Imprisonment and Lack of Access to Potential Deduction Documents Are Not Reasonable Cause for Failure to File Returns or Timely Pay Taxes
Taxpayers faced with a penalty for failure to file a return and failure to timely pay the tax can attempt to escape either or both penalties by arguing they had reasonable cause for the failure under §6651(a)(1) and (2). But in the case of George v. Commissioner, TC Memo 2019-128,[1] the taxpayer was unable to persuade the Court that such reasonable cause included being in prison after being convicted of wire fraud for running a real estate Ponzi scheme.
The relevant penalties and the reasonable cause defense is found at IRC §6651(a)(1) and (2) which provide:
(a)Addition to the tax
In case of failure—
(1)to file any return required under authority of subchapter A of chapter 61 (other than part III thereof), subchapter A of chapter 51 (relating to distilled spirits, wines, and beer), or of subchapter A of chapter 52 (relating to tobacco, cigars, cigarettes, and cigarette papers and tubes), or of subchapter A of chapter 53 (relating to machine guns and certain other firearms), on the date prescribed therefor (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate;
(2)to pay the amount shown as tax on any return specified in paragraph (1) on or before the date prescribed for payment of such tax (determined with regard to any extension of time for payment), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount shown as tax on such return 0.5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 0.5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate;
The Court found that there was no disputing the taxpayer had received a pension distribution of $208,111 during the year and, that being age 45 at the time of the distribution, was also subject to the 10% additional tax on premature distributions. The Court also accepted the IRS’s calculation of an overall deficiency, after giving account for taxes withheld from the distribution, of $70,318.[2]
So now we turn to the penalties, both for his failure to file a return (the IRS eventually filed a substitute for return that lead to the deficiency the agency sought to collect) and the failure to pay the tax when due. The taxpayer argued he had reasonable cause for this failure, noting:
Petitioner’s principal defense to respondent’s additions to tax is that he has been incarcerated, so that documents evidencing deductible expenditures are unavailable to him, and it would be inadvisable for him to file a 2013 return until he obtains documents that might evidence those deductible expenditures.
The taxpayer’s lack of access that documents that may have been relevant to his return was not found to create reasonable cause for the failure either to file the return or pay the tax due timely. The opinion points out:
The regulations provide that a taxpayer has reasonable cause for failure to timely pay a tax if “the taxpayer has made a satisfactory showing that he exercised ordinary business care and prudence in providing for payment of his tax liability and was nevertheless either unable to pay the tax or would suffer an undue hardship * * * if he paid on the due date.” Sec. 301.6651-1(c)(1), Proced. & Admin. Regs. The regulations further state:
In determining whether the taxpayer was unable to pay the tax in spite of the exercise of ordinary business care and prudence in providing for payment of his tax liability, consideration will be given to all the facts and circumstances of the taxpayer’s financial situation, including the amount and nature of the taxpayer’s expenditures in light of the income (or other amounts) he could, at the time of such expenditures, reasonably expect to receive prior to the date prescribed for the payment of the tax. * * * [Id.][3]
The Court, in applying these rules to this case notes:
Even if it were true that there is evidence of deductible amounts not available to petitioner, that would not necessarily establish reasonable cause and a lack of willful neglect for not filing or paying. The mere fact that petitioner was incarcerated when his return was due is not reasonable cause for his failure to file timely. Llorente v. Commissioner, 74 T.C. 260, 268-269 (1980), aff’d in part, rev’d in part on other grounds, and remanded, 649 F.2d 152 (2d Cir. 1981); Thrower v. Commissioner, T.C. Memo. 2003-139, 2003 WL 21107675, at *5. Nor is the unavailability of records generally reasonable cause for failure to file a timely return. Thrower v. Commissioner, 2003 WL 21107675, at *5.[4]
The Court first notes that he didn’t even attempt to file timely or compute or pay the tax due:
Nothing in the record suggests that petitioner applied for an extension of time to file his 2013 return. Nor has he shown specific facts raising a genuine dispute for trial that he could not have prepared a timely 2013 return with a reasonable degree of accuracy on the basis of the information available to him as of the due date of that return.[5]
The Court also notes that the taxpayer never described any sort of expenditure that might have been part of his missing records that could have given rise to a deductible expense that would have impacted his income tax return.[6]