Gurpreet S. Padda & Pamela B. Kane v. Commissioner

T.C. Memo. 2020-154UNITED STATES TAX COURT
GURPREET S. PADDA AND PAMELA B. KANE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 17338-16. Filed November 16, 2020.
James A. Kutten, for petitioners.
Teri L. Jackson and William R. Peck, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MORRISON, Judge: The petitioners, Gurpreet S. Padda and Pamela B.
Kane, filed joint returns for 2010, 2011, and 2012. The respondent (referred to
here as the IRS) issued a notice of deficiency determining the following
deficiencies in income tax, additions to tax, and penalties:
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[*2] Addition to tax Penalty
Year Deficiency sec. 6651(a)(1) sec. 6662(a)
2010 $380,934 $94,579.75 $76,186.80
2011 270,479 -0- 54,095.80
2012 424,963 20,931.85 84,992.60
Padda and Kane filed a timely petition. We have jurisdiction under section
6213(a).1
Padda and Kane have conceded the section 6651(a)(1) addition to tax for
late filing for the 2010 year. Taking this concession into account, here are the
remaining issues for decision:
(1) Did Padda meet the material-participation requirements of section
469 for the activities of five restaurants and a brewery? We hold he
did meet the requirements.
(2) Did Padda receive a constructive dividend in 2010 because his wholly
owned medical corporation2 paid $81,828 of his expenses? We hold
he did receive a constructive dividend.
1
Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
2
Interventional Center for Pain Management, Inc. (Interventional Center).
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[*3] (3) Are Padda and Kane liable for a section 6651(a)(1) addition to tax for
failing to timely file their 2012 return? We hold they are liable.
(4) Are Padda and Kane liable for accuracy-related penalties under
section 6662(a) for 2010, 2011, and 2012? We hold they are liable
for the penalty under section 6662(a) for 2010 for the portion of the
underpayment related to the constructive dividend.
FINDINGS OF FACT
The parties have stipulated some of the facts. These facts are adopted by the
Court as findings of fact.
Padda and Kane resided in Missouri when they filed their petition.
Padda and Kane are both medical doctors. Kane practices medicine at a
pediatric clinic.
Padda practices medicine through his wholly owned C corporation,
Interventional Center, a pain-management clinic in St. Louis, Missouri, that he
incorporated in the late 1990s. Padda is the president of Interventional Center and
has primary responsibility for its operations. Interventional Center employed a
number of physicians, nurse practitioners, chiropractors, and physical therapists
during the years at issue.
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[*4] During 2010 and 2011, Interventional Center’s hours of operation were
8 a.m. to 5 p.m., Monday through Friday, and 10 a.m. to 1 p.m. on Saturday. In
2012, Interventional Center shortened its Friday hours to 8 a.m. to 1 p.m. Padda
would typically work at Interventional Center for approximately three eight-hour
workdays and two four-hour workdays, Monday through Friday. Once every few
months he worked a few hours on a Saturday.
In 2006, Ami Grimes became the chief financial officer of Interventional
Center. She maintained Interventional Center’s books of accounts using the
QuickBooks program. She entered Interventional Center’s expenses and checks
into the program.
During the years at issue, Padda was the sole shareholder and corporate
president of Masala, Inc., an S corporation that operated a medical billing service
for Interventional Center under the names eProBill and eProCollect. eProBill
handled all of the medical billing for Interventional Center, and eProCollect
handled the collection of overdue payments. Padda and other Interventional
Center employees performed all of Masala’s functions. Padda spent between 210
and 220 hours per year exclusively on work for Masala during 2010, 2011, and
2012.
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[*5] Padda also operated another clinic called the Padda Institute Center for
Aesthetic and Laser Medicine (Padda Institute). The Padda Institute was a
medical spa specializing in skincare and laser hair removal treatments. It was
open for business Monday through Saturday. Padda did not spend significant
hours working on the business of the Padda Institute in 2010, 2011, or 2012. The
corporate form under which the Padda Institute operated is not revealed by the
record.
Between 2008 and 2012, Padda and Grimes opened five restaurants in the
St. Louis area.
Each of the five restaurants was operated by a separate partnership. Thus:
! CA Group, LLC,3 operated a full-service restaurant and bar under the
name Chuy Arzolas. It opened in 2009 and closed in 2013.
! Cafe Ventana, LLC, operated a cafe serving food and beverages. It
opened in 2008.
! Agave STL, LLC, operated a full-service restaurant and bar called
Sanctuaria. It opened in 2009.
! Hendricks BBQ, LLC, operated a full-service restaurant and bar. It
opened in August 2012 although planning for its operations occurred
in 2010 and 2011.
3
All limited liability corporations, or LLCs, mentioned in this opinion are
entities treated as partnerships for federal tax purposes.
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[*6] ! Diatina, LLC, operated a full-service restaurant and bar called
Diablitos Cantina. It opened in 2011 and closed in 2017.
During the relevant years, Padda owned a 50% interest in each of the five
restaurant partnerships; Grimes owned the other 50%. Grimes did not contribute
cash or other property to acquire her interests in the partnerships. Although Padda
owned only 50% of each of the five restaurant partnerships, he was allocated
100% of the losses. Grimes was not allocated any losses. The IRS does not
challenge this loss allocation.
Padda also invested in a brewery operated by Ninkasi, LLC. During the
years at issue, Padda owned a 90% interest in Ninkasi; Grimes owned 5% and
Padda’s brother (who was also his attorney) owned the remaining 5%. Ninkasi
opened for business in 2008 and operated under the name Cathedral Square
Brewery. Although Padda owned 90% of Ninkasi, he was allocated 100% of the
losses. Grimes and Padda’s brother were not allocated any of the losses. The IRS
does not challenge this loss allocation.
Padda was the sole shareholder of Padda Equipment Co., an S corporation
through which he purchased the furniture, fixtures, decor, and machinery for the
five restaurants and the brewery. Padda spent some time exclusively on its
operations.
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[*7] During 2010, Padda used Interventional Center’s corporate credit card to
pay for $81,828 of expenses for travel, meals, and event tickets.
On their 2010, 2011, and 2012 tax returns, Padda and Kane reported the
following losses from the restaurants and the brewery as nonpassive (and they
netted the losses against their nonpassive income):
Company name 2010 2011 2012
CA Group $375,390 $186,298 $49,418
Cafe Ventana 323,776 210,848 323,763
Hendricks BBQ 25,344 72,192 211,470
Ninkasi 149,657 38,692 214,019
Agave STL 278,739 47,677 100,665
Diatina n/a 317,394 329,002
Total 1,152,906 873,101 1,228,337
Padda and Kane hired a certified public accountant, Sylvia A. Ehrenreich, to
prepare their 2010, 2011, and 2012 federal income tax returns. She had prepared
Padda and Kane’s returns since at least 2006.
Ehrenreich also prepared the corporate federal income tax returns for
Interventional Center for 2010, 2011, and 2012. Ehrenreich relied on the trial
balance shown in Quickbooks for the amounts of meals and entertainment and
travel expenses that were deducted on Interventional Center’s 2010 return. She
was not asked to review any documentation related to these expenses, nor was she
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[*8] asked to determine whether any of the expenses paid were personal or were
properly substantiated.
Ehrenreich also prepared the federal income tax returns for the five
restaurant partnerships and the brewery partnership for the years at issue.
On their 2010 return, Padda and Kane filed an “Election to Group
Activities”. They elected to group the following activities: (1) Ninkasi with 3914
Lindell, LLC; and (2) Cafe Ventana with 3919 West Pine, LLC. The business
activities of 3914 Lindell and 3919 West Pine are not reflected in the record.4
For tax years 2006 through 2012, with the exception of 2011, Padda and
Kane’s federal income tax returns were filed with the IRS after the prescribed due
dates (including extensions).
Padda and Kane’s 2012 federal individual income tax return was due
October 15, 2013. On October 15, 2013, Padda and Kane signed IRS Form 8879,
“IRS e-file Signature Authorization” to authorize Ehrenreich’s accounting firm to
electronically file their 2012 Form 1040, “U.S. Individual Income Tax Return”.
On October 15, 2013, Ehrenreich’s accounting firm was electronically filing
several tax returns just before midnight. Ehrenreich’s accounting firm created an
4
Both 3914 Lindell and 3919 West Pine are listed on Schedule E,
Supplemental Income and Loss, of Padda and Kane’s 2010 return in Part 1,
Income or Loss From Rental Real Estate and Royalties.
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[*9] electronic version of Padda and Kane’s return on October 15, 2013, at
11:59 p.m. It transmitted the electronic version to the IRS on October 16, 2013, at
12 a.m. On October 16, 2013, the IRS rejected the return as a duplicate
submission. Ehrenreich’s accounting firm electronically resent the return on
October 25, 2013, and it was received and accepted by the IRS the same day.
On May 2, 2016, the IRS issued a notice of deficiency to Padda and Kane
for the 2010, 2011, and 2012 taxable years. The notice determined deficiencies
for all three years based on the following determinations: (1) the restaurants and
the brewery were passive activities for all three years and (2) Padda and Kane
failed to report constructive-dividend income for 2010. As indicated at the
beginning of the opinion, the notice of deficiency determined section 6662(a)
penalties for all three years. Before the IRS issued the notice of deficiency, the
group manager responsible for the examination of Padda and Kane’s returns for
the three years approved in writing the determination of the section 6662(a)
penalties for those years.
OPINION
The IRS’s determinations in the notice of deficiency are generally presumed
correct, and taxpayers generally bear the burden of proving otherwise. Rule
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[*10] 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933). Padda and Kane
concede in their opening brief that they bear the burden of proof.
1. Padda materially participated in the business operations of the five
restaurants and the brewery during 2010, 2011, and 2012.
a. The relevant legal tests
Taxpayers are allowed deductions for certain business and investment
expenses under sections 162 and 212. However, a taxpayer may not deduct losses
from passive activities to the extent the losses exceed the taxpayer’s income from
passive activities. Sec. 469(a)(1), (d)(1); sec. 1.469-1T(a)(1)(i), Temporary
Income Tax Regs., 53 Fed. Reg. 5700-5701 (Feb. 25, 1988). A passive activity is
generally an activity involving the conduct of a trade or business in which the
taxpayer does not materially participate. Sec. 469(c)(1).
Generally, taxpayers materially participate in an activity if they are involved
in the operations of the activity on a regular, continuous, and substantial basis.
Sec. 469(h)(1). Material participation in an activity may be established by any
reasonable means. Sec. 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed.
Reg. 5727 (Feb. 25, 1988). Generally, “reasonable means” include the
“identification of services performed over a period of time and the approximate
number of hours spent performing such services during such period, based on
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[*11] appointment books, calendars, or narrative summaries.” Id. While daily
time reports, logs, or similar documentation are not required, a taxpayer must
provide other reasonable means to establish participation in the activity. Id.A taxpayer can establish material participation in an activity by satisfying
any one of seven tests set forth in section 1.469-5T(a), Temporary Income Tax
Regs., 53 Fed. Reg. 5725-5726 (Feb. 25, 1988). Paragraph (a)(4) provides that the
fourth test is met if the “activity is a significant participation activity * * * for the
taxable year, and the individual’s aggregate participation in all significant
participation activities during such year exceeds 500 hours”. A significant
participation activity is a trade or business activity in which the individual
participates for more than 100 hours during the year. Id. para. (c), 53 Fed.
Reg. 5726.
For the purposes of determining whether the five restaurants and the
brewery were passive activities, we assume without deciding that the five
restaurants and the brewery each count as separate activities. A taxpayer may treat
one or more trade or business activities as a single activity if the activities
constitute an appropriate economic unit for the measurement of gain or loss for
purposes of the passive-activity rules. Sec. 1.469-4(c)(1), Income Tax Regs.
Once a taxpayer has grouped activities, the taxpayer may not regroup the activities
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[*12] in later taxable years unless the taxpayer complies with disclosure
requirements prescribed by the IRS. Id. para. (e)(1). On their 2010 return Padda
and Kane elected to group Ninkasi with 3914 Lindell (an entity not at issue), and
Café Ventana with 3919 West Pine (an entity not at issue). They did not elect to
treat as a single activity any combination of the five restaurants and the brewery.
The IRS argues that Padda and Kane cannot, for the purposes of this litigation,
make a retrospective election to regroup their activities for the years at issue.
Because (as we explain below) the time spent by Padda on each of the six
activities exceeded 100 hours for each year without grouping any of the activities
together, we need not determine whether Padda and Kane are entitled to regroup
the activities.5
b. Padda’s nontravel hours
Padda presented testimony to establish his hours spent on the restaurant and
the brewery activities. He personally testified for an entire day of trial, explaining
in detail his nontravel involvement in each restaurant and the brewery. Padda
stated the nontravel hours he spent working on the restaurants and the brewery
each year.
5
For all hours calculations, we exclude the year 2010 for Diatina because no
losses were claimed for Diatina for 2010.
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[*13] Following Padda’s testimony, 12 individuals testified regarding Padda’s
nontravel involvement in the restaurants and the brewery. They explained how
Padda was involved in every aspect of the restaurants and the brewery. This
included hands-on work and onsite instruction.
Padda’s testimony was also directed to how many hours he spent on each
activity for each year. For example, Padda testified that he spent 400 hours in
2011 on Cafe Ventana, of which 200 hours were spent on renovations.
On the basis of the testimony we described from Padda and the
corroborating witnesses, we find that the nontravel time Padda spent on each
activity exceeded 100 hours for each year at issue.
Because there are six activities involved in this calculation, our finding
means that Padda annually devoted more than 600 hours (i.e., 6 × 100 ' 600) of
nontravel time to the five restaurants and the brewery. This conclusion is valid
despite the IRS’s skepticism that Padda could have spent significant time on the
restaurants and the brewery given the demands of his work at his medical practice
(which was highly successful) and the lack of documentary evidence of his
personal involvement in the restaurants and the brewery. These reasons for
skepticism might be well placed in another case. But the record in this case is
consistent with our conclusions about Padda’s hours. Padda did not use
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[*14] correspondence or emails with respect to the restaurants and the brewery.
Instead he used the telephone and face-to-face meetings. Using these means of
communications, Padda exercised tight control of many aspects of the restaurants
and the brewery. In particular, he paid close attention to the quality and
ingredients of the food and beverages. He also rigorously controlled the decor and
appearance of the establishments. His employees confirmed his heavy
involvement. They complained in their testimony about his micromanagement.
Perhaps as a result of Padda’s efforts, the restaurants and the brewery were
lavishly appointed. The food and beverages were of the highest quality. The
restaurants and the brewery were also costly to operate. Year after year, they
produced massive financial losses that largely wiped out Padda’s profits from his
medical practice. Thus it was that Padda was a successful doctor and at the same
time spent significant time on the restaurants and the brewery.
c. Padda’s travel hours
In addition to the nontravel time he spent working on the five restaurants
and the brewery, Padda spent time traveling. Grimes accompanied Padda on most
of his trips. Grimes testified at length about the business nature of the trips using
her personal knowledge. Credible testimony by Padda and by Grimes established
that the trips were factfinding trips for the five restaurants and the brewery. They
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[*15] testified about how visits to particular establishments were related to
particular Padda-owned restaurants or the brewery.
Furthermore, Grimes created three spreadsheets before trial to summarize
Padda’s travel during 2010, 2011, and 2012, respectively. The spreadsheets
showed dates of travel, destination cities, and the names of bars, restaurants, and
breweries visited. Grimes testified extensively about the spreadsheets. Padda and
Kane exchanged with IRS counsel the documentation on which the spreadsheets
were based (credit-card receipts and invoices). The parties stipulated the
admissibility of the spreadsheets, and they were admitted.
According to the spreadsheets and Grimes’s testimony, Padda’s traveltime
related to the five restaurants and the brewery was 1,900 hours in 2010, 1,900
hours in 2011, and 1,100 hours in 2012. These hourly amounts are based on a
24-hour day, meaning that for a particular trip, every hour of each day of the trip
was counted, including time Padda spent not working (i.e., sleeping). If one were
to divide the annual traveltime totals by three to account for a typical eight-hour
work day, Padda’s restaurant and brewery traveltime becomes 633 hours in 2010;
633 hours in 2011; and 366 hours in 2012. We find these traveltime totals reliable
when adjusted as described.
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[*16] The preponderance of evidence, which includes the spreadsheets, Padda’s
testimony regarding his travel, and Grimes’ testimony regarding Padda’s travel,
shows that Padda spent at least 25 hours of travel time during each year at issue on
each of the five restaurants and the brewery. This is in addition to more than 100
hours of nontravel time that we find Padda spent each year at issue on each of the
five restaurants and the brewery.
d. Padda’s total hours, travel and nontravel
For each activity for each year (i.e., for each of the restaurants and the
brewery), Padda’s hours exceeded the 100-hour threshold required for an activity
to be a significant participation activity.6 This is because for each activity and for
each year his nontravel hours exceeded 100 hours and his travel hours exceeded
6
Not all time spent on a business activity counts as participation for the
purposes of these rules. Work performed in an individual’s capacity as an investor
does not qualify as participation unless the individual is directly involved in the
day-to-day management or operations. Sec. 1.469-5T(f)(2)(ii)(A), Temporary
Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988). Sec. 1.469-5T(f)(2)(ii)(B),
Temporary Income Tax Regs., 53 Fed. Reg. 5727 (Feb. 25, 1988), enumerates the
types of investor activities excluded from material participation. Investor-type
work includes studying and reviewing financial statements or reports on
operations of the activity; preparing or compiling summaries or analyses of the
finances or operations for the individual’s own use; and monitoring the finances or
operations in a nonmanagerial capacity. Id. None of Padda’s activities are those
listed in subdiv. (ii)(B). Therefore, we find that Padda’s participation in the five
restaurants and the brewery is not excluded as investor-type work as the IRS
alleges.
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[*17] 25 hours. Each activity was therefore a significant participation activity for
each year. See sec. 1.469-5T(c), Temporary Income Tax Regs., supra. Because
for each year Padda had at least these six significant participation activities,7 his
aggregate participation in all significant participation activities during the year
exceeded the 500-hour threshold of section 1.469-5T(a)(4), Temporary Income
Tax Regs., supra. The five restaurants and the brewery were not passive activities.
2. Padda and Kane failed to report dividend income in 2010 for expenses paid
by Interventional Center.
A distribution of property made by a corporation to a shareholder with
respect to its stock is governed by section 301(c). Sec. 301(a). Under section
301(c)(1), a distribution that is a “dividend” is includable in the shareholder’s
income. See also sec. 61(a)(7). A dividend is any distribution a corporation
makes to its shareholders out of earnings and profits. Sec. 316(a).
One type of distribution governed by section 301(c) is a constructive
distribution. United States v. Smith, 418 F.2d 589, 593 (5th Cir. 1969). To
determine whether a shareholder received a constructive distribution, this Court
looks to whether the distribution was primarily for the shareholder’s benefit rather
than for the corporation’s benefit. Hood v. Commissioner, 115 T.C. 172, 179-180
7
For 2010, Padda had no activities for Diatina, and therefore there were five
significant participation activities rather than six.
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[*18] (2000). The determination of whether the shareholder or the corporation
primarily benefits is a question of fact. Id. at 180.
During 2010, Padda (Interventional Center’s sole shareholder) used
Interventional Center’s corporate credit card to pay $81,828 of travel, dining, and
entertainment expenses for himself, his family, and his friends. Padda and Kane
do not dispute that Interventional Center had sufficient earnings and profits to
cause the $81,828 of expenses in 2010, if characterized as a distribution, to be
dividends.
Interventional Center reported deductions of these amounts on its corporate
return. Padda and Kane argue that the IRS entered into an agreement with
Interventional Center whereby it was allowed a business expense deduction for all
or some of the $81,828. Padda and Kane contend that the IRS is legally barred
from taking the position in this proceeding that the $81,828 in payments is a
constructive distribution to the extent the same payments were allowed as a
deduction to Interventional Center as part of the settlement agreement between the
IRS and Interventional Center.
It is undisputed that the IRS examined Interventional Center’s corporate
income tax return for 2010 and that the IRS reached an agreement with
Interventional Center about its income tax liability for that year. But that
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[*19] settlement has no effect on the determination of Padda and Kane’s income.
First, the settlement expressly governed only the question of whether
Interventional Center was entitled to deductions. The settlement did not purport to
address the question of what amounts are includable in Padda and Kane’s income.
Second, Interventional Center was a party to the settlement agreement, and Padda
and Kane were not.
At trial, Padda and Kane attempted to introduce into the record documents
marked as Exhibits 20-P, 49-P, 50-P, 51-P, and 52-P and related testimony (Tr.
250-256, 758-761) to prove which payments were governed by the settlement.
The IRS objected. The Court reserved ruling on the objection. We need not rule
on the objection. The evidence would have no effect on the outcome of this case.
The settlement has no effect on Padda and Kane’s income, as explained above.8
The question of whether Interventional Center’s payment of the $81,828 of
Padda’s expenses is a constructive dividend depends on whether Interventional
8
Padda and Kane also argue that the IRS is bound by a duty of consistency
to treat the reimbursements as other than distributions. The duty of consistency is
an obligation by which a representation made by a taxpayer to the IRS may be
binding on the taxpayer if the IRS relies on the representation to its detriment.
See, e.g., Beltzer v. United States, 495 F.2d 211, 212 (8th Cir. 1974). Even if the
duty of consistency governs the IRS (as opposed to taxpayers), the record does not
show that the IRS made a representation to Padda and Kane on which they
detrimentally relied.
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[*20] Center primarily benefited from paying the expenses. If it did primarily
benefit, then the payment is not a constructive dividend. If it did not, then the
payment is a constructive dividend.
Padda testified that as a general matter there was a business purpose for the
$81,828 in expenses. In our view, the testimony suggested that the business
purpose of the $81,828 in expenses was related to the five restaurants and the
brewery, not Interventional Center. We also observe that a portion of the $81,828
in expenses corresponds to the travel activities conducted by Padda for the five
restaurants and the brewery during 2010. See supra Part 1.c. Grimes and Padda
both testified about these travel activities, and Grimes created a spreadsheet for
each year about them. We concluded supra Part 1.c that the travel activities were
related to the five restaurants and the brewery.
The evidence we described in the paragraph above is the only evidence
regarding the $81,828 in expenses. The preponderance of the evidence shows that
the $81,828 did not benefit Interventional Center.
Therefore, we conclude that Padda and Kane received an $81,828
constructive dividend in 2010 for the travel, dining, and entertainment expenses
paid by Interventional Center.
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[*21] 3. Padda and Kane are liable for a section 6651(a)(1) addition to tax for
failing to timely file their 2012 return.
Section 6651(a)(1) imposes an addition to tax for failure to file a tax return
by its filing deadline (as extended) unless the taxpayer can establish that the
failure to timely file is due to reasonable cause and not due to willful neglect. The
section 6651(a)(1) addition to tax is 5% of the amount required to be shown on the
return if the failure is for not more than one month. Sec. 6651(b)(1).
The IRS bears the burden of production for additions to tax determined
under section 6651(a)(1). See sec. 7491(c); Higbee v. Commissioner, 116 T.C.
438, 446-447 (2001). The IRS satisfies its burden by producing sufficient
evidence to establish that the taxpayer failed to timely file a required return. See
Wheeler v. Commissioner, 127 T.C. 200, 207-208 (2006), aff’d, 521 F.3d 1289(10th Cir. 2008); Higbee v. Commissioner, 116 T.C. at 447. Once the IRS has
satisfied its burden of production, the taxpayer has the burden of proving that the
lateness was due to reasonable cause and not willful neglect. Higbee v.
Commissioner, 116 T.C. at 447. Reasonable cause excusing a failure to timely file
exists if the taxpayer exercised ordinary business care and prudence but
nevertheless was unable to file the return by the deadline. See sec. 301.6651-
1(c)(1), Proced. & Admin. Regs. Willful neglect means a conscious,
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[*22] intentional failure, or reckless indifference. United States v. Boyle, 469 U.S.
241, 245 (1985).
Padda and Kane’s 2012 return was due on October 15, 2013. The parties
have stipulated that the return was filed on October 25, 2013. Padda and Kane
seek to avoid the addition to tax because they claim that Ehrenreich’s accounting
firm was responsible for the untimeliness.
In considering whether a taxpayer has exercised reasonable care and
prudence, courts have held that the taxpayer’s duty to file a timely return cannot be
avoided by delegating to another party, including an accountant, the responsibility
for preparing and filing the return. Mauldin v. Commissioner, 60 T.C. 749, 762
(1973); see also Boyle, 469 U.S. at 251-252 (holding that reliance on an agent to
file a return does not establish reasonable cause because “[i]t requires no special
training or effort to ascertain a deadline and make sure that it is met”).9 Padda and
Kane argue that the reason that their 2012 return was filed late was that
9
As explained in the text, reliance on an accountant to file a return is not
reasonable cause for the failure to file on time. Reasonable cause for failure to file
may be established when a taxpayer relies on a competent adviser who advises that
the taxpayer is not required to file a return. Evans v. Commissioner, T.C. Memo.
2016-7, at *43. There is no evidence that Padda and Kane received this type of
advice. See United States v. Boyle, 469 U.S. 241, 251-252 (1985); Mauldin v.
Commissioner, 60 T.C. 749, 762 (1973); Niv v. Commissioner, T.C. Memo. 2013-
82, at *24; Owusu v. Commissioner, T.C. Memo. 2010-186, slip op. at 13.
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[*23] (1) Ehrenreich’s accounting firm pressed a button only a few seconds late,
(2) they relied on Ehrenreich’s accounting firm to timely file the return, and
(3) they themselves could not have pressed the button to timely file the return.
Even if sometimes it might be reasonable for a taxpayer to rely on his or her
accountant to timely file his or her returns (contrary to the caselaw), it was not
reasonable in this particular case for Padda and Kane to rely on Ehrenreich’s firm
to timely file their return. Padda and Kane have relied on Ehrenreich’s firm to file
their returns every year since at least 2006. And every year since then, except for
2011, their return was filed late. Yet they have continued to use Ehrenreich’s firm
to file their return year after year. Padda and Kane’s failure to ensure that
Ehrenreich’s firm timely filed their 2012 return demonstrates a lack of ordinary
business care, particularly in the light of the firm’s history of delinquent filings.
We find that Padda and Kane do not have reasonable cause, on the basis of
any reliance on Ehrenreich’s firm for their untimely 2012 return, and we hold that
Padda and Kane are liable for the section 6651(a)(1) addition to tax for failing to
timely file their 2012 return.
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[*24] 4. Padda and Kane are liable for a section 6662 penalty for 2010, but not
2011 and 2012.
Section 6662(a) and (b)(1) and (2) imposes a penalty equal to 20% of any
portion of an underpayment of tax that is attributable to negligence or to a
substantial understatement of income tax. An underpayment is the difference
between the correct tax and the tax reported on the return, with exceptions not
relevant here. Sec. 6664(a). Negligence includes any failure to make a reasonable
attempt to comply with the provisions of the internal revenue laws or to exercise
ordinary and reasonable care in the preparation of a tax return. Sec. 6662(c);
sec. 1.6662-3(b)(1), Income Tax Regs. Negligence may also include the failure to
properly substantiate an item. Higbee v. Commissioner, 116 T.C. at 449;
sec. 1.6662-3(b)(1), Income Tax Regs. A substantial understatement of income
tax exists if (1) the understatement exceeds 10% of the tax required to be shown
on the return and (2) the understatement exceeds $5,000. Sec. 6662(d)(1)(A). An
understatement is the difference between the correct tax and the tax reported on
the return, with exceptions not relevant here. Sec. 6662(d)(2)(A).
For any penalty the IRS determines applies to an individual, section 7491(c)
imposes the burden of production on the IRS. Higbee v. Commissioner, 116 T.C.
at 446. This means that the IRS is required to come forward with sufficient
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[*25] evidence that it is appropriate to impose the penalty. Sec. 7491(c); Higbee
v. Commissioner, 116 T.C. at 446.
No section 6662 penalty is imposed with respect to any portion of an
underpayment if it is shown that there was a reasonable cause for such portion and
that the taxpayer acted in good faith with respect to such portion. Circumstances
that indicate reasonable cause and good faith include reliance on the advice of a
tax professional. Sec. 1.6664-4(b), Income Tax Regs. The taxpayer has the
burden of proving that he or she acted with reasonable cause and in good faith.
Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446-447.
The notice of deficiency determined that Padda and Kane were liable for
penalties under section 6662(a) for 2010, 2011, and 2012. The underpayments for
all three years, as calculated in the notice of deficiency, were due to Padda’s
failure to meet the material-participation requirements. The underpayment for
2010 was due also to Padda and Kane’s failure to report as their income the
$81,128 in Padda’s credit-card expenses that Interventional Center paid.
However, we have concluded supra Part 1 that Padda met the material-
participation requirements. Therefore, Padda and Kane’s potential penalty under
section 6662 is limited to the tax year 2010. And the underpayment for that year
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[*26] relates to Padda and Kane’s failure to report the $81,828 of Padda’s credit-
card expenses paid by Interventional Center.
The IRS satisfied its burden of producing evidence that Padda and Kane
acted negligently in failing to report the $81,828. Padda and Kane failed to
provide their accountant, Ehrenreich, with the information necessary to ascertain
whether Interventional Center’s $81,828 payment of credit-card expenses was
includable in their income as a constructive dividend. They did not solicit or
receive advice from Ehrenreich on the tax consequences of paying the expenses
with Interventional Center funds.
Padda and Kane, who bear the burden of persuasion, have not adduced
sufficient evidence that the IRS’s negligence determination was incorrect. Nor
have they argued that the negligence determination was incorrect.10
We conclude that the underpayment for 2010 is due to negligence.
Therefore, Padda and Kane are liable for the section 6662 penalty for 2010,
although in a lesser amount than the amount computed in the notice of
10
For example, Padda and Kane do not argue that they had reasonable cause
and good faith with respect to the $81,828 because they relied on Ehrenreich.
Such a defense would be without merit anyway because, as we explain in the text,
they failed to supply Ehrenreich with necessary information about the credit-card
expenses and received no advice from her regarding the tax consequences of
payment of the expenses by Interventional Center.
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[*27] deficiency.11 Computations under Rule 155 will determine the amount of
the underpayment and the amount of the penalty. Computations under Rule 155
will also determine whether there is a substantial understatement for 2010. If there
is a substantial understatement, that will serve as an alternative basis for liability
for the penalty.
To reflect the foregoing,
Decision will be entered under
Rule 155.
11
The parties stipulated that the IRS satisfied the penalty-approval
requirement in sec. 6751(b) with respect to the penalties under sec. 6662.