Richard S. Hussey

156 T.C. No. 12UNITED STATES TAX COURT
RICHARD S. HUSSEY, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 19249-18. Filed June 24, 2021.
In 2012 P sold 16 investment properties and received from the
mortgage lender a discharge of indebtedness totaling $754,054 for 15
of those properties. In 2013 P sold seven investment properties. P
did not receive from the lender a discharge of indebtedness relating to
the 2013 property sales.
The parties agree that in 2012 P received a discharge of
qualified real property business indebtedness (QRPBI). The
discharge of QRPBI may be excluded from income if the taxpayer’s
bases in depreciable real properties are reduced by the amount of the
debt discharge. I.R.C. sec. 108(a)(1)(D), (c)(1). A basis reduction
occurs only to the extent that the taxpayer’s aggregate bases in
depreciable real properties equal or exceed the amount of debt
discharged. I.R.C. sec. 108(c)(2)(B). P’s aggregated bases exceeded
the amount of QRPBI in 2012.
Served 06/24/21
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The basis reduction generally occurs in the year following the
discharge of indebtedness. I.R.C. sec. 1017(a). However, as an
exception to that general rule, the basis reduction for discharge of
QRPBI occurs in the same year as the sale of “property taken into
account under I.R.C. sec. 108(c)(2)(B)”. I.R.C. sec.
1017(b)(3)(F)(iii). Thus, the basis reduction occurs in the year the
debt is discharged if the taxpayer sells, in the same year as the
discharge, depreciable real property that had been used to prove the
taxpayer had aggregated bases that exceeded the discharge amount.
P’s Form 1040X, Amended U.S. Individual Income Tax
Return, for 2012 and his Forms 1040, U.S. Individual Income Tax
Return, for the years at issue, 2013 and 2014, were prepared by a tax
law firm to which P was referred with the assistance of his long-time
financial adviser and a large accounting firm.
The parties dispute how provisions relating to the timing of the
basis adjustment for discharge of QRPBI in I.R.C. secs. 108 and 1017
apply; whether the lending bank discharged any of P’s debt in 2013;
and whether P is liable for accuracy-related penalties under I.R.C.
sec. 6662 for 2013 and 2014.
1. Held: P is required to reduce the bases of depreciable real
properties in 2012. See I.R.C. sec. 1017(b)(3)(F)(iii).
2. Held, further, the lending bank did not discharge any of P’s
QRPBI in 2013.
3. Held, further, P is not liable for accuracy-related penalties
under I.R.C. sec. 6662 for 2013 and 2014 because he relied in good
faith on professional tax advice in preparing his returns for those
years.
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Catherine E. Chollet, for petitioner.1
Catherine S. Tyson and Philip Edward Blondin, for respondent.
OPINION
COLVIN, Judge: Respondent determined that petitioner had income tax
deficiencies and is liable for penalties for taxable years 2013 and 2014 as follows:2
Penalty
Year Deficiency sec. 6662
2013 $59,905 $11,981
2014 33,969 6,794
The issues for decision are:
1. Whether, under sections 1017(a) and (b)(3)(F)(iii) and 108(c)(2)(B),
petitioner must reduce his bases in real properties for 2012 or 2013 as a result of
his sale of depreciable real properties in 2012. We hold that the basis adjustments
must be made for 2012.
1
Thomas J. Carnes appeared only for a procedural issue prior to the trial of
the tax issue.
2
Unless otherwise indicated, statutory references are to the Internal Revenue
Code, Title 26, U.S.C., in effect for the years in issue, and Rule references are to
the Tax Court Rules of Practice and Procedure.
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2. Whether petitioner received a discharge of debt in 2013. We hold that he
did not.
3. Whether petitioner is liable for accuracy-related penalties under section
6662 for taxable year 2013 or 2014. We hold that he is not.
Background
Some of the facts have been stipulated and are so found.
A. Petitioner’s Investment Properties
In 2009 petitioner purchased3 27 investment properties on which he
assumed outstanding loans totaling $1,714,520. All of the loans were held by the
same bank (the lending bank). By 2012 petitioner was struggling to make
payments on the loans.
In 2012 petitioner sold 16 of the properties, 15 of which he “sold short”, i.e.,
sold at a loss. The total sale proceeds for the 16 properties were $241,861. After
the sales, petitioner’s loans were modified and replaced with two notes: Note A,
totaling $265,600, which replaced the original loan assumption; and Note B,
3
The properties were purchased by Cobriel, LLC, a Missouri limited liability
company (LLC), of which petitioner is the only member. Because there is only
one member, and because the LLC has never filed Form 8832, Entity
Classification Election, see Castello v. Commissioner, T.C. Memo. 2016-184,
at *10, the LLC is disregarded for tax purposes, see secs. 301.7701-1, 301.7701-2,
and 301.7701-3, Proced. & Admin. Regs. Herein we treat the properties as owned
by petitioner as an individual.
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totaling $575,864, which replaced a line of credit petitioner had established with
the lending bank. The lending bank issued to petitioner 15 Forms 1099-C,
Cancellation of Debt, for 2012 (one for each property sold at a loss), which stated
that he had a total discharge of debt of $754,054. In 2013 petitioner sold short
seven of the remaining properties for $241,500. After the sales, petitioner
requested and the bank agreed to a loan modification, pursuant to which $10,200
from Note B was transferred to a new note, Note C. At that time, $539,341
remained on Note B and the bank documented that Note B was “[r]eplaced with
Note C - no more payments on Note B.” Bank records showed that there was a
“Net Charge-Off” of $529,665 for Note B, and also that “[p]ayments received (up
to $529,66[5]) will be posted as a[n] LLR [Loan Loss Reserve] Recovery”. The
lending bank did not issue any Forms 1099-C to petitioner for 2013. Around
October 25, 2015, the bank wrote that “$493,141[] is the remaining amount to be
booked as an LLR Recovery as of: 10/2/2015”.
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B. Petitioner’s 2012-14 Tax Returns
1. Original and Amended 2012 Tax Return4
Petitioner, through his then accountant, filed his Form 1040, U.S. Individual
Income Tax Return, for 2012 on October 13, 2013. The Form 4797, Sales of
Business Property, filed with that return, stated that petitioner had sold 17
investment properties (16 associated with the lending bank and 1 he had purchased
earlier) for a gain totaling $83,675.
Petitioner has no background in tax or accounting. When petitioner
suspected that his original return for 2012 was incorrect, he contacted his
long-time financial adviser to seek his opinion. His financial adviser told
petitioner that he also believed that the return was not correct. The adviser called
an acquaintance who was a certified public accountant (C.P.A.) at a large
accounting firm and scheduled an appointment for petitioner. Petitioner and his
financial adviser met with that individual, who reviewed petitioner’s 2012 tax
return. The individual stated that he believed the return was incorrect and
recommended that petitioner meet with a tax attorney at the Kohn Partnership
because of the complexity of the issues relating to that return.
4
Facts relating to the 2012 return are included because they relate to
petitioner’s 2013 and 2014 tax years.
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Petitioner and his financial adviser met with Michael Kohn of the Kohn
Partnership. Mr. Kohn had more than 30 years of experience as a practicing tax
attorney. During the meeting Mr. Kohn described what he said were various
errors on petitioner’s 2012 tax return. He also described how he believed tax law
applied to petitioner’s real estate transactions at issue here. As a result of this
meeting, petitioner hired the Kohn Partnership to prepare Form 1040X, Amended
U.S. Individual Income Tax Return, for 2012 and to prepare his Forms 1040 for
taxable years 2013 and 2014. Mr. Kohn called petitioner several times to request
documents while he worked on petitioner’s tax returns. Petitioner provided the
requested documents.
Petitioner filed the Form 1040X for 2012 prepared by the Kohn Partnership
on January 14, 2015. The Form 4797 attached to the amended return stated that
petitioner had sold 17 properties for a loss totaling $613,263. On Form 982,
Reduction of Tax Attributes Due to Discharge of Indebtedness (and Section 1082
Basis Adjustment), petitioner reported that he had excludable income of $685,281
“for a discharge of qualified real property business indebtedness applied to reduce
the basis of depreciable real property” (i.e., the debt discharged from the lending
bank).
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2. 2013 Tax Return
On October 15, 2014, petitioner filed his Form 1040 for 2013, which had
been prepared by the Kohn Partnership. On the Form 4797 included with that
return petitioner reported that in 2013 he had sold six investment properties5 and
his primary residence (which was also listed as an investment property) for a loss
totaling $499,417 ($437,650 for the investment properties and $61,767 for his
primary residence).
3. 2014 Tax Return
On October 15, 2015, petitioner filed his Form 1040 for 2014, which had
been prepared by the Kohn Partnership. Petitioner reported a net operating loss
carryforward of $423,431 from 2013. On Form 982 petitioner reported he had
excludable income of $65,914 from a discharge of qualified real property business
indebtedness (QRPBI). A Form 1099-C shows that petitioner received a discharge
of debt of $65,914 from the 2014 sale of his primary residence (the same residence
reported as sold in his 2013 tax return).
5
The record establishes that petitioner sold seven (not six) investment
properties in 2013. The investment property not reported on the 2013 return is
identified in the record as 4315 Gannett.
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C. Notice of Deficiency
On July 3, 2018, respondent issued a notice of deficiency to petitioner for
taxable years 2013 and 2014. For 2013 respondent disallowed the loss deductions
claimed on petitioner’s Form 4797. For 2014 respondent disallowed the loss
carryover deduction from 2013.6
Discussion
The taxable years at issue are 2013 and 2014. The issues for decision are
(1) when (i.e., in which year), under sections 108 and 1017, petitioner is required
to reduce the bases in his depreciable real properties for sales of those properties
in 2012; (2) whether the lending bank discharged any of petitioner’s QRPBI in
2013; and (3) whether petitioner is liable for accuracy-related penalties under
section 6662.
A. Whether Petitioner Is Required To Reduce His Bases for the Year the Debt
Was Discharged or for the Subsequent Year
We next decide when--that is, whether for 2012 or 2013--petitioner must
make basis reductions as a result of the bank’s discharge of QRPBI and his sales
of depreciable real properties in 2012. While petitioner’s tax year 2012 is not
6
Because respondent’s determination for 2014 depends upon our analysis of
the 2013 taxable year, whether the carryover is allowed is a computational
adjustment and not an issue for decision.
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before us in this case, we must decide this issue in order to decide the amount of
petitioner’s tax liability for 2013. See sec. 6214(b); Hill v. Commissioner, 95 T.C.
437, 439-440 (1990).
Sections 61(a)(10) and 108(a)(1)(D) provide an exclusion from income for
forgiveness of QRPBI. When that exclusion applies, the taxpayer must reduce his
or her bases in the depreciable real properties. Sec. 108(c)(1). The parties agree
that petitioner’s indebtedness on the 15 investment properties sold short in 2012
was QRPBI. See sec. 108(c)(1). The parties also agree that petitioner may
exclude the discharge of his QRPBI from income. See secs. 61(a)(10),
108(a)(1)(D). Finally, the parties agree that petitioner must reduce his bases in the
depreciable real properties as a result of that exclusion. See sec. 108(c)(1).
However, the parties dispute the year for which the basis reductions must be made.
Petitioner contends that the basis reductions must be made for 2013. Respondent
contends they must be made for 2012.
Petitioner points out that section 1017(a) states generally that basis
reductions resulting from the discharge of QRPBI are made the year after the debt
is discharged. If section 1017(a) applies here, the basis adjustments at issue
would, as petitioner contends, be made in 2013. However, section 1017(b)(3)(F)
provides three additional rules which govern reduction of basis following
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discharge of QRPBI.7 First, real property, the aggregate bases of which are
considered under section 108(c)(2)(B), includes only depreciable real property.
Sec. 1017(b)(3)(F)(i). Second, the depreciable real property may not be held as
inventory. Sec. 1017(b)(3)(F)(ii).
Third, section 1017(b)(3)(F)(iii) provides that, in the case of “property taken
into account under section 108(c)(2)(B), the [basis] reduction with respect to such
property shall be made as of the time immediately before [the] disposition if
earlier than the time under” section 1017(a) (i.e., the year following the discharge).
Application of this third rule requires consideration of whether “property [was]
taken into account under section 108(c)(2)(B)”; and if it was, then the “reduction
with respect to such property shall be made as of the time immediately before [the]
disposition [e.g., sale] if earlier than the time under” section 1017(a).
Thus we must decide whether, as stated in the third rule, section
1017(b)(3)(F)(iii), property was taken into account under section 108(c)(2)(B).
Section 108(c)(2)(B) provides:
Overall limitation.--The amount excluded under subparagraph (D) of
subsection (a)(1) [discharge of QRPBI] shall not exceed the aggregate
7
Where two provisions overlap in application, here, sec. 1017(a) and
(b)(3)(F), the more specific provision (sec. 1017(b)(3)(F)) takes precedence over
the more general provision. Bulova Watch Co. v. United States, 365 U.S. 753,
758 (1961).
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adjusted bases of depreciable real property (determined after any
reductions under subsections (b) and (g)) held by the taxpayer
immediately before the discharge (other than depreciable real
property acquired in contemplation of such discharge).
In other words, the amount of discharged QRPBI excluded from a
taxpayer’s income may not exceed the aggregate bases of the taxpayer’s
depreciable real properties held immediately before the discharge. The bank
discharged $754,054 of petitioner’s QRPBI in 2012. The record suggests, and the
parties do not dispute, that petitioner’s aggregate bases in depreciable real
properties for 2012 immediately before the discharge exceeded the $754,054
discharge of QRPBI.
Section 1017(b)(3)(F)(iii) also provides that in the case of “property taken
into account under section 108(c)(2)(B)” (i.e., depreciable real property which was
used to show that he had aggregated bases in excess of the discharge amount) in
the same year as the discharge, the basis reductions must occur immediately before
the sales of the properties and not in the year following the sales. Because in 2012
petitioner (1) received a discharge of QRPBI and (2) sold properties the bases of
which were used to show he had aggregated bases that exceed the discharge
amount, he was required to reduce his bases in the disposed properties
immediately before the sales of those properties in 2012, not in 2013. His reported
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bases for the properties sold in 2012 should have reflected these reductions, and
any remaining reductions should have been reflected in the bases of his remaining
properties for 2013.8
Our analysis of the question when the basis adjustment is required to be
made begins with the governing statutory text. See, e.g., Allen v. Commissioner,
118 T.C. 1, 7 (2002). Even though we see no ambiguity in the application here of
that text, we find it helpful to review Congress’ statement about the statute’s
purpose in the legislative history accompanying the enactment of these provisions
in 1993. See United States v. Am. Trucking Ass’ns, Inc., 310 U.S. 534, 543-544
(1940). Legislative history shows that the provisions central to this case were
enacted in 1993 to provide relief to owners of certain real estate which had
declined in value. Consistent with this purpose, section 108(c)(2)(A) limits the
income exclusion to the amount by which the value of the property is less than the
indebtedness on the property (i.e., the amount the property is “underwater”). The
8
“[F]or basis reductions under section 108(c), a taxpayer must reduce the
adjusted basis of the qualifying real property to the extent of the discharged
qualified real property business indebtedness before reducing the adjusted bases of
other depreciable real property.” Sec. 1.1017-1(c)(1), Income Tax Regs. The
parties do not contend that petitioner had sufficient bases in the properties sold in
2012 to cover the 2012 debt discharge; therefore, the basis reductions in excess of
those applied to the properties sold in 2012 should be reflected in properties
owned at the beginning of 2013.
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form of relief was to convert the consequence of the discharge of certain
indebtedness (QRPBI) from income, as would generally result under section 108,
to a basis adjustment. These provisions also determine the timing of the basis
adjustments by taking into account the amounts of the taxpayer’s bases in real
estate at the time of discharge of the QRPBI. The Report of the House Budget
Committee for the Omnibus Budget Reconciliation Act of 19939 accompanying
the enactment of those sections states:
The committee believes that where an individual has discharge of
indebtedness that results from a decline in value of business real
property securing that indebtedness [i.e., QRPBI], it is appropriate to
provide for deferral, rather than current inclusion, of the resulting
income. Generally, that deferral should not extend beyond the period
that the taxpayer owns the property.
* * * * * * *
The amount of debt discharge excluded under the provision is
applied, using the rules of section 1017 (as modified by the
provision), to reduce the basis of business real property held by the
taxpayer at the beginning of the taxable year following the taxable
year in which the discharge occurs. The election under sec.
1017(b)(3) to treat inventory as qualified property does not apply. If
the taxpayer disposes of real property (in the transaction that gave rise
to the discharge or otherwise) prior to the first day of the next taxable
year, then the reduction in basis of such property is made as of the
time immediately before the disposition.
9
The House Ways and Means Committee provided the text for the tax
provisions in the Report. See H.R. Rept. No. 103-111, at 593 (1993), 1992
U.S.C.C.A.N. 378, 824.
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H.R. Rept. No. 103-111, at 623-624 (1993), 1993 U.S.C.C.A.N. 378, 854-
855 (emphasis added).10 As stated in the Committee Report, the taxpayer must
make a basis adjustment for the year depreciable real property is sold if the
property is sold in the same year as the discharge.
Petitioner contends, however, that because the aggregated bases in his
remaining properties (i.e., the unsold properties) in 2012 exceeded the discharged
amount, he did not need to reduce his bases until the following year. Petitioner’s
argument misconstrues sections 108(c)(2)(B) and 1017(b)(3)(F)(iii). The property
referred to in section 108(c)(2)(B) is ascertained before the debt is discharged.
When section 1017(b)(3)(F)(iii) refers to the properties identified in section
108(c)(2)(B), that reference is to a set group of properties that is fixed once the
debt is discharged. Selling properties from that group triggers section
1017(b)(3)(F)(iii) with respect to the bases of the properties sold regardless of the
remaining bases in the properties not sold. Nowhere in section 1017(b)(3)(F)(iii)
or section 108(c)(2)(B) is there a reference to the “remaining” bases after the sale
10
See also Gerald J. Robinson, Federal Income Taxation of Real Estate,
para. 9.06[4][b] (2021), Westlaw FITRE WGL (“If the taxpayer disposes of
depreciable real property, either in the transaction giving rise to the discharge of
indebtedness or otherwise, prior to the first day of the next taxable year, the
reduction in basis is accelerated: It is made as of the time immediately before the
disposition.”).
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(i.e., disposition) of properties. Thus, petitioner was required under section
1017(b)(3)(F)(iii) to reduce his bases immediately before the sale of the
investment properties in 2012.
B. Whether Petitioner Had Discharge of Indebtedness in 2013
1. Whether Petitioner May Claim That the Lending Bank Did Not
Discharge Debt in 2013
Respondent contends that petitioner may not claim that the lending bank did
not discharge any of his debt in connection with the sale of seven properties in
2013 because petitioner did not raise this issue in the petition. See Rule 34(b)(4).
Petitioner raised this issue for the first time before the Court in his pretrial
memorandum, and he had previously raised it with respondent. We disagree with
respondent’s contention because respondent has fully addressed petitioner’s claim
on several occasions.
We may refuse to consider an issue not raised in the pleadings and raised
with the Court for the first time in the party’s pretrial memorandum, if our
consideration of the issue would surprise or prejudice the opposing party. Fox
Chevrolet, Inc. v. Commissioner, 76 T.C. 708, 733-736 (1981). Respondent does
not claim surprise or prejudice from petitioner’s argument. Instead, respondent
merely objects to the timing of petitioner’s raising of this issue. A review of the
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record shows that respondent was well aware of this argument before it was
presented to the Court because respondent’s pretrial memorandum addressed the
argument in full. Respondent has had ample opportunity to develop an argument
and address this issue. Respondent does not contend, nor does it appear, that
respondent was unable to find and provide evidence regarding this issue.
Respondent’s argument fully relies upon evidence proffered by the parties early in
this case. Therefore, we deny respondent’s objection and we proceed to the merits
of the parties’ arguments on whether the lending bank discharged any of
petitioner’s debt in 2013.
2. Whether the Lending Bank Discharged Any of Petitioner’s Debt in
2013
Respondent contends that the lending bank discharged some of petitioner’s
QRPBI in 2013 because petitioner’s debt was restructured in 2013 and the bank
charged off (i.e., considered unlikely to be paid) the remaining amount on Note B
(i.e., $529,665). If we agreed with respondent, we would decide whether
petitioner had for 2013 a basis reduction from the debt discharge and the sales of
properties in 2013. See supra Part A. After considering other evidence in the
record on this issue, we conclude that the bank did not discharge any of
petitioner’s debt in 2013.
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First, respondent relies on the bank’s records, which state that the debt on
Note B was “charged off”. However, in the light of other facts present here, this
entry does not establish discharge of indebtedness income. Kleber v.
Commissioner, T.C. Memo. 2011-233, 2011 WL 4485037, at *3 (citing Cozzi v.
Commissioner, 88 T.C. 435, 445 (1987)). Additionally, if an amount charged off
is retained on a creditors books (i.e., moved to a reserve account), the charge-off is
not a discharge of indebtedness. See Int’l Proprietaries, Inc. v. Commissioner, 18
T.C. 133, 139 (1952) (“[T]here is no authorization for a taxpayer[-creditor] to use
at the same time a charge-off and a reserve method for the deduction of bad
debts.” (quoting Commercial Bank of Dawson v. Commissioner, 46 B.T.A. 526,
530 (1942))). While the bank recorded a “net charge off” of $529,665 in 2013, it
also recorded that payments up to $529,665 “will be posted as LLR [Loan Loss
Reserve] Recovery.” Because the lending bank recorded both a net charge-off and
a loan loss reserve recovery of $529,665, the presence of the reserve account
suggests that the lending bank did not intend to discharge the debt.
The term “loan loss reserve” is familiar to this Court. See, e.g., Bank One
Corp. v. Commissioner, 120 T.C. 174 (2003) (discussing “loan loss reserve”),
aff’d in part, vacated in part, and remanded sub nom. JP Morgan & Chase Co. v.
Commissioner, 458 F.3d 564 (7th Cir. 2006); Cent. Pa. Sav. Ass’n & Subs. v.
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Commissioner, 104 T.C. 384 (1995) (same), supplemented by T.C. Memo. 1996-
172; Kosman v. Commissioner, T.C. Memo. 1996-112 (same). “[L]oss reserve” is
defined as, inter alia, “[a] bank’s reserve set aside to cover possible losses, as from
defaulting loans.” Black’s Law Dictionary 1422 (9th ed. 2009).11 It appears that
the lending bank merely moved the “net charge off” amount from one pocket
(Note B) to another pocket (the LLR Recovery). We believe that the lending bank
would not discharge debt and simultaneously increase by the same amount the
LLR, which is an account used to set aside money in anticipation of a default.
Second, the bank did not issue Forms 1099-C to petitioner showing that
debt had been discharged in 2013. The nonissuance of Forms 1099-C does not
necessarily indicate that debt had not been discharged, see Vaughn v.
Commissioner, T.C. Memo. 1992-317, aff’d without published opinion, 15 F.3d
1095 (9th Cir. 1993), but here it is persuasive evidence of that fact because for the
prior year, 2012, the bank issued Forms 1099-C showing the discharge in 2012 of
petitioner’s debt on the investment properties.
11
We often cite Black’s Law Dictionary, see, e.g., Moneygram Int’l, Inc. v.
Commissioner, 153 T.C. 185, 226 (2019) (quoting Black’s Law Dictionary), aff’d,
__ F.3d __, 2021 WL 2201277 (5th Cir. June 1, 2021); Blue Lake Rancheria Econ.
Dev. Corp. v. Commissioner, 152 T.C. 90, 113-114 (2019) (same); Dynamo
Holdings Ltd. P’ship v. Commissioner, 150 T.C. 224, 234 (2018) (same), and its
use here is not speculative but, rather, foundational in understanding the case
before us.
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Respondent contends that the fact that petitioner made short sales in 2013
shows that the bank intended to discharge the debt in 2013, citing Lowry v.
Commissioner, T.C. Memo. 2001-238, 2001 WL 1078110, as support. In Lowry,
a taxpayer sold a property encumbered by debt. Id., 2001 WL 1078110, at *1.
Before the sale, the taxpayer and the creditor holding the debt entered into an
agreement that a discharge of indebtedness would occur upon the conveyance (i.e.,
sale) of the property. Id. at *2. We held that, because the discharge was
contingent upon the sale of the property, it occurred when the property was sold
and not before. Id. In the case before us, however, the record does not include a
contract or other documentation showing when (or whether) the debt would be
discharged. While short sales are objectively identifiable events, they alone do not
establish that the lending bank intended to discharge the remaining portion of
Note B.
On the basis of the foregoing, the record shows that the lending bank did
not intend to discharge any of petitioner’s debt in 2013. Therefore, we hold that
petitioner did not have a discharge of indebtedness for 2013.
C. Whether Petitioner Is Liable for Accuracy-Related Penalties
Respondent determined and contends that petitioner is liable for the
accuracy-related penalties under section 6662(a) and (b)(1) and (2) for tax years
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2013 and 2014 due to a substantial understatement of income tax or, alternatively,
negligence or disregard of rules or regulations. Petitioner contends that he is not
liable for these penalties on the grounds that he had reasonable cause and acted in
good faith reliance on a qualified tax law firm to prepare his amended 2012 return
and his 2013 and 2014 returns. We conclude that petitioner’s claim of good faith
reliance is justified.
Taxpayers are not liable for penalties under section 6662 for any part of an
underpayment if the taxpayer had reasonable cause and acted in good faith. Sec.
6664(c)(1). Reliance on the advice of a professional tax adviser may demonstrate
reasonable cause and good faith. Sec. 1.6664-4(b)(1), Income Tax Regs. We may
recognize reasonable reliance on professional advice if the taxpayer shows that:
(1) the adviser was a competent professional who had sufficient expertise to justify
the taxpayer’s reliance on him or her; (2) the taxpayer provided necessary and
accurate information to the adviser; and (3) the taxpayer actually relied in good
faith on the adviser’s judgment. Neonatology Assocs., P.A. v. Commissioner, 115
T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002); see also Estate of Temple
v. Commissioner, 67 T.C. 143, 162 (1976).
The parties agree that petitioner satisfies the first and second requirements.
Petitioner’s tax lawyer here, Mr. Kohn, had more than 30 years of tax and legal
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experience when petitioner sought his advice. Petitioner provided Mr. Kohn with
the information the Kohn firm needed to prepare petitioner’s tax returns. In
dispute, however, is whether petitioner actually relied in good faith on the
adviser’s judgment.
We decide whether a taxpayer relied in good faith by considering all of the
facts and circumstances, including the taxpayer’s “experience, knowledge, and
education”. Sec. 1.6664-4(b)(1), Income Tax Regs. Petitioner, suspecting that his
2012 tax return was prepared incorrectly, consulted his financial adviser who
agreed with petitioner that his return seemed incorrectly prepared. The financial
adviser arranged for petitioner to meet with a C.P.A. at a large accounting firm,
who also agreed that petitioner’s 2012 tax return was not prepared correctly. The
C.P.A. referred petitioner to Mr. Kohn, who also told petitioner that he believed
that his 2012 tax return was incorrect, and described what he thought the errors
were.
Petitioner has no background in tax or accounting, and, therefore, sought the
advice of individuals he believed would have the knowledge needed to provide
help. Petitioner reasonably believed Mr. Kohn’s explanation was correct, and he
relied on Mr. Kohn’s advice in good faith. See Schwalbach v. Commissioner, 111
T.C. 215, 230-231 (1998).
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Respondent suggests, with no basis in the record and contrary to petitioner’s
undisputed testimony, that petitioner’s description of how he was referred to Mr.
Kohn was untrue and that he was shopping for a favorable tax result. We disagree
and find petitioner’s testimony credible.
Respondent contends that petitioner did not rely upon Mr. Kohn’s advice in
good faith because he knew or should have known that the tax result was “too
good to be true”. While that phrase has been applied in appropriate situations, we
believe it does not apply here because of the extensive steps petitioner took to
ensure he was receiving adequate professional advice.
Respondent points out that there are errors on petitioner’s returns prepared
by the Kohn Firm. For example, the bases in real properties retained by petitioner
in 2013 had not been reduced on petitioner’s 2013 return even though they should
have been under Mr. Kohn’s analysis. Respondent also points out that petitioner’s
home was erroneously listed as an investment property sold in 2013 and then
recorded that it had been sold again in 2014 when reporting debt cancellation on a
Form 982. Respondent contends these errors show that petitioner was not acting
in good faith. We disagree. We do not believe petitioner is responsible for
detecting errors of this nature in the reporting of complicated tax transactions.
Taking into account all of the facts and circumstances, we conclude that petitioner
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relied in good faith on the Kohn firm to prepare his amended 2012 and his 2013
and 2014 tax returns, and that he is not liable for penalties under section 6662.
To reflect the foregoing,
Decision will be entered under
Rule 155.