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Abatement of Chapter 42 First Tier Taxes due to Reasonable Cause

Issue Title:

Abatement of Chapter 42 First Tier Taxes due to Reasonable Cause

Description:

For any qualified first tier taxes to be abated, credited or refunded under IRC Section 4962, it must be established that:

  • A taxable event  was due to reasonable cause and not to willful neglect, and
  • Such event was corrected within the correction period.

The interest associated will also be abated, credited or refunded.

The term “qualified first tier tax” means any tax imposed by subsection (a) of Sections 4942, 4943, 4944, 4945, 4955, 4958, 4966, or 4967.  The term does not include the initial tax on self-dealing imposed by Section 4941(a).

IRC Section and Treas. Regulations:

IRC Section:

IRC Section 4962 Abatement of First Tier Taxes in Certain Cases

Treas. Regulation:

Although there are no Treasury Regulations under Section 4962, the Regulations under certain Chapter 42 excise tax provisions define “reasonable cause” with respect to the first-tier tax imposed on the management:

Treas. Reg. Section 53.4944-1(b)(2)(iii), Initial Taxes (Jeopardizing Investments)

Treas. Reg. Section 53.4945-1(a)(2)(v), Taxes on Taxable Expenditures

Additionally, the below regulation, which addresses failure to file returns or pay tax, also defines “reasonable cause”:

Treas. Reg. Section 301.6651–1, Failure to file tax return or to pay tax

Resources (Court Cases, Chief Counsel Advice, Revenue Rulings, Internal Resources):

Legislative History:

H.R. Rep. No. 432 (Pt. 2), 98th Cong., 2d Sess. 1472 (1984), and S. Rep. No. 169 (Vol. 1), 98th Cong., 2d Sess. 591 (1984), provide that where the foundation or foundation manager can establish that there was reasonable cause for such a violation and that there was no willful neglect of the rules, the IRS has discretionary authority to relieve the foundation or manager from the first-tier penalty tax, provided that the violation is corrected in the manner required in order to avoid liability for second-tier taxes. A violation which was merely due to ignorance of the law cannot qualify for such abatement.

Court Cases:

United States v. Boyle, 469 U.S. 241 n.3 (1985), To show reasonable cause, the taxpayer must "demonstrate that he exercised 'ordinary business care and prudence.'" Boyle, 469 U.S. at 246 (quoting Treas. Reg. Section  301.6651-1(c)(1)). The failure to make a timely filing of a tax return is not excused by the taxpayer's reliance on an agent, and such reliance is not "reasonable cause" for a late filing. It requires no special training or effort on the taxpayer's part to ascertain a deadline and ensure that it is met. That the attorney was expected to attend to the matter does not relieve the principal of his duty to meet the deadline. Additionally, the court stated, "This case is not one in which a taxpayer has relied on the erroneous advice of counsel concerning a question of law. Courts have frequently held that ‘reasonable cause’ is established when a taxpayer shows that he reasonably relied on the advice of an accountant or attorney that it was unnecessary to file a return, even when such advice turned out to have been mistaken."

In Woodsum v. Commissioner, 136 T.C. 585 (2011), the court determined that there was no reasonable cause for the failure to report $3.4 million in income when the taxpayer had provided its tax preparer with all of the information for it to know that the taxpayer had earned that income. The court said that a determination of whether a taxpayer acted with reasonable cause and in good faith depends on the pertinent facts and circumstances, including his efforts to assess his proper tax liability, his knowledge and experience, and the extent to which he relied on the advice of a tax professional. The court noted that the tax preparer’s failure to report the income on the return does not constitute professional advice on which the taxpayer could rely for not reporting the income. Woodsum presented no evidence to show that the income was omitted because of any “analysis or conclusion” or “judgment” that the income was not taxable rather than a clerical error. Therefore, the defense of reliance on professional advice was not available to Woodsum.

In Thorne v. Commissioner, 99 T.C. 67 (1992), the Court found that the taxpayer made numerous grants to organizations that were not tax-exempt, that he did not exercise expenditure responsibility under Section 4945(h) over grants made, and that he made grants to friends and relatives for personal purposes. Further, the petitioner agreed to the making of the expenditures, knowing that they were taxable expenditures. The Petitioner failed to exercise his responsibility with ordinary business care and prudence  and acted without reasonable cause. The court further found that the violations were both knowing and willful. The Court dismissed petitioner’s argument that he had acted according to advice given to him by his tax advisor, stating that section 53.4945-1(a)(2)(vi) requires that any legal advice be in the form of a “reasoned written legal opinion”, and observing that the advice petitioner had received from his tax advisor was primarily oral.

In de Belaieff v. Commissioner, 15 T.C.M. (CCH) 1426 (1956), the court held that ignorance of the law does not constitute reasonable cause. The taxpayer had shown that failure to file returns was not due to willful neglect, but was instead due to ignorance of the law. The taxpayer received advice from her attorneys regarding the tax treatment of income items, which at the time of the advice, was correct. Subsequently, for the years at issue, there was a change in the law and taxpayer continued to treat the items as nontaxable, even though they were now taxable. The court found that even though taxpayer had legal representation, the failure by the attorneys to provide advice and the failure by the taxpayer to seek advice, did not constitute reasonable cause.

IRS Tech. Adv. Mem. 2015-47-007 (Sept. 5, 2014), here, there was no contention that the Trust's failure was due to willful neglect or that the Trust had not corrected within the applicable correction period. It is not enough to show that the mistake was merely not due to willful neglect, the Trust must also show that it was due to reasonable cause. Reasonable cause is not defined in Section 4962. The Supreme Court, however, noted that to show reasonable cause, the Trust must demonstrate that it acted with ‘ordinary business care and prudence. The IRS denied relief because the trust failed to establish ordinary business care and prudence. While Trustees lacked knowledge of the expenditure responsibility requirements, ignorance of the law did not justify abatement. Not only could the Trust not be said to have relied upon the written advice of a lawyer or CPA that it had no expenditure responsibilities but the Trust could not rely on the lack of advice to perform certain acts as advice that such acts were not necessary. Technical Advice Memoranda may not be used or cited as precedent. See Section 6110(k)(3).

1992 EO CPE Text Abatement and Waivers
Provisions for abatement of tax or waiver of a requirement are "safety valves". They ameliorate problems that mechanical application of the laws can cause. Major provisions that apply to exempt organizations include IRC Section 4962, IRC Section 4961, Reg. Section 301.7611-1 A-14, and Reg. Section 1.9100-1.

IRM 4.76.4.5 Abatement of Excise Taxes
Abatement of excise taxes sets forth the guidelines for abatement of taxes and the procedures to be followed.

Analysis: 

Background:

Section 4962 does not define “reasonable cause.” There are guides, however, in the regulations and in many court cases that have considered whether particular circumstances amounted to reasonable cause.

Treas. Reg. Section 53.4944-1 and Section 53.4945-1 which provide rules for jeopardizing investments and taxable expenditures respectively state that a foundation manager's actions are due to reasonable cause if he has exercised his responsibility on behalf of the foundation with ordinary business care and prudence.

Treas. Reg. Section 301.6651-1(c), which provides rules for imposition of additional taxes and penalties for failure to file tax returns or pay tax, applies a standard of ‘ordinary business care and prudence.’ A failure to pay tax will be considered to be due to reasonable cause to the extent the taxpayer satisfactorily shows that he or she exercised ordinary business care and prudence in providing for the payment of the tax liability, but was either unable to pay or would have suffered an undue hardship if the liability had been paid on the due date.

Under Treas. Reg. Section 301.6651-1(c) and other provisions that impose a reasonable cause standard, determining whether reasonable cause was shown requires consideration of all the facts and circumstances.

Issue:

Does the organization have reasonable cause for abatement of the first tier excise tax pursuant to IRC Section 4962?

Analysis:

Generally, the determination of whether a taxpayer’s actions were due to reasonable cause and in good faith is made on a case-by-case basis. To show reasonable cause, the taxpayer must demonstrate that he exercised 'ordinary business care and prudence. The determination of whether a taxpayer acted with reasonable cause and in good faith depends on the pertinent facts and circumstances, including efforts to assess his proper tax liability, his knowledge and experience, and the extent to which he relied on the advice of a tax professional. Courts have frequently held that ‘reasonable cause’ is established when a taxpayer shows that he reasonably relied on the advice of an accountant or attorney that it was unnecessary to file a return, even when such advice turned out to have been mistaken. However, if no evidence to support the “analysis or conclusion” is shown, the defense of reliance on professional advice may not be available. Similarly, if the taxpayer’s legal representation failed to provide advice and the taxpayer failed to seek advice, this ignorance of the law does not constitute reasonable cause.

Issue Indicators or Audit Tips: Indicators of Reasonable Cause:

  • Did taxpayer rely in good faith, on the written advice of an attorney or accountant (dated prior to the transaction) that the transaction was not subject to Chapter 42 excise taxes?
  • Did taxpayer provide documentation showing that its reliance on advice of counsel was reasonable?
  • Did taxpayer provide documentation showing they secured information about the expertise of the counsel?
  • Did taxpayer provide evidence showing they provided necessary and accurate information to counsel in order for them to give organization proper advice about the tax matter?

Audit tips – the following are situations that would not support reasonable cause:

  • The foundation's officers, directors, and representatives state they were ignorant of the law;
  • The foundation's Form 990-PF for the tax period involved was prepared by a paid attorney, accountant, or enrolled agent, but gave no notice that a specifically identified questionable transaction occurred;
  • The foundation, a related foundation, or a predecessor foundation has had a previous tax amount abated under Section 4962 for the same type of taxable event; or
  • The transaction was not identified as a potential violation of Chapter 42 provisions by any party involved until the examination began and the costs of an examination were incurred, unless the foundation relied, in good faith, on the written advice, dated before the transaction, of an attorney or accountant.

Remember to consider the specific facts and circumstances of your case when analyzing reasonable cause.

Page Last Reviewed or Updated: 29-Aug-2016