The question of whether a taxpayer had reasonably relied upon the advice of tax professionals when taking a tax position was the sole issue before the court in the case of RB-1 Investment Partners v. Commissioner, TC Memo 2018-64.

The taxpayers in the case had gotten into a Son-of-BOSS tax shelter in an attempt to shelter from tax the gain from the sale of their very successful concrete business. While the taxpayers initially disputed the IRS’s disallowance of the benefits from the strategy, at this point the taxpayers had conceded that issue and now were only disputing the penalties in this case.

The “reasonable cause and good faith” defense to an understatement penalty is found at IRC §6664(c)(1) which provides:

(c) Reasonable cause exception for underpayments

(1) In general

No penalty shall be imposed under section 6662 or 6663 with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion.

The Tax Court, citing the case of Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff'd, 299 F.3d 221 (3d Cir. 2002) outlined the following criteria that must be met for a taxpayer to be found to qualify for the reasonable cause and good faith defense:

First, was the adviser a competent professional who had sufficient expertise to justify reliance?
Second, did the taxpayer provide necessary and accurate information to the adviser?
Third, did the taxpayer actually rely in good faith on the adviser's judgment?

The first two bullets look at whether the taxpayer acted in a way that would allow for the receipt of competent advice, while the last one looks at whether the taxpayer in the end acted in good faith and relied upon advice received from the advisor.

In this case the taxpayer claimed reliance on two different professionals:

The law firm which designed the program and issued an opinion letter on the transaction and
The accounting firm that prepared the taxpayers’ tax returns

The IRS conceded that the law firm was competent to provide advice on the matter and that the taxpayer provided the law firm with all relevant information. But the IRS argued that the taxpayer had not acted in good faith in relying on that advice because the firm was the entity promoting the shelter in question.

Generally, a taxpayer cannot rely on the advice of a promoter of a tax shelter to escape penalties, since, as the court notes “reliance on a promoter takes the good faith out of good-faith reliance.” That is, since the promoter only gets paid if the transaction moves forward and the payment represents the fee for the shelter rather than customized advice, a taxpayer should realize he/she cannot treat such advice the same way he/she would for advice that came from a party that did not have a stake in whether the transaction was entered into.

The taxpayer argued that he could not have known that the law firm was a promoter of this shelter, being unaware that the product was being marketed to other individuals. The Court did not agree:

Eric knew, or should have known, that J&G was selling this tax shelter to numerous parties. He learned about the transaction from Smith, who said it was a “big-boy deal with Jenkens & Gilchrist” — that it “took a lot of money to get in” and “there were some very positive tax ramifications.” Smith introduced Eric to other advisers, but we find that no other advisers were introduced with one specific transaction in mind. And Mayer left no doubt in Eric's mind that the transaction wasn't tailor-made for him: Mayer told him he'd undertaken the same type of transaction with other clients, and Eric “got the impression that it was lots” of clients. Eric even knew that the legal analysis in the J&G opinion letter wasn't written just for him. We therefore find that Eric knew the transaction was the same tax shelter that J&G offered to numerous parties.

After Eric agreed to proceed, J&G ran with the rest of the transaction. It completed all the documents to form the entities, open the accounts at Deutsche Bank, and transfer the options to RB-1 and RB-1's partnership interests to E&D. J&G provided the dubious opinion letter about the deal's tax consequences, and it ensured that RB-1's returns were completed and filed consistently with the opinion letter. And RB-1 paid J&G a $400,000 fee for its work — a fee that was supported by only a one-sentence invoice: “Fees for professional services rendered through November 20, 2000.” Before that, Eric had never paid a legal fee greater than $100,000, even for the work that Meadows Owens did for the CCI sale. The difference is that J&G wasn't paid to provide tax advice for a real transaction; its fee was for a packaged tax shelter. We therefore find that J&G was a promoter, and Eric may not rely upon J&G's advice in good faith.

But the taxpayer also claimed to rely upon advice from the accounting firm that prepared the tax return for the year in question. Again, the IRS does not question the competence of the accounting firm nor indicate that the taxpayer had not provided the firm with necessary information. Rather, the IRS argued that the firm, per its engagement letter and actions, did not provide any advice on this issue and relied solely on the promoter’s opinion.

The opinion notes the following about the work done by the accounting firm:

McBryde asked Eric to sign an engagement letter. The engagement letter said that W&T would rely on documents prepared by J&G “to give expert guidance on the handling of certain transactions” — they would “not render any additional opinion to the results of this position.” To make sure W&T prepared the return consistently with J&G's guidance, the engagement letter also authorized W&T “to provide draft copies of all the * * * tax returns to Erwin Mayer, Esq., of [J&G] for review and approval.” W&T told Eric they wouldn't complete the return without J&G's stamp of approval, and Eric admitted at trial that he didn't expect W&T to render an opinion separate from the J&G opinion.

The Tax Court found that the engagement letter and the taxpayer’s admission that he did not expect the firm to provide an addition opinion meant there was no accounting firm advice on which he could rely. The Court noted:

Not only did W&T fail to opine on the items reported on RB-1's return; it told Eric that it wasn't going to. The engagement letter that Eric signed said that W&T would rely on J&G's documents “to give expert guidance on the handling of certain transactions,” and W&T would “not render any additional opinion to the results of this position.” Eric authorized W&T to provide a draft copy of the return to Mayer at J&G for review and approval, and he was aware that W&T wouldn't complete the return without J&G's approval. The return was in fact completed only after J&G's attorneys approved it, and Eric never expected W&T to provide an opinion separate from J&G's. It is simply not enough that W&T completed the return and failed to tell Eric not to file it. See id. And it should come as no surprise that we don't think W&T provided any “advice” here: The engagement letter said that it wouldn't, and the steps that its accountants took to complete the return were consistent with that engagement letter.

J&G provided the only professional advice in this case. But RB-1 can't meet the reasonable-cause-and-good-faith defense to penalties by relying on the advice of a promoter. See, e.g., 106 Ltd., 684 F.3d at 90-91; Neonatology Assocs., 115 T.C. at 98.