Reliance on Professional Advice Defense to IRS Penalties

When the IRS proposes changes to a taxpayer’s return that result in an underpayment of tax, it will always consider penalties under Internal Revenue Code § 6662 - Imposition of Accuracy-Related Penalty on Underpayments. The most common penalties proposed by the IRS are negligence and substantial understatement of income tax, both of which are 20% of the tax due.

Section 6664(c)(1) provides that the penalties under § 6662(a) will not apply to any portion of the tax underpayment if there is reasonable cause for the taxpayer’s position and the taxpayer acted in good faith. The determination of reasonable cause is made on a case-by-case basis, considering all the facts and circumstances, with the most important factor being the taxpayer’s efforts to assess the proper tax liability. Reliance of professional advice may constitute reasonable cause and good faith, but only if considering all the circumstances, is such reliance was reasonable. In Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43 (2000), the Tax Court ruled that reasonable cause exists if a taxpayer relies in good faith on the advice of a qualified tax adviser where the following three elements are present: (1) the adviser was a competent professional who had sufficient expertise to justify the reliance; (2) the taxpayer provided necessary and accurate information to the advisor; and (3) the taxpayer actually relied in good faith on the advisor’s judgement.

In addition, the taxpayer must prove that the advisor considered all pertinent facts and circumstances, and the taxpayer disclosed all relevant facts that he or she knows or should have known. Finally, the advice cannot be based on unreasonable factual or legal assumptions.

In Kroner v. Commissioner, T.C. Memo. 2024-41, the Tax Court, after upholding the IRS determination that $24 million in transfers to Mr. Kroner by his business partner were taxable, considered the taxpayer’s reasonable cause/reliance defense to penalties. In applying the elements of Neonatology, the Court determined there was no credible testimony or documentary evidence showing that the taxpayer ever disclosed the details of the transaction to his tax attorney. The court further observed that “if Mr. Kroner accurately provided Mr. Bernstein with all the information needed to determine the taxability of Mr. Haring’s transfers and Mr. Bernstein determined that the transfers were tax free, then it was remarkably bad advice. We think that the better explanation is the one supported by the record: Mr. Kroner did not supply Mr. Bernstein with necessary and accurate information to reach an informed judgment about the taxability of the transfers.” The court also pointed out there was no evidence that the taxpayer relied on the advice, noting that the taxpayer failed to inform his associates and return preparer of the advice regarding the tax status of the transfers.

If you would like more information about this blog post or any other tax-related matter, please free to contact me at jcrouch@meadowscollier.com.