Tax Blog/Blawg

Following up on our earlier post, Deconstructing Canal Corp. v. Commissioner – Part I, we now examine the second question raised by Judge Kroupa’s opinion.  Specifically, where a taxpayer relies on the opinion of an advisor to establish a “reasonable cause and good faith” defense to the imposition of penalties, have the modifications to the penalty preparer rules of Code section 6694 obviated the need for a judicial rule disallowing taxpayer reliance on the opinion of an advisor who has a conflict of interest?

Many practitioners were taken aback by the recent Tax Court decision in Canal Corp. v. Commissioner, where Judge Kroupa issued a stinging opinion that not only recast a leveraged partnership distribution as a disguised sale, but also upheld penalties against the taxpayer for what the judge characterized as the taxpayer’s unreasonable reliance on the opinion of its tax advisor.  Judge Kroupa’s analysis, which should be on the forefront of every tax advisor’s mind, raises a number of interesting, if thorny, questions, including:

• Should a fixed and/or contingent fee arrangement necessarily render tax advice unreliable for purposes of avoiding a substantial understatement penalty under the “reasonable cause and good faith” exception?

• Has the enactment of section 6694 undercut the rationale for prohibiting taxpayers from relying on advisors that have a conflict of interest?

• When (if at all) should courts defer to the opinion of a reputable tax advisor in deciding whether to uphold an assessment of penalties against a taxpayer?

Today, we tackle the first of these three questions.

The House of Representatives passed, and the President signed into law, H.R. 1586, the "FAA Air Transportation Modernization and Safety Improvement Act," which curiously became the chosen vehicle for Congress and the Administration to provide assistance to states with budget shortfalls while paying for that assistance with changes in a number of international tax provisions.  The final bill is available in pdf here.  See here for our prior summary of the relevant international tax provisions.

Although the changes are largely similar to what was proposed in earlier legislation, it ...

Although death and taxes might, according to Benjamin Franklin, be the only certainties in this world, Congress is surely striving to add another - that is, the certainty of uncertainty.  Congress, it seems, is committed to keeping taxpayers in as much doubt as possible for as long as possible about the status of a variety of important provisions that will affect both substantive tax liabilities and compliance obligations.

This is a question I hear from a lot of clients who owe the IRS money, because either they were not able to pay everything on their tax return when it was filed, or they endured an IRS audit and adjustments were unfavorable to them.  The fact of the matter is that, outside the confines of an Offer in Compromise based on doubt as to collectability, which is governed by I.R.C. § 7122 and an analysis of the taxpayer's ability to pay the liability in full, the IRS has a lot less discretion in this area than most people think.

Let's look at interest first.  Pursuant to I.R.C. § 6601, interest generally runs from the time a tax return is due until the time the tax is paid.  One exception is an “assessable” penalty, for which case the interest runs from the date the penalty is assessed.  Internal Revenue Code § 6404(g) permits the IRS to waive interest, but two circumstances must be present.  First, this only relates to interest on income tax, so that if we're talking about estate tax, excise tax, or employment tax, there is no legal authority for the IRS to "waive" interest.  Second, there must be a showing that the interest ran as a result of some error or delay on the part of the Internal Revenue Service in the performance of a "ministerial" act.  As you can imagine, the IRS rarely admits that such a mistake has occurred, and there are disappointingly few cases in which taxpayers have successfully gone to Court and had this position overturned as an abuse of discretion.