No Harm, No Foul Does Not Create Reasonable Cause for Late Filing of S Corporation Return

The taxpayer in the case of ATL & Sons Holding Inc. v. Commissioner, 152 TC No. 8, sought to have the Tax Court order the IRS to stop pursuing a failure to file penalty imposed on the taxpayer’s S corporation.  The taxpayer argued that there had been no harm to the government since the shareholders had timely filed their personal returns and reported the income.  While they may not have applied for an extension of time to file the S corporation return, they had filed for such an extension on their personal return and filed within the time period for such filing.

IRC §6699 provides, in part:

(a) General rule

In addition to the penalty imposed by section 7203 (relating to willful failure to file return, supply information, or pay tax), if any S corporation required to file a return under section 6037 for any taxable year—

(1) fails to file such return at the time prescribed therefor (determined with regard to any extension of time for filing), or

(2) files a return which fails to show the information required under section 6037,

such S corporation shall be liable for a penalty determined under subsection (b) for each month (or fraction thereof) during which such failure continues (but not to exceed 12 months), unless it is shown that such failure is due to reasonable cause.

(b) Amount per month

For purposes of subsection (a), the amount determined under this subsection for any month is the product of—

(1) $195, multiplied by

(2) the number of persons who were shareholders in the S corporation during any part of the taxable year.

The S corporation return in question, while due on March 15, 2013, was not actually filed until September 13, 2013.  All of the S corporation stock was held by Mr. and Mrs. Allen.  They had filed a Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return, prior to the due date of their personal return in April 2013 and timely filed their personal return on October 14, 2013.  Their return properly reported the information contained on the K-1 issued by the corporation.

The taxpayers argued the penalty should not apply since there was no harm to the Government—all income was reported and tax paid timely.  But the Tax Court did not accept that view, noting:

…an S corporation is an entity separate from its shareholders. In general, the S corporation does not incur a liability for Federal income tax. Sec. 1363(a). But see infra note 9. Rather, its shareholders are taxed on their respective shares of the S corporation's income. Sec. 1366(a)(1). As we noted above, an S corporation is required to file an annual information return on its own Form 1120S, and on that return it reports its own income, deductions, and other matters. Sec. 6037(a); 26 C.F.R. sec. 1.6037-1(a), Income Tax Regs. To extend the time to file the S corporation return, a separate form — Form 7004 — is required. See 26 C.F.R. sec. 1.6081-3(a)(1), Income Tax Regs.; 2012 Instructions for Form 1120S. ATL did not file Form 7004 nor any other document requesting an extension of the deadline for filing its 2012 Form 1120S.

But IRC §6699(a) does provide that the penalty will not apply if the failure is due to reasonable cause.  The taxpayers argued what some have tried in many situations to use to justify not following the clear requirements of the law—that so long as the Treasury isn’t harmed by the loss of revenue, there should be no penalty for noncompliance.

The Tax Court rejects that argument in this case:

…ATL argues that the reasonable cause exception should apply because ATL’s two shareholders were aware of the business loss for taxable year 2012 and “no one else has been harmed” — i.e., no harm, no penalty. ATL evidently conceives that the sole purpose of the Form 1120S is to give a shareholder the information that he or she needs in order to file a Form 1040 tax return; and since Mr. and Mrs. Allen knew the affairs of ATL, did eventually file their Form 1040 timely (under an extension), and did not fail to report any income, the intended purpose of the S corporation’s filing requirement was accomplished and the penalty was moot. ATL cites no authority in support of its claim that the penalty should be waived on the grounds that its two shareholders were aware of the information to be shown on the return. Section 6699 does not include a condition of harm before the penalty is imposed; it simply imposes a penalty when the filing is late (without reasonable cause). A taxpayer may not disregard a filing deadline and be excused from this penalty simply because it reckons that no harm was done.

The Tax Court also used this case to expand the penalties that it holds are covered by IRC §6751(b)(2)’s exception to requiring supervisory approval before a penalty is assessed by the IRS.  As was true in the case of Walquist v. Commissioner, 152 TC No. 3, the Tax Court determined this was a case of an “automatically calculated” penalty as described in IRC §6751(b)(2).  Such penalties do not require approval by a supervisor before a penalty is imposed, a rule that applies under the general rule of IRC §6751(b)(1).

The Tax Court rejected the taxpayer’s contention that, because the penalty does not apply if reasonable cause existed for the failure to timely file, the penalty is not truly automatically calculated.  A supervisor should have been involved to determine that such reasonable cause did not exist before the penalty was assessed.

The Tax Court points out that there is a list of specific penalties excepted in IRC §6751(b)(2)(A), along with “other automatically calculated penalties.”  Most of the specifically listed penalties have a reasonable cause exception, yet the Court notes the law seems to view them as automatically calculated penalties, pointing out the reference to other automatically penalties in §6751. 

While the penalty under IRC §6699 is not in that list, the Court finds it still can be an “automatically calculated” penalty:

Evidently, a penalty can be “automatically calculated” for purposes of section 6751(b)(2)(B) even if non-arithmetical issues might be invoked to challenge the liability so calculated. The section 6699 penalty applies unless reasonable cause “is shown” — i.e., shown by the taxpayer.

The Court in this case doesn’t indicate in this case if the taxpayer had originally challenged the penalty prior to assessment—the case arose as a collection due process (CDP) case, so it seems likely the taxpayer failed to initially challenge the penalty’s imposition.

In the Walquist case the Court had noted that if the taxpayer had protested the substantial understatement penalty in a timely fashion, then the IRS position was that supervisory approval was needed to assess the penalty.  That issue is not addressed in this case, but presumably if the taxpayer had presented what the taxpayer asserted was reasonable cause in response to the notice that supervisory approval of assessing the penalty would likely be deemed to be required under §6751 by the Court.