporations employed that individual as their vice president to prepare their returns, they no longer had reasonable cause to avoid the penalty.

Background. Under Code Sec. 6662(a) and Code Sec. 6662(b)(2), a 20% penalty applies for any substantial underpayment of income tax. The accuracy-related penalty under Code Sec. 6662(a) doesn't apply, however, to any portion of an underpayment if a taxpayer shows that there was reasonable cause for it, and that the taxpayer acted in good faith with respect to that portion. (Code Sec. 6664(c)(1), Reg. §1.6664-4(a)) In determining reasonable cause, pertinent facts and circumstances include the taxpayer's efforts to assess his proper tax liability, the taxpayer's knowledge and experience and the reliance on the advice of a professional in determining whether the taxpayer acted with reasonable cause and in good faith. (Reg. §1.6664-4(b)(1))

Facts. William Mues, a certified public accountant, worked as a consultant from February 2001 until March 2002 for Seven W. Enterprises, Inc. (7W) and Highland Supply Corporation (HSC)—(collectively, the Corporations), two closely held businesses controlled by the Weder family. 7W and HSC, were each the parent of a group of corporations which filed a consolidated Federal income tax returns, 7W Group and HSC Group, respectively. Mues, who had previously been employed by the Corporations beginning in 1990 until resigning in January 2001, provided his consulting services from February 2001 until March 2002 as an independent contractor under an agreement with the Corporations and was not subject to the Corporations' supervision or direction.

During this period, Mues prepared 7W Group's 2000 tax return and HSC Group's 2001 tax return. In March 2002, the Corporations hired Mues as their vice president of taxes. In this position, Mues prepared and signed, on the Corporations' behalf, 7W Group's 2001, 2002, and 2003 tax returns and HSC Group's 2002, 2003, and 2004 tax returns. In 2000 through 2004, Mues incorrectly concluded that the Corporations weren't liable for personal holding company taxes and, as a result, understated their tax liabilities for those years.

IRS issued 7W Group a notice of deficiency relating to 2000 through 2003 and HSC Group a notice of deficiency relating to 2003 and 2004. IRS determined, and the Corporations agreed, that incorrect reporting of personal holding company tax on their returns for the years in issue resulted in substantial tax understatements. In addition, IRS contended that the Corporations were liable for accuracy-related penalties.

In response, the Corporations argued that the accuracy-related penalty was inapplicable. They maintained that they had reasonable cause for their underpayments and acted in good faith. Alternatively, they contended that they reasonably relied on the advice of Mues in 2000 when he served as a consultant and in 2001 through 2004 when he served as vice president of taxes.

Court's conclusion. The Tax Court held that under Reg. §1.6664-4(b)(1) and Reg. §1.6664-4(c)(1), 7W Group wasn't liable for an accuracy-related penalty relating to 2000 because it reasonably relied on Mues to prepare its tax return. Mues signed 7W Group's 2000 return as a paid preparer and the consulting agreement specifically provided that he wasn't subject to 7W Group's supervision. 7W Group provided Mues, an experienced and knowledgeable tax professional, with all of the relevant information necessary to prepare the return and relied in good faith on Mues to accurately and correctly prepare its 2000 return.

However, the Tax Court disagreed with the Corporations' contention that they exercised ordinary business care and prudence on their 2001 through 2004 returns. Further, the Court found that Mues didn't qualify as “a person, other than the taxpayer,” under Reg. §1.6664-4(c)(2), for the returns which he signed on behalf of the Corporations. The Court reasoned that a corporation can act only through its officers. The Corporations authorized Mues to act as both the vice president of taxes and the taxpayer. Unlike the 2000 return, which Mues signed as a paid preparer, the 2001 through 2004 returns were signed by Mues on the Corporations' behalf. Thus, the Corporations didn't have reasonable cause for the 2001 through 2004 underpayments, and they were liable for accuracy-related penalties for those years.

References: For accuracy-related penalties, see FTC 2d/FIN ¶V-2000; United States Tax Reporter ¶66,624; TaxDesk ¶863,005; TG ¶71626.

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