Monday, February 6, 2023

Blind Ignorance and Unjustifiable Reliance Fail The Reasonable Cause Exception to the Negligence Penalty

William Delaney, EA
Westwood, MA

Ashenafi G. Mulu engaged Dave, the Tax Doctor (aka David Clerie) to prepare his personal income tax return for 2018, as he had for several years prior. Since Clerie did not have a PTIN, the e-filed returns were submitted as being self-prepared. Apparently, the taxpayer thought that this was business as usual (blind ignorance).

The year before (2017), Mulu purchased a rental house which he renovated, but it did not generate any rental income until the following year (2018). There was a net rental loss (passive loss) which was claimed for that year. In addition, a Schedule C was filed (business described as “driver”). The occupation shown on form 1040 was “laborer” although Mt. Mulu was employed (W-2) as a pharmacist.

Before the return was fully prepared and filed, Cleric (the tax preparer) died and his brother took over the tax practice and completed/filed the tax return. The brother’s tax preparation background, and the presence or absence of credentials, apparently were never a subject of conversation between Clerie (brother) and Mulu (customer/client).

It is sufficient to say that the IRS was not much impressed with the quality of the return preparation because they issued a notice of deficiency. In addition, an accuracy-related penalty [§6662(a)] of $1,212.20 was imposed. Mr. Mulu sought to abate the penalty in full, which it is often possible to do with a well-written reasonable cause explanation.

Mr. Mulu claimed reasonable cause and good faith because he relied on the tax preparer (unjustifiable reliance) and had no understanding of taxation, depreciation, and accounting for expenses (some of which were disallowed in-part or in-full). He also claimed that he was the victim of an unscrupulous return preparer.

This argument fell on its head. One problem, of course, is that the tax preparers (Dave, the Tax Doctor and his brother) were unlicensed and ineligible to e-file an income tax return (you need a PTIN to do that), so the taxpayer filed the tax return as being self-prepared*. Another difficult problem for the taxpayer to overcome was his apparent indifference to what “he” was reporting to the IRS. (He failed to exercise diligence and/or prudence). Mulu actually admitted that he did not review the tax return before it was filed (a “where do I sign” client).

If your thought is, well I can get “them” to waive the penalty, don’t take on a client like Ashenafi Mulu. Mulu v. Comm., TC Summary Opinion 2023-2 (1/25/2023).

*Your editor once acquired a client whose return was self-prepared. She knew that the preparer (a college professor) was preparing tax returns as a sideline and did not want to leave his fingerprints anywhere, because he wasn’t reporting the income. This didn’t bother her. I discovered, among other things, that he continued to deduct depreciation beyond the asset’s useful life (because he did not maintain cumulative records). She, also, did not have a clue but, at least, she didn’t pretend to be ignorant.

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