The Fifth Circuit Court of Appeals upheld a lower court ruling that a taxpayer did not have reasonable cause for late filing of his tax returns when the attorney he had hired to handle such affairs while the taxpayer was incarcerated had embezzled the funds meant to be used to pay the taxes and had not filed the returns in question.[1] The case illustrates just how difficult it is for a taxpayer to escape such penalties by claiming reliance on a tax professional, even when that professional has intentionally misled the taxpayer about having filed the returns in question.

Embezzlement and Request for Reasonable Cause Relief

The opinion outlines the facts of the situation as follows:

Lindsay was incarcerated from April 2013 to June 2015. In May 2013, he executed a Universal Power of Attorney (“POA”) appointing Keith Bertelson as his attorney in fact. According to the terms of the POA, Bertelson had complete control of Lindsay’s bank accounts and retained full authority to “manage [his] affairs.” While incarcerated, Lindsay directed Bertelson to file his tax returns and pay his taxes. Although Bertelson assured Lindsay that he was filing his returns and paying his taxes, he was actually embezzling hundreds of thousands of dollars from him. Lindsay’s tax returns for 2012 through 2015 were not timely filed, nor were his taxes or estimated quarterly taxes timely paid. While still incarcerated, Lindsay discovered Bertelson’s malfeasance and revoked the POA in April 2014. Lindsay then sued Bertelson for embezzlement and after a jury trial in 2015, he was awarded $705,414.61 in actual damages and $1 million in punitive damages.[2]

After his release from incarceration, Mr. Lindsay filed all of the delinquent returns and paid all of the taxes, interest and penalties due on the returns. He then filed a claim for refund which the IRS denied, after which he brought suit to recover the penalties:

In his complaint, Lindsay argued that his failure to file his tax returns and pay his taxes was due to reasonable cause and not willful neglect. He alleged that his incarceration qualified as a “disability” and that, considering his unusual circumstances, penalizing him for late filing and payments would go against equity and good conscience.[3]

The IRS moved to dismiss the case, relying on the US Supreme Court case of United States v. Boyle, 469 US 241 (1985). Generally, Boyle holds that a taxpayer is not due reasonable cause relief for a late filing if the taxpayer relies upon an agent to timely file the returns in question, and the taxpayer could have determined the proper date for filing (thus he/she is not relying on the professional expertise of the agent).[4]

While the magistrate judge hearing the matter recommended against granting this motion, the District Court disagreed and dismissed the case:

In its order, the district court explained that while it was sympathetic to Lindsay’s specific circumstances, the “weight of authority indicates he has failed to state a claim upon which relief can be granted.” Beginning with Boyle, 469 U.S. at 245, the district court navigated the relevant caselaw and concluded that Lindsay was not entitled to assert the reasonable cause defense under I.R.C. § 6651(a)(1)–(2) or § 6654(a).[5]

Late Filing/Payment and Reasonable Cause

IRC §6651(a)(1) and (2) provide for penalties to apply for late filing of returns and the late payment of the related taxes, but subject to a reasonable cause exception:

(a) Addition to the tax. In case of failure—

(1) to file any return required under authority of subchapter A of chapter 61 (other than part III thereof), subchapter A of chapter 51 (relating to distilled spirits, wines, and beer), or of subchapter A of chapter 52 (relating to tobacco, cigars, cigarettes, and cigarette papers and tubes), or of subchapter A of chapter 53 (relating to machine guns and certain other firearms), on the date prescribed therefor (determined with regard to any extension of time for filing), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate;

(2) to pay the amount shown as tax on any return specified in paragraph (1) on or before the date prescribed for payment of such tax (determined with regard to any extension of time for payment), unless it is shown that such failure is due to reasonable cause and not due to willful neglect, there shall be added to the amount shown as tax on such return 0.5 percent of the amount of such tax if the failure is for not more than 1 month, with an additional 0.5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate;...

The court notes that the Treasury provides some guidance on reasonable cause in Reg. §301.6651-1(c)(1) which provides, in part:

If the taxpayer exercised 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 payment of his tax liability and was nevertheless either unable to pay the tax or would suffer an undue hardship . . . if he paid on the due date.[6]

The panel stated that this means there are two questions to be resolved in the taxpayer’s favor for reasonable cause relief to be granted:

Did the taxpayer use ordinary business care and prudence in attempting to comply with the law’s requirements? and
Was the taxpayer nevertheless unable to pay the tax?[7]

Exercise of Ordinary Business Care and Prudence

The taxpayer argued that the facts show he had exercised ordinary business care and prudence:

Lindsay claims that he exercised ordinary business care and diligence by giving Bertelson his power of attorney and by directing Bertelson to file his income tax returns and to pay his taxes. Lindsay routinely asked Bertelson whether he was handling Lindsay’s tax obligations, and Bertelson said that he was. In Lindsay’s view, he has a reasonable cause for late filings and delayed payments because he used ordinary business care and prudence but was nevertheless unable to file his returns and pay his income taxes due to circumstances beyond his control, i.e., Bertelson’s malfeasance.[8]

However, the panel found that the Supreme Court had rejected this delegation of the duty to file and pay the tax in Boyle:

Boyle established that taxpayers have a non-delegable duty to promptly file and pay their taxes. 469 U.S. at 249–50. Unlike cases where taxpayers seek and detrimentally rely on tax advice from experts, “one does not have to be a tax expert to know that tax returns have fixed filing dates and that taxes must be paid when they are due.” Id. at 251.[9]

Mr. Lindsay would have known (or could easily have determined) the dates upon which the returns must be filed and could have filed them himself to assure that the act took place. But he decided to rely upon his attorney to take care of these acts.

IRS Audit Technique Manual and the Unavoidable Absence

Mr. Lindsay claimed that the IRS Audit Technique Manual for Estate Tax Examiners provides for eight reasons the agency considers to constitute reasonable cause for late filing which the taxpayer argues should apply to his failures as well. One of those exceptions involves the taxpayer’s unavoidable absence, which Mr. Lindsay claimed should apply to his incarceration.

However, the panel did not accept this position, noting:

Lindsay points to his incarceration as an example of an unavoidable absence, but “the mere fact that [Lindsay] was incarcerated when his return was due is not reasonable cause for his failure to file timely.” George v. Comm’r, T.C. Memo 2019-128, 2019 WL 4686285, at *3 (collecting cases)). “Nor is the unavailability of records generally reasonable cause for failure to file a timely return.” Id.[10]

Not Physically Capable of Complying

Finally, Lindsay argues that Boyle does not apply when a taxpayer is not “physically and mentally capable of knowing, remembering, and complying with a filing deadline…” citing the concurring opinion in Boyle penned by Justice Breyer. He also cites a U.S. District Court decision in the Brown case:

He argues that his incarceration rendered him incapable of complying with his filing deadline, and he relies on Brown v. United States, 630 F. Supp. 57 (M.D. Tenn. 1985). In Brown, the district court concluded that Boyle did not govern the § 6651(a)(1) analysis where an elderly man entrusted his tax responsibilities to an attorney, the attorney became ill and filed the return late, and the elderly man was “incapable of meeting the criteria of ordinary business care and prudence” given his age, health, and lack of experience. Id. at 58, 60.[11]

But the panel found that the facts indicated that Mr. Lindsay was able to conduct other activities while incarcerated, thus he was not like the elderly man in Brown:

Even if we read Boyle and Brown as creating an exception to the reasonable cause rule, Lindsay was not incapable of meeting the filing and payment deadlines. Lindsay could have used ordinary business care and prudence to assure that his taxes were filed and paid, much like he conducted business and employed a CPA while incarcerated. Lindsay failed to act with such care, and we affirm the district court's dismissal accordingly.[12]

The Court also found that the fact the attorney was embezzling from him did not incapacitate him:

Lindsay also contends that his agent's embezzlement incapacitated him, and he should be exempted from the reasonable cause standard under Matter of American Biomaterials Corporation, 954 F.2d 919 (3rd Cir. 1992). That case is distinguishable because unlike the company in American Biomaterials, Lindsay could have controlled his agent.[13]

Fundamentally, it appears the panel’s view is that the problem was that had Mr. Lindsay taken steps to handle this matter directly without relying upon an agent, he would not have been disadvantaged at all by the attorney’s deceit and embezzlement.

Impact of the Case

While this case specifically deals with a professional that was clearly violating his professional duty to his client, it points out that taxpayers will not be able normally to get relief if, for whatever reason, the professional fails to timely file the return or extension, or fails to submit a payment timely. This means that professionals who simply make a mistake and fail to submit documents timely aren’t likely to find the IRS willing to forgive the mistake and not pursue the penalty from the client.

This also means that, generally, a request for reasonable cause relief from penalties should not spend time arguing for failures on the part of the professional to perform such mundane tasks as filing the document on time, since Boyle indicates such reasons won’t count. Rather, only errors that relate to tax advice the taxpayer needed to obtain from the professional will normally be deemed relevant.

But just because federal law doesn’t treat such a failure to timely file a document or make a payment as excusable for the taxpayer due to the professional’s error, that does not mean the client won’t be able to pursue and be awarded reimbursement from the professional in a separate action in state court.

[1] Lindsay v. United States, CA 5, Case No. 20-50994, July 9, 2021, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/individual-has-no-defense-to-late-filing%2c-late-payment-penalties/76vdj (retrieved July 13, 2021)

[2] Lindsay v. United States, CA 5, Case No. 20-50994, July 9, 2021

[3] Lindsay v. United States, CA 5, Case No. 20-50994, July 9, 2021

[4] Lindsay v. United States, CA 5, Case No. 20-50994, July 9, 2021

[5] Lindsay v. United States, CA 5, Case No. 20-50994, July 9, 2021

[6] Lindsay v. United States, CA 5, Case No. 20-50994, July 9, 2021

[7] Lindsay v. United States, CA 5, Case No. 20-50994, July 9, 2021

[8] Lindsay v. United States, CA 5, Case No. 20-50994, July 9, 2021

[9] Lindsay v. United States, CA 5, Case No. 20-50994, July 9, 2021

[10] Lindsay v. United States, CA 5, Case No. 20-50994, July 9, 2021

[11] Lindsay v. United States, CA 5, Case No. 20-50994, July 9, 2021

[12] Lindsay v. United States, CA 5, Case No. 20-50994, July 9, 2021

[13] Lindsay v. United States, CA 5, Case No. 20-50994, July 9, 2021