SCOTUS Reports

Tag: IRC Section 6664

  • Woodsum v. Commissioner of Internal Revenue, 136 T.C. 585 (2011): Reasonable Cause Defense to Accuracy-Related Penalty

    Woodsum v. Commissioner of Internal Revenue, 136 T. C. 585 (U. S. Tax Court 2011)

    In Woodsum v. Commissioner, the U. S. Tax Court ruled that taxpayers cannot rely on a preparer’s error to avoid accuracy-related penalties under IRC section 6662. Stephen Woodsum and Anne Lovett omitted $3. 4 million from their 2006 tax return, despite receiving a Form 1099-MISC. The court held that their failure to review their return and ensure all income was reported negated the ‘reasonable cause’ defense, emphasizing taxpayers’ responsibility to verify their returns, especially for significant income items.

    Parties

    Stephen G. Woodsum and Anne R. Lovett were the petitioners. The Commissioner of Internal Revenue was the respondent. The case originated in the United States Tax Court, with petitioners seeking redetermination of an accuracy-related penalty assessed by the IRS for the tax year 2006.

    Facts

    In 2006, Stephen Woodsum, a financially sophisticated individual and founding managing director of Summit Partners, terminated a ten-year total return limited partnership linked swap transaction, resulting in a net payout of $3,367,611. 50, which was reported by Deutsche Bank on a Form 1099-MISC as income. Woodsum and Lovett, who had a total adjusted gross income of nearly $33 million for that year, provided over 160 information returns, including the Deutsche Bank Form 1099-MISC, to their tax preparer, Venture Tax Services, Inc. (VTS). VTS, supervised by David H. Hopfenberg, prepared a 115-page return that omitted the $3. 4 million from the swap termination. Despite a meeting with Hopfenberg to review the return, petitioners did not recall discussing specific items or comparing the return with the information returns provided. They signed and filed the return, which did not include the swap income, leading to a tax deficiency and an accuracy-related penalty assessed by the IRS.

    Procedural History

    The IRS assessed a tax deficiency of $521,473 and an accuracy-related penalty of $104,295 against Woodsum and Lovett for the 2006 tax year. Petitioners conceded the tax deficiency and paid it, but disputed the penalty, arguing they had reasonable cause under IRC section 6664(c)(1). The case was submitted to the U. S. Tax Court fully stipulated under Rule 122, with the court considering only the issue of the penalty’s applicability.

    Issue(s)

    Whether Woodsum and Lovett had “reasonable cause” under IRC section 6664(c)(1) for omitting $3. 4 million of income from their 2006 joint Federal income tax return, thereby avoiding the accuracy-related penalty under IRC section 6662(a)?

    Rule(s) of Law

    IRC section 6662(a) and (b)(2) impose a 20 percent accuracy-related penalty for a substantial understatement of income tax, defined as an understatement exceeding the greater of $5,000 or 10 percent of the tax required to be shown on the return. Under IRC section 6664(c)(1), a taxpayer may avoid this penalty if they can show reasonable cause and good faith for the underpayment. 26 C. F. R. section 1. 6664-4(b)(1) states that the determination of reasonable cause and good faith is made on a case-by-case basis, considering the taxpayer’s efforts to assess proper tax liability, their knowledge and experience, and reliance on professional advice.

    Holding

    The U. S. Tax Court held that Woodsum and Lovett did not have reasonable cause for omitting the $3. 4 million income item from their 2006 tax return. The court found that their reliance on their tax preparer did not constitute reasonable cause, as they failed to adequately review the return to ensure all income items were reported.

    Reasoning

    The court reasoned that the taxpayers knew the swap termination income should have been included on their return, as evidenced by the Form 1099-MISC they received and provided to their tax preparer. The court emphasized that reliance on a professional to prepare a return does not absolve a taxpayer of the responsibility to review the return and ensure its accuracy, particularly for significant income items. The court cited United States v. Boyle, 469 U. S. 241 (1985), which established that taxpayers cannot rely on a preparer’s error when they know or should know the correct treatment of an income item. The court also noted that the taxpayers’ review of the return was insufficient, as they did not recall the specifics of their review or compare the return to the information returns provided. The court concluded that the taxpayers’ lack of effort to ensure the accuracy of their return precluded a finding of reasonable cause and good faith under IRC section 6664(c)(1).

    Disposition

    The U. S. Tax Court entered a decision for the respondent, upholding the accuracy-related penalty assessed against Woodsum and Lovett.

    Significance/Impact

    Woodsum v. Commissioner reinforces the principle that taxpayers bear the responsibility to review their tax returns and ensure all income items are reported, even when using a professional tax preparer. The case underscores the limitations of the ‘reasonable cause’ defense to accuracy-related penalties, particularly when taxpayers fail to adequately review their returns. This decision may impact how taxpayers approach the preparation and review of their tax returns, emphasizing the need for diligence in verifying the accuracy of reported income, especially for significant amounts. The case also highlights the importance of maintaining records of the review process, as the taxpayers’ inability to recall the specifics of their review contributed to the court’s finding against them.

  • Feller v. Commissioner, 135 T.C. 497 (2010): Validity of Regulations Under IRC Section 6664 for Fraud Penalties

    Feller v. Commissioner, 135 T. C. 497 (2010) (U. S. Tax Court, 2010)

    The U. S. Tax Court upheld the IRS’s imposition of civil fraud penalties on Rick D. Feller for overstated withholding tax credits, affirming the validity of Treasury regulations defining ‘underpayment’ to include such overstatements. Feller, a CPA, had fraudulently claimed refunds by inflating his withholding credits over six years, a practice he admitted to in a criminal plea. The court’s ruling clarifies that overstated withholding credits can be considered in calculating fraud penalties, impacting how tax fraud is assessed and penalized.

    Parties

    Rick D. Feller, the petitioner, challenged the IRS’s determination of civil fraud penalties. The Commissioner of Internal Revenue, the respondent, defended the imposition of the penalties. Feller’s case progressed from a criminal conviction to a civil tax dispute, with Feller as the appellant in the U. S. Tax Court.

    Facts

    Rick D. Feller, a certified public accountant, was a partner in an accounting firm and president of SFT Health Care Corp. , which owned two nursing homes. From 1992 to 1997, Feller filed false tax returns claiming fictitious wages and withholding tax credits, resulting in overstated refunds totaling $320,078. After an IRS audit and criminal investigation, Feller pleaded guilty to willfully submitting a false tax return for 1997. The IRS issued notices of deficiency for 1992-1997, asserting fraud penalties under IRC section 6663 due to Feller’s overstated withholding credits.

    Procedural History

    The IRS issued notices of deficiency on November 22, 2006, determining fraud penalties for 1992-1997 based on Feller’s overstated withholding credits. On November 27, 2006, the IRS assessed adjustments related to these overstatements using mathematical error assessment procedures. Feller sought redetermination in the U. S. Tax Court, arguing the statute of limitations barred the deficiency notices and that the regulations defining ‘underpayment’ were invalid. The Tax Court, applying the Chevron deference standard, upheld the regulations and affirmed the fraud penalties.

    Issue(s)

    Whether the issuance of the notices of deficiency for 1992-1997 was barred by the statute of limitations under IRC section 6501? Whether Feller’s overstated withholding credits for 1992-1997 resulted in underpayments of income tax attributable to fraud pursuant to IRC sections 6663 and 6664? Whether Treasury Regulation section 1. 6664-2(c)(1) and section 1. 6664-2(g), Example (3), Income Tax Regs. , validly include overstated withholding credits in the calculation of underpayments for fraud penalties?

    Rule(s) of Law

    IRC section 6663 imposes a 75% penalty on any portion of an underpayment attributable to fraud. IRC section 6664 defines an ‘underpayment’ as the amount by which the tax imposed exceeds the sum of the tax shown on the return and amounts previously assessed or collected, minus rebates made. Treasury Regulation section 1. 6664-2(c)(1) specifies that the tax shown on the return is reduced by excess withholding credits claimed over actual withholdings for the purpose of calculating an underpayment.

    Holding

    The Tax Court held that Feller filed false returns with intent to evade tax within the meaning of IRC section 6501(c), thus the issuance of the deficiency notices was not time-barred. Furthermore, the court upheld the validity of Treasury Regulation section 1. 6664-2(c)(1) and section 1. 6664-2(g), Example (3), confirming that overstated withholding credits are included in calculating underpayments for fraud penalties. Consequently, Feller was subject to the fraud penalty for each year at issue.

    Reasoning

    The court applied the two-step Chevron analysis to determine the validity of the regulation. Under Chevron step 1, the court found that IRC section 6664 is ambiguous regarding the definition of ‘underpayment’ as it does not explicitly address withholding credits. Under Chevron step 2, the court concluded that the regulation’s inclusion of overstated withholding credits in the calculation of underpayment is a permissible construction of the statute. The court reasoned that the regulation aligns with the legislative intent to distinguish between ‘deficiency’ and ‘underpayment,’ and that Congress’s subsequent amendments to section 6664 did not alter the regulation’s interpretation. The court also emphasized Feller’s clear intent to evade tax, supporting the imposition of the fraud penalties.

    Disposition

    The Tax Court affirmed the IRS’s imposition of fraud penalties on Feller for the years 1992-1997, upholding the validity of the relevant Treasury regulations.

    Significance/Impact

    The decision in Feller v. Commissioner clarifies the scope of IRC section 6664 and the regulations under it, affirming that overstated withholding credits can be included in calculating fraud penalties. This ruling impacts how the IRS assesses fraud penalties, reinforcing the agency’s ability to penalize taxpayers who manipulate withholding credits to evade taxes. The case also sets a precedent for applying Chevron deference in tax law, affirming the IRS’s regulatory authority in defining ambiguous statutory terms.