Jury Verdict of Reasonable Cause for Late Filing Vacated Due to Flawed Jury Instructions

(Parker Tax Publishing July 2024)

The Fifth Circuit vacated a jury verdict awarding a limited partnership a refund of penalties for failure to timely file information returns and remanded for a new trial after finding that the district court's jury instructions regarding what qualifies as an impediment to timely filing under Reg. Sec. 301.6724-1(c) were irredeemably flawed. The Fifth Circuit found that the instruction incompletely and incorrectly delineated allowable impediments by stating that an agent's incapacity, alone, was a sufficient basis to excuse a taxpayer's late filing. RSBCO v. U.S., 2024 PTC 214 (5th Cir. 2024).

Background

RSBCO is a limited-partnership subsidiary of Argent Financial Group, a wealth management firm. For the 2012 tax year, RSBCO was required to file with the IRS more than 21,000 annual information returns. Gregory Smith, Argent's operations manager, was responsible for electronically filing RSBCO's returns through the IRS's Filing Information Returns Electronically (FIRE) system by March 31, 2013.

Smith attempted to file RSBCO's returns the day they were due. Days later, however, the FIRE system sent Smith an automated message that certain of the files containing the returns had errors that prevented them from being processed and that RSBCO was required to send replacement files. The FIRE system thereafter sent two additional reminder emails to Smith. On July 16 and 17, 2013, Smith filed corrected returns that were accepted and processed.

Over a year after Smith filed the corrected returns, the IRS sent RSBCO a notice of proposed penalties for the delay in filing processable 2012 returns. The notice made clear that RSBCO was entitled to dispute the penalty if it believed its failure was due to reasonable cause. RSBCO did not respond to the notice. Instead, RSBCO said it was unaware of the notice until it was discovered in Smith's desk after Smith was terminated in November 2014. In October 2015, almost a year after RSBCO discovered the notice of proposed penalties in Smith's desk, the IRS actually assessed penalties against RSBCO for $510,700 ($500,000 for the late filing of 20,328 returns, and $10,700 for filing 107 returns with incorrect information).

When the IRS sent RSBCO a notice of intent to levy in January 2018, RSBCO requested a hearing and asserted a reasonable cause defense. After the telephonic hearing, the IRS offered to concede 25 percent of the penalty amount, but RSBCO instead paid the penalties and accrued interest in full and filed an administrative refund claim for $579,198, grounded on the same reasonable cause defense. The IRS failed to act on the claim within six months, so RSBCO filed a complaint for a refund in district court, again asserting reasonable cause for its untimely filings. After extensive motions practice, including denied cross-motions for summary judgment, the question of whether RSBCO had reasonable cause for its filing delay, as defined in Reg. Sec. 301.6724-1, was tried before a jury.

RSBCO contended that its failure to file was caused by Smith's clinical depression - an event beyond RSBCO's control. Smith testified that he suffered from clinically diagnosed depression in 2013, and as a result, he had been suicidal and struggled to focus and complete tasks at work. Specifically, Smith's depression inhibited him from properly filing RSBCO's 2012 information returns.

The jury returned a verdict for RSBCO, finding that RSBCO established that it had acted in a responsible manner and that there were either significant mitigating factors or events beyond RSBCO's control that contributed to its failure to file timely returns. The district court denied the government's post-trial motions for judgment as a matter of law or a new trial and then granted RSBCO's post-trial motion for attorney fees. The government appealed to the Fifth Circuit, challenging both the jury verdict as based on faulty instructions and the award of attorney fees and costs.

In 2013, filers like RSBCO that were required to file more than 250 information returns had to do so electronically by March 31 for the 2012 tax year. Failure to file a processable return within 30 days after the due date resulted in a penalty of $60 per return. The maximum amount imposed on a delinquent 2012 filer was capped at $500,000.

Under Code Sec. 6724(a)(1), a filer is not liable for penalties if it can show that its failure to file timely was due to reasonable cause and not willful neglect. Under Reg. Sec. 301.6724-1(a), reasonable cause exists if the filer establishes either that "there are significant mitigating factors with respect to the failure ... or the failure arose from events beyond the filer's control ([an] impediment)."

Under Reg. Sec. 301.6724-1(c)(1), "events beyond the filer's control," i.e., impediments, that may excuse untimely filing, "include but are not limited to" (1) the unavailability of the relevant business records, (2) an undue economic hardship relating to filing on magnetic media, (3) certain actions of the IRS, (4) certain actions of an agent (as described in Reg. Sec. 301.6724-1(c)(5)), and (5) certain actions of the payee or any other person providing necessary information with respect to the return or payee statement. Reg. Sec. 301.6724-1(c)(5), in turn, cabins which "actions of an agent" qualify as impediments to proper filing. It provides that in order to establish reasonable cause under Reg. Sec. 301.6724-1(c)(1) due to actions of an agent, the filer must how that (1) the filer exercised reasonable business judgment in contracting with the agent, and (2) the agent satisfied either the reasonable cause criteria set forth in Reg. Sec. 301.6724-1(b) (i.e., mitigating factors) or Reg. Sec. 301.6724-1(c)(2) through (6) (i.e., impediments).

Reg. Sec. 301.6724-1(c)(2) provides that, to establish reasonable cause due to the unavailability of the relevant business records, the filer's business records must have been unavailable under such conditions, in such manner, and for such period as to prevent timely compliance (ordinarily at least a 2 - week period prior to the due date of the required return), and the unavailability must have been caused by a "supervening event." Under Reg. Sec. 301.6724-1(c)(2)(iii), a "supervening event" includes, but is not limited to, the "unavoidable absence (e.g., due to death or serious illness) of the person with the sole responsibility for filing a return or furnishing a payee statement."

On the issue of impediments under Reg. Sec. 301.6724-1(c)(2)-(6), the district court provided the following instruction: "The law does not define Impediments. However, an impediment is generally defined as "a hindrance or obstruction in doing something." And the IRS provides examples of Impediments potentially warranting a Reasonable Cause refund or waiver including but not limited to: (i) Actions of the filer's agent. ("Events which are generally considered beyond the filer's control include but are not limited to: (iv) Certain actions of an agent . . ."); (ii) The death, serious illness, or unavoidable absence of the filer. ("Death, Serious Illness or Unavoidable AbsenceDeath, 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.")

On appeal to the Fifth Circuit, the government argued that the district court's jury instruction on impediments was erroneous in two respects: it incorrectly stated the law regarding the allowable actions of an agent; and it likewise misstated the law regarding "unavoidable absence" "due to death or serious illness of the person with the sole responsibility for filing a return." RSBCO disagreed, contending that the district court appropriately defined "impediments" based on its "plain and ordinary meaning," and that Smith's depression substantially impeded RSBCO. RSBCO pointed out that the list of impediments in Reg. Sec. 301.6724-1(c)(2)-(6) is not exhaustive and argued that Smith's illness thus could qualify as an impediment standing alone.

Analysis

The Fifth Circuit found that the district court's jury instruction on impediments was irredeemably flawed and therefore it vacated the verdict and remanded for a new trial. And because RSBCO was no longer the prevailing party, the court also vacated the attorney fees and costs awarded to RSBCO.

The Fifth Circuit found that the district court's instruction on impediments was both overbroad and oversimplified. It was overbroad, the court reasoned, because it stated without qualification that examples of impediments warranting a reasonable cause refund or waiver include, but are not limited to, actions of the filer's agent. The court found that nowhere did the district court explain to the jury which "certain actions" could constitute impediments consonant with the fairly intricate parameters of Reg. Sec. 301.6724-1(c). Not every action of a filer's agent, the court observed, excuses improper filing. Reg. Sec. 301.6724-1(c)(5)(ii) makes clear that only those that fall within Reg. Sec. 301.6724-1(b) or Reg. Sec. 301.6724-1(c)(2)-(6) qualify. In the view of the Fifth Circuit, the district court erred by giving such an open-ended instruction and allowing the jury to find that any of Smith's actions that constituted "a hindrance or obstruction" to RSBCO's timely filing constituted reasonable cause.

It was also error, according to the Fifth Circuit, for the instruction to state that the "death, serious illness, or unavoidable absence of the filer" was an example of an impediment potentially warranting a reasonable cause refund. The Fifth Circuit found that "death, serious illness, or unavoidable absence of the filer" is not included as an "example" of a cognizable impediment in Reg. Sec. 301.6724-1(c)(2) - (6). Instead, "death, serious illness, or unavoidable absence of the filer" is enumerated only as a "supervening event" justifying the "unavailability of the relevant business records" under Reg. Sec. 301.6724-1(c)(2). In other words, Smith's incapacity, alone, was not a sufficient basis to excuse RSBCO's late filing and to the extent the jury was allowed to find otherwise, the instruction was flawed.

The Fifth Circuit agreed with RSBCO that the list of impediments in Reg. Sec. 301.6724-(1)(c)(2)-(6) is not exclusive. However, the court found that "death, serious illness, or unavoidable absence of the filer" is expressly included in Reg. Sec. 301.6724-1(c)(2)(iii) not as an impediment but as a "supervening event" justifying one - the unavailability of the relevant business records. In the court's view, that suggested that the regulation excludes a filer's "unavoidable absence" as a stand-alone impediment in its own right. Regardless, the Fifth Circuit concluded that the jury instruction at issue fell directly within the ambit of Reg. Sec. 301.6724-1(c)(2). It followed, the court found, that the instruction should have fully delineated what RSBCO was required to prove for "actions of an agent," or the "unavoidable absence (e.g., due to ... serious illness)" of the filer, to have impeded RSBCO from timely filing processable returns. By contrast, the Fifth Circuit found that the instruction as given glossed over the regulation's granularity, creating a substantial and ineradicable doubt whether the jury was properly guided in its deliberations.

For a discussion of the reasonable cause exception to information reporting penalties, see Parker Tax ¶262,130.

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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