No Harm No Foul? Fuhgeddaboudit!

I am looking at a case involving whether a penalty requires a supervisor’s approval before being imposed.

It is dry stuff.

The rest of the case is what caught my eye.

Mr and Mrs Allen extended their individual tax return. They also owned 100% of an S corporation.

COMMENT: An S corporation’s income is reportable on its shareholder’s personal return. Since M/M Allen owned 100% of their S, all of the S corporation’s income would be reported on their return.

Somebody somewhere forgot to extend the S corporation return. It was due March 15, and it was filed on September 13.

COMMENT: Meaning it was filed 6 months late. The penalty is $195 per month per owner. The math is ($195 times 2) times 6 = $2,340. Not filing that extension got expensive.

The Allens thought that this was outrageous. After all, all of the corporation’s income went on their return, and their return was properly extended. There was no harm to the Treasury. Surely that lack of harm was reasonable cause for abatement.

The IRS told them to pound salt.

Off to Tax Court they went.

Let’s slide to the side a bit. If this had been a partnership, they would have requested abatement under Rev Proc 84-35. A partnership comes under 84-35 scope if:

·        There are 10 or fewer partners

·        Who are individuals (except nonresidents) or an estate

·        The partners each have the same income/loss allocation percentage

·        Each partner has reported his/her share of the income/loss on a timely filed return

·        There is one more requirement concerning audit procedures, which need not concern us here

Rev Proc 84-35 says that – if you meet the above – you have “reasonable cause.” Consider that reasonable cause is grounds to abate a penalty and 84-35 is a way out of a penalty.

Guess what: S corporations have no equivalent to Rev Proc 84-35. Why? Who knows? Is it fair? What does fair have to do with anything?

So the Allens have no 84-35 pass. They instead based everything on their correctly extended underlying personal return.

Here is the Court:

[] evidently conceives that the sole purpose of the Form 1120S is to give the shareholder the information that he or she needs in order to file a Form 1040 tax return; and since Mr. and Mrs. Allen knew the affairs of [], did eventually file their Form 1040 timely …, and did not fail to report any income, the intended purpose of the S corporation’s filing requirement was accomplished and the penalty was moot.”

Lots of shade here, Tax Court. The Allens were instead arguing no loss to the Treasury, so the Treasury could afford to be magnanimous and not impose an otherwise burdensome penalty just because. Save us from the French court of Louis XVI, why don’t you?

Back to the Court:

[] cites no authority in support of its claim that the penalty should be waived on the grounds that its two shareholders were aware of the information to be shown on the return. Section 6699 does not include a condition of harm before the penalty is imposed; it simply imposes a penalty when the filing is late (without reasonable cause).”

I am at a loss why the Court is looking for “authority” when all the Allens are requesting is reasonable cause. Reasonable cause is an equity and not statutory argument. It does not need to be based on chapter and verse from the dustiest tome in the most unvisited tax library in the land. Statutory says you stop and wait at a red light. Equity says you stop and then run the light because you are transporting someone experiencing a heart attack to the hospital.

Ahh, you know how this case turned out.

And I continue to point out that the IRS long ago stopped using penalties to disincentive bad tax behavior and abatement to incentivize good tax behavior. The IRS is now using penalties to pad its budget. In that world, abatement is tantamount to the IRS taking money from its own wallet, something it will not do willingly.

I was saddened to see the Tax Court drink the same Kool-Aid. To be fair, I suppose the Court did not want to go where the IRS has been reluctant to proceed regulatorily. I nonetheless argue that the Court whiffed on a chance to force the IRS to be reasonable when determining reasonable cause.

Our case this time was ATL & Sons Holding Inc v Commissioner.