Court Voids Penalties for Late Filing Where Taxpayer Had a String of Bad Luck

(Parker Tax Publishing August 2016)

The Tax Court held that the taxpayer was not liable for penalties for failing to timely file and pay the tax due for her 2009 tax year, concluding that she had reasonable cause for believing that, because of an unreimbursed casualty loss, she was not required to file a return for that year. The court was sympathetic to the taxpayer's situation, which included two apartment fires that gave rise to the loss, bouts of depression, a fractured skull, and temporarily living in dehumanizing conditions at the YWCA. Rogers v. Comm'r, T.C. Memo. 2016-152.

Background

In 2006, Carolyn Rogers lived in an apartment in a cooperative. She operated a business from her apartment, called Talk of the Town Singles, which assisted single people in meeting other singles. A fire in Rogers' apartment that year did significant damage and she had to move. After that, she no longer conducted her home business because she didn't have a home office or the necessary storage space. Rogers moved into another apartment and, in 2007, a fire damaged that apartment. At the time of the 2007 fire, Rogers was in the apartment working by candlelight packing items to be put into storage. Shortly after the 2007 fire, the New York City Department of Buildings barred her from reoccupying her apartment until it was declared safe by the department.

The local newspaper printed a negative article about Rogers describing her involvement in the fires. Subsequently she was harassed by people in her neighborhood. After the second fire, Rogers rented a very small room (with shared kitchen and bath facilities) at a Young Women's Christian Association (YWCA). While living at the YWCA, Rogers had considerable difficulty dealing with the YWCA board and with several other residents. On occasion, the police were called to resolve conflicts. Rogers said that she found living under those conditions to be dehumanizing.

After the fires, Rogers experienced bouts of depression. In 2009, she fell off a subway platform and hit her head on the subway rails, fracturing her skull. As a result, she spent five days in a hospital in the intensive care unit. While in the hospital, Rogers saw a psychiatrist. After the fall, Rogers suffered from dizzy spells.

Rogers' insurance company paid her $21,469 for damages from the 2006 fire. She notified the insurance company a day or two after the 2007 fire that damage had occurred and subsequently gave the insurance company a list of destroyed or damaged personal property. She estimated that her losses from the 2007 fire exceeded $150,000. In 2009, Rogers received $43,964 in payment of her claim for damages from the 2007 fire.

Rogers prepared and timely filed her 2006, 2007, and 2008 Forms 1040. She prepared her returns herself after consulting books and electronic sources describing tax rules she thought applied to her. She sometimes contacted the IRS for information, but did not have an accountant or use the services of tax preparers to prepare her tax returns. Rogers did not claim a casualty loss deduction relating to the 2007 fire on her 2007 or 2008 Form 1040. When she filed those returns, she erroneously believed that her casualty loss was not deductible until her insurance claim was settled. Rogers did not file a Form 1040 for 2009 because she believed that, after taking into account her deductible casualty loss, she was not required to file an income tax return for 2009.

In 2013, the IRS prepared a substitute for return for Rogers's 2009 tax year. Subsequently, Rogers met with the IRS in an effort to settle her case. She realized that she had erred regarding the year of deduction of her casualty loss, and she settled that issue except for penalties assessed under Code Sec. 6651(a)(1) for her failure to timely file her 2009 return and Code Sec. 6651(a)(2) for her failure to time pay the 2009 tax due. Before the Tax Court, Rogers argued that she should not be liable for the penalties because she had reasonable cause for not filing the return or paying the tax due.

Analysis

The Tax Court held that Rogers was not liable for either of the penalties because her failure to file her return and pay the tax due in a timely manner was due to reasonable cause and not willful neglect. Reasonable cause exists, the court noted, if the taxpayer exercised ordinary business care and prudence but nevertheless could not file or pay the tax when due. On the other hand, willful neglect means a conscious, intentional failure or reckless indifference. Citing Reg. Sec. 1.6651-1(c)(1), the court observed that a delay in filing a return is due to reasonable cause if the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time. According to the court, Rogers correctly handled her tax filings and payments before 2009 and testified that she believed her loss was deductible for the year she settled the insurance claim and that her casualty loss (to the extent not compensated by insurance) more than offset her 2009 income, obviating the requirement that she file a 2009 return.

The Tax Court found Rogers' error regarding the proper year of deduction of the portion of a casualty loss for which there is no prospect of recovery from insurance to be considerably different from the errors made by a taxpayer whose failure to file, late filing, or late payment is chronic. Erroneously deducting a loss in a year later than the correct year is not usually considered to be a blatant tax avoidance technique, the court said. The court found that Rogers' living conditions and the resulting bouts of depression made it reasonable to believe that she did not understand the correct year of a casualty deduction. Thus, taking into account all of the facts and circumstances, the court concluded that Rogers exercised ordinary business care and prudence under the difficult circumstances in which she was living at the time leading up to the due date of her 2009 return and that her error (claiming a deduction for a year later than the current year) did not constitute a conscious, intentional failure or reckless indifference to her tax filing obligations for 2009. The court applied the same analysis to its conclusion that Rogers was not liable for the penalties for failing to timely pay the tax due.

For a discussion of proper timing of a casualty loss deduction, see Parker Tax ¶84,540.

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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