But I Relied on My Accountant! the Scope of the Reasonable Cause Defense to Penalties

August–September 2012 But I Relied On My Accountant! The Scope of the Reasonable Cause Defense to Penalties

By Larry A. Campagna, Caroline D. Ciraolo and Ellis L. Reemer

Larry A. Campagna, Caroline D. Ciraolo and Ellis L. Reemer examine the scope of the reasonable case defense to penalties.1

ractitioners have seen an increase in the imposi- statutory exceptions; (3) administrative waivers;4 and (4) tion of penalties and a corresponding increase in correction of service error.5 The most common defense Pclients seeking penalty abatement. Taxpayers who asserted by taxpayers is under Section 6664(c), the seek relief from penalties often plead reliance on their reasonable cause defense. “No penalty may be imposed tax advisors as their reasonable cause defense. While under [Code Sec.] 6662 with respect to any portion of many penalties may be abated or eliminated based on an underpayment upon a showing by the taxpayer that “reasonable cause,” recent cases have narrowed the there was reasonable cause for, and the taxpayer acted ability of taxpayers to demonstrate the reasonableness in good faith with respect to, such portion.”6 Reasonable of their reliance on tax advice. This article addresses cause is based on all relevant facts and circumstances.7 A claims for relief based on reasonable cause, in particu- taxpayer must establish that it exercised ordinary business lar,laar, reasonablereasr sonna cause based on a taxpayer’s reliance on care and prudence in determining its tax obligations, but professionalprroffeessionan advice.dvice. nonetheless failed to comply with those obligations.8 The Penalty Handbook (Part 20 of the Manual) sets forth TheeS StaStatutes, Regulations,g and Manual various examples of reasonable cause, but any reason thatthat esestablishestabblishes tthat despite the exercise ordinary business The Internal Revenueenu ManualManual setssets forth fo th theeI IRS’sRSS’s policypolicy ono carecare aandnd pprudence,rude a taxpayer was unable to comply penalties.2 Simply stated, penalties are used to enhance with a required duty within the required time will be voluntary compliance by demonstrating the fairness of considered by the IRS.9 the tax system to compliant taxpayers and increasing the In considering a request for abatement based on cost of noncompliance. IRS Examiners and their manag- reasonable cause, the Manual instructs IRS employees ers3 are advised to consider the applicability of penalties to ask the following:10 in each case, and fully develop the penalty issue when 1. What happened and when did it happen? the initial consideration indicates that penalties should 2. During the period of time the taxpayer was non- apply. Full development of the penalty issue is important compliant, what facts and circumstances prevented for the IRS Appeals ofﬁ ce to sustain a penalty and for the taxpayer from ﬁ ling a return, paying a tax, and/ Counsel to successfully defend that penalty in litigation. or otherwise complying with the law? The IRS has established four primary categories for 3. How did the facts and circumstances result in the penalty relief, including: (1) reasonable cause; (2) taxpayer not complying? 4. How did the taxpayer handle the remainder of their affairs during this time? Larry A. Campagna is a shareholder with Chamberlain, 5. Once the facts and circumstances changed, what Hrdlicka, White, Williams & Aughtry in Houston, Texas; Caroline D. Ciraolo is a partner with Rosenberg Martin attempt did the taxpayer make to comply? Greenberg, LLP in Baltimore, Maryland; and Ellis L. Reemer The IRS views the most important factor in determining is a partner at DLA Piper LLP (US) in New York, NY. reasonable cause to be a taxpayer’s effort to report the

JOURNAL OF TAX PRACTICE & PROCEDURE 51 The Scope of the Reasonable Cause Defense

proper tax liability.11 Other factors considered include the advice, the