Taxpayers Fails to Show They Reasonably Relied Upon Tax Advice

In the case of Keenan v. Commissioner, TC Memo 2018-60, the taxpayers argued that they should not face penalties under IRC §6662.  They argued they had reasonably relied on the advice of their CPA and attorney/insurance agent in claiming a deduction of over $3,000,000 related to a Benistar 419 plan.

The taxpayers were back in court after the Ninth Circuit Court of Appeals had sent the case back down to the Tax Court to consider the taxpayer’s claims that their situation was different enough from that of the taxpayers in the Curcio case[1] to justify a different result.  The taxpayers, who were one of many taxpayers facing proposed disallowance of deductions for Benistar 419 plans, had agreed to be bound by the result of a set of test cases involving similarly situated taxpayers that were all part of the Curcio decision.

The Tax Court, sustained by the Second Court of Appeals, had ruled in the Curcio case that the promised tax benefits from the arrangement were not available under the law.  As well, the Court ruled that the taxpayers in the test cases were subject to penalties under §6662(a).  The Court rejected the taxpayers’ claims in those cases that they had relied on their accountants and insurance agents.  The court found the taxpayers had not shown that their accountants had any special expertise in the law regarding 419 plans, nor that the taxpayers believed their accountant had such expertise.

The Tax Court initially, pointing out the taxpayers had agreed to be bound by the results in the Curcio case and, as such, found they owed the penalties.  The Ninth Circuit overruled this holding, finding that the taxpayers might be able to be relieved of that agreement to be bound by the Curcio case if “manifest injustice would otherwise result” from continuing to hold them to that result.  The Ninth Circuit did not look into the issue of whether such “manifest injustice” existed in this case, rather instructing the Tax Court to look into this issue.

The opinion notes the following about how the taxpayers came to enter into this arrangement and claim the large deduction on the tax return:

Bernard Bunning, petitioner's accountant, first approached petitioner about the Benistar 419 Plan in 2003. Petitioner also discussed the plan with Christopher Ewing, a lawyer and licensed life insurance salesman, who did estate planning for petitioner. Petitioner was interested in life insurance because he had health problems that he assumed would make it difficult to purchase policies. He did not seek life insurance through any other sources.

Petitioner did not do any research on deductibility of payments to a section 419 plan. He discussed it with Bunning and Ewing, and they discussed it between themselves. Petitioner and Ewing agreed that Ewing would be paid commissions as a life insurance salesman if he acquired the plan and would not be paid his regular fees for tax planning services. Petitioner participated in meetings with Bunning, Ewing, and unidentified persons associated with Benistar, but he relied on the advice of Bunning and Ewing in making his decision to adopt a section 419 plan.

The taxpayer admitted at trial that he did not normally review his return and, specifically, did not do so for the year in which the deduction was claimed.

The taxpayer also admitted that payments of $1,000,000 had been made in 2003 and $1,460,000 in 2004 to the plan.  He could not explain how to reconcile those payments with the fact a deduction for $3,060,000 was claimed on his 2003 return.

While that $3,060,000 deduction was clearly related to the benefit plan, it was reported on the tax return as cost of goods sold.  The taxpayer’s CPA testified as follows on why this was done:

Q Was he worried about being audited?

A I think we all feared that a $3,000 [sic] deduction on a tax return with revenues of $6,000,000, a fifty percent deduction, there was a high likelihood that the return would be audited. I mean, that was always a —

THE COURT 3 million.

A Pardon?

THE COURT You said 3,000.

THE WITNESS Oh, I mean 3 million. That's always — you know what? That’s always in your — you know, to be honest, that would always be in my mind for any client.

The taxpayers first argued that there was substantial authority for the positions claimed on the returns.  If substantial authority existed, then then penalty would not apply.  But the Court had found in Curcio that was no substantial authority for this position and did not see any reason presented about why this particular case was different in that regard.

The Court also rejected the taxpayer’s argument that the position was adequately disclosed, noting:

We reject that argument because the deduction of over $3 million was mislabeled in the return as costs of goods sold, was not disclosed as called for on the form and return instructions, and was reported by a cash basis taxpayer who had paid only $1 million as of the end of the taxable year. Moreover, Bunning made clear that the purpose of that treatment was to minimize the chance of an audit. Although he attempted to rationalize his justification for burying the deduction, the effect was nondisclosure. There is no injustice in declining to accept that claimed defense.

The taxpayer’s main argument was that they had distinguishing and superior facts to those found in Curcio and they were not aware of the facts in Curcio when they agreed to be bound by its results.

The Tax Court looked at the taxpayers’ facts and held that their facts did not support the assertion that they, unlike the taxpayers in Curcio, had reasonable cause for their actions.

The key test to escape the penalty under the “reasonable cause” exception the taxpayer must show they acted with reasonable care and in good faith.  A key factor is a showing that the taxpayer took reasonable steps to determine the proper tax liability.

The Court found the taxpayers failed to meet that test.  The opinion notes:

We cannot conclude that petitioner’s claimed reliance on Bunning and Ewing was reasonable and in good faith. Petitioner failed to make any real effort to determine the deductibility of $3,060,000 in relation to the Benistar 419 Plan in view of the $1 million he had paid in 2003. Bunning relied on Benistar 419 Plan promotional materials. Ewing had no special expertise with respect to the subject matter of section 419, he received compensation based on petitioner’s purchase of the life insurance, and he relied heavily on promotional materials that warned that the Commissioner might disallow the deductions related to the Benistar 419 Plan. Petitioners’ defense to the section 6662 penalty is no better than that of the taxpayers in the Curcio group of cases. The participants in the Benistar 419 Plan are similarly situated in all material respects. There is no injustice in holding petitioners to the stipulation to be bound.

[1] Curcio v. Commissioner, T.C. Memo. 2010-115, aff'd, 689 F.3d 217, 229 (2d Cir. 2012)