Pickering v. United States

82-1 USTC ¶9375]James E. Pickering v. United States of America

U. S. District Court, East. Dist. Ark., West. Div., No. LR C 81 613;, No. LR C 81 614;, No. LR C 81 615;, No. LR C 81 616;, No. LR C 81 617;, No. LR C 81 618, 4/20/82

The penalty for wilful understatement of taxpayer liability was imposed against a return preparer for corporate returns he prepared since he had actual knowledge that bills and expenses submitted for personal expenses of shareholders and their children were included as deductible expenses on the corporation's books. The preparer did not wilfully understate income on returns he prepared for individual shareholders since he did not complete them at the same time or from the same information as the corporate returns and the penalties were not sustained as to those returns. Moreover, with respect to the individual returns, the personal expenditures discovered on audit of the corporate books involved shareholders' children who were not employees of the corporation and the preparer had reasonable cause to believe that other deductions claimed by the corporation were legitimate business expenses and not disguised payments to its shareholders.



Memorandum and Order


OVERTON, District Judge:


This case was tried by the Court without a jury on April 20, 1982. Before trial the parties entered into a stipulation of fact which is adopted and supplemented by this memorandum.


Stipulation of Fact


1. These are actions instituted pursuant to and jurisdiction arises under the provisions of 28 U. S. C. §1346(a)(1), Internal Revenue Code of 1954, §6694(c)(1)(2) for the recovery of Internal Revenue taxes and penalties.


2. The plaintiff is an individual with his residence in Mayflower, Arkansas, within the Eastern District of Arkansas.


3. The plaintiff is an income tax return preparer as defined in Internal Revenue Code of 1954, §7701A(36). Plaintiff prepared the following income tax returns:


1. 1976 form 1120 return for APT Construction, Inc.


2. 1976 form 1040 return for Harry Wall.


3. 1977 form 1120 return for APT Construction, Inc.


4. 1977 form 1040 return for Harry Wall.


5. 1977 form 1040 return for Leonard and Miriam Thompson.


6. 1977 form 1040 return for Gail Richardson.


The returns were timely filed.


4. The defendant, the United States of America, by its agent District Director of the Internal Revenue Service, Paul D. Williams, by a letter dated January 29, 1981, imposed tax preparer penalties in the total amount of $3,000.00 upon the income tax returns referred to in Paragraph 3.


5. As authorized by Internal Revenue Code of 1954, §6694(c), plaintiff paid 15% of each of the penalties. Claims dated February 23, 1981, for refund of the $75.00 payments were timely filed by plaintiff. The plaintiff's claims were disallowed by Internal Revenue Service letters dated August 11, 1981.


6. Plaintiff timely filed on September 9, 1981, suits for refund of the payments made and asked for abatement of the remaining portion of the penalties.


7. The returns listed in Paragraph 3 were examined by the Internal Revenue Service and it was determined that there was an understatement of liability with respect to each of the returns. Each of the taxpayers involved agreed with those determinations. 1


8. With respect to the returns of APT Construction Company, various deductions were disallowed as not being ordinary or necessary business deductions or for not meeting the substantiation requirements of §274 of the Internal Revenue Code. The disallowed deductions were claimed under the following headings:


a. Equipment repairs;


b. Equipment supplies;


c. Taxes and licenses;


d. Dues and subscriptions;


e. Travel and allowances;


f. Insurance;


g. Telephone;


h. Equipment fuel;


i. Office utilities;


j. Depreciation; and


k. Miscellaneous.


9. With respect to the returns of Harry Wall, taxable income was increased by dividends which were not included in income on the returns. These dividends resulted from the corporate payment of Mr. Wall's personal expenses. Some of those expenses were the same amounts for which deductions were disallowed to the corporation.


10. With respect to the return of Leonard and Miriam Thompson, taxable income was increased by dividends as in the case of Mr. Wall. Income was also increased by a salary bonus for which a deduction was taken by the corporation, but which was not included on the Thompsons' return.


11. With respect to the return of Gail Richardson, taxable income was increased by dividends as in the case of Mr. Wall. Income was also increased by a salary bonus for which a deduction was taken by the corporation, but which was not included on Richardson's return.


Supplemental Findings of Fact and Conclusions of Law. 1. With respect to the corporate returns, the disallowed items were reviewed and Mr. Pickering offered explanations as to why the items were included as deductible expenses to the corporation. It is not necessary to review each category and make a specific finding as to whether there was a willful attempt to understate the corporation's liability. Suffice it to say the Court credits the testimony of Vinita Smith, the bookkeeper for APT. Mrs. Smith said that she was concerned about bills and expenses which were submitted to the corporation for personal expenses of the shareholders and their children. Such expenses were repair bills for cars used by the children of Leonard Thompson and Gail Richardson, taxes and licenses for the automobiles, gasoline bills and insurance for those cars, and the weekly salary paid to Richy Richardson, who was at college in Fulton, Missouri.


Mrs. Smith said that she asked plaintiff about those expenses and what the IRS would do about them if there was an audit. Pickering told her "not to worry about it". Mrs. Smith also pointed out that Pickering was aware of the automobiles purchased by the company and that he set up the depreciation schedule for the vehicles.


2. Although the Court agrees with plaintiff's argument that the tax preparer has a right to rely upon the taxpayer and the information furnished by the taxpayer, that reliance does not permit the tax preparer to ignore information which is called to his attention or inferences which are plainly available to him.


3. The questions about personal expenditures Mrs. Smith brought to the attention of Mr. Pickering called for further investigation and inquiry on his part. This is particularly true in view of the itemized expenditures listed on the various ledger cards examined by Mr. Pickering.


4. Although the Court concludes that Mr. Pickering should have been aware that the corporation claimed deductible expenses which were not properly deductible, it does not necessarily follow that he willfully understated the personal income of Harry Wall, Leonard Thompson and Gail Richardson on their personal returns. Mr. Pickering testified that the information for corporate returns was gathered at the end of the year and W-2 forms were furnished Wall, Thompson and Richardson in January. Sometime in February a decision was made to adjust the personal expenditure accounts which, in effect, resulted in a dividend to the shareholders. There were no corrected W-2 forms issued and when Pickering prepared the personal returns of Wall, Thompson and Richardson in early April, the "adjustment" was overlooked. Pickering cites his workload as the excuse for forgetting the adjustments which resulted in the failure to declare the dividends on the returns of the individual taxpayers. It is significant that the personal returns were not prepared at the same time or from the same information as the corporate returns, Given the circumstances, the Court concludes that the failure to include the dividends on the individual returns was the result of oversight on the part of Mr. Pickering.


5. Aside from the dividend "adjustment" problem, no testimony was offered on the issue of Mr. Pickering's alleged "willfulness" in understating Mr. Wall's personal income on his 1976 and 1977 returns. Presumably the Court should infer that Mr. Pickering was on sufficient notice from his audit of the corporate books that Wall received substantial personal benefit from corporate expenditures which were not deductible to the corporation.


The difficulty with such an inference is the Court's conclusion that the personal expenditures which should have put Mr. Pickering on notice were principally those involving the children who were not employees of the company. That area was apparently of most concern to Mrs. Smith and presumably the expenditures called to the attention of Mr. Pickering by her.


Furthermore, with respect to the Hot Springs property, Pickering had some basis for believing it was used for business purposes since Wall and a superintendent stayed there while working on a job at DeQueen. Wall also told Pickering that he maintained records supporting the use of the property as an "entertainment facility". It is noteworthy that Pickering had little or not experience in handling corporate deductions for "entertainment facilities".


Apparently Pickering did not question the $50 per week payment to Wall and Thompson for "expenses" believing that it was not necessary to substantiate per diem expenditures in those amounts. While it may be argued that country club dues and other such expenditures are not proper expenses in this particular case, such expenses may be proper if documented. In any event, the Court concludes that the proof is not convincing that Mr. Pickering willfully understated Mr. Wall's personal income by failing to report such expenditures as personal income on his 1976 and 1977 returns.


6. Plaintiff was furnished information by Mrs. Smith which put him on notice that some of the corporation expenditures were not reasonable and necessary corporate expenditures. When plaintiff failed to inquire or investigate those expenditures, he ignored the implications of information furnished to him. The Court concludes that plaintiff thereby willfully reduced the tax liability of APT Corporation for the years 1976 and 1977.


7. The Secretary failed to prove by a preponderance of the evidence that plaintiff willfully attempted to understate the liability for tax on the personal returns of Harry Wall, Leonard Thompson or Gail Richardson.


8. The plaintiff is liable for penalties in the amount of $500 each for the preparation of the following income tax returns:


a. 1976 return of APT Corporation;


b. 1977 return of APT Corporation.


9. The plaintiff is not liable for penalties in the amount of $500 each for the preparation of the following income tax returns:


a. 1976 return of Harry Wall;


b. 1977 return of Harry Wall;


c. 1977 return of Leonard and Miriam


Thompson; and


d. 1977 return of Gail Richardson.


Judgment shall be entered in accordance with these findings.


1 The Court finds, however, that the original estimate of the amounts subject to adjustment on the APT returns were reduced when Leonard Thompson and Gail Richardson offered satisfactory explanations for some of the expenses initially disallowed. Leonard Thompson and Gail Richardson agreed with final tax assessments computed by the auditing agent and paid those sums. Harry Wall died before the audits were initiated. The representative of his estate agreed that certain expenses could not be substantiated as business expenses of APT and agreed to a tax payment.