Corporation Still Owed Penalties Even After Its Officers Died

I had a conversation this week with another practitioner.

He has an elderly client who is having memory issues. This client in turn is represented by another person – an agent. The agent refuses to sign or provide consent to the filing of the elderly client’s tax return.

My first thought was that there must be odd stuff on the client’s return, but I am assured that is not the case. The agent is – how to say this delicately – not a likeable person.

The practitioner asked me what I would do.

The issue is that a tax return is confidential information. We – as CPAs – are not allowed to release a return, even to the IRS, without permission from the client. The IRS requests that this permission be in writing, which is why you sign a form and return it to your preparer before he/she electronically files your return.

Theory is easy. Life is messy.

Let’s segue by looking at a penalty case.

The taxpayer was protesting $58 thousand in penalties.

Turns out the taxpayer was an S corporation. This type of corporation (normally) does not pay tax. Rather it divides up its income among its shareholders (on Form K-1, to be specific), who in turn include those numbers on their individual tax returns.

For years 2011 through 2013 the company did not file returns with the IRS.

Yep, that is going to hurt.

But it did issue K-1s to its shareholders, so (supposedly) all taxes were timely and correctly paid to the Treasury.

Seems odd. Why would the company issue K-1s but not file the return itself with the IRS?

Turns out that there were a number of related family companies – 19 of them, in fact. The patriarch of the family (Victor) hired a CPA (Tapling) to function as CFO for all his companies.

Victor was diagnosed with and treated for cancer. He died December 30, 2013.

We are talking about penalties for years 2011 through 2013, so I suspect that Victor’s illness is involved.

In 2010 Tapling himself was diagnosed with cancer. He eventually died from complications in 2016.

Tapling prepared and distributed the K-1s for years 2011 through 2013 but did not however send the returns to the IRS. Why? Perhaps he was waiting for the passing of authority within the family. Perhaps he did not consider it within his corporate authority to actually sign the returns. Maybe the transition involved family members who wanted Tapling gone, and he did not want to provide easy reasons for his dismissal.    

The IRS came in hot.

It led with the Boyle decision (of which we have spoken before), arguing that the corporation was more than Victor or Tapling. It had a Board of Directors, for example, and the Board could have – should have – stepped in to be sure that returns were being filed.

The company argued that Boyle involved an agent. This situation involved corporate officers and not agents. Its officers were gravely ill and did not timely discharge their responsibilities, much to the company’s detriment.

I see both sides.

To me, the IRS and the company should compromise. Perhaps the IRS could abate 50% of the penalty, and the company would hold its nose and write a check. Both sides could acknowledge that the other side had valid points. Life is messy.

Not a chance:

Consequently the court grants defendant’s motion for summary judgement and denies plaintiff’s motion for summary judgement.”

The IRS won it all.

Our case this time for the home gamers is Hunter Maintenance & Leasing Corp., Inc.v United States.

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.