Current Federal Tax Developments

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Taxpayer's Dementia Possible Reasonable Cause for Late Filing, But Failure of POA Holder to Act Would Not Be

An IRS memorandum discusses the potential facts that would and would not be relevant in determining if a taxpayer can have failure to file and failure to pay penalties abated for reasonable cause (CCA 201637012).

In this case a taxpayer had appointed a person to act under a durable power of attorney.  She later filed her tax return late for a year, subjecting her to failure to pay and failure to file penalties.  However, the holder of the power of attorney petitioned a state court for appointment of an Emergency Guardian and Conservator for the taxpayer because the power holder believed she suffered from dementia.  A court found that the taxpayer was an “incapacitated person.”

The question arose about whether, under these facts, the IRS should grant relief from the penalty either because:

  • The taxpayer’s dementia provides reasonable cause for the late filing or
  • The power of attorney’s failure to insure the return was timely filed creates reasonable cause for the late filing on behalf of the taxpayer.

However, the author of the memorandum suggested that before any of these issues were considered, the IRS should consider if the taxpayer qualifies for the “First Time Abatement” (FTA) relief.  That relief is found in Internal Revenue Manual

A taxpayer can qualify for relief from certain penalties if they meet the following qualifications:

  • The taxpayer has not previously been required to file a return or has no prior penalties (except the estimated tax penalty) for the preceding 3 years, and
  • The taxpayer has filed, or filed a valid extension for, all currently required returns and paid, or arranged to pay, any tax due.

The relief applies to failure to file penalties (IRC §6651(a)(1), IRC §6698(a)(1) and IRC §6699(a)(1)), failure to pay penalties (IRC §6651(a)(2) and IRC §6651(a)(3)) and failure to deposit penalties (IRC §6656).

Thus, if the taxpayer had been compliant in the prior three years, the taxpayer would appear to qualify for FTA relief and the question of reasonable cause would not arise.

But if the taxpayer did not qualify for FTA relief, the author of the memorandum noted that the dementia may have created a situation where the taxpayer would qualify for reasonable cause relief.

The applicable regulation provides the following test to determine if reasonable cause exists:

…If the taxpayer exercises ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time, then the delay is due to a reasonable cause.  A failure to pay will be considered to be due to reasonable cause to the extent that the taxpayer has made a satisfactory showing that he exercised ordinary business care and prudence in providing for the payment of his tax liability and was nevertheless either unable to pay the tax or would suffer an undue hardship (as described in § 1.6161-1(b) of this chapter) if he paid on the due date…. (Reg. §301.6651-1(c)(1))

The memorandum notes that if the taxpayer can show she was suffering from dementia during the early part of the year when she should have filed the return she failed to file, and was therefore unable to handle her financial affairs, that would support a finding of reasonable cause for the late filing.  That determination is a factual one.

However, the memorandum rejects the idea that the failure of the holder of the power of attorney to act could serve as an alternative reasonable cause.

The memorandum points out:

In United States v. Boyle, 469 U.S. 241 (1985), the Supreme Court opined that Congress placed the burden of prompt filing of tax returns on the taxpayer, not on some agent or employee of the taxpayer.  The Court rejected the argument of an estate’s executor that the estate should be excused from the addition to tax for late filing under section 6651(a)(1) because it relied in good faith on an attorney to timely file the return.  The Court held that “[t]he 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).”  469 U.S. at 252.

Thus, if she cannot show that she was suffering from dementia and unable to handle her affairs, the fact that another person who could have acted failed to do so would not represent reasonable cause.