Three different Administrative Law Judges recently issued decisions in matters involving challenges by tax return preparers to penalties assessed by the Department of Taxation and Finance. In two cases, the penalties were upheld; in one they were canceled. 

Penalties imposed for filing returns taking improper positions.

Two cases involved the assertion of penalties against tax preparers under Tax Law former § 685(aa)(1), which provided for tax preparer penalties of up to $1,000 with respect to each return or claim when a return or refund claim takes a position for which “there was not a reasonable belief” that the tax treatment was more likely than not correct, the preparer knew or reasonably should have known of the position, and the position was not disclosed or there was no reasonable basis for the treatment. 

In Matter of Lael Cathey, DTA No. 827909 (N.Y.S. Div. of Tax App., Nov. 21, 2019), the Department asserted that the preparer had filed returns for the 2013 and 2014 years on behalf of personal income taxpayers who had claimed unsubstantiated itemized deductions for amounts such as employee job expenses and charitable deductions. The Department asserted that on 789 returns – which amounted to approximately 79% of the returns that the preparer, Ms. Cathey, had prepared – the taxpayers’ deductions had been questioned by the Department. Of those returns, 506 had been selected for pre-refund audit inquiry and, according to an affidavit from a Department employee, none of the 506 taxpayers “was able to substantiate the itemized deductions.” However, the record did not disclose the number of taxpayers who responded or whether, even in the absence of a response, the Department was able to reach a conclusion about the propriety of the deductions. The Department’s position was that a significant, although unspecified, number of Ms. Cathey’s taxpayer clients were public sector employees, and she should have known that their job expenses were reimbursed or reimbursable by their employers, so she should not have treated the expenses as deductible on the returns.

The Department also alleged that approximately 84 pieces of supporting documentation, submitted for more than 20 different taxpayers, appeared to be fraudulent. For example, four letters were submitted to verify the expenses claimed by the taxpayers, but the letters, despite ostensibly coming from different employers with different letterheads, were essentially identical and bore the exact same signature of the identical “HR Manager.” Similarly, four photocopies of the same receipt for police equipment that were identical in amount, date, items purchased, and cost were submitted showing four different individuals as purchasers. 

To determine whether the imposition of penalty was warranted, the ALJ applied three criteria: the egregiousness of the position; the audit success; and the total number of returns on which the position was claimed. The ALJ found that the reporting position taken on the returns “was not, per se, an improper position” because taxpayers are clearly entitled to claim deductions for gifts to charities and unreimbursed expenses, and that the taxpayers’ inability to provide substantiation on audit “does not necessarily support” the finding that the deductions were an improper reporting position. While the Department claimed that Ms. Cathey could not reasonably rely upon her clients’ desire to claim the expenses in the absence of supporting documentation, the ALJ found that tax preparers may reasonably and in good faith rely on information supplied by their clients and are not under an obligation to audit or examine books and records, as is recognized by the Department’s regulation, which provide that a “tax return preparer . . . generally may rely in good faith without verification upon information furnished by the client.” 20 N.Y.C.R.R. 2600-4.3[h][6]. 

The ALJ did find “very troubling” the submission to the Department of what it described as “obviously manufactured documents,” and noted that they could expose Ms. Cathey to unspecified sanctions other than tax preparer penalties. However, the ALJ determined that those documents did not necessarily establish that Ms. Cathey knew at the time of filing the returns that the claimed deductions were not valid. He rejected the Department’s argument that Ms. Cathey should generally have known that expenses were not deductible by state and municipal employees as a “thin rationale,” and found it an insufficient basis to support the imposition of penalties. 

In the second case involving tax preparer penalties, Matter of Yesenia Almonte, DTA No. 827891 (N.Y.S. Div. of Tax App., Dec. 12, 2019), the Department had asserted penalties against Ms. Almonte for preparing returns on behalf of her clients on which “other losses” from businesses engaged in by the taxpayers had been claimed. Many of Ms. Almonte’s clients had losses from their investments in a business loaning money to others, which turned out to be a “pyramid type scheme,” and many of these clients had advised her that they understood they could report those losses on IRS Form 4797. After conducting “internet research” and consulting with unidentified individuals to research her clients’ loan businesses, Ms. Almonte reported her clients’ purported losses by filing a Form 4797, and including the amount of loss on line 8 of the clients’ Forms IT-201. Ms. Almonte charged her clients between $75 and $350 for preparation of their returns.

The Department audited 713 of the 1408 returns filed by Ms. Almonte for the 2014 year, and found that none of the taxpayers were entitled to claim losses on Form 4797, which applies only to taxpayers who sold or exchanged assets used in a trade or business, while the taxpayers at issue claimed such items as capital losses or adjustments to federal income for student loan interest. The Department assessed penalties of $713,000, $1,000 for each of the 713 returns.

In this case, the ALJ sustained the penalties. She found that Ms. Almonte, who was a registered tax return preparer, had completed college course accounting work and a tax preparation course at H&R Block, and should have known that the use of Form 4797 and the filing positions taken on the returns were incorrect. The ALJ also noted, without explaining the relevance to the imposition of tax preparer penalties, that Ms. Almonte did not report any of the income she earned from her tax preparation business on her own personal income tax return, paid her employees in cash, and did not pay withholding tax or file Forms W-2 with regard to her employees.

Penalties for Failing to File Electronically

Finally, the third case, Matter of Ronald Bellantonio and Richard Rock, DTA Nos. 828044 & 828045 (N.Y.S. Div. of Tax App., Dec. 5, 2019), involved penalties of $4,900 asserted under Tax Law § 29, which requires all tax return preparers who prepare more than 100 returns in a calendar year to file the tax returns electronically, and imposes a penalty for failure to file electronically unless the failure is due to reasonable cause and not willful neglect. Here, the tax preparer argued that all of his clients were “middle-aged, older and elderly” and “not astute in the area of tax and money” or otherwise vulnerable to identity theft; that they elected to file paper returns for federal purposes; and that he “exercised professional judgment in not wanting to subject [the] clients’ personal information to possible cyber theft.”

The ALJ sustained the penalties. She noted, first, that New York State does not have the opt-out provision to avoid electronic filing that is available at the federal level, and also that Tax Law § 29 was explicitly amended in 2010 to remove as a basis for reasonable cause a taxpayer’s election not to electronically file. The ALJ also found that the allegations about the clients’ age and status were not supported by the record, since most of the clients listed professional occupations on their returns and were not middle-aged or elderly.


The difference in the results in the two cases involving preparer penalties for taking improper positions seems to involve the conduct that was charged. In the Cathey case, the positions taken on the taxpayers’ returns were on their face correct and in accordance with the law. While the taxpayers may not have had the right circumstances and documentation to support their claims, the preparer was held to be entitled to rely on the information she had been given by the taxpayers. In the Almonte case, the treatment of the losses on the taxpayers’ returns was improper on its face, since it relied on a statute and submission of a tax form that would not have applied even accepting the facts supplied to the preparer by the taxpayers.

The statute imposing tax return preparer penalties that was at issue in the first two cases, Tax Law former § 685(aa), expired and was deemed repealed on July 1, 2015. It was initially replaced by a new version that applied until April 12, 2019, and then by the current version, effective beginning April 12, 2019. The statute now provides for the imposition of penalties if the preparer takes a position that either understates the tax liability or increases a refund claim, and, similar to the language in the earlier version, knew or reasonably should have known that the position was not proper, and the position was not adequately disclosed on the return. Under these circumstances, the statute now imposes a penalty of between $100 and $1,000. However, if the position is due to the preparer’s “reckless or intentional disregard of the law, rules or regulations,” the statute imposes a penalty of between $500 and $5,000.