5 Tips by Tax Lawyer Philip Falco:
- Scan all of your receipts and email the questionable expenses to your CPA for review.
- Keep a mileage log and provide the actual log to your CPA. Telling your CPA what your mileage was is not enough to avoid the IRC 6662(a) accuracy related penalty.
- Work with a CPA who has integrity and who will be willing to “fall on the knife” if he gave you incorrect tax advice. Everyone makes mistakes, not everyone is willing to own up to them.
- Categorize your expenses all year long. If you are not sure if something is a business expense, ask right away and properly categorize it. It is up to the taxpayer to show the IRS you properly categorized an expense. This seems simple but is subtly complex. The IRS will willingly categorize an expense as personal unless taxpayer shows otherwise.
- Evidence is the name of the tax game. In the digital age, there is no excuse for not archiving old receipts. These documents can be critically important many years down the road. Keep them, especially those pertaining to rental real estate (purchase, improvements) and business expenses. Really any real estate evidence should be archived since an owner occupied real estate holding can be converted to a rental. If so, adjusted basis (ex depreciation) becomes very important.
Accuracy Related Penalty IRC 6662(a)
Section 6662(a) imposes an accuracy-related penalty equal to 20% of the underpayment to which section 6662 applies. Section 6662 applies to the portion of any underpayment which is attributable to, among other things, negligence or disregard of rules or regulations. Sec. 6662(b)(1). Underpayment of tax is typically attributable to negligence.
IRC Section 6662(c) provides that “[f]or purposes of section 6662, the term ‘negligence’ includes any failure to make a reasonable attempt to comply with the provisions of the Code, and the term ‘disregard’ includes any careless, reckless, or intentional disregard.”
Negligence also includes any failure to exercise ordinary and reasonable care in the preparation of a tax return or any failure to keep adequate books and records and to properly substantiate items. Sec. 1.6662-3(b)(1), Income Tax Regs.
Burden of Proof
Section 7491(c) provides that the Commissioner bears the “burden of production” with regard to penalties and must come forward with sufficient evidence indicating that it is appropriate to impose the penalty. See Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once the Commissioner meets his “burden of production”, however, the “burden of proof” remains with the taxpayer, including the burden of proving that the penalty is inappropriate because of reasonable cause under section 6664. See Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446-447.
Exception: Reasonable Cause for Taxpayer’s Position
Section 6664(c)(1) provides that the penalty under section 6662(a) shall not apply to any portion of an underpayment if it is shown that there was reasonable cause for the taxpayer’s position and that the taxpayer acted in good faith with respect to that portion. See Higbee v. Commissioner, 116 T.C. at 448. The determination of whether the taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all the pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. Petitioners have the burden of proving that the penalty is inappropriate because of reasonable cause under section 6664. See Rule 142(a); Higbee v. Commissioner, 116 T.C. at 446-447.
Reasonable cause can be reliance on a CPA’s tax advice. However, For reliance to be reasonable, “the taxpayer must prove by a preponderance of the evidence that the taxpayer meets each requirement of the following three prong test: (1) The adviser was a competent professional who had sufficient expertise to justify reliance, (2) the taxpayer provided necessary and accurate information to the adviser, and (3) the taxpayer actually relied in good faith on the adviser’s judgment.” Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 99.
As an example, if a taxpayer tells his CPA about mileage without also giving the CPA a mileage log, this has been held to be not sufficient, and the accuracy related penalty was imposed.
It is up to the taxpayer to show that he provided his CPA with sufficient documentation of a deduction.