Tax Court Case Addresses Reasonable Cause Standard and Tax Penalties

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A recent Tax Court decision addresses the “reasonable cause” standard — a frequent issue in the IRS-penalty context.  As the case demonstrates, whether a taxpayer acted with reasonable cause and in good faith is determined on a case-by-case basis. Woll highlights the fact that a taxpayer who has an advanced degree, such as an attorney, will likely have more difficulty demonstrating reasonable cause. Based on the Woll decision, reliance on a computer program or failure to read a tax form, such as a Form 1099-R, is not sufficient without more to prove reasonable cause.

Woll v. Comm’r, Bench Opinion| April 29, 2021 | Holmes, J. | Dkt. No. 7024-20

Short Summary: Petitioner Molly Woll was laid off from her employer in 2017, resulting in the termination of her 401(k) savings plan that had a balance of more than $86,000. Ms. Woll and her husband spent part of the proceeds from the plan on paying back a loan, as well as paying medical expenses, student loan payments, mortgage bills, house expenses, and other bills. This resulted in a taxable distribution.

Ms. Woll prepared the couple’s 2017 tax return and reported the taxable distribution but did not add the extra 10 percent tax imposed by I.R.C. § 72(t). This triggered an IRS audit, which resulted in the assessment of the 10 percent tax, as well as a substantial understatement penalty. Mr. and Mrs. Woll timely filed their tax court petition.

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Insight: Whether a taxpayer acted with reasonable cause and in good faith is determined on a case-by-case basis. Woll highlights the fact that a taxpayer who has an advanced degree, such as an attorney, will likely have more difficulty showing reasonable cause. Reliance on a computer program or failure to read a tax form, such as a Form 1099-R, are not sufficient alone to prove reasonable cause.