Everyone is human. Sometimes we forget that 1099 on the tax return. Today, the Tax Court looked at a case where a tax professional omitted just one 1099. The problem was that this 1099 represented $3.4 million of income, and the IRS assessed a $104,295 accuracy-related penalty. The petitioner argued that because he relied on the advice of a professional, he shouldn’t have to pay the accuracy-related penalty. The IRS disagreed, and The Tax Court had to decide what to do.

The basic facts weren’t in dispute. The petitioners ended a “swap” transaction, and realized $3.4 million of income in 2006. For reasons that are unknown, the 1099 from Deutsche Bank didn’t make it on to their return. Mind you, this wasn’t a simple return: “Petitioners’ payors reported that income to petitioners and to the IRS on more than 160 information returns, e.g., Schedules K-1 and Forms 1099, including the Deutsche Bank Forms 1099-MISC and 1099-INT…For 2006 petitioners filed 27 State income tax returns and a joint Federal income tax return.” The return itself was 115 pages thick.

There also wasn’t a dispute about the taxpayers using a professional. “To prepare their 2006 Federal income tax return, petitioners hired Venture Tax Services, Inc. (“VTS”), a niche firm specializing in tax work for private equity and hedge funds as well as such funds’ general partners…The VTS employee charged with actually preparing the return was a Massachusetts certified public accountant (“C.P.A.”) who similarly had more than 20 years of tax compliance experience, including employment with major accounting firms.”

The IRS discovered the omission, and assessed the additional tax. This increased the total tax from $3.7 million to $4.2 million. The petitioners paid the tax and interest, but disputed the penalty. The law allows,

A taxpayer who is otherwise liable for the accuracy-related penalty may avoid the liability if he can show, under section 6664(c)(1), that he had reasonable cause for a portion of the underpayment and that he acted in good faith with respect to that portion.

And relying on a professional is an exception: “Reliance on * * * professional advice * * *constitutes reasonable cause and good faith if, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith.”

The problem for the petitioners was that, in the view of the Tax Court, no advice was given by the professional that the income shouldn’t have been included.

The taxpayer must show (in the words of Neonatology Associates, 115 T.C. at 99 (emphasis added)) that he “relied in good faith on the adviser’s judgment.” Petitioners present no testimony of the preparer (nor any other evidence) to show that the income was omitted from the return because of any “analysis or conclusion” or “judgment” by VTS that the income was not taxable. When the Supreme Court discussed the “reasonable cause” defense in Boyle, it characterized the relevant professional role as giving “substantive advice”, id. at 251, and contrasted that professional function with things that “require[] no special training”, id. at 252. No “special training” was required for Mr. Woodsum to know that the law required him to include on that return an item of income that he had received and that Deutsche Bank had reported on Form 1099.

A similar theory allows for a return preparer’s error to allow for the removal of the accuracy-related penalty. But the petitioners fail here, too. First, the case was submitted fully stipulated, and there was no stipulation regarding the cause of the error. Second, there was no evidence that the taxpayers spent time reviewing the return.

“Even if all data is furnished to the preparer, the taxpayer still has a duty to read the return and make sure all income items are included.” Magill v. Commissioner, 70 T.C. 465, 479-480 (1978), affd. 651 F.2d 1233 (6th Cir. 1981).

Mr. Woodsum, however, makes no showing of a review reasonable under the circumstances. He personally ordered the termination that gave rise to the income; he received a Form 1099-MISC reporting that income; that amount should have shown up on Schedule D as a distinct item; but it was omitted…A review undertaken to “make sure all income items are included” (in the words of Magill)–or even a review undertaken only to make sure that the major income items had been included–should, absent a reasonable explanation to the contrary, have revealed an omission so straightforward and substantial.

The Tax Court concluded,

That is, when his own receiving of income was in question, Mr. Woodsum was evidently alert and careful. But when he was signing his tax return and reporting his tax liability, his routine was so casual that a half million-dollar understatement of that liability could slip
between the cracks. We cannot hold that this understatement was attributable to reasonable cause and good faith.

Case: Woodsum v. Commissioner, 136 T.C. No. 29