Can You Get Penalty Abatement If Your Accountant Dies?

What if you give your tax documents to your CPA and your CPA dies before preparing your return?

I am reading a case where that happened.

I will lead with this: the IRS assessed almost $41,000 in penalties.

The Willetts had a longstanding relationship with their CPA (Goode). In August, 2015 they gave her all the tax documents to prepare their 2014 tax return.

Time passed and the Willetts attempted to reach Goode, but without success. In October, she finally responded, explaining she had been ill and in a nursing home. She would cover any penalties and interest associated with their return.

In November, 2015 (mind you, the return was due October 15) Mrs Willett visited Goode at her home. Ms Goode assured her she would bounce back and finish their return.

That was the last time the Willetts spoke with Goode, who passed away in February, 2017.

The Willetts had some foreboding, however, as they contacted other CPA firms to address their 2014 return. There were obstacles – Goode had original documents, for example – but they were trying. The Willetts were told that the firms were already too busy with individual returns or that their return was too complex.

COMMENT: Folks, that sounds odd to this practitioner. Methinks there is more to the story.

They finally found and hired a CPA in June, 2016. They filed their 2014 return in September, 2016 – eleven months late.

You already know the IRS came back hot with penalties and interest.

The Willetts took the case to a District Court in California.

COMMENT: That means that they had to pay the penalties and then litigate for a refund. Had they gone to Tax Court, they would not have had to pay the penalties and interest before bringing suit. That would be the upside. The downside to the Tax Court is that the judges are tax specialists. It is a little harder to spin a tale to a specialist, as opposed to a district judge who is a generalist and hears a spectrum of cases.

Penalties can be abated for reasonable cause, but there is a case out there – Boyle – that greatly circumscribes a taxpayer’s ability to rely on an accountant in order to abate penalties. The Boyle decision (sort of) divided tax practice into two categories for purpose of penalty abatement:

(1) The first category is “routine” compliance, such as looking up when a tax return is due and making sure it gets filed by then.

(2) The second category includes professional advice, such as whether a Code section affects a taxpayer or what certain provisions from the 2017 Tax Cut and Jobs Act even mean.

The Boyle court acknowledged that one could rely on an accountant for column two issues, but one probably could not rely for purposes of column one.  The IRS has subsequently interpreted Boyle aggressively, arguing that the qualifier “probably” is not even required in the preceding sentence.

So how does Boyle work when your CPA dies? Is it more like column one or more like column two?

The Court discussed issues surrounding taxpayer reliance on an agent, but at heart the Court was looking at someone who relied on an accountant – apparently a sole practitioner – who was quite ill, in and out of nursing facilities and incapable of producing timely work.

Question: what would a reasonable person do?

After all, the concept is reasonable cause.

The Court was not at all persuaded that reasonable people would wait endlessly for their accountant to recover from a nursing home stay before preparing their return. A reasonable person would seek-out another accountant – even if it was a one-off engagement - in order to meet their tax responsibilities.

There was no reasonable cause.

I admire the Willetts’ loyalty to their practitioner, but their delay cost them $41 grand.

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.

Mental Illness And The Statute Of Limitations

Many people and most tax practitioners (hopefully) know the statute of limitations on refunds from the IRS:

§ 6511 Limitations on credit or refund.

(a)  Period of limitation on filing claim.

Claim for credit or refund of an overpayment of any tax imposed by this title in respect of which tax the taxpayer is required to file a return shall be filed by the taxpayer within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever of such periods expires the later, or if no return was filed by the taxpayer, within 2 years from the time the tax was paid. Claim for credit or refund of an overpayment of any tax imposed by this title which is required to be paid by means of a stamp shall be filed by the taxpayer within 3 years from the time the tax was paid.

We can shorthand this as the “3 and 2” rule.

Then there was the Brockamp case in 1997, which many felt was unfair and which led Congress to write this beauty:

§ 6511 Limitations on credit or refund.

(h)  Running of periods of limitation suspended while taxpayer is unable to manage financial affairs due to disability.

(1)  In general.

In the case of an individual, the running of the periods specified in subsections (a) , (b) , and (c) shall be suspended during any period of such individual's life that such individual is financially disabled.

(2)  Financially disabled.

(A)  In general. For purposes of paragraph (1) , an individual is financially disabled if such individual is unable to manage his financial affairs by reason of a medically determinable physical or mental impairment of the individual which can be expected to result in death or which has lasted or can be expected to last for a continuous period of not less than 12 months. An individual shall not be considered to have such an impairment unless proof of the existence thereof is furnished in such form and manner as the Secretary may require.

Like so much of the tax Code, the heavy lifting is in the details. Brockamp had been senile. Congress addressed the issue by introducing the phrase “medically determinable,” and then handed the baton to the IRS to define what that verbal salad meant.

COMMENT: And there you have a capsule summary of how the Code has gotten away from us over the years. Congress writes words and then leaves it to the IRS and courts to determine what they mean. Congress did the pooch again with the Tax Cuts and Jobs Act.  Google “qualified business income” and tell me that isn’t an elmore waiting to happen.

           

The IRS issued its interpretation of “medically determinable” in Rev Proc 99-21:

SECTION 4. PROCEDURE Unless otherwise provided in IRS forms and instructions, the following statements are to be submitted with a claim for credit or refund of tax to claim financial disability for purposes of § 6511(h).

(1)   a written statement by a physician (as defined in § 1861(r)(1) of the Social Security Act, 42 U.S.C. § 1395x(r)), qualified to make the determination, that …

The IRS is pointing to the Social Security rules to define what a physician is. Methinks this is poor work. Why not reference Beat Bobby Flay to define meal expenses or Car Talk to define transportation expenses?

Let’s look at the Green case.

Richard Green and his wife (Hae Han) went to Tax Court in 2009. There were taxes due and tax refunds and quite the debate about offsetting one against the other.  The case eventually got to Sec 6511(h), and here is what the Court had to say about it:

An individual will not, however, be considered financially disabled unless proof of a medically determinable physical or mental impairment is provided in such form and manner as the Commissioner may require. More specifically, the Commissioner requires a written statement from a physician. Ms. Han, however, did not establish that she was financially disabled. In addition, she was treated by a clinical psychologist, not a physician, and thus could not and did not provide the requisite documentation.

Ms. Han’s letter was written by a psychologist. 

COMMENT: I am thinking: why is a psychologist not considered a “physician?” An optometrist is considered one for this purpose, although an optometrist has an O.D. and not an M.D.

There was no relief for Green and Han.

A number of practitioners considered this decision to be nonsense. The IRS had grafted a Medicare definition concerning payment for services onto Sec 6511(h), which was supposed to be a relief provision in the tax Code.

Enter the Estate of Stauffer, which is presently in Court.

Carlton Stauffer died in 2012 at the age of 90. His son is administering the estate. He discovered that his dad had not filed tax returns for 2006 through 2012. He filed those returns on behalf of his dad. One year alone – 2006 – had a refund of approximately $137,000.

The IRS denied the refund as outside the 3-year window.

The son appealed and pointed at Sec 6511(h).

His father had been seeing a psychologist, who treated him from 2001 until his death in 2012. The psychologist wrote a persuasive letter explaining how Carlton had suffered from psychological problems in addition to ailments including congestive heart failure, chronic obstructive pulmonary disease, leukemia, and chronic pneumonia. He explained how all these factors negatively impacted Carlton’s mental capacity, cognitive functioning, decision making and prevented him from successfully managing his affairs.

The IRS said: show us the “M.D.”

Why wouldn’t they? They had won with that play before.

The estate sued in District Court.

The IRS motioned to dismiss, order boneless chicken wings and watch the NBA over a pitcher of beer.

The District Court denied the IRS motion.

The Court pointed out that – for all the IRS’ power – that it could still review Rev Proc 99-21 under the “arbitrary and capricious” standard that government agencies are held to. The IRS had to articulate a rational connection for its standard, as well as explain why it rejected any reasonably obvious alternatives to the challenged rule.

The Court pointed out that Social Security does not restrict the types of professionals who may opine on whether someone has a disability qualifying for disability benefits. In fact, the opinion of a psychologist is given great weight in such a determination.

The Court did not see how the IRS dismissal of a psychologist’s letter passed the “arbitrary and capricious” standard.

Mind you, the Estate of Stauffer won a motion only; this does not mean that it will win the overall case.  

I for one hope it does.

Benefitting Too Much From A Charity

I suspect that many of us know more about public charities and foundations than we cared to know a couple of years ago.

What sets up the temptation is that someone is not paying taxes, or paying extraordinarily low taxes. For example, obtain that coveted 501(c)(3) status and you will pay no taxes, barring extreme circumstances. If one cannot meet the "publicly supported" test of a (c)(3), the fallback is a private foundation - which only pays a 2% tax rate (and that can be reduced to 1%, with the right facts).

We should all be so lucky.

Let's discuss the issues of charities and private benefit and private inurement.

These rules exist because of the following language in Section 501(c):

No part of the earnings [of the exempt organization] inures to the benefit of any private shareholder or individual….”

In practice the Code distinguishes inurement depending upon who is being benefitted.

If that someone is an “insider,” then the issue is private inurement. An insider is someone who has enough influence or sway to affect the decision and actions of the organization.

A common enough example of private inurement is excessive compensation to a founder or officer.  The common safeguard is to empower an independent compensation committee, with authority to review and decide compensation packages. While not failsafe, it is a formidable defense.

If that someone is an “outsider,” then the term is private benefit.

Here is a question: say that someone sets up a foundation to assist with the expenses of breast cancer diagnosis and treatment. Several years later a family member is so diagnosed. Have we wandered into the realm of private inurement or benefit?

The Code will allow one to receive benefits from the charity – if that individual is also a member of a charitable class. In our example, that class is breast cancer patients. If one becomes a member of that class, one should sidestep the inurement or benefit issue.

The “should” is because the Code will not accept too small a charitable class. Say – for example - that the charitable class is restricted to the families of Cincinnati tax CPAs who went to school in Florida and Missouri, have in-laws overseas and who would entertain an offer to play in the NFL. While I have no problem with that charitable class, it is very unlikely the IRS would approve.

By the way, the cost of failing can be steep. There may be penalties on the charity and/or the insider. Push it too far and the organization's exempt status may be revoked altogether.

Or you may never be exempt to begin with. Let’s look at a recent IRS review of an application for exempt status.

A family member has a rare disease. You establish a foundation to "assist adolescent children and families in coping with undiagnosed and/or debilitating diseases."

The Code allows you to operate for a while and retroactively apply for exemption, which you do.

Sounds good so far.

You and your spouse are the incorporators.

This is common. You can still establish an independent Board.

Your organizing paperwork does not have a "dissolution" clause.

Big oversight. The dissolution clause means that - upon dissolution - all remaining assets go to another charity. To say it differently, remaining assets cannot return to you or your spouse.

The charity is named after your son, who suffers from an unidentified illness.

Not an issue. I suspect many foundations begin this way.

Your fundraising materials specifically request donations to help your son.

You are stepping a bit close to the third rail with this one.

Since inception, the only individual to receive funds is your son. Granted, you have said you intend to make future distributions to other individuals and unrelated nonprofits with a similar mission statement. Those individuals and organizations will have to apply, and a committee will review their application. It just hasn’t happened yet.

Problem.

The IRS looked at your application for exemption and bounced it. There were two main reasons:

First, the problem with the paperwork, specifically the dissolution clause. The IRS would likely have allowed you the opportunity to correct this matter, except that ...

Secondly, there were operational issues. It does not matter how flowery that mission statement is. The IRS reserves the right to look at what you are actually doing, and in this case what you were actually doing was making your son's medical expenses tax-deductible by introducing a (c)(3). Granted, there was language allowing for other children and other organizations, but the reality is that your son was the only beneficiary of the charity's largesse. The rest was just words.

The IRS denied the request. All the benefits of the organization went to your family, and the promise of future beneficiaries was too dim and distant to sway the answer. You had too small a charitable class (that is, a class of one), and that constitutes private inurement.

And you still have a tax problem. You have an entity that has collected money and made disbursements. The intent was for it to be a charity, but that intent was dashed. The entity has to file a tax return, but it will have to file as a taxpaying entity.

Are the monies received taxable income? Are the medical expenses even deductible? You have a mess.

The upside is that you would only be filing tax returns for a year or two, as you would shut down the entity immediately.