One of the traditions of tax season for advisers is filing extensions for taxpayers on April 15.  The case of Laidlaw, et ux. et al v. Commissioner, TC Memo 2017-167 deals with a problem when the IRS claimed not to have received an extension that the taxpayer’s adviser claimed to have filed.

The taxpayers filed their tax returns for 2005 at the extended due date of October 16, 2006.  The taxpayers had filed Forms 4868 for each of the prior three years—but the IRS did not have a record of receiving one for 2005.  The forms were not sent by certified or registered mail, but rather the taxpayer’s adviser testified that he sent them in by regular mail.

The question was whether the taxpayer is liable for a failure to timely penalty under IRC §6651(a).  The taxpayer would not be liable if either an extension request had been timely filed or the taxpayer had reasonable cause for the late filing.

Under IRC §7502(a)(1) a document is deemed to be timely delivered to the IRS if the document is delivered by the U.S. Postal Service and the document bears a postmark made by the Postal Service on or before the due date.  Under IRC §7502(c) the taxpayer may establish that postmark date using either registered or certified mail.

In this case, the Court described the following about the adviser’s actions right around the original, unextended due date:

On April 17, 2006, the due date for filing tax returns for the preceding tax year, Mr. Morgan decided to apply for extensions of time to file petitioners’ 2005 Federal income tax returns because he did not yet have Schedules K-1, Partner’s Share of Income, Deductions, Credits, etc., for that year. That day, Mr. Morgan and his staff prepared corresponding extension requests and estimates. Mr. Morgan’s tax preparation business’ billing records show that on April 17, 2006, he worked on “extensions” for Jarold and Diane Laidlaw and for Brent and Rebecca Laidlaw. In preparing the tax estimates for 2005, Mr. Morgan had in his possession Jarold Laidlaw’s 2005 Forms W-2, Wage and Tax Statement, one from Laidlaw’s Harley Davidson Sales, Inc., and the other from Laidlaw’s Rental Center, Inc., which together showed wage income of $468,244. Mr. Morgan also had Brent Laidlaw’s 2005 Forms W-2 from the same payors, together showing wage income of $501,149. Mr. Morgan was aware that petitioners had received partnership distributions reportable on Schedules K-1, which for Jarold and Diane Laidlaw were reported on their 2005 Form 1040, U.S. Individual Income Tax Return, as $124,455, and for Brent and Rebecca Laidlaw were reported as $124,162.

…The 2005 Forms 4868 provided by petitioners to respondent on November 22, 2016, but ostensibly prepared by Mr. Morgan on April 17, 2006, reported zero amounts for estimated total tax liability, total 2005 payments, balance due, and amount being paid presently. The 2005 forms were not sent by certified mail, and respondent claims not to have received them. Mr. Morgan avers that both Forms 4868 were mailed in the same envelope. There is no copy of the envelope in which the forms were mailed.

The IRS argued that the taxpayers did not have proof of actual filing of the extension to the level required under the regulations and prior case law in the Ninth Circuit, which is the court that would hear an appeal of this decision.

As the Court notes:

Respondent maintains, first, that petitioners do not have proof of mailing or a copy of the envelope in which the extension requests purportedly were mailed and, second, that he has introduced account transcripts rebutting any presumption that he received the Forms 4868. Petitioners’ case relies on the testimony of their tax preparer, Mr. Morgan. Respondent does not believe Mr. Morgan to be credible because (1) the reliability of Mr. Morgan’s recollections about mailing an envelope over a decade ago is dubious, (2) Mr. Morgan had many clients, (3) Mr. Morgan’s billing records indicate that he began work on petitioners’ extension requests and tax estimates on the day of the filing deadline, and (4) Mr. Morgan failed to verify that the envelope ostensibly containing petitioners’ Forms 4868 had proper postage. Respondent further contends that petitioners’ timely filing of their extension requests and tax returns in prior years does not prove timely filing for tax year 2005.

The IRS argues that the taxpayer’s case is different from two prior cases the taxpayers cite where it was held the taxpayer had shown timely mailing, the case of Anderson v. United States, 966 F.2d 487 (9th Cir. 1992) and Lewis v. United States, 144 F.3d 1220 (9th Cir. 1998).  The Court notes:

Respondent distinguishes Anderson and Lewis by claiming that those taxpayers presented corroborating evidence in addition to their self-serving testimony, and this evidence was judged credible by the trial courts. Respondent further distinguishes Lewis by pointing out that the copies of the California extension request forms and checks presented by petitioners are meaningless without Mr. Morgan’s testimony that the forms and checks were timely sent to and received by the State of California. Respondent also distinguishes Lewis by the fact that there the IRS had received the request for extension of time and deemed it late, whereas here respondent never received the request. In short, respondent asserts that absent any extrinsic evidence corroborating timely filing, Mr. Morgan’s testimony stands alone, and no rebuttable presumption of timely mailing exists.

The Tax Court, examining the evidence of timely filing, sided with the IRS.  First, the Court noted that the adviser in question did not testify, but rather the case was submitted by the parties under Rule 122 where there is no trial.  The Court found that this meant it was missing a key item necessary to rule in favor of the taxpayers—the ability to judge the credibility of the adviser as a witness.

In evaluating extrinsic evidence to establish a document’s timely mailing where the only proof thereof is a witness’ testimony, the Court of Appeals for the Ninth Circuit instructs us that the witness’ credibility is key. Anderson, 966 F.2d at 492. We ascertain credibility by observing the witness’ candor, sincerity, and demeanor during his testimony. See, e.g., Gerdau Macsteel, Inc. v. Commissioner, 139 T.C. 67, 155 (2012). However, because the parties submitted this case under Rule 122, we had no opportunity to observe Mr. Morgan’s credibility as a witness. The reliability of a witness’ testimony hinges on his credibility. We were not provided a full opportunity — so critical to our being able to find the witness reliable — to evaluate Mr. Morgan’s credibility on the issue of timely filing because petitioners never offered his live testimony in a trial setting. Instead, petitioners merely offered to the Court a transcript of the witness’ deposition. While we can learn much from reading the testimony, it is not the same as a firsthand observation of the witness’ demeanor and sincerity, both essential aspects of credibility and reliability.

The Court also found concerns with the testimony that was submitted from the adviser:

Moreover, we have reservations about the content of Mr. Morgan’s testimony. While petitioners claim that Mr. Morgan’s recollections have remained fresh because petitioners are significant clients who have undergone an audit and undertaken litigation in this Court, respondent casts doubt on whether Mr. Morgan could remember specific details of mundane events that transpired over a decade ago. Mr. Morgan has many clients and prepares between 215 and 250 income tax returns annually, in addition to filing between 75 and 100 extension requests. Multiple filing deadlines have passed since April 17, 2006, and we agree that it is incredible that Mr. Morgan would specifically remember filing petitioners’ extension requests on that busy day. Indeed, he admitted in his deposition that he did not recall the days on which he filed Jarold and Diane Laidlaw’s 2004 and 2006 extension requests, nor the days on which he filed Brent and Rebecca Laidlaw’s 2004 and 2006 tax returns.

The Court noted that these concerns with the submitted testimony might have been overcome had the Court been able to evaluate the adviser’s testimony in person. 

As well, the Court noted that the adviser was not a disinterested party regarding this matter. 

[Mr. Morgan’s] timeliness in mailing necessary documents reflects upon his accountancy practice and affects his professional relationship with his clients. While self-serving testimony is not invariably untrustworthy, a contrary determination requires that we find the witness credible and forthright, cf. Herman v. Commissioner, 84 T.C. 120, 136 (1985) (“Though such testimony is arguably self-serving, we found the witnesses credible and forthright and accept their testimony on its face.”), something that we cannot do here — again, because of the parties’ decision to submit this case under Rule 122. The burden of proof falls upon petitioners, and this is a burden not satisfied by the testimony of a tax preparer whose credibility is at best a toss-up.

At trial the taxpayers claimed that, regardless of the issue with the mailing of the extension, they should qualify for relief from the penalty under the IRS’s First Time Abate policy.  The policy, found at Internal Revenue Manual 20.1.1.3.6.1, provides that a taxpayer requesting reasonable cause relief from late filing and certain other penalties can obtain an administrative waiver of the penalty if the taxpayer has no penalties for the three preceding years and has filed all currently required tax returns and paid all tax due.

But the Court found that the taxpayers had no basis on which to raise that issue at trial.  The Court noted:

This policy, appearing in the IRM, is a form of administrative relief. Its location at IRM pt. 20.1.1.3.6.1 places it under the “Reasonable Cause Assistant” category in IRM pt. 20.1.1.3.6, which refers to a tool used by the IRS to consider reasonable cause penalty relief. As we noted above, petitioners have not argued reasonable cause. Moreover, since there is no evidence that petitioners have requested any abatement or that respondent has denied such, we find no basis upon which to entertain petitioners’ argument.

Advisers should take note of the significant risks involved when extension requests are not filed in a manner that provides acceptable evidence of timely filing (certified mail, registered mail or via electronic filing).

As well, it’s important in any dispute to assert all available remedies.  The Court sidestepped whether a taxpayer could have been deemed to have reasonable cause outside of an abatement request by simply noting the taxpayer hadn’t argued for reasonable cause.