Tracy v. Commissioner, T.C. Summ. Op. 2023-20[1], presented the Tax Court with the question of whether a disabled and elderly attorney should be eligible for relief from penalties due to late payment and late filing concerning payroll taxes associated with the winding down of his law practice.

The Law for Failure to Pay and Failure to File – IRC §6651

IRC §6651(a)(1) establishes a penalty for taxpayers who fail to timely file their tax returns, encompassing the payroll tax returns discussed in this particular case. Nevertheless, the penalty can be exempted if the taxpayer can establish that the failure to file was attributable to reasonable cause rather than willful neglect.

The provision reads as follows:

(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;

Another penalty associated with these circumstances is specified in IRC §6651(a)(2), which addresses the failure to make timely payments of taxes when they are due. As with the aforementioned penalty, this penalty can be waived if the taxpayer can establish that the failure to pay was a result of reasonable cause rather than willful neglect.

IRC §6651(a)(2) reads as follows:

(a) Addition to the tax. In case of failure—

…

(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;

Within this particular case, it is evident that the taxpayer failed to meet the deadlines for paying the payroll tax liabilities and filing the corresponding tax returns. Hence, the pivotal question revolves around whether the taxpayer can provide evidence to establish that these failures were due to reasonable cause and not the outcome of willful neglect.

Facts of this Case

The opinion commences by providing an overview of the factual background of this case.

Petitioner, 92 years old at the time of this Opinion, was a sole proprietor who operated a law practice during the periods in issue and had done so for approximately 60 years. He did not timely file returns or timely pay his employment tax liabilities for the periods ending September 30, 2017, through June 30, 2019. During this time petitioner was 87 to 88 years old and was closing his solo law practice because of his declining health and advanced age.[2]

During the period of these failures, the taxpayer was grappling with a wide array of substantial challenges and difficulties in his personal life:

A Navy veteran, petitioner had long been determined disabled because of hearing loss and a back injury that had worsened with time. He was nearly deaf and had significant balance difficulties. Petitioner also suffered from joint disease in his knees and hips (which were in poor condition and needed replacing), atrial fibrillation, hypertension, and cardiopulmonary disease. As he took the steps necessary to close his law practice, petitioner’s assistant of more than 25 years helped him in his daily business operations while another attorney substantially worked petitioner’s cases. In addition, he relied on a part-time aide for his daily living activities, including grocery shopping, errands, laundry, cooking, and cleaning. During this time, petitioner also cared for his dying wife of 55 years.[3]

The closure of a law practice presents a distinct set of responsibilities and challenges that exceed those encountered when shutting down other types of businesses. It is crucial to recognize that these responsibilities cannot be disregarded solely due to the challenges confronting the taxpayer.

An attorney, petitioner had an ethical obligation to his remaining clients. He could not simply close his practice and walk away. Although petitioner’s law practice continued to operate, it was not he who did the bulk of the work. Petitioner’s assistant and another attorney kept the law practice operating until it closed.

Petitioner’s assistant handled his bookkeeping and payroll. Another of petitioner’s assistant’s duties was to communicate with petitioner’s tax preparer and handle petitioner’s employment taxes on petitioner’s behalf.[4]

However, it is important to recognize that the assistant was keenly aware of the circumstances where the income of the law firm was declining while substantial bills still awaited payment:

However, the assistant, privy to the law practice’s declining income and fearful of losing her job, did not perform the duties assigned to her in relation to petitioner’s employment taxes.

Petitioner was not aware that his assistant had shirked her duties. Upon learning of the unfiled returns and unpaid taxes, petitioner promptly filed the returns and paid the taxes. He did not pay the additions to tax but requested that the IRS abate them. The IRS granted petitioner partial abatement of section 6651(a)(2) failure to pay penalties.[5]

Following a Collection Due Process (CDP) hearing, the taxpayer was unable to secure the abatement of other penalties.

Respondent issued petitioner a levy notice dated August 16, 2021, proposing to collect the unpaid penalties. Petitioner timely requested a collection due process (CDP) hearing, challenging his liability for the penalties. The IRS Independent Office of Appeals (Appeals) assigned the case to a settlement officer (SO). The SO determined that petitioner did not meet the criteria for penalty abatement for reasonable cause under Internal Revenue Manual 20.1.1.3.2.2.1 (Nov. 25, 2011). The SO further found that the IRS had already granted petitioner a partial abatement of the failure to pay penalties. Accordingly, Appeals issued a notice of determination dated April 14, 2022, sustaining the penalties.[6]

The Internal Revenue Manual section referred to by the settlement officer reads as follows:

20.1.1.3.2.2.1 (11-25-2011)

Death, Serious Illness, or Unavoidable Absence

1. Death, serious illness, or unavoidable absence of the taxpayer, or a death or serious illness in the taxpayer’s immediate family, may establish reasonable cause for filing, paying, or depositing late for the following:

a. Individual: If there was a death, serious illness, or unavoidable absence of the taxpayer or a death or serious illness in the taxpayer’s immediate family (i.e., spouse, sibling, parents, grandparents, children).

b. Corporation, estate, trust, etc.: If there was a death, serious illness, or other unavoidable absence of the taxpayer (person responsible), or a member of such taxpayer’s immediate family, and that taxpayer had sole authority to execute the return, make the deposit, or pay the tax.

2. If someone other than the taxpayer, or the person responsible, is authorized to meet the obligation, consider the reasons why that person did not meet the obligation when evaluating the request for relief. In the case of a business, if only one person was authorized, determine whether this was in keeping with ordinary business care and prudence.

3. Information to consider when evaluating a request for penalty relief based on reasonable cause due to death, serious illness, or unavoidable absence includes, but is not limited to, the following:

a. The relationship of the taxpayer to the other parties involved.

b. The date of death.

c. The dates, duration, and severity of illness.

d. The dates and reasons for absence.

e. How the event prevented compliance.

f. If other business obligations were impaired.

g. If tax duties were attended to promptly when the illness passed, or within a reasonable period of time after a death or return from an unavoidable absence.

The Tax Court Finds Taxpayer Qualifies for Relief

The Tax Court initiates its analysis by providing an overview of the applicable law and the criteria by which a taxpayer can demonstrate reasonable cause and establish the absence of willful neglect.

Whether a taxpayer had “reasonable cause” and lacked “willful neglect” are questions of fact, and the burden of establishing these facts is on the taxpayer. United States v. Boyle, 469 U.S. 241, 245 (1985). To prove reasonable cause for failure to timely file a return, the taxpayer must show that he exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time. Crocker v. Commissioner, 92 T.C. 899, 913 (1989); Treas. Reg. § 301.6651-1(c)(1). A taxpayer can show that he did not act with “willful neglect” if he can “prove that the late filing did not result from a 'conscious, intentional failure or reckless indifference.'” Niedringhaus v. Commissioner, 99 T.C. 202, 221 (1992) (quoting Boyle, 469 U.S. at 245-46).[7]

In particular, the Court discusses how a taxpayer may qualify for relief based on illness or incapacity.

A taxpayer may have reasonable cause for failure to timely file a return where he experiences an illness or incapacity that prevents him from filing the return. Boyle, 469 U.S. at 248 n.6; Jordan v. Commissioner, T.C. Memo. 2005-266; Paradiso v. Commissioner, T.C. Memo. 2005-187. “Where a taxpayer’s disability is raised as part of a reasonable cause defense, we have looked to the severity of the disability and the impact it had on the taxpayer’s life. . . .” Jones v. Commissioner, T.C. Memo. 2006-176, 2006 WL 2423425, at *6.

Illness or incapacity generally does not prevent a taxpayer from filing returns where the taxpayer is able to continue his business affairs despite the illness or incapacity. See Hazel v. Commissioner, T.C. Memo. 2008-134, 2008 WL 2095614, at *3-4; see also Watts v. Commissioner, T.C. Memo. 1999-416, 1999 WL 1247548, at *2 (“[A] taxpayer’s selective inability to perform his or her tax obligations, while performing their regular business, does not excuse failure to file.”). Further, failure to timely file is not excused by a taxpayer’s reliance on an agent, and such reliance is not reasonable cause for a late filing under section 6651(a)(1). McNair Eye Ctr., Inc. v. Commissioner, T.C. Memo. 2010-81, 2010 WL 1558164, at *2 (citing Boyle, 469 U.S. at 252).[8]

Through an examination of the taxpayer’s actions in navigating the difficulties he confronted, the Tax Court concludes that there existed reasonable cause for the failure to timely file the returns in question.

Notwithstanding petitioner’s many difficulties due to his failing health and advanced age, petitioner was diligent in exercising ordinary business care and prudence. He had systems in place to ensure tax compliance. Petitioner’s systems had not previously failed him in his approximately 60 years of solo law practice. It was reasonable, and not willfully neglectful, for petitioner to trust his systems’ continued reliability. Further, it was not petitioner’s reliance on his assistant but his inability to adequately supervise her (due to his failing health and advanced age) that caused his failure to file. Petitioner acted quickly to file the outstanding returns upon discovering he was out of compliance. Had he been able to supervise his assistant properly, petitioner would have ensured that the returns were filed.[9]

Recognizing the similarity in criteria for demonstrating reasonable cause between failing to timely pay the tax and failing to timely file, the Court determines that reasonable cause indeed exists for the taxpayer's failure to timely pay the tax in question.:

Given all the facts and circumstances, petitioner was diligent in exercising ordinary business care and prudence in providing for payment of his tax liabilities but was nevertheless unable to pay timely because of his poor health and advanced age. As previously discussed, petitioner had effective systems in place that failed him in his final years of law practice only because he was unable to supervise his assistant properly.[10]

Unique Facts Lead to a Unique Result

The unique set of circumstances in this case results in a outcome that deviates from the potential consequences your client may face when confronted with a failure to file and failure to pay penalty, particularly if an employee entrusted with these responsibilities fails to ensure prompt adherence to the required obligations.

Typically, a taxpayer will not be deemed to have exercised ordinary business care and prudence if they merely delegate actions to a third party but fail to adequately oversee and supervise the actions of that party to ensure the fulfillment of the obligation.

Similarly, if a taxpayer can maintain the continuity of their business operations despite encountering illness or other adversities, it is improbable that the IRS and courts will excuse a failure to meet tax obligations.

In this case, the taxpayer’s reliance on the assistant was deemed justified due to multiple factors. Firstly, the assistant had been implementing procedures that had proven successful for the taxpayer throughout his extensive 60-year practice. Additionally, the taxpayer’s illness and the responsibility of caring for his terminally ill spouse contributed to the unique circumstances. The Court determined that it was the rare combination of the assistant’s procedures failing precisely when the taxpayer encountered numerous challenges that excused his failure to identify the issues earlier.

In a similar vein, despite the law practice’s ability to remain functional during this period, it was primarily individuals other than the taxpayer who assumed the responsibility of carrying out the essential business activities required to meet the attorney’s obligations towards clients. The practice operated in a manner that deviated significantly from its regular operations during the majority of its existence.

[1] Tracy v. Commissioner, T.C. Summ. Op. 2023-20, May 30, 2023, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/court-finds-reasonable-cause-for-ailing-attorney%e2%80%99s-failure-to-pay/7gtf0 (retrieved June 3, 2023)

[2] Tracy v. Commissioner, T.C. Summ. Op. 2023-20, May 30, 2023

[3] Tracy v. Commissioner, T.C. Summ. Op. 2023-20, May 30, 2023

[4] Tracy v. Commissioner, T.C. Summ. Op. 2023-20, May 30, 2023

[5] Tracy v. Commissioner, T.C. Summ. Op. 2023-20, May 30, 2023

[6] Tracy v. Commissioner, T.C. Summ. Op. 2023-20, May 30, 2023

[7] Tracy v. Commissioner, T.C. Summ. Op. 2023-20, May 30, 2023

[8] Tracy v. Commissioner, T.C. Summ. Op. 2023-20, May 30, 2023

[9] Tracy v. Commissioner, T.C. Summ. Op. 2023-20, May 30, 2023

[10] Tracy v. Commissioner, T.C. Summ. Op. 2023-20, May 30, 2023