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Sometimes "The Truth" is Reasonable Cause for IRS Penalties

By Joel N. Crouch on June 5, 2023
In the Seinfeld episode called "The Truth",  Jerry is being audited by the IRS because Kramer convinced him to make a charitable contribution to help the victims of a volcano eruption in the nation of "Krakatoa, east of Java".  It turns out the charity was fake, but luckily George is dating a CPA, who used to be "a high placed official with a little outfit called the IRS" and she will be representing Jerry in the audit.  However, George soon breaks up with the CPA, by telling her "The Truth" and she throws out Jerry's records.  Things don't go well for Jerry at the IRS audit.  He probably had to pay penalties, because his story about relying on advice from Kramer and relying on a tax professional who trashed his records because George broke up with her, would not make sense to the IRS. HERE are Jerry's comments about the audit at the end of the show.

I was reminded of this Seinfeld episode when I read the summary opinion by the Tax Court in Tracy v. Commissioner, T.C. Summ. Op. 2023-30, where the judge held that the taxpayer had reasonable cause for his failure to file employment tax returns and pay employment taxes because he had a good story to tell.  In Tracy, the taxpayer was a lawyer in his late 80's, who was slowing down and starting to close his practice due to declining health and advanced age.  As he was closing his practice, he started relying more heavily on his assistant of over 25 years to handle his bookkeeping, payroll and communications with his tax return preparer.  Unfortunately, the assistant failed to do anything regarding the firm's employment taxes for almost two years.  When Mr. Tracy learned about the unfiled tax returns and unpaid taxes, he immediately filed the delinquent returns and paid the tax.  In addition, he asked the IRS to abate the penalties based on reasonable cause.  The IRS would only agree to a partial abatement of the penalties and Mr. Tracy filed a petition asking the Tax Court to review the denial.

The Tax Court agreed that Mr. Tracy had reasonable cause and abated the penalties. "Notwithstanding petitioner's many difficulties due to his failing health and advanced age, petitioner was diligent in exercising ordinary business care and prudence.  He had a system in place to ensure tax compliance.  Petitioner's systems had not previously failed him in his approximately 60 years of solo law practice.  It was reasonable, and not willfully neglectful, for petitioner to trust his systems' continued reliability".  The court noted that Mr. Tracy acted quickly to file once he learned of the situation and his inability to supervise his assistant, due to his health, was what caused his delinquency.   As the decision in Tracy illustrates, having a good and believable story to tell is the key to a reasonable cause defense to tax penalties.

If you have any tax-related questions please feel free to contact me at jcrouch@meadowscollier.com.