The case of Doyle v. Commissioner, TC 2019-8 is remarkable not so much for the decision that Mr. Doyle owed additional tax, but for the Court’s analysis of why he should not face penalties.  The taxpayer in this case was able to prove had reasonably relied upon the advice of a tax professional.

The IRS has revised the adequate disclosure Revenue Procedure (Revenue Procedure 2018-11).  The procedure that contains the provisions that would provide for adequate disclosure for purposes of avoiding certain penalties under §6662 (accuracy related penalty imposed on taxpayers) and §6694 (paid preparer penalties).

The procedure is meant to provide guidance as to what constitutes adequate disclosure of positions that do not have substantial authority but do have a reasonable basis.  Adequate disclosure of such positions in most cases serves to eliminate the accuracy related penalty due on substantial understatements of tax or the paid preparer penalty for a tax deficiency related to an unreasonable position.

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The penalty for a substantial understatement of tax found at IRC §6662(b)(2) is triggered whenever a taxpayer faces a sufficiently large underpayment at the end of an examination.  A substantial understatement exists for an individual if the understatement is greater than the greater of:

• $5,000 or
• 10% of the tax required to be shown on the return for the taxable year.

Once the IRS establishes an underpayment that exceeds the thresholder, to escape the penalty, the taxpayer must meet one of the following criteria:

• If the underpayment did not arise from a tax shelter (as defined at IRC §6662(d)(2)(C)) either:
  • There was or is substantial authority for the treatment of the item or
  • There was adequate disclosure (generally on a Form 8275 or Form 8275-R) and there exists or existed a reasonable basis for the position that gave rise to the underpayment (IRC §6662(d)(2)) or
• There existed reasonable cause for the underpayment, the taxpayer acted in good faith (IRC  §6664(c)) and the underpayment did not arise from a tax shelter (again as defined at IRC §6662(d)(2)(C)).

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Although the TEFRA Partnership audit rules are now living on borrowed time, cases looking at new issues continue to arise under those rules, and many involve concepts that likely will carry over to the new partnership audit regime.  One such issue arose in the case of Malone v. Commissioner, 148 TC No. 16.

Congress in 1997 modified the TEFRA partnership audit rules to bring certain issues involving penalties applicable to partnership items under the TEFRA rules where the matter had to be decided in a partnership proceeding, and not in proceedings for individual partners.

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The tax laws are complicated and, at times, the results are not what a taxpayer might like. The combination of these two facts cause some taxpayers to start “opinion shopping” when they receive an answer they don’t like. In the case of Mallory v. Commissioner, TC Memo 2016-110, the taxpayers ended up casting about for someone who would tell them what they wanted to hear.

The Mallories had purchased a single premium variable life insurance policy on Mr. Mallory for $87,500 in 1987. The policy provided that Mr. Mallory could borrow from the carrier and the loan would be secured by the policy, with any unpaid interest on the loan being added to the loan amount. Beginning in 1991 Mr. Mallory took advantage of this “tax free” source of funds, eventually taking out cash of over $133,000 by the end of 2001.

The only issue remaining to be decided by the Tax Court in the case of Brinks, Gilson & Lione a Professional Corporation v. Commissioner, TC Memo 2016-20 was whether the corporation could escape the accuracy related penalty under IRC §6662 for a substantial understatement of tax.

In this case the corporation had conceded the issue of whether a portion of what it had paid in salaries to shareholders should be treated as dividends.  The resulting tax assessments for each of the years in question exceeded 10% of the tax required to be shown on the return[1], in which case the penalty will automatically apply unless the taxpayer can show it qualifies for one of the exceptions.

In revising the annual Revenue Procedure (Revenue Procedure 2016-13) that contains the provisions that would provide for adequate disclosure for purposes of avoiding certain penalties under §6662 (accuracy related penalty imposed on taxpayers) and §6694 (paid preparer penalties), the IRS reduced the amount of information certain taxpayers must provide on Schedule M-3 to have adequate disclosure.

Wanting something to be true won’t necessarily make it true.  And, it turns out, hiring advisers to help you achieve the tax result you want, but then “editing” the information you provide them doesn’t allow you to rely on their work or get out of penalties when you are found to owe tax due to reality not comporting with your view of what should have been the reality.

This was the problem in the case of Brinkley v. Commissioner, TC Memo 2014-227, affirmed CA5, No. 15-60144.  The taxpayer in this case was an individual who was working for a technology company start-up and was given stock in the enterprise.  As is often true in such entities, the organization went out regularly to obtain new equity funding which served to dilute the interest of existing shareholders.

The open transaction doctrine, if applicable to a case (and that’s a really big if), provides that a taxpayer generally treats amounts received as a return of capital until the taxpayer’s basis has been entirely recovered.  Unfortunately for the taxpayers in the case of Friedman v. Commissioner, TC Memo 2015-177, the Tax Court did not find their situation to be one where that doctrine applied.