Consent
7216-
Disclosure of Tax Information: Consent
Rev.
Rul. 77-303, 1977-2 CB 481
Section 7216.--Disclosure or Use of Information by Preparers of
Returns
26 CFR 301.7216-3: Disclosure or use only with formal consent of
taxpayer.
[IRS Headnote] Return information used to sell insurance policy.--
A consent for the use of tax return information, obtained from the
customer by a return preparer that is a member of an affiliated group
with a life insurance agency selling retirement income-life insurance
endowment policies, permits the insurance agency and its agents, who are
not its employees, to use the return information in selling such a
policy to the preparer's customer.
[Text]
Advice
has been requested whether, under the circumstances described below, tax
return information may be used in selling a life insurance policy if the
consent required by section 7216 of the Internal Revenue Code of 1954
has been secured.
X,
an insurance agency which sells retirement income-life insurance
endowment policies, is a subsidiary of Y, a tax return preparer,
and a member of the same affiliated group within the meaning of section
1504 of the Code. Y secured from its customer A (in response to Y's
initial request and prior to A's receipt of the completed tax
return), a consent as described in section 301.7216-3(b) of the
Regulations on Procedure and Administration. The consent permitted the
use by X and its agents of A's return information for
selling to A a retirement income-life insurance endowment policy.
Y gave the return information to X whose agent used the
return information in selling to A a retirement income-life
insurance endowment policy. The agent was not an employee of X.
Section
7216 of the Code provides that the disclosure by a tax return preparer
of any information furnished to the preparer in connection with the
preparation of any tax returns is prohibited with certain exceptions.
One exception is the disclosure or use of information that is permitted
by the regulations.
Section
301.7216-3(a)(1) of the Regulations on Procedure and Administration
provides that if a tax return preparer has obtained the consent of the
taxpayer, the preparer may use the tax return information of such
taxpayer to solicit from the taxpayer any additional current business in
matters not related to the Internal Revenue Service that are offered to
the public. This authorization to use tax return information does not
apply, however, for purposes of facilitating the solicitation of the
taxpayer's use of any services of facilities furnished by a person other
than the tax return preparer, unless such other person and the tax
return preparer, are members of the same affiliated group within the
meaning of section 1504. Moreover, this authorization does not apply for
purposes of facilitiating the solicitation of additional business to be
furnished at some indefinite time in the future, as, for example, the
future sale of mutual fund shares for life insurance, or the furnishing
of future credit card services.
Accordingly,
since X is an affiliate of Y and the additional business
to be solicited by X (the sale of the particular policy) is a
business service currently provided by X of a type that X
regularly offers to the general public, X may use tax information
obtained from Y to sell a retirement income-life insurance
endowment policy to Y's customer A. Further, X may
be represented by agents who are not employees since the required
consent has been obtained from the customer, and the customer has
directed that the tax information may be used by X's agents for
the purpose of selling its retirement income-life insurance endowment
policy. Sales of other plans, policies or securities by the agent for X
require similar consents properly obtained.
Whether
taxpayers that elect to deduct advanced royalties when paid or accrued
pursuant to section 1.612-3(b)(3) of the Income Tax Regulations may
deduct the cumulative minimum royalties due over the term of a lease in
the initial year of the lease. See Rev. Rul. 77-489, page 177.
Rev.
Rul. 79-114, 1979-1 CB 441
Section 7216.--Disclosure or Use of Information by Preparers of
Returns
26 CFR 301.7216-3: Disclosure or use only with formal consent of
taxpayer.
[IRS Headnote] Return preparers; disclosure or use of return
information; consents.--
A corporation that, in addition to preparing income tax returns, makes
loans and provides business counseling to farmers and compiles general
anonymous statistical data for its own use and for public dissemination
must obtain separate written formal consents described in section
301.7216-3(b) of the regulations from the individual farmers before
using information from returns prepared by it.
[Text]
Advice
has been requested whether section 7216 of the Internal Revenue Code of
1954 requires a tax return preparer to have the formal consents of a
taxpayer to use information from a tax return under the circumstances
described below.
X,
a corporation owned by farmers, makes short term and intermediate term
loans to the farmers. In addition, X provides business counseling
services and an electronic records program for farmer-borrowers. As an
extension of the records program, X initiated a tax return
preparation service to assist farmers in the preparation of their
Federal income tax returns. X is not a corporate fiduciary as
defined by section 301.7216-2(f) of the Regulations on Procedure and
Administration. X extracts and uses information from the tax
return of a customer taxpayer for (1) business counseling of that
customer; (2) planning and servicing the customer's loans or
applications for loans; (3) soliciting business counseling and loan
business from the customer taxpayer if the customer does not already use
X for these purposes; and (4) compiling general anonymous
statistical data, such as average tax rates, for the use of X and
for public dissemination.
Section
7216(a) of the Code provides a criminal penalty if any tax return
preparer discloses or uses any information furnished for the preparation
of a tax return or declaration of estimated tax. Statutory exceptions
are provided in section 7216(b)(1) and (2), and regulatory exceptions
prescribed by the Secretary of the Treasury are authorized under section
7216(b)(3).
X's
proposed uses of a customer's tax return information in the current
business counseling of that customer and in the current planning and
servicing of loans for the customer do not come within any of the
statutory or regulatory exceptions.
Accordingly,
the tax return information cannot be used by X unless the
individual customer executes separate written consents for each separate
use or disclosure, under section 301.7216-3(b) of the regulations.
With
respect to X's proposed uses of tax return information for
soliciting additional business, section 301.7216-3(a)(1) of the
regulations specifically applies, and provides that if a tax return
preparer has obtained from the taxpayer a consent described under
section 301.7216-3(b), the preparer may use the tax return information
of such taxpayer to solicit from the taxpayer any additional current
business, in matters not related to the Internal Revenue Service, which
the preparer provides or offers to the public. The request for such
consent may not be made later than the time the taxpayer receives the
completed tax return, and if the consent is not granted, no follow-up
request may be made. Section 301.7216-3(a)(1)(i) further provides,
however, that this authorization to use tax return information of the
taxpayer does not apply to the solicitation of additional business to be
furnished at some indefinite time in the future.
Accordingly,
because X currently offers the services of business counseling,
and of planning and servicing farmer's loans or applications for loans, X
may use information from a customer's tax return for soliciting of these
additional businesses, only if X requests the separate written
consents of such customer before the customer receives the tax return
completed by X, and if such consents are in accord with the
requirements under section 301.7216-3(b) of the regulations, from that
customer. However, X cannot use information from a customer's tax
return to solicit such customer for business services unrelated to the
Internal Revenue Service which X does not presently offer, but
may furnish at some indefinite time in the future.
With
respect to X's proposed use of tax return information for
compiling anonymous statistical data, section 301.7216-3(a)(2) of the
regulations specifically applies and provides that if a tax return
preparer has obtained the required written consent of the taxpayer, the
preparer may disclose the tax return information to such third persons
as the taxpayer may direct. Accordingly, X must obtain a separate
written consent from a customer taxpayer before it may extract
information from that customer's tax return for purposes of compiling
general anonymous statistical data for its own use or for public
dissemination.
[Dec.
48,203(M)] Steven R. and Terri
T. Loftus v. Commissioner
Docket No. 24801-89., TC Memo. 1992-266, 63 TCM 2944, Filed
May 11, 1992
[Appealable, barring stipulation to the contrary, to CA-11.]
[Code
Secs. 6653 (Prior to
amendment by P.L. 101-239), 6661 (Prior to repeal by P.L. 101-239) and
7216 ]
Additions to tax: Civil penalties: Negligence: Substantial
understatement of tax: Disclosure of tax information.--A sole
shareholder and president of a corporation who used the corporation for
numerous personal expenses was liable for negligence and substantial
understatement penalties. The corporation improperly deducted the
personal expenditures because the taxpayer failed to separate business
from personal expenses on corporate books. The taxpayer failed to
provide correct information to his accountant, follow advice or review
the return. Thus, relying on his accountant to separate personal from
business expenses was unreasonable. Accordingly, the additions to tax
determined by the IRS were upheld, and the IRS did not abuse its
discretion by declining to waive the substantial understatement
penalties. A tax return of a third-party taxpayer was inadmissible as
evidence. The taxpayer attempted to introduce the return by having the
document authenticated by the return preparer instead of the taxpayer to
whom the return related. Although the taxpayer argued that the return
preparer would only acknowledge that he prepared the return, without the
consent of the third party such authentication is prohibited disclosure
by a return preparer.
Douglas
R. Thompson and Lisa Gill Rowling,
3350 Peachtree Rd., N.E.
,
Atlanta
,
Ga.
, for the petitioners. Carolyn Lee Harber, for the respondent.
Memorandum
Findings of Fact and Opinion
HAMBLEN,
Judge:
Respondent
determined additions to tax under sections 6653(a)(1) and (2) and 6661 in the respective
amounts of $2,075.60, 50 percent of the interest due on $41,512, and
$10,378 related to petitioners' understatement of income tax for the
taxable year 1983 in the amount of $41,512. Unless otherwise indicated,
section references are to the Internal Revenue Code in effect for the
taxable year at issue, and Rule references are to the Tax Court Rules of
Practice and Procedure.
The
issues for decision are: (1) Whether a purported tax return of a
third-party taxpayer should be admitted into evidence; (2) whether
petitioners were negligent under section 6653(a) by understating their
1983 tax liability by $41,512; and (3) whether respondent abused her
discretion in refusing to waive the addition to tax under section
6661 .
Findings
of Fact
Some
of the facts have been stipulated and are found accordingly. The
stipulation of facts, supplemental stipulation of facts, second
supplemental stipulation of facts, and exhibits are incorporated by this
reference.
Petitioners,
husband and wife, resided in Atlanta, Georgia, at the time they filed
their petition in this case. After filing for an automatic extension,
petitioners timely filed their joint Federal income tax return for 1983.
In February 1988, Mr. Loftus executed a Form 870, wherein he waived the
restrictions on assessments and collection of deficiencies in income tax
for the year 1983. In so doing, petitioners conceded that they
understated their 1983 income tax liability by $41,512. They paid the
delinquent amount prior to the trial of this case. The adjustments to
income related to $74,080 of unreported income from Shawnee Enterprises
Inc. (Shawnee), $22,169 of disallowed partnership losses, and $8,883 of
disallowed itemized deductions. Subsequently, respondent determined the
additions to tax at issue in this case. Respondent later declined
petitioners' request to waive the additions to tax.
Terri
T. Loftus (Mrs. Loftus) graduated from high school in 1967. She then
attended Western Illinois University but did not graduate. She has been
a flight attendant with Delta Airlines for approximately 21 years.
Steven
R. Loftus (Mr. Loftus) graduated from high school in 1969. After a brief
period of employment at a plant nursery, he worked from 1970 through
1981 for Delta Airlines in the areas of customer service and ground
operations. During 1981 Mr. Loftus was employed by Griffin Medical
Service, Inc., as a commissioned salesperson. Since that time, Mr.
Loftus has been a manufacturer's representative for the sale of
prosthetic ocular devices, such as intraocular lenses, lens implants,
and eye implants to physicians and hospitals located in North Carolina
and South Carolina.
Shawnee
was incorporated by Mr. Loftus' father, Robert E. Loftus, during 1980.
On
April 1, 1982
, Mr. Loftus acquired control of Shawnee from his father. Since his
acquisition of control of Shawnee, Mr. Loftus has been president,
director, sole shareholder, and an employee of Shawnee. Mr. Loftus used
Shawnee to receive commission checks paid by companies for whom he sold
ocular devises. Mr. Loftus considered himself and Shawnee to be one and
the same. He authorized all of Shawnee's expenditures. Mrs. Loftus was
the treasurer and an employee of Shawnee during 1983. However, Mrs.
Loftus performed only minor clerical duties, such as mailing, errands,
and answering the telephone for Shawnee.
Since
1983 Mr. Loftus has been a successful, competent businessman as
demonstrated by the over $830,000 of total gross revenues generated by
Shawnee from 1983 through 1985. Moreover, Mr. Loftus invested in
numerous financial ventures. He was a limited partner in two limited
partnerships and a general partner in another partnership.
Mr.
Loftus hired Secretarial Group, Inc. (Secretarial Group), to perform
secretarial and bookkeeping services and balance checking accounts for
Shawnee. Secretarial Group balanced Shawnee's checking accounts,
prepared and maintained monthly journals, general ledgers, adjusting
trial balances, a suspense and commission analysis, adjusting journal
entries, at least one employment tax return, and some expense reports
for Mr. Loftus. Secretarial Group prepared all reports based upon the
descriptions provided by Mr. Loftus on Shawnee checks, check stubs, cash
tickets, gasoline and meal receipts, and credit card receipts. Mr.
Loftus generally classified payments made from Shawnee's checking
account by making entries on the checks and check stubs. However, he did
not always indicate whether the expenditure was a business or a personal
expense. Mr. Loftus did not provide Secretarial Group with gas credit
card statements, nor did he inform Secretarial Group that Mrs. Loftus
signed on Shawnee credit card accounts. Mr. Loftus did not maintain a
log of his personal and business mileage, but with the assistance of
Secretarial Group maintained weekly travel expense reports.
If
Secretarial Group was unable to determine whether an item was personal
or business from the information which Mr. Loftus provided, it would
enter the expenses in journal and ledger accounts entitled
"suspense" or "miscellaneous" to be resolved later
by Mr. Loftus or Shawnee's return preparer. Mr. Loftus did not advise
Secretarial Group of his personal withdrawals of funds from Shawnee
accounts, nor did he request that Secretarial Group adjust entries in
the company's books for payments of petitioners' personal expenses and
investments. Moreover, he did not review the records prepared by
Secretarial Group. Consequently, the journals and ledgers prepared by
Secretarial Group did not properly separate personal and corporate use
of Shawnee's funds and disguised Shawnee's payment of a substantial
amount of petitioners' personal expenses. Mr. Loftus took for granted
that Secretarial Group and his return preparer would decipher the
personal expenses from the information which he provided to them.
Petitioners
retained Universal Accounting Services, Inc. (Universal), to prepare
their personal income tax returns as well as the corporate tax returns
for Shawnee for the taxable years 1983 through 1985. Mr. Loftus first
met with Comer B. Thompson (Mr. Thompson), president and treasurer of
Universal, concerning preparation of the income tax returns in September
of 1982. Mr. Thompson prepared petitioners' personal tax return as well
as Shawnee's corporate return for 1983. Although Mr. Thompson
represented himself as a bookkeeper and return preparer, petitioners
postulated that he was a tax expert and a certified public accountant
based on such things as the presence of tax law books in Mr. Thompson's
office, Mr. Thompson's comments that he was going to attend certain tax
seminars, and the name of the company, Universal Accounting. Mr.
Thompson earned a degree from Auburn University in accounting and
management. Mr. Thompson was aware that petitioners relied upon him to
be their "professional tax man".
Since
1963 Universal provided bookkeeping services and prepared income,
employment, and unemployment tax returns for individuals and small
corporations. Mr. Loftus did not employ Universal to audit petitioners'
or Shawnee's books or to prepare employment or unemployment tax returns
for Shawnee. It was Mr. Loftus' impression that Mr. Thompson was
obligated to go through the books and formulate a return for Shawnee.
However, this impression was misplaced and was beyond the scope of
Universal's engagement with petitioners. Universal was not involved in
establishing the books and records of Shawnee, nor did it compile any
ledgers or journals for Shawnee during any relevant time. During 1983
Shawnee was the only client which Universal prepared income tax returns
for which it did not also prepare and maintain books. Universal did not
perform audits of any of its other clients during the relevant time.
To
prepare returns for Shawnee, Mr. Loftus, personally or through
Secretarial Group, provided Universal with monthly journals, ledgers,
adjusting journal entries, trial balances, commission analysis, and
other information specifically requested by Universal. Mr. Loftus never
instructed Mr. Thompson as to whether amounts were personal or business
expenses. When Universal did not understand an item set forth in the
records prepared by Secretarial Group, Universal contacted Mr. Loftus
and discussed the item. Petitioners provided Universal with year end
interest summaries from credit cards and the checking account register
for Shawnee. Mr. Thompson never saw Mr. Loftus' expense reports until
the Internal Revenue Service audit in this case was commenced. If Mr.
Thompson needed more specific information, he would have to specifically
request that information, such as monthly bills or bank statements. Mr.
Loftus never refused to provide the additional information when
requested.
Mr.
Thompson generally respected Mr. Loftus' explanation of items set forth
in Shawnee's books. He did not question the journal entries because he
believed that Secretarial Group provided competent bookkeeping services.
If Mr. Thompson could not obtain satisfactory information regarding an
item in the suspense or miscellaneous accounts, he included such item in
petitioners' 1983 income. As part of preparing petitioners' returns, Mr.
Thompson also made adjusting journal entries for Shawnee at yearend.
In
addition to information related to Shawnee, petitioners provided Mr.
Thompson with Mrs. Loftus' Forms W-2, interest statements issued in
petitioners' names, Schedules K-1 related to numerous partnerships, a
check register relating to petitioners' personal checking account, and
information related to petitioners' personal affairs as specifically
requested by Universal. Because Universal had difficulty in obtaining
the information from Mr. Loftus which was necessary to file income tax
returns for Shawnee before
March 15, 1984
, and petitioners before
April 15, 1984
, Universal filed for extensions of time to file Shawnee's and
petitioners' returns for 1983 until
September 15, 1984
, and
August 15, 1984
, respectively.
Mr.
Loftus did not advise Universal of payments of personal expenses and
investments other than to reply to direct inquiries from Mr. Thompson
concerning the payments reflected in the suspense, miscellaneous, or
commission accounts of Shawnee. Instead petitioners relied on Universal
and Mr. Thompson to classify expenses as personal or business based on
the information which they provided.
The
majority of items which were not correctly included on petitioners'
individual return were personal expenses of petitioners which were paid
for by Shawnee. These items were mischaracterized as corporate rather
than personal expenses. Petitioners used funds from Shawnee's checking
and brokerage accounts to pay for personal expenses and investments,
such as expenses for swimming pool care, pest control, and landscape
services at petitioners' residence; deposits related to petitioners'
individual retirement accounts; jewelry; meals; travel; health club
memberships; clothing; petitioners' personal charges on credit cards;
home telephone service; income tax liabilities; a time-share interest in
a condominium located at Sugar Mountain, North Carolina; a condominium
located at Vail, Colorado; petitioners' interest in Columbian oil and
gas drilling program, G.K.B. properties, and Danville Realty Investors,
Ltd.; funds invested in TWM, Inc.; and personally owned rental property.
Additionally, petitioners used Shawnee funds to purchase automobiles.
The promissory notes and interest statements related to the automobile
loans were issued in petitioners' names, and the interest expenses were
claimed on their personal income tax returns for the year at issue.
Shawnee improperly deducted many of the above personal expenditures on
its 1983 return.
While
preparing the income tax returns for petitioners and Shawnee, the
interactions between Mr. Loftus and Mr. Thompson were limited. Because
Mr. Loftus traveled during the business week, there was often a delay in
getting requested information from Mr. Loftus. During the preparation of
petitioners' and Shawnee's returns, Mr. Thompson cautioned Mr. Loftus
about claiming depreciation and expenses related to three automobiles on
Shawnee's return. Mr. Loftus insisted that Shawnee deduct all expenses
related to the automobiles.
During
1982 Mr. Loftus received a salary of $14,000 and sales commissions
totaling $47,631 from Shawnee. Mr. Thompson advised Mr. Loftus about
Shawnee's withholding and employment tax obligations, but Mr. Loftus
disregarded the advice. Mr. Loftus determined that after 1982 Shawnee
would compensate him as a commissioned salesman and not as an employee.
The
1983 corporate return of Shawnee and petitioners' individual return
inconsistently reported the income designated as compensation which Mr.
Loftus received from Shawnee. Petitioners' individual return reported
the income on the Schedule C as commission income, while the corporate
return treated the amount as compensation to officers. Mr. Thompson
explained that, in his opinion, the amount could not be classified as
salary on Shawnee's return because there had been no withholding, that
the distinction between salary and commission was merely a difference in
terminology, and that provided that the amount was reported as income it
was proper to report the amount in the manner which he chose.
Based
upon the information provided by Secretarial Group and Mr. Loftus,
petitioners expected Universal to ferret out personal use of Shawnee's
funds and other assets and determine the proper tax treatment of items
of income and expenses. Mr. Loftus understood the distinction between
personal expenses and corporate expenditures. Petitioners did not
intentionally conceal any information from Mr. Thompson, but portions of
the materials which they provided to Mr. Thompson were incomplete.
At
trial petitioners expressed confidence in Mr. Thompson's ability to
prepare their tax returns and related that they depended on him to
prepare accurate returns. But, there is no indication that they
communicated this to Mr. Thompson. Petitioners determined that it was
not necessary to review either the 1983 corporate return for Shawnee or
their 1983 personal income tax return to determine the accuracy of
income, deductions, and losses prior to signing and filing the returns.
Mr. Loftus admitted at trial that, had he reviewed the records which
Secretarial Group prepared for Shawnee for 1983, he would have been able
to determine the correct amounts of Shawnee's payments for petitioners'
personal expenses and his income from Shawnee.
Finally,
during the pendency of this case, petitioners failed to provide portions
of the documentation which respondent requested. Consequently,
respondent moved for sanctions against petitioners. The Court granted
respondent's motion and issued an order prohibiting petitioners' from
producing records at trial relating to petitioners checking, savings,
certificate of deposit, credit card, and individual retirement account
maintained by petitioners or Shawnee.
Opinion
A.
Admissibility of Evidence
Before
addressing the negligence and substantial understatement issues, we
first address the admissibility of an incomplete, unsigned, telefaxed
copy of a purported return of athird-party taxpayer. At trial,
petitioners attempted to introduce as evidence the purported 1983
corporate tax return of Eye Technology, Inc. (ETI). During
cross-examination of Mr. Thompson, petitioners' counsel attempted to
introduce the evidence for purposes of rebutting Mr. Thompson's
testimony concerning his return preparation practices. Respondent
objected to the admission of the copy based on section 7216 , the lack of
proper foundation, authentication, and third-party taxpayer's consent.
Moreover, respondent argued that petitioners failed to satisfy the
requirements of rules 901, 1002, 1003, and 1004 of the Federal Rules of
Evidence. Respondent conceded that section
6103 and the Freedom of Information Act, 5 U.S.C. sec. 552 (1988), do not
prohibit the introduction of the document.
Because
the parties could not agree on the admissibility of the document at
trial, the Court asked that both parties address this issue on brief.
Mr. Thompson testified that he could not recall whether he prepared
ETI's tax return for 1983. However, the document was not presented to
Mr. Thompson to identify or authenticate.
Respondent
contends that the return of ETI should not be considered as evidence
because Mr. Thompson is a return preparer and as such is subject to the
nondisclosure provisions of section
7216 . Sec.
301.7216-1(b)(2) , Proced. & Admin. Regs. Petitioners
concede that Mr. Thompson is a return preparer, and is therefore,
subject to the nondisclosure provisions of section 7216 . Petitioners,
however, contend that section 7216 does not
prohibit the introduction of the return because Mr. Thompson was not
asked to disclose any tax return information. According to petitioners,
Mr. Thompson would only be asked to acknowledge that he did prepare the
return and that it was prepared in a manner similar to those of
petitioners' and Shawnee's returns. Petitioners assert that section 7216 does not
prohibit the introduction of the evidence because they were the party
who wished to disclose the contents of the return, not the return
preparer.
Rule
901 of the Federal Rules of Evidence requires that documents be
authenticated or identified before they may be admitted into evidence. 1 Section 7216(a) prohibits
the disclosure or use of tax return information by return preparers,
unless one of the exceptions provided for in section 7216(b) applies. 2 Tax return
information includes "any information, including but not
limited to a taxpayer's name, address, or identifying number". Sec.
301.7216-1(b)(3) , Proced. & Admin. Regs. (Emphasis
added.) Section 7216 prohibits such
a disclosure, and violation of the section could result in a 1-year jail
sentence and/or a $1,000 fine.
Although
section 7216 does not
define disclosure, section
6103(b)(8) which relates to the Government's ability to
disclose tax return information broadly defines disclosure as
"making known to any person in any manner whatever a return or
return information." In this case, the act of authenticating the
return would be tantamount to making a disclosure of tax return
information. Authenticating the document causes the tax return to be
known and identified. Although petitioners argue that they would be
disclosing the information, not Mr. Thompson, petitioners acting in
tandem with Mr. Thompson would in fact be introducing the tax return
into the public record.
If
petitioners wished to introduce such evidence, they could have asked the
president of the company to authenticate the document. Mr. Thompson
testified that Mr. Turner, the president of ETI, was a close friend. It
is inexplicable why Mr. Turner was not present to authenticate the
document. Accordingly, in the absence of a Court order, section
7216 prohibits Mr. Thompson from authenticating the return of
a third-party taxpayer without the third-party's consent.
B.
Negligence
Section
6653(a)(1) imposes an addition to tax if any portion of an underpayment
is due to negligence or disregard of the rules and regulations. Section
6653(a)(2) provides for an addition to tax in the amount of 50 percent
of the interest on the portion of the underpayment attributable to
negligence. Negligence for purposes of section 6653(a) is defined as the
failure to exercise the due care that a reasonable and ordinarily
prudent person would exercise under the circumstances. Neely v.
Commissioner [Dec. 42,540 ], 85 T.C. 934,
947 (1985); Marcello v. Commissioner [67-2 USTC ¶9516 ],
380 F.2d 499, 506 (5th Cir. 1967), affg. [Dec. 27,048(M) ] on this
issue T.C. Memo. 1964-299. Respondent's determination that petitioners'
underpayment was due to negligence is "presumptively correct and
must stand unless the taxpayer can establish that he was not
negligent." Hall v. Commissioner [84-1
USTC ¶9341 ], 729 F.2d 632, 635 (9th Cir. 1984), affg. [Dec. 39,110(M) ] T.C. Memo.
1982-337. Accordingly, petitioners have the burden of proving that
respondent's determination is erroneous. Stovall v. Commissioner
[85-2 USTC ¶9450 ],
762 F.2d 891, 895 (11th Cir. 1985), affg. [Dec. 40,320(M) ] T.C. Memo.
1983-450; Luman v. Commissioner [Dec. 39,500 ], 79 T.C. 846,
860-861 (1982); Bixby v. Commissioner [Dec. 31,493 ], 58 T.C. 757,
791 (1972).
Petitioners
have the burden of proving that they were not negligent in understating
their tax liability. Respondent determined negligence additions against
petitioners only, not their return preparer. The determination to impose
return preparer liability is within the discretion of respondent. As
such, we are limited to determining whether petitioners acted in a
reasonably prudent manner in filing their return. Although we cannot
ignore the return preparer's actions, petitioners must demonstrate that
they acted reasonably, independent of the return preparer's conduct.
Petitioners
contend that they exercised the due care of a reasonable, prudent person
in the preparation of their 1983 income tax return. In support of their
contention they assert the following: (1) They provided their return
preparer, Mr. Thompson, with all the information necessary to prepare
their return accurately; (2) they relied exclusively upon Mr. Thompson
for tax advice; (3) Mr. Thompson was responsible for the proper
characterization of items on their individual income tax return and the
1983 Shawnee corporate return; (4) the majority of the income omitted
from their 1983 return was due to Mr. Thompson's mischaracterization of
personal items as corporate expenses; and (5) they are unsophisticated
in tax matters and would have been unable to discern an error in
characterization.
Respondent
contends that the record does not support petitioners' assertions. To
the contrary, respondent contends that petitioners failed to provide Mr.
Thompson with all relevant information, that petitioners made numerous
misrepresentations to Mr. Thompson, that petitioners disregarded Mr.
Thompson's tax advice, and that they failed to review their tax return.
We agree with respondent and find that the errors on petitioners' return
were due to petitioners' failure to provide Mr. Thompson with all the
necessary information, Mr. Loftus' failure to review the records
prepared by Secretarial Group, and petitioners' failure to review their
tax return.
Generally,
the duty of filing accurate returns cannot be avoided by placing the
responsibility on a return preparer. Metra Chem Corp. v. Commissioner
[Dec. 43,787 ], 88 T.C. 654,
662 (1987). However, in limited situations, a taxpayer may insulate
himself from the negligence addition to tax. To avoid liability a
taxpayer must establish the following: (1) That he provided the return
preparer with complete and accurate information from which the tax
return could be properly prepared; (2) that an incorrect return was the
result of the preparer's mistakes; and (3) that the taxpayer in good
faith relied on the advice of a competent return preparer. Jackson v.
Commissioner [Dec. 42,958 ], 86 T.C. 492,
539-540 (1986), affd. [89-1 USTC ¶9123 ]
864 F.2d 1521 (10th Cir. 1989); Daughtery v. Commissioner [Dec. 38,943 ], 78 T.C. 623,
641 (1982); Magill v. Commissioner [Dec. 35,225 ], 70 T.C. 465,
479 (1978), affd. [81-1 USTC ¶9437 ]
651 F.2d 1233 (6th Cir. 1981); Pessin v. Commissioner [Dec. 31,796 ], 59 T.C. 473
(1972). Finally, even if a taxpayer establishes the above requirements,
he still has a duty at least to read and make a cursory review of the
return and make sure that all income items are included. Metra Chem
Corp. v. Commissioner, supra at 662; Magill v. Commissioner,
supra at 479-480. 3
In
evaluating the evidence in this case, we must keep in mind that the
ultimate responsibility for a correct return lies with the taxpayer who
must furnish the necessary information to the agent who prepares his
return. Pessin v. Commissioner, supra at 489. Relying on dictum
in United States v. Boyle [85-1
USTC ¶13,602 ], 469 U.S. 241, 251 (1985), petitioners
contend that they should be excused from the negligence additions on the
ground that they reasonably relied upon substantive tax advice provided
by Mr. Thompson. In Boyle, the taxpayer, an executor of his
mother's will, retained an attorney to handle the estate. Id. at
242. The taxpayer provided the attorney with all the necessary
information, but the estate return was filed 3 months late apparently
because of a clerical oversight in omitting the filing date from the
attorney's calendar. Id. at 243. The Commissioner determined an
addition to tax was due under section
6651(a)(1) for late filing. Id. The Supreme Court held
that the failure to timely file was not excused by the taxpayer's
reliance on an agent as such reliance was not reasonable cause under section 6651 . United
States v. Boyle, supra at 252. The taxpayer, not his attorney, had
the duty to comply with the statute. The Supreme Court distinguished Boyle
from the situation in which a taxpayer relied on the erroneous advice of
counsel concerning a question of law. Id. at 250. In this case
however, petitioners did not establish that they relied on substantive
tax advice provided by Mr. Thompson. Petitioners employed Mr. Thompson
to prepare their tax returns from the information which their
bookkeepers provided. The evidence reflects that Mr. Loftus did not seek
tax advice and on at least one occasion declined to follow the advice
which Mr. Thompson offered.
The
situations in which we have declined to uphold respondent's negligence
determinations based on the reliance of a return preparer are far more
limited than petitioners assert. "A close examination of these
cases reveals that they raised questions as to the tax treatment of
complex tax transactions". Metra Chem Corp. v. Commissioner,
supra at 662; Jackson v. Commissioner, supra at 539; Pessin
v. Commissioner, supra at 489. Such is not the case here. Moreover,
any complexity that arose out of this case was the doing of petitioners.
Petitioners chose to commingle their personal and business expenditures
and as such are responsible for insuring the correct allocation of
income and expenses on their income tax returns.
We
do not believe that petitioners should be allowed to sidestep their duty
of filing an accurate return by simply alleging that they supplied the
correct information to their accountant and relied fully on him. First,
petitioners did not review the returns prepared by Mr. Thompson.
Petitioners failed to report $74,080 of taxable income, or approximately
35 percent of Mr. Loftus' taxable income from Shawnee during 1983. We
believe that such a substantial underreporting of income would not have
gone unnoticed if petitioners had made even a cursory review of their
return. Mr. Loftus testified that if he had reviewed the records of
Shawnee for 1983 he would have been able to determine that correct
amount of Shawnee's payments of petitioners' personal expenses and his
income from Shawnee. There is no reasonable justification for not doing
so. It is not only unreasonable to fail to check a return for accuracy
prior to signing it, but in this case, where there was such a
commingling of personal and business expenses, it is also irresponsible.
A return preparer who does not even prepare the journals and ledgers
cannot be held to such an onerous burden as deciphering the difference
between personal and business expenses.
Second,
petitioners failed to establish that they supplied their accountant with
complete and accurate data. The most significant example of their
failure to disclose is Mr. Loftus' furnishing to their accountant
corporate records that incorrectly reflected petitioners' personal
expenditures and use of Shawnee's funds and assets as legitimate
corporate expenses. Taxpayers who control the affairs of a corporation
cannot establish that they provided correct information to their return
preparer when they provide corporate records that incorrectly reflect
that alleged business expenses did not benefit the individual. Magill
v. Commissioner [Dec.
35,225 ], 70 T.C. at 479.
Third,
as the sole shareholder, director, and president of Shawnee, Mr. Loftus
controlled the financial affairs of Shawnee and commingled Shawnee's and
petitioners' personal affairs. Mr. Loftuns used Shawnee's funds to pay
substantial personal expenses and to purchase assets and make
investments titled in petitioners' names. However, Mr. Loftus failed to
disclose or concealed from Mr. Thompson the true extent of personal
expenditures and investments made with Shawnee's funds by providing
canceled checks, check stubs, and receipts that did not reflect the
personal nature of the expenditures and investments.
Finally,
petitioners argue that they were unsophisticated in tax matters and that
we should follow the holdings in Ware v. Commissioner [Dec. 43,315(M) ], T.C.
Memo. 1986-406, and Casa Loma, Inc. v. Commissioner [Dec. 36,832(M) ], T.C.
Memo. 1980-78. In Ware the taxpayer, who was unsophisticated in
tax matters and relied exclusively on his accountant's tax counseling,
turned over to his accountant all of his receipts and documents. To the
contrary, in this case, Mr. Loftus turned over ledgers and journals and
only provided his accountant with receipts and more specific documents
when the accountant requested. Moreover, the record does not support
that petitioners were unsophisticated in tax matters; for example, Mr.
Loftus declined to follow Mr. Thompson's tax advice on at least one
occasion. In Casa Soma we held that the directors of the
corporate taxpayer were unsophisticated in tax matters and made a good
faith attempt to furnish their accountant with all the necessary
information. Considering that petitioners commingled their personal and
business expenses to such a large extent and that Mr. Loftus did not
check the ledgers and journals which were sent to Mr. Thompson, it is
impossible to find that petitioners made a good faith attempt to provide
all relevant data. The unchecked ledgers and journals simply did not
adequately disclose the extent to which petitioners used Shawnee's funds
to pay for personal expenditures.
Petitioners
in this case "must stand ready to accept the ultimate blame." Pritchett
v. Commissioner [Dec.
32,840 ], 63 T.C. 149, 175 (1974). Accordingly, we hold that
petitioners are liable for the additions to tax under section 6653(a)
for negligence.
C.
Substantial Understatement
The
final issue presented for our decision is whether respondent abused her
discretion in refusing to waive the addition to tax under section 6661 . Petitioners
contend that they had reasonable cause for the understatement on their
1983 return and acted in good faith based upon their reliance on Mr.
Thompson. Consequently, they argue that respondent should have waived
any addition to tax under section
6661 .
Section 6661(a) provides
that, if there is a substantial understatement of income tax for any
taxable year, there shall be added to the tax an amount equal to 25
percent of the amount of any underpayment attributable to such
understatement. Pallottini v. Commissioner [Dec.
44,671 ], 90 T.C. 498 (1988). There is a substantial
understatement of income tax if the amount of the understatement exceeds
the greater of 10 percent of the tax required to be shown on the return
for $5,000. Sec. 6661(b)(1) .
Petitioners concede that they understated their income tax by $41,512 in
1983.
The
amount of understatement may be reduced by the portion of the
understatement which the taxpayer shows is attributable to either of the
following: (1) The tax treatment of any item for which there was
substantial authority for its treatment on the return; and (2) the tax
treatment of any item which is adequately disclosed on the return. Sec.
6661(b)(2)(B) . In this case, there was no substantial
authority for the income omitted from or the deductions improperly
claimed on petitioners' 1983 tax return, nor was there adequate
disclosure as to the items.
Section 6661(c) authorizes
the Commissioner to waive any part of the addition to tax imposed under section 6661(a) upon a
showing by the taxpayer of reasonable cause for the understatement and
that the taxpayer acted in good faith. The most important factor in
determining whether to grant a waiver is "the extent of the
taxpayer's effort to assess the taxpayer's proper tax liability under
the law." Sec. 1.6661-6(b) , Income
Tax Regs.; Mailman v. Commissioner [Dec. 45,218 ], 91 T.C.
1079, 1083-1084 (1988). Reliance upon the advice of a professional will
not constitute a showing of reasonable cause and good faith unless,
under all the circumstances, such reliance was reasonable in light of
the taxpayer's experience, knowledge, and education. See Metra Chem
Corp. v. Commissioner [Dec. 43,787 ], 88 T.C. 654
(1987); sec.
1.6661-6(b) , Income Tax Regs.
The
Commissioner's authority to grant a waiver is discretionary. Mailman
v. Commissioner, supra at 1084. The appropriate standard of review
for the denial of a waiver is whether respondent abused her discretion;
whether respondent exercised her discretion arbitrarily, capriciously,
or without sound basis in fact. Id. at 1083-1084. Petitioners
bear the burden of proving that respondent abused such discretion. Rule
142(a); Welch v. Helvering [3 USTC ¶1164 ], 290 U.S.
111 (1933); Mailman v. Commissioner [Dec. 45,218 ], 91 T.C. at
1083-1084.
Petitioners
argue that based on the following respondent was arbitrary in not
waiving the addition: (1) Petitioners were unsophisticated in tax law;
(2) while Mr. Loftus is a successful businessman, he never directly
dealt with the type of tax matters in issue; (3) the majority of items
which caused the understatement resulted from a mischaracterization of
items by Mr. Thompson; (4) even if petitioners had reviewed the tax
returns prepared by Mr. Thompson, they were not sophisticated enough in
tax matters to recognize the mischaracterizations; and (5) petitioners
provided Mr. Thompson with all available information including
additional matters requested by Mr. Thompson.
The
evidence establishes that petitioners made no good faith efforts to
assess the extent of their income tax liability for 1983 or the contents
of their return. Petitioners admitted they did not review their return
and Mr. Loftus did not review the bookkeeping information which he
provided to the accountant to prepare the 1983 returns. Petitioners'
failure to review their own return reflects that Petitioners completely
abdicated their duty to file a correct return by closing their eyes to
facts that they could have discerned. The facts demonstrate that the
understatement was not due to reasonable cause, that petitioners did not
make a good faith effort to determine their correct tax liability, and
that petitioners are not entitled to a waiver of the addition to tax
under section 6661 . Accordingly,
we hold that respondent did not abuse her discretion in declining to
waive the section
6661 addition to tax.
To
reflect the foregoing,
Decision
will be entered for respondent.
1
Fed. R. Evid. 901(a) provides: "The requirement of authentication
or identification as a condition precedent to admissibility is satisfied
by evidence sufficient to support a finding that the matter in question
is what its proponent claims."
2
Sec. 7216 provides as follows:
(a)
GENERAL RULE.--Any person who is engaged in the business of preparing,
or providing services in connection with the preparation of, [income tax
returns], * * * or any person who for compensation prepares any such
return * * * for any other person, and who--
(1)
discloses any information furnished to him for, or in connection with,
the preparation of any such return, or
(2)
uses any such information for any purpose other than to prepare, or
assist in preparing, any such return * * *, shall be guilty of a
misdemeanor, and, upon conviction thereof,
shall
be fined not more than $1,000, or imprisoned not more than 1 year, or
both, together with the costs of prosecution.
(b)
EXCEPTIONS.--
(1)
DISCLOSURE.--Subsection (a) shall not apply to a disclosure of
information if such disclosure is made
(A)
pursuant to any other provision of this title, or
(B)
pursuant to an order of a court.
(2)
USE.--Subsection (a) shall not apply to the use of information in the
preparation of, or in connection with the preparation of, State and
local tax returns and declarations of estimated tax of the person to
whom the information relates.
(3)
REGULATIONS.--Subsection (a) shall not apply to a disclosure or use of
information which is permitted by regulations prescribed by the
Secretary under this section.
3
The responsibility to review a return cannot be trivialized. In Morrow
v. Commissioner [Dec.
47,214(M) ], T.C. Memo. 1991-101, we held that supplying
records to an accountant and relying on the accountant to prepare a
return was not sufficient to relieve a taxpayer of the "ultimate
responsibility for the correctness of their returns." Based on the
taxpayers' failure to adequately review their returns, we sustained the
Commissioner's negligence determination.