IRS Practice and Procedure News Briefs for November 2020

LATE-FILING PENALTIES – Padda v. Commissioner, T.C. Memo. 2020-154 (2020)

Why this Case is Important:  Many taxpayers believe that once they give their accountant authority to file their tax return electronically, they have done everything they need to do in order to file the return on time, and will not be penalized in the event the accountant, through no fault of the taxpayer, fails to file the return on time. As this case shows, that belief is wrong.

Facts:  In Padda, the taxpayers hired the same accounting firm that had filed their federal income tax returns since 2006 to file their 2012 return, despite the fact that every return since 2006 had been filed late. Because they had requested a filing extension, the 2012 return was due on October 15, 2013. On October 15, the taxpayers signed an IRS Form 8879 authorizing the accounting firm to file their return electronically. The accounting firm began filing a group of returns that included the taxpayers’ return just before midnight. It created an electronic version of the taxpayers’ return at 11:59 p.m. and transmitted the return at 12:00 a.m. on October 16. The IRS rejected the return as a duplicate submission. The accounting firm resubmitted the return on October 25 and the IRS accepted it. The IRS assessed a late-filing penalty against the taxpayers of almost $21,000, among other assessments, and the taxpayers filed a Tax Court petition contesting that assessment.

Law and Conclusion:  Under Section 6651(a)(1) of the Internal Revenue Code, taxpayers are subject to penalties for failing to file returns on time unless the failure was due to reasonable cause and not willful neglect. Over time, the penalty can grow to as high as 25% of the unpaid tax due with the return. To demonstrate that reasonable cause exists for failure to timely file a return, an individual must demonstrate that he or she exercised ordinary business care and prudence but was unable to take the required action within the prescribed time. In this case, the taxpayers argued that because they relied on their accountants to file their return and gave them authority to file the return prior to the filing deadline, and because their accountants first attempted to file the return only a few seconds after the filing deadline, they should not be penalized. However, citing the general rule that a taxpayer cannot avoid late-filing penalties by claiming that he or she relied on a third party, the Court rejected the taxpayers’ arguments. The Court also cited the history of late filings by the taxpayers’ accountants as evidence that the taxpayers, in again hiring the same accountants, did not exercise ordinary business care and prudence. Therefore, the Court found in favor of the IRS and upheld the penalty assessment.



INTERVENTION IN INNOCENT SPOUSE CASES - Leith v. Commissioner, T.C. Memo. 2020-149 (2020)

Why this Case is Important:  Taxpayers requesting innocent spouse relief may not realize that their spouses or former spouses have the right to oppose their requests for relief, even when the IRS agrees that relief should be granted, as was the case here.

Facts:  In Leith, the taxpayer was requesting relief as an innocent spouse from her obligation to pay the past-due 2010, 2011, and 2013 federal income taxes owed jointly by her and her former husband. During the years at issue, her ex-husband ran his own business, which she had no involvement in. The IRS audited the couples’ 2010 and 2011 returns and determined that the taxpayer’s ex-husband underreported his income and it disallowed certain employment expenses deducted by the taxpayer. The couple also failed to remit payment with their 2013 tax return. In total, the couple owed the IRS approximately $15,000 for these three years. In 2015, they divorced. The following year, the taxpayer filed a request for innocent spouse relief for all three years seeking relief from all liability that related to her husband’s income. In that request, she indicated that the couple kept their finances completely separate during the marriage and that her ex had been in charge of preparing and filing their tax returns. She also asserted that, because her ex-husband was abusive, she was scared to question him regarding their finances or taxes. He submitted a response to her request alleging that she was involved in the preparation of the returns and had knowledge of their finances. When the IRS denied the taxpayer’s request for relief, the taxpayer filed a Tax Court petition protesting the denial. Her ex-husband then exercised his right to become a party to the litigation as an intervenor, also opposing the taxpayer’s request.

Law and Conclusion:  When innocent spouse relief is not available under other provisions of the Internal Revenue Code, taxpayers may be eligible for “equitable” relief under Section 6015(f). To qualify for equitable relief, a taxpayer must meet certain threshold conditions, including that he or she did not knowingly participate in the preparation of a fraudulent tax return and that the tax liability in question is attributable to an item of the non-requesting spouse. The taxpayer met all threshold conditions. Where these conditions are met, relief will be granted under streamlined procedures where certain additional criteria are met, including that the taxpayer (1) is no longer married to the non-requesting spouse, (2) would suffer economic hardship if not granted relief, and (3) did not know or have reason to know the return understated the tax due or, if there was no understatement, that that the non-requesting spouse would not or could not pay the tax due as shown on the return. In this case, the IRS conceded at trial that the taxpayer met all of these streamlined requirements and that relief should be granted. Still, because her ex-husband, a party to the case, asserted that she did not meet requirement #3, the IRS had to rule on the issue. Despite her ex-husband’s arguments, based on the evidence presented at trial, the Court found that the taxpayer did meet all requirements for relief and found in her favor.

If you would like more details about these cases, please contact me at 312-888-4113 or jnesser@lavellelaw.com.