6694 v. negligence

In the present case, the issue was whether income received was royalty income or capital gain. The court determined that the income was royaly income. The classification of income frequently arises. The reason this is also a 6694 issue is that the 2nd Circuited that the taxpayer was liable for the Code Sec. 6662 accuracy-related penalty. The couple failed to demonstrate either good faitlh or reasonable cause for the underpayment. The taxpayers admitted that they neither sought nor followed professional tax advice or that they provided complete and accurate information to the firm that signed their tax returns. Anytime a taxpayer is liabile for the negligence penalty raises the issue of whether the return preparer can be subject to the 6694 penalty. You can write this down in stone: ANYTIME THE TAXPAYER IS LIABLE FOR THE NEGLIGENCE PENALTY AUTOMATICALLY RAISES THE 6694 PENALTY BECAUSE THE "SUBSTANTIAL AUTHORITY" STANDARD WAS NOT MET AND THERE WAS NO "REASONABLE CAUSE." BET ON THAT RESULT. The 2nd Circuit indicated that there would have been a "reasonable cause" issue because they did not get professionl advice.
H. Garfield, Carol Garfield, Petitioners v. Commissioner of Internal Revenue, Respondent.

U.S. Court of Appeals, 2nd Circuit; 07-2474-ag, August 18, 2008.

Unpublished opinion affirming the Tax Court, 92 TCM 496; CCH Dec. 56,701(M); TC Memo. 2006-267.



Patent royalties received by a married couple were ordinary income, not long-term capital gain. The income received from the transfer of patent rights did not qualify as long-term capital gain under Code Sec. 1235 because the patents were transferred to a related person. Although the taxpayers argued that the patent rights were transferred to an unrelated entity by operation of a forbearance agreement, the only evidence of such an agreement was the taxpayer's testimony, which was not credible. Further, the income did not qualify as capital gain under Code Secs. 1221 or 1222 because the taxpayers did not hold the rights for the required period before the transfer.


A married couple who were denied long-term capital gain treatment for patent royalty income was liable for the Code Sec. 6662 accuracy-related penalty. The couple failed to demonstrate either good faitlh or reasonable cause for the underpayment. The taxpayers admitted that they neither sought nor followed professional tax advice or that they provided complete and accurate information to the firm that signed their tax returns.


Before: Jacobs, Chief Judge and Raggi and Livingston, Circuit Judges.




SUMMARY ORDER


UPON DUE CONSIDERATION, IT IS HEREBY ORDERED, ADJUDGED AND DECREED that the judgment of the Tax Court be AFFIRMED .

Nathaniel Garfield and his wife, Carol Garfield, with whom he jointly filed tax returns during the relevant years, appeal from a judgment of the Tax Court (Foley, J.), entered December 18, 2006, which sustained the Commissioner's assessment of both a deficiency and an accuracy-related penalty. We assume the parties' familiarity with the underlying facts, the procedural history, and the issues on appeal. We review the Tax Court's findings of fact for clear error, see Am. Valmar Int'l Ltd. v. Comm'r, 229 F.3d 98, 101 (2d Cir. 2000), and its legal determinations de novo, see Texasgulf, Inc. v. Comm'r, 172 F.3d 209, 214 (2d Cir. 1999).

[1] We agree with the Tax Court's conclusion that the patent royalty payments do not qualify for long-term capital gains treatment under 26 U.S.C. §1235 because, to the extent Garfield transferred patent rights to Mechanical Plastics Corp. ("MPC"), he transferred those rights to a related person. See 26 U.S.C. §§267(b)(2), 1235(d). Garfield asserts that he transferred his patent rights to an unrelated entity by operation of a "forbearance agreement" executed in 1969. There is no evidence of a forbearance agreement in the record aside from Garfield's testimony that it existed, which the Tax Court rejected as not credible. Having reviewed the record, we conclude that the Tax Court's finding was not clearly erroneous.

The Tax Court rejected Garfield's alternative argument that the royalties were long-term capital gains under 26 U.S.C. §§1221- 1222. The court found that Garfield failed to hold any patent right for the requisite period before transferring it. See id. §1222. Our review of the record reveals no clear error in the Tax Court's finding.

Garfield argues that the Commissioner is estopped from challenging his tax treatment of patent royalties because the Commissioner approved that treatment during a 1983 audit. Even assuming (as we do not) that the Commissioner may be estopped from challenging tax treatment after previously indicating his approval, Garfield fails to show that the Commissioner approved his treatment of royalty income as long-term capital gain. Rather, the record shows that MPC --not Garfield --obtained a "no change" letter following an audit of MPC's 1981 corporate return.

[2] Garfield unsuccessfully argued to the Tax Court that he was entitled to protection from an accuracy-related penalty, see 26 U.S.C. §6662, because he acted in good faith and with reasonable cause when underpaying his taxes, see id. §6664(c)(1). In sustaining the penalty, the Tax Court noted that Garfield did "not contend that [he] followed, or even sought, the advice of a tax professional." Garfield acknowledged at oral argument that he never contended to the Tax Court that he sought or followed professional tax advice. While his Forms 1040 for the years 2000-2002 were signed by Cohen, Estis and Associates, L.L.P., Garfield conceded at oral argument that nothing in the record indicates that Cohen, Estis and Associates, L.L.P. is a tax professional; nor does the record reflect that Garfield provided Cohen, Estis and Associates with complete and accurate information. See Crigler v. Comm'r, 85 T.C.M. (CCH) 1091 (2003).

We have considered Garfield's remaining arguments and find them to be without merit. For the foregoing reasons, the judgment of the Tax Court is AFFIRMED .
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The following is another case just published on Auguest 26, 2008 with a similar result.

Eugene Cobaugh v. Commissioner.TC Memo. 2008-199, August 26, 2008.

The individual's failure to file and failure to pay were not due to reasonable reliance on professional advice because there was no credible evidence regarding the advisor's professional credentials and his advice consisted only of groundless and frivolous arguments. This rationale would also result in "reasonable cause" for a tax return preparer who relied on professional advice.



If you have questions on the relationship of the negligence penalty to the 6694 penalty ask for a tax attorney at 888 712-7690 ex 106