STEPHEN G. WOODSUM AND ANNE R. LOVETT, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Docket No. 18934-09.
United States Tax Court
Filed June 13, 2011.
136 T.C. 585
We conclude that petitioners’ underpayments of Federal income tax were the result of negligence or disregard of rules or regulations under
We have considered all arguments of the parties, and to the extent not mentioned they are moot or without merit. To reflect concessions and our conclusions stated above,
Decisions will be entered under Rule 155.
David H. Hopfenberg, for petitioners.
Patrick F. Gallagher, for respondent.
GUSTAFSON, Judge: This case is before the Court pursuant to
Background
The parties submitted this case fully stipulated, pursuant to Rule 122. We incorporate by this reference the stipulation of facts filed December 6, 2010, and the associated exhibits.
Petitioners’ backgrounds
Petitioners Stephen G. Woodsum and Anne R. Lovett are married. At the time they filed their petition, they resided in New Hampshire.
Ms. Lovett received a bachelor of arts degree from Yale University in 1977, and the stipulated record shows nothing more about her background. Mr. Woodsum received a bachelor of arts degree from Yale University in 1976 and a master‘s in management from the Kellogg School of Management at Northwestern University in 1979. Mr. Woodsum is the founding managing director of Summit Partners, a private equity investment firm founded in 1984.
Petitioners are not tax experts. But Mr. Woodsum is financially sophisticated, and he has a basic understanding of the taxation of interest income, dividend income, and income from the sale of stocks and bonds.
The swap transaction
In 1998 Mr. Woodsum signed an agreement that undertook a financial transaction that the parties describe as a “ten year total return limited partnership linked swap” (and that we refer to herein as “the swap“). In entering into this transaction,
21. The Swap required * * * [Deutsche Bank] to pay Petitioners the value of the Reference Fund less the Calculation Amount on the Termination Date.
22. The Reference Fund was Spring Point Partners, L.P., a Delaware Limited Partnership.
23. According to the terms of the Swap, the Specified Interest in the Reference Fund was “a limited partnership interest in the Reference Fund that would result from a capital contribution to such Reference Fund of USD 2,612,156 on December 31, 1997, if one were to be made.”
24. The Swap required Petitioners to make quarterly payments to * * * [Deutsche Bank] based upon the product of the Notional Amount (as adjusted) times the USD-LIBOR–BBA rate plus 1.50% (the “LIBOR Payments“). The agreement further required the Petitioners to provide Collateral to * * * [Deutsche Bank].
After the end of every calendar quarter, petitioners received account statements with respect to the swap showing the total appreciation or depreciation in the value of their interest. They began receiving these quarterly reports at least as early as December 31, 2003 (when petitioners’ interest had appreciated to $5,816,401), and until March 31, 2006 (when petitioners’ interest had appreciated to $6,368,506). On their returns for the tax years preceding 2006, petitioners reported income and deductions relating to the collateral and LIBOR payments in connection with the swap.
The swap‘s ten-year term was apparently scheduled to end in early 2008, but Mr. Woodsum believed that the reference fund was not performing as well as it should. He therefore informed Deutsche Bank in writing on February 3, 2006, of his intention to terminate the swap effective March 31, 2006. The net payout to petitioners in connection with the termination of the swap was $3,367,611.50, all of which, the parties agree, was taxable income to petitioners. Mr. Woodsum discussed the termination with Mr. Hopfenberg before it took place, and Mr. Hopfenberg advised Mr. Woodsum when the
Petitioners’ income in 2006
In 2006 petitioners received adjusted gross income totaling almost $33 million (including the $3.4 million from terminating the swap). Petitioners’ payors reported that income to petitioners and to the IRS on more than 160 information returns, e.g., Schedules K-1 and Forms 1099, including the Deutsche Bank Forms 1099-MISC and 1099-INT.
The $3.4 million reported on Deutsche Bank‘s Form 1099-MISC was not the largest amount reported on the information returns that petitioners received for 2006. However, if the $3.4 million from Deutsche Bank had been included on petitioners’ 2006 return, it would have been the third largest long-term capital gain amount reported as a line item on Schedule D, Capital Gains and Losses.
Preparation of petitioners’ 2006 return
For 2006 petitioners filed 27 State income tax returns and a joint Federal income tax return.
To prepare their 2006 Federal income tax return, petitioners hired Venture Tax Services, Inc. (“VTS“), a niche firm specializing in tax work for private equity and hedge funds as well as such funds’ general partners. VTS employed Mr. Hopfenberg, whom petitioners had retained for investment and tax advice since 1996. As of 2006, Mr. Hopfenberg had more than 20 years of tax compliance and consulting experience, including employment in the tax departments of major accounting firms. For VTS‘s preparation of petitioners’ 2006 return, Mr. Hopfenberg acted as reviewer. The VTS employee charged with actually preparing the return was a Massachusetts certified public accountant (“C.P.A.“) who similarly had more than 20 years of tax compliance experience, including employment with major accounting firms.
The Form 1040, U.S. Individual Income Tax Return, that VTS prepared for petitioners was 115 pages long. The return did report the $60,291.69 of interest income that petitioners received from Deutsche Bank. However, for reasons the record does not show,3 the return that VTS prepared did not include the $3.4 million that Deutsche Bank paid and reported. If the $3.4 million had been included on the return, that amount would have appeared on Schedule D as a distinct line item in Part II, “Long-Term Capital Gains and Losses—Assets Held More Than One Year“. But, again, it was not reported on the return that VTS prepared.
Review and signing of petitioners’ 2006 return
Petitioners had obtained an extension of the due date for filing their 2006 return. As a result, the return was due October 15, 2007. At 11 a.m. on that date, petitioners met with Mr. Hopfenberg to discuss several subjects, including their return. At that meeting Mr. Hopfenberg turned the 115 pages of the return and discussed various items of income and deduction with Mr. Woodsum. Petitioners characterize this as their “perform[ing] more than a cursory review of the return.” However, the parties have stipulated that petitioners do not recall—
- which specific items of income and deduction were discussed at the meeting, or
- the amount of time they spent reviewing the return, or
- the amount of time they spent reviewing the Schedule D and the attachments and statements thereto.
During the discussion of the return, Mr. Woodsum did not compare or match the items of income reported on the Form 1040 and its schedules with the information returns that the third-party payors had provided. Consequently, petitioners
Petitioners signed the return on that same day—October 15, 2007. We assume that, when they did so, petitioners were unaware of the omission of the $3.4 million.4
The IRS received Deutsche Bank‘s Form 1099-MISC reporting the $3.4 million, compared it with petitioners’ return, and determined a deficiency in tax of $521,473 and an accuracy-related penalty under
However, petitioners filed their petition in this Court disputing the accuracy-related penalty. The parties jointly submitted the case fully stipulated under Rule 122.
Discussion
I. The relevant law
A. Accuracy-related penalty under section 6662(b)(2)
B. Reasonable cause under section 6664(c)(1)
A taxpayer who is otherwise liable for the accuracy-related penalty may avoid the liability if he can show, under
The determination of whether a taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances. * * * Generally, the most important factor is the extent of the taxpayer‘s effort to assess the taxpayer‘s proper tax liability. Circumstances that may indicate reasonable cause and good faith include an honest misunderstanding of fact or law that is reasonable in light of all of the facts and circumstances, including the experience, knowledge, and education of the taxpayer. An isolated computational or transcriptional error generally is not inconsistent with reasonable cause and good faith. * * * Reliance on * * * professional advice * * * constitutes reasonable cause and good faith if, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith. * * * [
26 C.F.R. sec. 1.6664-4(b)(1) , Income Tax Regs.]
Whether the taxpayer acted with reasonable cause and in good faith thus depends on the pertinent facts and circumstances, including his efforts to assess his proper tax liability, his knowledge and experience, and the extent to which he relied on the advice of a tax professional.
II. Application of the law to petitioners
A. Substantial understatement
The undisputed tax deficiency attributable to petitioners’ omitted income is $521,473. That amount is obviously in excess of $5,000. That amount is also in excess of “10 percent
The accuracy-related penalty is mandatory; the statute provides that it “shall be added“.
B. Reasonable cause and good faith
1. Reliance on professional advice
For purposes of
for a taxpayer to rely reasonably upon advice so as possibly to negate a section 6662(a) accuracy-related penalty determined by the Commissioner, the taxpayer must prove by a preponderance of the evidence that the taxpayer meets each requirement of the following three-prong test: (1) The adviser was a competent professional who had sufficient expertise to justify reliance, (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. * * *
Seeking to meet these standards, petitioners assert (1) that VTS and its attorney and C.P.A. were competent and experienced professionals, (2) that petitioners provided VTS with the necessary and accurate information, i.e., the Form 1099-MISC reporting the $3.4 million, and (3) that petitioners relied on VTS to prepare the return and report the $3.4 million—all of which the parties have stipulated. However, for purposes of proving reliance on professional advice, these assertions miss the mark.
The IRS‘s regulations define “advice” as follows:
(2) Advice defined.—Advice is any communication, including the opinion of a professional tax advisor, setting forth the analysis or conclusion of a person, other than the taxpayer, provided to (or for the benefit of) the tax-payer
and on which the taxpayer relies, directly or indirectly, with respect to the imposition of the section 6662 accuracy-related penalty. Advice does not have to be in any particular form. [ 26 C.F.R. sec. 1.6664-4(c)(2) .]
A premise only implicit in petitioners’ position is that their return preparer‘s unexplained omission (i.e., the omission of what Mr. Woodsum knew to be includable as a substantial income item on their return) constituted “advice” to exclude that item. However, the fact that the regulation defines “advice” broadly enough to include “any communication“, whether or not “in any particular form“, provides no grounds for reliance by petitioners: In United States v. Boyle, 469 U.S. 241 (1985), where the taxpayer knew or should have known of the applicable filing deadline, he lacked reasonable cause for his attorney‘s untimely filing of his return; similarly, since petitioners knew their Form 1099 income should have been included, they lack reasonable cause for their preparer‘s failure to include the income.
In order to constitute “advice” within the definition of the regulation, the communication must reflect the adviser‘s “analysis or conclusion“. The taxpayer must show (in the words of Neonatology Associates, 115 T.C. at 99 (emphasis added)) that he “relied in good faith on the adviser‘s judgment.” Petitioners present no testimony of the preparer (nor any other evidence) to show that the income was omitted from the return because of any “analysis or conclusion” or “judgment” by VTS that the income was not taxable. When the Supreme Court discussed the “reasonable cause” defense in Boyle, it characterized the relevant professional role as giving “substantive advice“, 469 U.S. at 251, and contrasted that professional function with things that “require[] no special training“, id. at 252. No “special training” was required for Mr. Woodsum to know that the law required him to include on that return an item of income that he had received and that Deutsche Bank had reported on Form 1099. The including of that income on their tax return is what petitioners say they intended when they handed over their information returns to VTS.
Petitioners make no suggestion that VTS gave them “substantive advice” to omit the $3.4 million or that petitioners relied on any such substantive advice. On the contrary, petitioners stipulated that they “relied upon Venture Tax Serv-ices
2. Return preparer‘s error
More pertinent to this case is the principle, quoted above, that “[a]n isolated computational or transcriptional error generally is not inconsistent with reasonable cause and good faith.”
Even if we assume that the $3.4 million omission was an innocent oversight by the return preparer, the reasonable cause defense is unavailing here. Taxpayers sometimes do avoid the accuracy-related penalty by showing that their understatement was the result of a return preparer‘s error. See, e.g., Thrane v. Commissioner, T.C. Memo. 2006-269, 92 T.C.M. (CCH) 501.7 However, as we stated in Metra Chem
Corp. v. Commissioner, 88 T.C. 654, 662 (1987) (citations omitted):
As a general rule, the duty of filing accurate returns cannot be avoided by placing responsibility on a tax return preparer. As the petitioners have noted, this Court has declined to sustain the addition to tax under section 6653(a) in cases in which the taxpayer relied in good faith on the advice of a tax expert. However, a close examination of these cases reveals that they raised questions as to the tax treatment of complex transactions and that the position taken on the returns with respect to such items had a reasonable basis.
This case presents no such difficult issues. Ronald Laroche simply failed to report over $10,000 in cash dividends which he received from corporations controlled by him. Richard Laroche similarly failed to report over $6,800 in such dividends. The unreported dividends constituted over 21 percent of Ronald and Beverly Laroche‘s gross income for 1977 and over 20 percent of Richard and Shirley Laroche‘s gross income for such year. We believe that such a substantial underreporting of income would not have gone unnoticed if the petitioners had made even a cursory review8 of their returns. Under such circumstances, the petitioners may not shift responsibility for the accuracy of their returns to their accountant.
However complex the swap may have been in its creation and its operation, its termination resulted in Deutsche Bank‘s issuing to petitioners a standard and uncomplicated Form 1099-MISC that, petitioners admit, should have resulted in a distinct and identifiable entry on Schedule D of their return. Like Metra Chem, “This case presents no such difficult issues.” Id.
“Even if all data is furnished to the preparer, the taxpayer still has a duty to read the return and make sure all income items are included.” Magill v. Commissioner, 70 T.C. 465, 479-480 (1978), aff‘d, 651 F.2d 1233 (6th Cir. 1981).9 We do not hold that a taxpayer must duplicate the work of his return preparer, or that any omission of an income item in
Mr. Woodsum, however, makes no showing of a review reasonable under the circumstances. He personally ordered the termination that gave rise to the income; he received a Form 1099-MISC reporting that income; that amount should have shown up on Schedule D as a distinct item; but it was omitted. The parties stipulated that petitioners’ “review” of the defective return was of an unknown duration and that it consisted of the preparer‘s turning the pages of the return and discussing various items. Petitioners understated their income by $3.4 million—an amount that was substantial not only in absolute terms but also in relative terms (i.e., it equaled about 10 percent of petitioners’ adjusted gross income). A review undertaken to “make sure all income items are included” (in the words of Magill) or even a review undertaken only to make sure that the major income items had been included—should, absent a reasonable explanation to the contrary, have revealed an omission so straightforward and substantial.
In evaluating reasonable cause, “the most important factor is the extent of the taxpayer‘s effort to assess the taxpayer‘s proper tax liability.”
Mr. Woodsum terminated the swap ahead of its set termination date because his watchful eye noted that it was not performing satisfactorily as an investment. That is, when his own receiving of income was in question, Mr. Woodsum was
To reflect the foregoing,
Decision will be entered for respondent.