by Brian Mahany
Stephen W. and his wife Anne hired both a lawyer and a CPA to prepare their tax return.The couple had many business interests and showed a taxable income of $29.2 million on their 2006 federal income returns. Unfortunately, that income figure failed to include an additional $3.4 million in income realized in a swap transaction.The IRS caught the error and assessed tax and penalties. Everyone concedes that the couple owed the tax (which was immediately paid upon discovery of the error.) Everyone also concedes the couple provided all the relevant documents to their tax professional.
The issue on appeal at Tax Court was the penalties. The couple contested the $104,295 accuracy related penalty assessed by the IRS because of the error. The couple claimed that they reasonably relied on their tax preparers and should not personally be responsible for the error.
Did they win? No says the tax court.
The Internal Revenue Code says that a taxpayer liable for the accuracy-related penalty may avoid the liability if he can show that he had reasonable cause for a portion of the underpayment and that he acted in good faith with respect to that portion. In layman’s terms, if your accountant makes a mistake, you may not have to pay penalties.
The test is whether the reliance was reasonable. The taxpayers here noted that they have no tax background, hired a lawyer and a CPA each of whom had 20 years tax experience, had over 160 informational returns that year and had to file tax returns in 27 states. Their 2006 federal return alone was 115 pages!Under these circumstances, they argued that their return was so complicated that they could not possibly know that a mistake had been made.
The courts have said that in order to assert the reliance on professional advice provision, a taxpayer must show three things:
1)the tax professional was a competent professional (relying on the guy who does returns at his kitchen table probably doesn’t qualify);
2)the taxpayer provided all information to the preparer; and
3)the taxpayer relied in “good faith” on the preparer.
In adopting a very hard line and ruling against the taxpayer, the Tax Court has set a dangerous precedent. First, taxpayers may now be responsible for penalties even if he or she believed their accountant was preparing a valid return.
Accountants are also now exposed to more liability as well.
Mistakes happen. Lawyers and accountants try to avoid them but sooner or later everyone makes them. As long as the penalties are abated, everyone is happy. When the IRS holds the taxpayer responsible, however, for an honest mistake made by the preparer, you can believe that the taxpayer is going to demand payment from the preparer.
If your tax preparer makes a mistake, you generally are still responsible for any tax owed. It might be a bit painful but you still must pay what you owe. Penalties, however, are a different story.
If you gave your accountant all the necessary information and they still made a mistake, you may have a claim against them if they refuse to pay your penalty assessment.
If you are given a higher tax bill because of your accountant’s mistake, pay the tax as soon as possible. The interest and penalty clock keeps ticking and won’t stop until the tax itself is paid. As stated above, you are almost always personally on the hook for the unpaid tax.
Next see if your preparer will assist with appealing any penalties. Sometimes you may want to hire your own lawyer. Some accountants will pay for that as well. After all, if the tax attorney can get the IRS to abate the penalty, you don’t need to worry about who is paying the penalty.
If the IRS doesn’t abate the penalty – and as seen from this case, the IRS is getting tough – you may have a claim against your accountant. Luckily, most reputable tax preparers have malpractice insurance.If the accountant won’t pay, however, then consider hiring a lawyer.
One word of caution, many states have a very short time window in which malpractice suits against professionals are allowed.Do not wait too long.
Mahany & Ertl is a full service boutique law firm that helps people with tax problems. While no one likes suing his or her accountant or lawyer, we can assist with that if necessary. Thankfully, in most situations, lawsuits can be avoided.
For more information, contact attorney Brian Mahany at (414) 704-6731 (direct) or by email at
Mahany & Ertl, LLC – America’s Tax Lawyers. Offices in Milwaukee, Wisconsin; Detroit, Michigan; Portland, Maine & San Francisco, California. Services nationwide.