As April 15th rolls around, most CPAs with high net worth clients file automatic extension requests (Form 4868) on behalf of those clients as a matter of course. Oftentimes these clients have investments in partnerships and other entities that do not issue necessary forms until after the April 15th deadline. These clients understand that their CPAs will file for an extension every year, and there is usually no need for the client to sign anything in connection with the extension. While the IRS’s electronic filing program has made filing these extensions as easy as pushing a button, sometimes those extensions get lost. When that happens, the client can be on the hook for failure to file penalties – up to 25% of the taxes owed. Surprisingly, in these situations, the client is not entitled to an abatement of the penalties, even though the client relied on his or her accountant to file the extension using the appropriate tax software. While this result seems to fly in the face of the plain language of the applicable Treasury Regulations, a 1985 Supreme Court decision (U.S. v. Boyle) has made it very difficult for clients to avoid penalties when relying on their accountants to file (electronically or otherwise) necessary tax forms.
Under the Internal Revenue Code, failure to file penalties will not be imposed if the late filing is due to “reasonable cause.” A taxpayer has reasonable cause for failing to timely file a return if “the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time.” One would think that relying on a tax-expert, such as a CPA, to file an automatic extension request (electronically or otherwise) is exercising ordinary business care and prudence. In fact, in nearly all circumstances, CPAs are far better equipped to file such forms than the taxpayers themselves. However, the 1985 Supreme Court Boyle ruling established a bright-line rule that the filing of returns is a “non-delegable” duty, thus a taxpayer does not have “reasonable cause” for the late-filing of a return if the taxpayer relied on an accountant to file the return and the accountant failed to do so in a timely manner. 469 U.S. 241 (1985). In 1997, the Second Circuit extended the bright-line rule to the filing of automatic extension requests. McMahan v. Comm’r, 114 F. 3d 336, 369-370 (2d. Cir. 1997). The McMahan court ruled that a taxpayer does not exercise ordinary business care and prudence in relying on his CPA to file extensions. To hold otherwise, the court observed, “would render ineffective the bright-line rule of U. S. v. Boyle, and thereby unduly burden the administration of our self-reporting tax system.”
Since the Boyle decision, there have been significant technological changes in the manner in which returns are prepared and filed. In Boyle, the taxpayer provided all necessary information for filing an estate tax return to his attorney, and was assured that the return would be filed on time. The Supreme Court held that relying on an adviser to file a return (as opposed to preparing a return) did not satisfy the “reasonable cause” exception because “it requires no special training or effort to ascertain a deadline and make sure that it is met.” Certainly taxpayers today are aware of the April 15th, deadline. But is it as easy today to file extension requests as it was when the Supreme Court decided Boyle? We would argue that it is not.
While extension requests can be filed either in paper or electronically, typically the requests are generated by tax software in the hands of the CPA, and filed electronically through that same software. The complexity of our tax system has made many high net worth taxpayers dependent on tax software to calculate their liability. More often than not, such software is used by CPAs to electronically file extension requests and returns for their clients. In an era requiring the use of specialized tax software and electronic filing, the Supreme Court’s decree in Boyle that the obligation to timely file returns is “non-delegable” should no longer apply where that very obligation MUST be delegated in order to be met.
Notwithstanding these new challenges, taxpayers have not been successful in convincing the courts or the IRS to deviate from the bright-line rule established in Boyle. Accordingly, if anyone other than the taxpayer is charged with filing a tax form and that form is filed late, in most cases the taxpayer cannot be excused from penalties on the basis of reasonable cause. While we think the Boyle bright-line rule should be redefined to take into account certain limitations associated with tax software and e-filing, it is unlikely that the IRS will change its application of the rule until the Supreme Court revisits this issue.
Despite the cloud Boyle casts over the use of the reasonable cause defense for a failure to file penalty, a little known “silver lining” exists that taxpayers (and their CPAs) can use to avoid failure to file or failure to pay penalties. The silver lining to the Boyle cloud is the IRS’s poorly publicized First Time Abatement Program.
The First Time Abatement program (“FTA”) allows taxpayers to obtain an administrative waiver of failure to file or failure to pay penalties if the taxpayer has a clean compliance history. Many taxpayers and practitioners are unaware of this program; therefore these administrative waivers are issued far less often than they are otherwise available. A client qualifies for the FTA if the client is currently compliant with all payment and filing requirements and has a clean penalty history for the three prior years. Taxpayers can seek a waiver under the FTA while also requesting abatement based on the reasonable cause exception. Requests for an FTA waiver of penalty can be made over the phone or through a written request to the IRS (and in some instances, the IRS may require a written submission). If the client is under audit, the request must be made directly through the compliance function. In any event, a taxpayer who seeks abatement under the FTA program will not be able to obtain this administrative waiver in future years, thus it is always preferable to obtain abatement on reasonable cause grounds.