A former major league baseball discovered that certain tax related responsibilities cannot be delegated to paid advisers, as the Sixth Circuit found the taxpayer liable for penalties despite misconduct on behalf of his advisers in the case of Vaughn v. United States, CA6, Case No. 14-3858.
There’s little question Mo Vaughn is clearly a victim and was taken advantage of. As the Court noted:
The facts of this case are straightforward and undisputed. Maurice "Mo" Vaughn was a major league baseball player from 1991 to 2003. [R. 23 at Pg. ID# 180.] In May 2004, he hired Ra Shonda Kay Marshall and her company, RKM Business Services, Inc., to manage his financial affairs, invest his money, pay his taxes, pay his bills, and allocate funds for his immediate use. [Id. at 181.] Vaughn gave expansive powers to Marshall, including a durable power of attorney but the arrangement was subject to immediate revocation by Vaughn for any reason. [Id.] Vaughn also hired a tax accountant, David Krebs of CPA Advisory Group, Inc., to advise and assist in the preparation and filing of his tax returns. [R. 23 at Pg. ID# 181.] Vaughn continued with this arrangement until late 2008. [Id. at 182.]
Vaughn had two bank accounts—one personal account and one business account for Mo Vaughn Investments, LLC. [Id. at 181-82.] Vaughn deposited his income in these accounts, and Marshall was the sole signatory on both accounts. [Id.] As such, Marshall was responsible for paying all of Vaughn's bills, giving him a monthly budget, and paying his taxes. [Id.] In 2004, 2005, and 2006, Marshall properly filed Vaughn's tax returns, but only the 2004 and 2005 taxes were properly paid. [Id. at 181-83.] In 2007, Marshall neither filed nor paid Vaughn's taxes. [Id.]
Sometime late in 2008, Vaughn decided to manage his financial affairs on his own, and he terminated his arrangements with both Marshall and Krebs. [Id. at 182.] In the course of reviewing his bank statements, Vaughn discovered that Marshall had been cheating him for years and embezzling large sums of money from his accounts. Rather than investing Vaughn's money, growing his portfolio, and paying his taxes, Marshall was stealing his money, draining his portfolio, and failing to pay his taxes. [Id. at 182-84.] In fact, at the time Vaughn's 2007 taxes were due, his bank accounts were so depleted that he did not even have enough money to cover his tax liability. [Id. at 183-84.] Vaughn sued Marshall and RKM Business Services, [Id. at 184-85] and currently has outstanding judgments against them for $1.5 million and $3.5 million, respectively. [R. 24-3 at Pg. ID# 232-34; R. 24-4 at Pg. ID# 235-36.]
The IRS argued that despite the fact that Mo was scammed, he could not avoid the penalties for having failed to file his 2007 income tax returns. Mo argued that he had reasonably relied upon Ms. Marshall to take care of these issues and had no reason to have known that his 2007 tax returns had not been filed, nor had his 2006 or 2007 taxes been paid.
The Court summarized his argument as follows:
Vaughn advances two basic arguments as to why he meets this "reasonable cause" exception: (1) because he used ordinary business prudence and care in the selection and use of agents to file and pay his taxes, he should not be responsible for his agents' violating his specific instructions and disregarding their fiduciary duties; and (2) because his agents had the unfettered power to file and pay his taxes, their fraud and embezzlement left him unable to file and pay. Neither argument has merit.
The IRS argued that Mo Vaughn had a basic duty to insure his taxes were filed timely and paid. The agency also argued that a taxpayer cannot avoid this responsibility by “letting someone else take care of it” as it takes no special expertise to insure a return is actually filed in a timely fashion and to determine that funds were paid from the taxpayer’s account to discharge that tax liability.
With regard to whether Vaughn had used ordinary business prudence and care in the selection and use of agents to handle the tax matters, the Court cited the Supreme Court’s “bright line” rule found in the case of United States v. Boyle:
In United States v. Boyle, the Supreme Court specifically addressed the issue of penalties assessed against a taxpayer for his agent's failure to file and pay his taxes. 469 U.S. 241 (1985). In explaining the "reasonable cause" exception, the Court noted that the Treasury Regulations require a taxpayer to "show that he exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time." Id. (emphases added) (internal quotation marks omitted); see 26 CFR § 301.6651-1(c)(1). Addressing the question of whether one could satisfy the "reasonable cause" exception by relying on a professional agent to complete and file one's taxes, the Boyle Court said that "[t]he time has come for a rule with as `bright' a line as can be drawn consistent with the statute and implementing regulations." Boyle, 469 U.S. at 248. The Court went on to hold:
Congress has placed the burden of prompt filing on the executor, not on some agent or employee of the executor. The duty is fixed and clear; Congress intended to place upon the taxpayer an obligation to ascertain the statutory deadline and then to meet that deadline, except in a very narrow range of situations. Engaging an attorney to assist in the probate proceedings is plainly an exercise of the "ordinary business care and prudence" prescribed by the regulations, but that does not provide an answer to the question we face here. To say that it was "reasonable" for the executor to assume that the attorney would comply with the statute may resolve the matter as between them, but not with respect to the executor's obligations under the statute. Congress has charged the executor with an unambiguous, precisely defined duty to file the return within nine months; extensions are granted fairly routinely. That the attorney, as the executor's agent, was expected to attend to the matter does not relieve the principal of his duty to comply with the statute.
. . . .
It requires no special training or effort to ascertain a deadline and make sure that it is met. The failure to make a timely filing of a tax return is not excused by the taxpayer's reliance on an agent, and such reliance is not "reasonable cause" for a late filing under § 6651(a)(1).
Id. at 249-50, 52.
While Mo (like many people who find taxes to be messy, confusing and something they’d like to not think about) may have hired someone to “handle the matter,” he either needed to check to insure they had actually done what was required or personally face the consequences in terms of the penalties that would apply if they failed to do so.
As the Court notes:
Taxpayers are not required to be experts on the tax code, but they are expected to know that they must file a return and pay their taxes. Vaughn is not facing penalties from the IRS because he relied on the advice of his agents; rather, he is facing penalties because he relied on them to complete and file his tax returns.
The Court also found that the fact that Mr. Vaughn no longer had the ability to pay the taxes did not excuse him either. Vaughn attempted to rely on the case of Matter of American Biomaterials Corp., 954 F.2d 919 (3rd Cir. 1992).
As Court summarized the Biomaterials ruling:
In Biomaterials, two corporate officers were discovered defrauding their corporation, failing to file and pay its taxes, and embezzling corporate funds. Id. at 920-21. These officers were the CEO/Chairman of the Board and CFO/Treasurer of the corporation—"the only officers . . . with the responsibility to file tax returns and ensure payment." Id. at 922. The court held that the corporation itself was not vicariously liable for the failures of its officers or for the penalties resulting from those failures. Id. at 927. A corporation can act only through its agents and employees. Id. at 923. So, when the very corporate officers responsible for filing and paying the corporation's taxes engaged in fraud and embezzlement instead, the corporation was suddenly devoid of an agent or employee through which it might act to file and pay its taxes. Id. at 927. In this way and to this extent, the corporate officers' criminal actions left the corporation unable to pay its taxes, and the corporation was not held liable for penalties. Id.
The Court noted a key difference—Mr. Vaughn himself is, at least initially, the only person who has the ability to file and pay his taxes and even though he hired outsiders to assist him, he clearly always had the ability to take back control.
The Court found that his inability to pay was the consequence of his own decisions that turned out to be ones he would later regret. As the Court noted:
Again, according to Boyle, a disability is something that is beyond the taxpayer's possible control and oversight, not something that occurs under his authorization and subject to his control. Boyle, 469 U.S. at 248 n.6. Hence, the proper question is whether Vaughn had an intrinsic objective inability to meet his tax liabilities or whether he brought that inability on himself by failing to exercise any oversight and ensure that his taxes were filed and paid. When the issue is framed this way, Conklin Bros. is directly analogous:
In Biomaterials, the criminal conduct committed by corporate officers and the Chairman of the Board of Directors was beyond the corporation's control because they were the control people in the corporate structure. Supervision over such people was not possible. In this instance, Conklin had control over Stornetta. She was a manager/controller whose actions were subject to being supervised by Bowers, Conklin's president and majority shareholder, and by Conklin's outside accountants.
Conklin Bros., 986 F.2d at 318. Since oversight was possible and feasible here, this case is much closer to Conklin Bros. than Biomaterials.
The case leads to two very important take-aways for those in practice. First, while relief from penalties may be available to taxpayers who relied upon the advice of a bad adviser they had no reason to disbelieve, there will not be reasonable cause for failure to file where the prior adviser simply failed to insure timely filing. Note that if the taxpayer was given advice no filing was necessary that would be grounds for arguing for reasonable cause because that would be actual advice dealing with the tax law.
Second, the also makes clear that advisers must be aware that in their own case a failure to, say, timely file an extension request on behalf of a client will also generally not be a penalty that can be avoided based on “reasonable cause” since, as is noted here, that is a duty that the client cannot designate.