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Return Preparer Liable for Penalty After Failing to Perform Due Diligence

(Parker Tax Publishing February 2017)

The Court of Federal Claims held that a tax preparer was liable for a $2,500 penalty after failing to perform due diligence with respect to a return on which an earned income credit was claimed. Testimony indicated that the return preparer told the taxpayer that she could receive a tax refund if she reported additional income on her return rather than just the $16 that her W-2 showed. Foxx v. U.S., 2017 PTC 46 (Fed. Cl. 2017).


In February 2008, Shakeena Bryant went to Dr. George Foxx for assistance in preparing her 2007 tax return. She was accompanied by a friend, Herman James. Foxx held himself out as the "Tax Doctor" and claimed to have more than 37 years of tax preparation experience and to have prepared over 7,000 tax returns between 2004 and 2014. Bryant brought her W-2, which indicated that she had received a total of $16 in 2007 from a brief employment at Busch Gardens, and information regarding her children. She did not bring any documents indicating additional income.

According to Bryant and James, Foxx told Bryant that she could receive a tax refund if she reported additional income from a business. Bryant left Foxx's office, applied for and received a business license for auto detailing, and returned to Foxx's office that same day with the license. Foxx then prepared Bryant's tax return and reported $18,288 in business income from Bryant's purported auto-detailing business. As a result, Bryant qualified for earned income tax credits and received a refund of $2,577 from the IRS. Bryant paid Foxx $169 as a tax preparation fee.

The IRS subsequently audited Bryant's tax return. In the course of that audit, Bryant stated that she had never owned an auto-detailing business. She told the IRS that her 2007 tax return was incorrect, while also stating that she reported her false business income under the instructions of Foxx. The IRS then contacted Foxx, who responded in March 2009 that he reasonably relied upon the statements of Bryant and exercised due diligence in preparing her return. Foxx also provided Bryant's auto-detailing business license and two pages of handwritten notes, written by Foxx, relating to that business.

In May 2009, the IRS imposed a $5,000 tax return preparer penalty on Foxx under Code Sec. 6694(b) for his willful, or reckless or intentional disregard of a rule or regulation in preparing Bryant's inaccurate 2007 tax return. According to the IRS, this conduct caused an improper tax refund to be issued to Bryant. Foxx filed a pre-assessment appeal in which he stated that he relied upon the verbal statements of Bryant regarding her business income. Subsequently, the IRS reduced Foxx's penalty to $2,500.

Foxx paid the $2,500 penalty in April 2012 and then filed a claim for a refund of that penalty through submission of a Form 843, Claim for Refund and Request for Abatement. The IRS denied the claim and Foxx filed suit in the Court of Federal Claims, seeking to recover the $2,500 penalty he paid to the IRS. In his complaint, Foxx alleged that he followed the rules of due diligence and acted in good faith and therefore the penalty should not have been imposed.

Court of Federal Claims Upholds IRS Penalty

Code Sec. 6694(b) provides in part that a penalty will be assessed on any tax return preparer who prepares a tax return with respect to which any part of an understatement of liability is due to a willful attempt in any manner to understate the liability for tax on the return or claim, or a reckless or intentional disregard of rules or regulations. Under Code Sec. 6694(e), the term "understatement of liability" is defined as any understatement of the net amount payable with respect to any income tax imposed or any overstatement of the net amount creditable or refundable with respect to any such tax.

The validity of the penalty under Code Sec. 6694, the Federal Claims Court stated, depended on whether (1) Foxx prepared Bryant's 2007 tax return, (2) Bryant's return contained an understatement of liability, and (3) such understatement was due to Foxx's willful action or his reckless or intentional disregard of rules or regulations. The first two elements, the court noted, were undisputed.

During the trial, both Bryant and James stated that Bryant obtained a business license pursuant to Foxx's instruction. According to James, Foxx explained that such a license would allow him to obtain more money for Bryant, and Foxx, not Bryant, created the false business income that appeared on Bryant's tax return.

The Federal Claims Court held that tax preparer penalty assessed against Foxx was justified. The court noted that, under the regulations, Foxx was required to perform due diligence before filing Bryant's tax return for earned income credits and he intentionally or recklessly disregarded tax preparer rules and regulations. This due diligence, the court observed, included an obligation to make reasonable inquiries if the information furnished to, or known by, Foxx appeared to be incorrect, inconsistent, or incomplete.

The Court Declines to Sanction the IRS for Subpoena

Before the beginning of the trial, the government sent a subpoena to Nova Southeastern University to verify Foxx's claim that he had received a doctorate from that university. Foxx argued that the government, through this subpoena, "sought irrelevant evidence," requested the "disclosure of privileged or other protected information," and hindered Foxx's ability to be hired by Nova Southeastern University in the future. He further asserted that the subpoena served no purpose but to hurt him. The IRS countered that it reasonably sought independent information about the legitimacy of Foxx's claimed credentials and his credibility and that such information was relevant to the case. Foxx asked the Court of Federal Claims to sanction the IRS for its inquiry to Nova Southeastern University.

The court also rejected Foxx's request to sanction the IRS. The court concluded that the IRS's request for information from Nova Southeastern University was permissible and sanctions were not appropriate.

For a discussion of the tax preparer penalty under Code Sec. 6694(b), see Parker Tax ¶276,315.

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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