I have become cynical about IRS penalties.
Like many accountants, I initially learned that
penalties were in the system as a deterrent. If one complies with reporting
responsibilities, penalties should not enter the picture. If they do, they surely
would be for ministerial causes (think late payment of an estimated tax) and
minor, and – if somehow major – waivable upon showing reasonable cause for the mistake.
Poppycock.
Congress has been raising and creating penalties for
decades to “pay for” their tax bills. I would also argue that the IRS has used
penalties as a backstop to its funding, especially during Republican budget stringency
after the Lois Lerner fiasco.
The IRS often assesses penalties automatically,
without anyone even glancing at your return. This transfers tax administration from
the IRS to you – and then by extension – to me. Say that you have a reportable
interest in a foreign corporation. The IRS says you must file a certain
information report. I get it: the IRS wants to know what is going on. You file the
report, but you file it late. Why late? Who knows. Your accountant was on
health leave. You were misadvised. You were never advised because you did not recognize
it as a tax-sensitive issue. You will – soon enough – get an automatic IRS
notice for a $10,000 penalty – or more. You complied, but not fast enough.
Reasonable cause?
Depends on who defines reasonable. As a practicing tax
CPA for decades, I am much more open to reasonable cause. Why? I am closer to
the day-to-day, so I do not have the anesthesia of distance and disinterest. Things
... just … happen. No one likes paying, but let’s not use that same brush to accuse
one of gaming the system.
Let’s take a look at Wrzesinski.
We will call him “W” to keep our sanity.
W was born in Poland. He moved to the United States
when he was 19 years old.
A few years later his mom, who still lived in Poland,
won the Polish lottery.
Sweet.
Mom gifted him $830,000 over a couple of years.
W knew about U.S. tax. He contacted his tax advisor to
ask what the consequences would be. His advisor (G) correctly told him that the
gift would not be taxable, but incorrectly told him that no further reporting
was required.
I know that G was wrong, but how could the IRS expect
W to know that?
Fast forward a few years and W wanted to make a gift
to his godson in Poland. He did an internet search, at which time he realized
that – while not taxable – reporting was still required. He realized this situation
as his own years before, and he contacted an attorney with expertise in foreign
tax matters.
W got into an IRS program for late filing of certain
foreign-related returns. The IRS would tread lightly if one had reasonable
cause, and both W and his attorney thought he had reasonable cause to spare.
I agree.
The IRS came back with its automatic penalties: they
wanted $87,500 for one year and $120,000 for the second.
Their reason?
The Notices stated that …
… ignorance of the tax laws was not a basis for penalty abatement under the “reasonable cause” standard and that ordinary business care and prudence require that the taxpayers be aware of their obligations and file or deposit accordingly.”
I would argue the opposite: good faith
“ignorance” of tax laws is exactly the basis for the reasonable cause standard.
We have more than once huddled here at Galactic Command analyzing tax consequences,
especially if planning a transaction. We sometimes disagree. We have run into
gaps in tax law, as Congress is churning out this stuff faster than the IRS and
the profession can interpret. We have run into contradictions in tax law, especially
when the aforesaid gaps are working their way through the courts system. Did I
mention that we are all CPAs with varying tax backgrounds? I am, for example, a
tax specialist. It is all I do and have done for years.
Consider that there was no tax shelter here, no
attempt to avoid reporting income or of claiming bogus deductions. There was a gift
from a mother to a son. A gift unfortunately involving some of the most arcane reporting
rules embedded in the tax Code. There was no need for the IRS to flog the guy.
W and his attorney protested the penalties.
The IRS lost W’s protest.
Yes, they “lost” his protest.
It took the Taxpayer Advocate to find it.
The IRS abated all but $40 thousand or so of
penalties.
W paid it.
And he immediately filed claims for refund.
I like this guy.
The IRS bounced the first claim, saying he did not
establish reasonable cause.
You may be figuring out the IRS schtick when in this
situation. It is a one-play gamebook: nothing is reasonable. Boyle. Go
away.
The IRS bounced the second claim, saying that it was
“frivolous.”
Folks, never ever tell a tax practitioner that his/her
position is “frivolous.” That is a loaded word in tax practice.
This thing … NO SURPRISE … went to Court.
Let’s fast forward.
In a too-rare taxpayer win, the DOJ conceded the case
on February 7, 2023, and requested six to eight weeks to refund W his remaining
penalties.
But look at the effort it took.
Our case this time was Krzysztof Wrzesinski v The
United States, U.S. District Court, Eastern District of Pennsylvania.
