My client called in a panic. He was being audited, and the IRS wanted to know why he claimed $2,500 in mileage expense on his Schedule C. My client doesn’t own a Schedule C business. The IRS also questioned my client’s $10,000 loss on his professional stamp collecting – another fictional activity. His tax preparer made these things up. “I didn’t read the return,” the client told me. “I just signed it when the return preparer sent it to me, and then I sent it to the IRS. I appreciated that he got me a $5,000 refund, though; that money sure came in handy.”
The IRS determined that this fellow had understated his taxes by $17,000, leading to a deficiency in income tax of $5,500 and a negligence penalty of $1,100, as well as interest. So much for the refund secured by the tax preparer. “But my return preparer messed this up; he’s the one who lied,” my client asserted. “Am I really responsible for this?”
Taxpayers Owe Correct Tax No Matter Who Prepared Return
Yes. Yes, you are. Taxpayers owe the correct amount of tax, regardless of whether it was reported correctly; they can’t shift their own tax responsibility onto the person who prepared the return, no matter how poorly it was prepared, or how little interest a taxpayer takes in looking over the work of a preparer to ensure it is correct – or at least has no screaming falsehoods, exaggerations or omissions. You earned the money, you owe taxes on it – whether it was you who calculated the amount owed, a tax preparer, or the IRS. Moreover, in cases like this, where the tax preparer was deliberately lying, my client will still owe interest on the underpayment. What’s the IRS’s reasoning here?
Interest on Underreported Income
Paying interest on underreported income doesn’t harm the taxpayer, according to the IRS, since any lender would have charged the taxpayer interest for a loan. And the government considers tax payments made after the April 15th deadline a taxpayer use of government money – thus interest is appropriately charged. In order to treat all taxpayers equally and fairly, Congress has made it extraordinarily difficult to avoid paying interest. As an IRS docket attorney, I found it easier to cut the principal amount of tax owed than to lower the interest required to be paid.
Negligence Penalty for Underpayment of Taxes
Occasionally, the IRS will waive negligence penalties on underpayment of taxes. Every tax return contains the declaration that the taxpayer has “examined this return and accompanying schedules and statements, and to the best of my knowledge and belief, they are true, correct, and complete.” And every tax return must be signed. Back to my schoolteacher client: while he’s a non-expert in tax law, he could have reasonably have caught businesses he doesn’t actually have, if he had been paying attention. So, he owed negligence penalties on top of the underpaid taxes and the interest.
Let’s say a preparer’s error was something non-obvious or technical – such as how to report capital gains – and it was the first time a taxpayer was claiming capital gains: if the preparer put them on the wrong line, the IRS would likely not have expected a layperson to have caught this error. After all, it is precisely for such arcane, detailed expertise that most of us hire tax preparers in the first place. I.R.C. § 6664 and associated regulations outline how the negligence penalty can be waived if a professional was used to prepare returns. Broadly, in order to qualify, the taxpayer has to provide all pertinent information to the preparer, the preparer has to be competent, and the taxpayer has to show a good-faith effort to report the proper amount of tax.
Finally, my client wanted to know if he could sue his return preparer. In the U.S., anyone can sue anyone else, at any time, for any reason. But I advised my client that he would not win. That’s because he signed the return saying he examined it and believed it to be correct.
Bottom line? Taxes are the responsibility of the taxpayer, even when you rely on someone else to guide you. If you sign the tax return, expect to answer for what it says.
January 18, 2016