CPA's Advice Did Not Provide Reasonable Cause for Late Returns and Tax Payments

(Parker Tax Publishing November 2021)

The Tax Court found that a couple was liable for penalties for failing to timely file tax returns, failing to timely pay taxes, and failing to pay estimated taxes. The court rejected the taxpayers' argument that they reasonably relied on the advice of their CPA that filing returns while under audit for earlier years could subject them to perjury charges because, the court said, allowing such a basis for reasonable cause would make timely filing optional for any taxpayer under audit. Morris v. Comm'r, T.C. Memo. 2021-120.

Background

James Morris and Lori Egbers-Morris are husband and wife. James is a successful businessman and owned multiple businesses including Morris Packaging, LLC (Morris Packaging), Morris Converting, LLC (Morris Converting), and Roar Food Group, LLC. During 2015 and 2016, the years at issue, James made most of the day-to-day decisions for these businesses. The Morrises each owned shares in S corporations, James in Heartland Supply Co. and Lori in Commercial Bag Co. In 2013, James expanded his packaging business into the manufacture of converted packaging and formed Morris Converting. He constructed a production facility and invested millions of dollars in machinery and equipment which he financed at least in part through intercompany transactions. Morris Converting expanded rapidly and grew to employ around 175 people.

The Morrises' tax returns for the years at issue were prepared by Dennis Knobloch, a CPA with the firm of Striegel, Knobloch & Co. (SKC). Knobloch prepared the couple's joint returns from 2000 to 2018. James also used SKC as the accountants for his businesses although he employed a receptionist who performed some bookkeeping. SKC had full access to the businesses' bookkeeping records. James relied on SKC to perform monthly reconciliations of his business records, and SKC was able to input and modify bookkeeping entries as necessary without James's approval. A different CPA firm prepared the S corporation returns. James realized after the years at issue that he needed to change his accounting system because of the growth of his businesses and his expansion into manufacturing. He has since expanded the internal accounting staff, hired a chief financial officer, and engaged a new CPA firm to prepare tax returns.

Around 2016, the IRS began an audit for the Morrises' 2013 and 2014 tax years which involved issues relating to capital expenditures incurred by Morris Converting. The Morrises did not timely file a return for 2014 and had not filed a return when the 2016 audit began. SKC represented the Morrises during the audit. James understood that Knobloch was concerned about filing the 2015 return during the audit and duplicating errors on the 2015 return, which had to be signed under penalties of perjury. Knobloch recommended to James that the Morrises settle the years under audit. The IRS received the Morrises' 2014 return in November of 2017. It reported tax of $27,852 and an overpayment of $24,080. The IRS closed the audit in 2018.

The Morrises timely requested extensions for filing their 2015 and 2016 returns, but did not file them by the extended due dates. They did not make a payment of tax with the request for an extension for the 2015 return. Further, the Morrises did not make any estimated tax payments during the years at issue and did not have tax withheld from their paychecks during 2015. James had a minimal amount of tax withheld from his wages during 2016. For 2015 and 2016, the Morrises, respectively, had ordinary income from their S corporations of over $2.2 million and $3 million. During the audit for 2013 and 2014, the revenue agent asked the Morrises to provide their 2015 return to him by May 15, 2017.

The IRS prepared substitute returns for James and Lori for 2015 and 2016 with the filing status married filing separately. In 2018, the IRS received the Morrises' Form 1040 for 2015 showing total tax of $598,926, and for 2016 showing total tax of $1,691,853. The Morrises paid $469,000 with their 2015 return and paid an additional $210,000 toward the tax owed for 2015 by July 1, 2019. They did not make a payment with their 2016 return. In May of 2018, the IRS issued a notice of deficiency for 2015 and 2016 that determined deficiencies on the basis of the substitute returns. The Morrises and the IRS stipulated that the couple had joint deficiencies of $599,469 and $1,691,959 for 2015 and 2016, respectively. Unresolved was their liability for additions to tax for failure to timely file their returns and pay the taxes owed under Code Sec. 6651(a)(1) and (2), and for failure to pay estimated tax under Code Sec. 6654.

The additions tax for failure to timely file returns and pay taxes under Code Sec. 6651(a)(1) and (2) apply unless the taxpayer proves that such failures are due to reasonable cause and not due to willful neglect. There is no reasonable cause exception for failing to pay estimated taxes. Under U.S. v. Boyle, 469 U.S. 241 (S. Ct. 1985), reasonable cause for a failure to file exists where the taxpayers exercised ordinary care and prudence but were nevertheless unable to file the return by the due date. Reasonable cause for failure to pay exists where the taxpayer exercised ordinary business care and prudence in providing for payment but was nevertheless either unable to pay the tax or would have suffered undue hardship if he or she had paid it. Under Boyle, taxpayers may demonstrate reasonable cause through their good-faith, reasonable reliance on the advice of an independent, competent tax professional that no return was required to be filed or that no tax was owed. However, taxpayers have the burden of filing returns and paying taxes owed, and they cannot delegate those duties to an agent or accountant. One does not have to be a tax expert, the Court remarked in Boyle, to know that taxes must be paid when they are due.

The Morrises argued that they had reasonable cause for their failure to timely file their 2015 and 2016 tax returns because Knobloch advised them that filing while under audit for earlier years could subject them to perjury charges, which they argued involved a question of law. They also asserted that they lacked the education and experience to prepare and file their returns themselves because of complicated issues relating to their businesses. Regarding their failure to pay the taxes they owed, the Morrises claimed that they had reasonable cause because they initially believed they would not owe tax for 2015 and 2016 due to the millions of dollars that they spent to start Morris Converting. They contended that they understood from Knobloch that James's businesses would have a tax loss for 2015.

Analysis

The Tax Court held that the Morrises did not have reasonable cause for their untimely filings and tax payments. Regarding their late filings, the court noted that the Morrises were advised to delay filing returns while audits for prior years were completed. In the court's view, allowing such advice to provide a basis for reasonable cause to avoid late filing penalties would make timely filing optional for any taxpayer under audit. The court said that the Morrises were aware that they had a duty to file their return on time and they consciously failed to file. The court further found that, although Knobloch may have informed the Morrises that resolution of the Morris Converting capital expenditures issues might affect reporting for 2015 and 2016, such advice did not excuse their failure to file or their failure to pay tax on their income unrelated to Morris Converting.

The court noted that, during the audit, the revenue agent sought the Morrises' 2015 return and asked them to provide it by May 15, 2017, but the Morrises did not file the 2015 return until nearly a year later. In the court's view, it was not reasonable for the Morrises to continue to rely on Knobloch's alleged advice when the revenue agent was telling them to file the return. The court further found that the Morrises filed their 2016 return more than six months after the audit closed, and only after the IRS issued notices of deficiency to them. The untimely filing of the Morrises' 2014 return in November of 2017, over 2-1/2 years after its prescribed due date, also caused the court to doubt the Morrises' argument that they relied on their CPA to delay filing their 2015 and 2016 returns.

The Tax Court also was not persuaded by that the Morrises reasonably relied on Knobloch's advice that they would not owe tax for 2015 and 2016. The court thought it was significant that the Morrises did not have federal income tax withheld from their wages or pay tax on the substantial amounts of income from their S corporations unrelated to the business expansion of Morris Converting. It was unreasonable, in the court's view, for the Morrises to have believed that they would not owe tax on this income, and Knobloch's alleged advice did not explain why they did not have tax withheld from their wages or pay tax on the S corporation income. Noting that the Morrises had stipulated that their tax for 2015 was over $500,000, and finding that they did not take any steps to ensure timely payment for either year at issue, the court concluded that the Morrises did not exercise ordinary business care and prudence. Nor did they assert or offer any evidence that they were unable to pay the tax owed, or that payment would cause them undue hardship.

With respect to the addition to tax for failing to pay estimated taxes, the court held that the IRS met its burden of showing that the Morrises were required to make payments for both years and failed to make them. Further, the court said, the Morrises did not qualify for any of the exceptions to the penalties listed in Code Sec. 6654(e). Accordingly, the Morrises were liable for the Code Sec. 6654(a) addition to tax for both years.

For a discussion of abatement of penalties due to reasonable cause and acting in good faith, see Parker Tax ¶262,127.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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