Tax Court in Brief | Mulu v. Comm’r | Accuracy-Related Penalty and No Reasonable-Cause Excuse

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The Tax Court in Brief – January 23rd – January 27th, 2023

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Tax Litigation:  The Week of January 23rd, 2022, through January 27th, 2023

Mulu v. Comm’r, T.C. Summary Opinion 2023-2| January 25, 2023 | Leyden, J. | Dkt. No. 12975-21S

Summary: In this non-precedential opinion (see section 7463(b)), the Tax Court addresses whether or not to uphold an accuracy-related penalty assessed to taxpayer, Ashenafi Getachew Mulu (Mulu). Mulu hired David Clerie—self-coined, “Dave, Tax Doctor”—to prepare Mulu’s federal income tax return as Clerie had done for at least four years. Mr. Clerie did not have a preparer tax identification number (PTIN), and the federal income tax return in issue (2018) was electronically submitted as though it had been self-prepared by Mulu. In 2017 Mulu purchased a house. Clerie advised Mulu to renovate the house for the purpose of renting certain floors. Mulu began renting out those floors during 2018. Clerie visited Mulu’s workplace in February 2019 to gather information to prepare the 2018 tax return. Mulu’s return prepared by Clerie claimed deductions and reported expenses related to the purchase of the house and costs incurred with respect to the rental. Mulu claimed passive activity losses on Form 8582, Passive Activity Loss Limitations, and deductions on Schedule E, Supplemental Income and Loss, related to the purchase of the house. Mulu substantiated only a portion of the repairs expense. Mulu claimed deductions for car and truck expenses on Schedule C, Profit or Loss From Business, and reported his principal business or profession as a “driver.” Mulu actually worked as a pharmacist, but the return listed Mulu’s occupation as “Laborer.” Soon before April 15, 2019, Mulu learned, from Clerie’s brother, that Clerie died on March 8, 2019. The brother told Mulu that the brother was handling Clerie’s tax return preparation business. No qualifications were given. Mulu did not review the tax return before it was e-filed by the brother. The IRS examined the 2018 tax return. The IRS later sent a Form 4549, Report of Income Tax Examination Changes, and a Civil Penalty Lead Sheet and Civil Penalty Approval Form was signed by a review agent supervisor, personally approving of an accuracy-related penalty. Mulu petitioned the Tax Court. After concessions, the sole issue related to the accuracy-related penalty assessed by the IRS.

Key Issues: Whether for 2018 Mulu is liable for a section 6662(a) accuracy-related penalty of $1,212.20?

Primary Holdings: Yes. The Civil Penalty Lead Sheet and the Civil Penalty Approval Form signed by the IRS examiner’s immediate supervisor met the section 6751(b) written supervisory approval requirement. And, the record showed an undisputed understatement of tax that meets the definition of a substantial understatement of income tax under section 6662(d). Mulu was not entitled to a reasonable cause excuse. He did not exercise diligence and prudence or good faith because he did not review the tax return before it was filed.

Key Points of Law:

Accuracy-Related Penalty. Section 6662(a) and (b)(2) imposes an accuracy-related penalty equal to 20% of the amount of any underpayment of tax required to be shown on a return that is attributable to any substantial understatement of income tax. An understatement is a “substantial understatement” if it exceeds the greater of $5,000 or 10% of the tax required to be shown on the return. I.R.C. § 6662(d)(1)(A).

Burden of Production. The IRS bears the burden of production with respect to an individual taxpayer’s liability for any penalty. I.R.C. § 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446–47 (2001). Once the IRS meets his burden of production, the taxpayer must come forward with persuasive evidence that the IRS’s determination is incorrect. See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Substantial understatement penalties generally must be approved in writing by the immediate supervisor of the IRS employee who made the penalty determination. See I.R.C. § 6751(b).

Reasonable Cause and Good Faith. A taxpayer may avoid a section 6662(a) penalty by showing that there was reasonable cause for the underpayment and that the taxpayer acted in good faith. I.R.C. § 6664(c)(1). This determination is made on a case-by-case basis, taking into account all pertinent facts and circumstances. Treas. Reg. § 1.6664-4(b)(1); see Higbee, 116 T.C. 438. “Relevant factors include the taxpayer’s efforts to assess his proper tax liability, including the taxpayer’s reasonable and good faith reliance on the advice of a professional such as an accountant.” Higbee, 116 T.C. at 448–49. A taxpayer must exercise diligence and prudence in filing his return. Stough v. Commissioner, 144 T.C. 306, 323 (2015). Reasonable cause is not met if a cursory review of a return might have revealed errors. Walton v. Commissioner, T.C. Memo. 2021-40, at *12. A taxpayer has a duty to read and review his return. Id. at *12–13.

Insights: Mulu claimed he acted with reasonable cause and in good faith because he lacks knowledge regarding tax and finance and had always relied on a tax return preparer to prepare his federal income tax returns. He claimed he did not understand the depreciation and expenses and that he was victimized by an unscrupulous return preparer who had been recommended to him by family and friends. Such blind ignorance and unjustifiable reliance was not “reasonable cause” to avoid accuracy-related penalties.