In a U.S. Tax Court case released today, the Tax Court provided a helpful case study in why it might not be advisable for a company’s in-house tax advisor to sign the company’s income tax returns.
The facts in Seven W. Enterprises, Inc. v. Commissioner of Internal Revenue are fairly straightforward.
The IRS assessed accuracy-related penalties against the taxpayer company based on a tax position that the taxpayer had taken on several years of tax returns that the Service found to be unjustified under existing law.
The Company asserted that it was entitled to rely on the advice of its tax advisor.
Under Section 6664(c)(1) of the Internal Revenue Code, no accuracy-related penalty can be imposed if a taxpayer demonstrates that there was a reasonable cause for the underpayment in question and that the taxpayer acted in good faith. The determination of whether a taxpayer acted with reasonable cause and in good faith depends upon the facts and circumstances, including the taxpayer’s efforts to assess his or her proper tax liability; experience, knowledge, and education; and reliance on the advice of a professional tax advisor.
In this case, the Company’s tax advisor had acted as the Company’s independent certified public accountant in one of the tax years in question and had signed the return for that year as a paid preparer.
For that particular year, the Tax Court determined that the Company had acted in good faith on the tax advisor, and it was reasonable for the Company to rely on him to prepare the Company’s tax return. Accordingly, the Tax Court held that the accuracy-related penalty could not be imposed by the IRS for that particular year.
With respect to the other years in question, however, the same tax advisor, who had been hired by the Company and served as its vice president of taxes, signed the Company’s tax returns not as an independent tax preparer, but rather on behalf of the Company as an officer of the Company.
The Court noted that pursuant to Treasury Regulation 1.6664-4(c)(2), the term “advice,” with respect to a taxpayer may be able to rely to avoid the accuracy-related penalty is defined as “any communication . . . setting forth the analysis or conclusion of a person, other than the taxpayer.
The Company argued that their in-house tax advisor was not the taxpayer, but rather an employee of the taxpayer, and, thus, the Company should have been able to rely on his tax advice with respect to avoiding the accuracy-related penalty.
The Court pointed out that a corporation can act (in this case, sign its income tax return) only through its officers. Since the Company had authorized its in-house tax advisor/employee to act both as its vice president of taxes and as the Company itself by signing its tax return, the Company’s in-house tax advisor could not be treated as separate from the Company itself. As the Court said, in this case, the in-house tax advisor “does not qualify ‘as a person, other than the taxpayer’ with respect to the returns he signed on behalf of the taxpayer.”
What lesson can be gleaned from this case?
One lesson may be that an in-house tax advisor to a corporation should not be authorized to sign and should not sign the corporation’s income tax return. If he is so authorized and does sign the return, then the corporation may have waived its right to claim that it relied in good faith on independent tax advice for purposes of avoiding the accuracy-related penalty.