Warning: Choose your tax preparer wisely
"It's my accountant's fault" is not a good defense in a tax audit. Tax season is just around the corner and the airwaves will soon be awash with ads for tax services fighting for a piece of the $168 billion income tax preparation market[i]. While, most of tax firms provide quality services, there are invariably bad actors who come out of the woodwork. The foregoing highlights the importance of selecting a competent tax professional who is knowledgeable in tax accounting for truck drivers lest your effort to blame the accountant for a tax bill will fall on deaf ears.
The tale of Johnny the truck driver
For the tax year under audit Johnny showed tax owed on his return of $446. Unfortunately, an audit revealed Johnny did not take the time to properly review his tax returns and ask questions of his tax preparer. He failed to report over $40,000 of income, which resulted in:
a tax deficiency of over $10,000, and
assessment of a 20% substantial understatement of tax penalty.
His defenses: He blamed his accountant.
Taxpayer due diligence
Taxpayers in similar situations can avoid the substantial understatement of tax penalty if they can show that they relied on the advice of a professional tax adviser[ii]. Even if the court assumed Johnny received “advice,” the case law lists three factors to decide whether reliance on a professional was reasonable[iii].
Was the adviser a competent professional?
Did the taxpayer provide accurate information?
Did the taxpayer actually rely in good faith on the adviser’s judgment?
Johnny claimed he relied on Frank, a qualified professional tax preparer. As proof, he provided printouts of the preparers advertising material. He argued that each type of truck driving requires a different type of tax preparer, but he provided no evidence for this theory.
Due diligence burden of proof
However, the courts biggest issue was that Johnny could not possibly have relied on advice from a tax preparer to whom he did not give the necessary tax information. Afterall, he did not report all of the income from the Forms 1099-MISC that he received. And not reporting income is a special sign of negligence[iv], and it might not get a taxpayer off the hook for a penalty even if he gives the information to his preparer[v]. Therefore, it is not surprising that the court concluded Johnny did not meet the "due diligence" burden of proof.
It's my accountant's fault inquiry
Johnny’s lone defense in claiming "It's my accountant's fault" was providing Frank’s advertising material. However, the court discovered:
Frank was an interior designer who became a truck driver and then an unlicensed tax preparer.
They noted that his website material had not been updated in nearly 15 years
It was unreasonable for Johnny to rely on an unlicensed tax preparer whose own website showed no training for at least nine years[vi].
The court concluded Frank not to be a “competent professional” and found that Johnny could not reasonably have thought him to be one.
U.S. Tax Court Ruling:
Johnny could not rely on the "It's my accountant's fault" defense
He did not properly review his tax returns.
He did not give the preparer all the information.
Could not reasonably have thought the preparer to be competent.
Was negligent and liable for the 20% substantial understatement of tax penalty[vii]
As this case demonstrates novel theories for tax deductible items will not survive scrutiny in a tax audit. Prudence demands a taxpayer ensure their tax preparer is competent, has the proper licensing and industry-specific tax experience when required. The unique nature of the trucking industry compels drivers to exercise due diligence when assembling tax records and reviewing the tax return lest you end up like Billy.
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Disclaimer: This article is for information purposes only and cannot be cited as precedent or relied upon in a tax dispute before the IRS.
[ii] Sec. 1.6664-4(b), Income Tax Regs.
[iii] Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d , 299 F.3d 221 (3d Cir. 2002).
[iv] sec. 1.6662-3(b)(1)(i), Income Tax Regs.
[v] see Metra Chem Corp. v. Commissioner, 88 T.C. 654, 662-63 (1987) (reliance on preparer with complete information not reasonable cause where cursory review would have revealed errors); Magill v. Commissioner , 70 T.C. 465, 479-80 (1978) (taxpayer still has duty to read return to make sure all income included even if all data given to tax preparer), aff’d , 651 F.2d 1233 (6th Cir. 1981).
[vi] IRS Circular 230 governs licensed tax preparers and establishes the annual continuing professional education requirements
[vii] SHALOM JOHNNY, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent UNITED STATES TAX COURT - SUMMARY OPINION T.C. Summary Opinion 2015-3 Docket No. 21078-11S. Filed January 20, 2015.