Owner of Tax Prep Firm Was Not Liable for Penalties on Returns Signed by Employees

(Parker Tax Publishing October 2018)

A district court held that the sole owner of a tax return preparation business was not liable under Code Sec. 6694(b) for penalties relating to understatements of tax on returns prepared and signed by employees or independent franchisees of the business. The court found that there was no evidence of the owner's involvement with the returns, much less evidence of willful or reckless conduct as required under Code Sec. 6694, and it rejected the government's argument that the employer was liable regardless of the extent of his involvement with the returns or whether he signed them. Lowery v. U.S., 2018 PTC 329 (W.D. N.C. 2018).

Background

Marshall Lowery was the sole member of Computer Plus, LLC, d/b/a "Rapid Tax." Computer Plus employed individuals including Lowery to provide paid tax preparation services to its clients. In 2014, the IRS sought to impose $170,000 in tax preparer penalties against Lowery arising out of 34 tax returns prepared for 2009 and 2010.

Lowery appealed the penalties. IRS Appeals Officer Maria Frazier concluded that there was insufficient evidence to support a penalty for nine of the now 25 returns at issue, and recommended reducing the penalty from $170,000 to $100,000. Lowery sent a request under the Freedom of Information Act for every document in the IRS's files relating to the proposed penalties, but the IRS provided no documents in response.

Before the final penalties were assessed, Lowery's appeal was reassigned to IRS Appeals Officer Sandra Mical. Mical recommended an assertion of $77,500 in penalties: a full penalty of $5,000 each for six returns prepared by Lowery, and a 50 percent penalty for 19 returns prepared by independent franchisees or employees of Computer Plus. In recommending the reduced penalties, Mical noted that there were "hazards to both parties" as to whether Lowery would be determined to be the tax return preparer. She also noted a significant lack of evidence with respect to five of the returns.

In 2016, the IRS sent a notice and demand to Lowery for penalties assessed under Code Sec. 6694(b) arising out of all 25 of the returns. Lowery paid 15 percent of each penalty and filed Forms 6118, Claim for Refund of Tax Return Preparer and Promoter Penalties. After six months of inaction on the IRS's part, Lowery sued for a refund in a district court.

Analysis

Under Code Sec. 6694(b), a tax return preparer is liable for a penalty if a return understates a tax liability and the understatement is willful or the preparer recklessly or intentionally disregards the rules or regulations. Reg. Sec. 1.6694-1(b)(2) provides that, in general, the preparer who signs the return is primarily responsible for all of the positions on the return. However, a nonsigning return preparer who prepares all or a substantial part of a return, and who has overall supervisory responsibility for the position giving rise to the understatement, is generally considered the return preparer who is primarily responsible for purposes of the penalty. Under Reg. Sec. 1.6694-3(a)(2), a firm that employs a return preparer is liable only if an officer of the firm participated in or knew about the wrongful act.

In the district court, Lowery and the IRS filed cross motions for summary judgment. Lowery argued that he was not a nonsigning preparer because the IRS had done nothing to determine whether the signing preparers were or were not primarily responsible for the positions on the returns. Lowery also contended that even if he did play a role in preparing the returns not signed by him, there was no evidence he disregarded any information provided by the taxpayer or intentionally or recklessly disregarded any rule or regulation. According to Lowery, if he was the return preparer, then it was only his conduct that would give rise to the imposition of penalties, which he asserted was consistent Reg. Sec. 1.6694-3(a)(2) and which, he said, imposes liability on a firm only when it can be shown that the firm was complicit in the wrongful act. Lowery cited legislative history to support his contention that Code Sec. 6694 was not intended to impose mere vicarious liability on the employer of a return preparer. Lowery then went on to assert that he was not the employer of any of the signing return preparers; Computer Plus was, and there was no evidence he had a supervisory role or any involvement with the returns signed by other preparers. With respect to the six returns Lowery signed, Lowery argued that there was no evidence he disregarded information or acted willfully or with reckless disregard.

The government argued that whether Lowery was a signing or nonsigning preparer was irrelevant because there was no dispute that he prepared and signed six returns and that he employed individuals who prepared and signed the remaining 19. According to the government, Lowery was a return preparer as an employer because he was the sole member of Computer Plus, which employed the preparers who signed the returns. Reg. Sec. 1.6694-3(a)(2) was inapplicable, according to the government, because it refers to a firm, but the IRS never asserted firm liability.

The district court denied the government's motion and granted summary judgment for Lowery with respect to the 19 returns signed by other preparers, but denied his motion with respect to the six returns he signed. For the six returns prepared by Lowery, the court found that whether his conduct was willful or reckless were questions of fact that should be decided by a jury.

However, the district court found that even if Lowery was considered a return preparer of the 19 returns in question, there was no evidence that he took a position on any of them. In the court's view, there was no evidence of Lowery's involvement with the returns not signed by him, much less evidence of willful or reckless conduct as required under Code Sec. 6694. The court was not persuaded that Lowery could be held liable under Code Sec. 6694(b) for returns he was not involved with and that were signed by other return preparers.

The district court disagreed with the government's assertion that Lowery could be held liable for all of the returns as the employer of the preparers. The court distinguished the district court cases cited by the government, noting that in each case where an employer was found liable, the employer was also the signer of the returns. The court found that Lowery did not sign any of the 19 returns and saw no reason to rebut the presumption that the actual signers of the returns were responsible, especially where there was no evidence that Lowery prepared a substantial portion, or any portion, of the returns. The court concluded that the government had failed to meet its burden of showing willful conduct and that Lowery had adequately shown the absence of reckless or intentional disregard.

For a discussion of the penalty for willful or reckless understatement of a liability by a tax return preparer under Code Sec. 6694(b), see Parker Tax ¶276.315.

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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