a case dealing with "substantial authority"

John R. Hernandez v. CommissionerDocket No. 17244-96., TC Memo. 1998-46, 75 TCM 1714, Filed February 5, 1998

One of the issues in this case is whether petitioner, a CPA, was liable for accuracy-related penalties under section 6662(d) for substantial understatements of income tax. The purpose of presenting an excerpt from this case is to illusrate how the Tax Court will apply the "substnatial authority" standard which is presently the standard for determining the return preparer penalty under section 6694(a)(2)(A) as legislated under the Emergency Economic Stabilization Act of 2008. The IRS proposed regulations require an analysis of the relevant authority under section 1.6662-(4)(d)(3). This is the reason cases like the present Hernandez case provides guidance for the 6694(a) issues.


OPINION

Issue 5. Petitioner Is Liable for the Accuracy-Related Penalty Under Section 6662(d) for Substantial Understatements of Income Tax



Respondent is foreclosed from imposing the accuracy-related penalty if a taxpayer has substantial authority for the treatment of the items at issue or if the taxpayer adequately disclosed such items. Sec. 6662(d)(2)(B)(i) and (ii). Petitioner has the burden of showing either that he had substantial authority for the tax treatment of the tax certificate interest or that he adequately disclosed his treatment on the returns for each year in issue. Rule 142(a).


The substantial authority standard is "an objective standard involving an analysis of the law and application of the law to relevant facts. The substantial authority standard is less stringent than the 'more likely than not' standard, * * * but more stringent than the reasonable basis standard". Sec. 1.6662-4(d)(2) , Income Tax Regs.


Section 1.6662-4(d)(3)(i) , Income Tax Regs., states that substantial authority for a taxpayer's treatment of an item exists "only if the weight of the authorities supporting the treatment is substantial in relation to the weight of authorities supporting contrary treatment."


With respect to the issue of whether petitioner may exclude tax certificate interest under section 103(a) , petitioner did not have substantial authority to support such an exclusion. This Court had issued a Memorandum Opinion directly on point, Barrow v. Commissioner [Dec. 39,947(M) ], T.C. Memo. 1983-123, long before petitioner filed his income tax return for any of the tax years in question. That Memorandum Opinion is substantial authority that directly contradicts petitioner's position. Sec. 1.6662-4(d)(3) (iii), Income Tax Regs.


Petitioner stated in open court that he would show that our opinion in Barrow v. Commissioner, supra, is wrong. He has failed to do so. Indeed, he has cited no authority at all to support his position, nor has he provided any persuasive reasoning to support his assertions so as to invoke section 1.6662-4(d)(3) (ii), Income Tax Regs.

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The return preparer industry has been generally passive about the need to provide technical support for the positions taken (i.e.,the need to provide "substantial authority" for undisclosed positions). For the 2008 tax year, you better be certain that the positions taken are supported by the applicable statute, regulations, and (as in the present case) the applicable case law. That means, guys & gals, that you can no longer be content to just plug in numbers into return preparation software. You are going to be expected to be a technical expert on the position taken in the tax return. In the John R. Hernandez case, it is apparent that this CPA did not do the necessary research on the interest issue. If this were a 6694 case, the CPA would be hit with the 6694(a)penalty and be at risk that he was sufficiently "reckless" that he might also be subject to the 6694(b) much higher $5,000 penalty. The IRS coud easily take the position that the CPA was "reckless" for his failure to check out an apparent case that woulod have negated the position taken. I have been taken aback by the failure of the return preparer professional organizations to issue a "wake up" call to all return preparers that they must be prepared to provide complete technical support for the positions taken. What you need to think about is whether you have the technical resources to research the relevant tax law. How are you going to handle the difficult issues? Those decisions should be made before the tax returns are filed for the 2008 tax year.


Continue to send comment to ab@irstaxattorney.com if you want to see more examples of how the "substantial authority" standard will be applied. If you are wrong on any position that is not disclosed to the IRS, can you handle a $5,000 penalty if you cannot justify that you were not "reckless" to the IRS? Suppose you make a careless mistake; will you be able to justify that you were not "reckless?" The return preparation industry is presently passive when they should be making all return preparers aware of the need to support all factual and legal issues with relevant analysis and technical support.