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Doctor Escapes Penalty for Inaccurate Returns by Proving Reliance on Return Preparer

(Parker Tax Publishing June 2017)

The Tax Court held that a doctor was not liable for a 20 percent negligence penalty where she exercised ordinary business care and prudence by relying on her long-term tax return preparer, whom she believed to be a competent professional, to accurately report gain from a large stock sale on the appropriate year's tax return. The court concluded that where a taxpayer is completely unaware of a return preparer's numerous errors, those errors cannot be used retroactively to prove that the preparer is incompetent. Whitsett v. Comm'r, T.C. Memo. 2017-100.


Carolyn Whitsett is a doctor specializing in blood transfusions. In 1982, she and her then husband purchased 4,000 shares of Immucor, Inc. (Immucor) common stock for $11,000. The couple subsequently divorced and, under the terms of their divorce settlement, she became the sole owner of the Immucor shares. In July 2011, TPG Capital (TPG) agreed to acquire Immucor and made an offer to Immucor's shareholders to purchase their stock for $27 per share. At that time, Whitsett owned (as a result of stock splits, among other things) 63,594 shares of Immucor stock.

In August 2011, she notified her longtime tax return preparer, Joe Whittemore, that she intended to accept TPG's offer. Whittemore had been a tax return preparer for more than 25 years. Before founding his own company, PM Group Atlanta, Inc., in 1995, he worked as a return preparer for several small firms. He prepares on average 100 to 125 returns each year, primarily for doctors and dentists. On December 21, 2011, Whitsett completed and submitted the required stock redemption form.

In January 2012, TPG's agent, Computershare Trust Co. (Computershare), sent Whitsett a check, dated January 4, 2012, for $1,717,038 (63,594 shares x $27 per share). This check was accompanied by a document captioned "Corporate Action Advice" that showed the "payment date" as August 19, 2011, and the "tax year" as 2012. Computershare also enclosed a letter dated January 9, 2012, stating that Whitsett's stock redemption was "processed" as of January 4, 2012.

After speaking with Whitsett and reviewing the documents she provided, Whittemore decided (erroneously) that 2011 was the proper tax year for which to report Whitsett's gain from the sale of the Immucor stock. To determine her gain, he first subtracted from the sale proceeds her original cost basis of $11,000, which he obtained by calling a stockbroker to obtain the average selling price for the Immucor stock on the purchase date. He then subtracted what he thought were reinvested dividends of $628,437, which he obtained by looking at Whitsett's prior tax returns. On the basis of this calculation, he determined that Whitsett had a long-term capital gain for 2011 of $1,077,601 ($1,717,038 - $639,437).

Whittemore needed additional time to prepare Whitsett's 2011 return so an extension request was filed on April 11, 2012. The extension request showed an estimated balance due of $154,776. Whittemore derived this estimate by adding the expected tax on that stock sale to Whitsett's prior year tax liability. On the basis of the extension request and an instruction letter from Whittemore, Whitsett sent the IRS a check for $154,776, dated May 16, 2012, to cover her estimated balance due for 2011.

Whittemore did not file Whitsett's 2011 return by the extended due date, October 15, 2012. On February 19, 2013, he sent her a letter accompanied by a completed copy of her 2011 return. This document reported the sale of the Immucor stock and showed a balance due of $5,393 after taking into account the earlier $154,776 payment. Whittemore sent Whitsett an email concurrently with the completed 2011 return and a letter stating that he had "filed the return electronically." Whittemore enclosed with this letter a Form 1040-V, Payment Voucher, and instructed Whitsett to mail this form with her payment to the IRS. On March 4, 2013, Whitsett sent the IRS a check for $5,393 accompanied by the Form 1040-V.

Whittemore did not in fact file Whitsett's 2011 return. Unaware of that fact, Whitsett retained Whittemore to prepare her 2012 return. In early 2013, Computershare sent Whitsett a Form 1099-B, Proceeds From Broker and Barter Exchange Transactions, for the Immucor sale. This form reported gross proceeds of $1,717,038 and showed the sale date as January 4, 2012. Whitsett provided this form to Whittemore shortly after receiving it.

After reviewing all of the documents Whitsett had provided to him, Whittemore determined that no capital gain attributable to the Immucor stock sale needed to be reported on Whitsett's 2012 return because he had already reported (or thought he had reported) that income on her 2011 return. He accordingly did not include a Schedule D, Capital Gains and Losses, with the 2012 return, which he filed (late) on November 4, 2013.

On December 9, 2013, Whitsett received an IRS notice stating that her 2011 account had a credit of $165,562 but that no 2011 return had been filed. She promptly sent the IRS a letter expressing her understanding that Whittemore had filed her 2011 return electronically. She enclosed with this letter a copy of the 2011 return that he had provided to her.

On January 6, 2014, Whitsett emailed Whittemore and asked him whether it would be advisable to send the IRS another copy of her 2011 return for processing. He replied that there was no need to do this because he had already efiled it. On September 15, 2014, the IRS sent Whitsett a second notice that again showed a large credit balance on her 2011 account but again stated that no 2011 return had been filed. Whitsett responded to this notice on October 18, 2014, again noting her understanding that her 2011 return had been electronically filed.

Shortly thereafter, the IRS informed Whitsett that she had a balance due of $680,086 for 2012. She contacted Whittemore who told her to execute a Form 2848, Power of Attorney and Declaration of Representative, so that he could speak with the IRS on her behalf to discuss these notices. In four subsequent email exchanges during the ensuing three months, Whittemore assured Whitsett that he was communicating with the IRS on her behalf with regard to her 2011 and 2012 tax years.

In an email dated February 2, 2015, Whittemore informed Whitsett, for the first time, that the proceeds from the Immucor stock sale should have been reported on her 2012 return. He stated that he was preparing an amended return for 2012 to report the stock sale and an amended return (it would actually have been the original return) for 2011 reporting no capital gain. He informed Whitsett that he could not file these returns electronically and that he would send paper amended returns for her to file. Whitsett never received these returns, and there was no evidence that such amended returns were ever filed.

IRS Actions and Taxpayer's Amended Returns

After receiving no response to their notice, the IRS issued Whitsett a notice of deficiency for 2012, determining a deficiency of $541,552 and an accuracy-related penalty under Code Sec. 6662 of $107,995, attributable chiefly to the unreported proceeds from the Immucor stock sale. After receiving the notice, Whitsett realized that something had gone seriously wrong. She sought new assistance and ultimately hired an attorney to represent her. On April 10, 2015, the attorney prepared and filed a 2011 return that (correctly) did not report the Immucor stock sale proceeds. This return, which functioned as a protective refund claim, reported an overpayment of $174,359 for 2011, which Whitsett designated to be applied against her 2012 tax liability.

On April 24, 2015, Whitsett timely petitioned the Tax Court for redetermination of the deficiency and the penalty. Before trial, the parties agreed that (1) 2012 was the correct year to report the proceeds of the Immucor stock sale; (2) Whitsett's aggregate basis in the Immucor stock was $11,000; (3) Whitsett's gain on the sale was $1,706,038; (4) the gain was properly taxable as long-term capital gain for 2012; and (5) Whitsett was liable for a deficiency for 2012. The question before the court was whether to uphold the IRS's negligence penalty assessment under Code Sec. 6662(a) equal to 20 percent of the portion of the underpayment attributable to the deficiency.

Negligence Penalty and Reasonable Cause Exception to the Penalty

Under Code Sec. 6662, a 20 percent penalty on the portion of any underpayment of tax attributable to negligence or disregard of rules and regulations or any substantial understatement of income tax. Negligence includes any failure to make a reasonable attempt to comply with the internal revenue laws. An understatement of income tax is substantial if it exceeds the greater of $5,000 or 10 percent of the tax required to be shown on the return. The IRS bears the burden of production with respect to the liability of any individual for any penalty.

Under Code Sec. 6664(c)(1), a taxpayer may avoid the accuracy-related penalty by showing that he or she acted with reasonable cause and in good faith. Reasonable cause requires that the taxpayer exercise ordinary business care and prudence as to the disputed item. Good faith means, among other things, an honest belief and an intent to perform all lawful obligations. Both of these determinations are made on a case-by-case basis, taking into account all relevant facts. Circumstances that may indicate reasonable cause and good faith include (among other things) an honest misunderstanding of fact or law that is reasonable in light of all the circumstances, including the taxpayer's experience, knowledge, and education. The most important factor is the taxpayer's efforts to assess her tax liability correctly.

Reg. Sec. 1.6664-4(c)(1) provides that a taxpayer may demonstrate reasonable cause and good faith by showing reliance on the advice of a tax professional, such as an accountant or a lawyer, regarding a particular item's tax treatment. To establish that she relied in good faith on the advice of a professional, the taxpayer must meet each requirement of the following three-prong test espoused in Neonatology Assocs. P.A. v. Comm'r, 115 T.C. 43 (2000):

(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."

The IRS argued that Whitsett was liable for the negligence penalty because she did not exercise ordinary business care and prudence. In so arguing, the IRS relied principally on the documents Whitsett received from Computershare in January 2012. According to the IRS, a person exercising ordinary business care and prudence would have understood from these documents that any gain from the Immucor stock sale would be properly reportable on a 2012 tax return.

Tax Court's Decision

The Tax Court held that Whitsett was not liable for the negligence penalty. The court rejected the IRS's argument that Whitsett did not exercise ordinary business care and prudence. According to the court, although Whitsett is a highly educated person and a skilled physician, she had no knowledge of federal income taxation. She had tendered her stock to Immucor for redemption in December 2011. Although the documents she received in January 2012 said that her redemption was "processed" on January 4 and that the "tax year" was 2012, they also stated that the "payment date" was August 19, 2011. As a lay person unfamiliar with tax law, the court said, Whitsett reasonably referred her questions on this to her longtime tax return preparer.

Given the time value of money, the court opined that it would obviously have been in Whitsett's economic interest to report her million-dollar gain on a 2012 return rather than on a 2011 return. The court thought that Whitsett displayed admirable business care and prudence by referring this question to Whittemore and accepting his advice to report the gain for 2011, rather than deciding unilaterally what would be best for her pocketbook.

The court also considered whether Whitsett met the three requirements under Neonatology Assocs. P.A. v. Comm'r (discussed above) to establish a "reliance on professional advice" defense to the accuracy-related penalty.

In determining if Whitsett reasonably relied on a tax professional, the court observed that Whittemore has a well-established tax return preparation business; he specializes in preparing returns for physicians such as Whitsett; and he had prepared returns for Whitsett for many years with no IRS challenge apart from an occasional math error. The court noted that, although Whittemore was not a CPA, Whitsett assumed that he was because he was a member of several accounting societies. Whitsett, the court said, had every reason to believe that Whittemore was a competent tax professional with sufficient expertise to justify her reliance.

While agreeing with the IRS that Whittemore committed many errors in handling Whitsett's 2011 and 2012 tax returns, the court noted that whenever a taxpayer advances a "reliance on professional advice" defense against an accuracy-related penalty, the adviser will have made one or more mistakes. If the taxpayer is completely unaware of the adviser's errors, as was true here, the court said that those errors cannot be used retroactively to demonstrate the adviser's lack of competence.

The court also found that Whitsett supplied all information relating to her returns to Whittemore and relied in good faith on Whittemore's judgment.

For a discussion of the exceptions to the application of the negligence penalty, see Parker Tax ¶262,127.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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