Failure to Review Return Undermines Couple’s Penalty Defense

Bench Opinion by Judge Lewis R. Carluzzo

February 3, 2022

Candice L. Busch & Randall P. Busch v. Commissioner

THE COURT: The Court has decided to render oral findings of fact and opinion in this case and the following represents the Court's oral findings of fact and opinion (bench opinion). Section references made in this bench opinion are to the Internal Revenue Code of 1986, as amended, in effect for the relevant period, and Rule references are to the Tax Court Rules of Practice and Procedure. This bench opinion is made pursuant to the authority granted by section 7459(b) and Rule 152.

This proceeding for the redetermination of a deficiency is a small tax case subject to the provisions of section 7463 and Rules 170 through 174. Except as provided in Rule 152(c), this bench opinion shall not be cited as authority, and pursuant to section 7463(b) the decision entered in this case shall not be treated as precedent for any other case.

Candice L. Busch and Randall P. Busch appeared without counsel. Jody N. Swan appeared on behalf of respondent.

In a notice of deficiency dated November 9, 2020 (notice), respondent determined a deficiency in petitioners' 2017 Federal income tax and imposed a section 6662(a) accuracy-related penalty (penalty).

The deficiency and penalty determined in the notice result from an overstatement of a mortgage interest deduction claimed on petitioners' 2017 joint Federal income tax return (return). Candice Busch prepared the return using a popular version of return preparation software. According to petitioners, the program allows only for the entry of items of income and deduction in whole dollar amounts, that is, it does not allow for the entry of cents, or numbers to the right of the decimal point. Petitioners paid $21,201.25 of mortgage interest during 2017, and they are entitled to a mortgage interest deduction in that amount for that year. That being so, when Mrs. Busch entered $21,201.25, on the line for the deduction for mortgage interest, the deduction was shown as $2,120,125 instead. The overstated deduction is taken into account in the computation of petitioners' taxable income and Federal income tax, both shown as zero on the return, which in turn resulted in the refund of all of the Federal income tax withheld from both of their wage incomes over the course of 2017.

The correct amount of their mortgage interest deduction is taken into account in the computation of the deficiency shown in the notice. Petitioners now concede that deficiency. We are called upon to decide whether they should be held liable for the accuracy-related penalty imposed in the notice. According to petitioners, the overstatement was due to an "honest" mistake, and they should not be penalized for that mistake. According to respondent, imposition of the penalty is appropriate under the circumstances.

As relevant here, section 6662(a) imposes a penalty of 20% of the portion of an underpayment of tax attributable to the taxpayer's substantial understatement of income tax. Sec. 6662(a) and (b)(2). In this case the underpayment of tax, as defined in section 6664(a), is equal to and computed in the same manner as the deficiency, see sec. 6211, and that underpayment of tax is a substantial understatement of income tax because it exceeds the greater of $5,000 or 10% of the amount of tax required to have been shown on petitioners' 2017 return, see sec. 6662(d)(1)(A).

Respondent bears the burden of production with respect to the imposition of the penalty. See sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). Subject to exceptions not applicable here, section 6751(b)(1) provides that "no penalty shall be assessed unless the initial determination of the assessment is personally approved in writing by the immediate supervisor of the individual making the determination or such higher-level official as the Secretary may designate." In cases such as this one, respondent must show compliance with section 6751(b)(1) in order to satisfy his burden of production. Chai v. Commissioner, 851 F.3d 190, 221 (2d Cir. 2017), aff'g in part, rev'g in part T.C. Memo. 2015-42. If only be express stipulation, the evidence shows that respondent obtained the requisite supervisory approval for the penalty. Accordingly, respondent has met his burden of production with respect to the imposition of the penalty here in dispute. See secs. 6662(a) and (b)(2), 6751(b)(1), 7491(c).

The penalty will not apply, however, to any part of the underpayment of tax that resulted from the overstatement of the mortgage interest deduction if petitioners establish that they acted with reasonable cause and in good faith with respect to that portion. Sec. 6664(c)(1); See Higbee v. Commissioner, 116 T.C. at 449.

According to petitioners, they should not be liable for the penalty because the overstatement of their home mortgage interest deduction was due to a return preparation software feature or limitation that resulted in an unnoticed error made by Mrs. Busch after the amount of mortgage interest was entered in the program. According to petitioners, the penalty should not apply to any portion of the underpayment of tax. As they see, they had reasonable cause and acted in good faith with respect to the entire amount of the underpayment of tax that resulted from the mistaken entry. They ask the Court to recognize, as they point out that honest mistakes are sometimes made. As a general proposition of life, we agree with petitioners on the point, and we further agree with petitioners' suggestion that not every mistake made on a Federal income tax return should result in the imposition of an accuracy-related penalty. A person preparing a return might understandably get distracted while doing so and enter the wrong amount for an item, or if not distracted, when transferring numbers from one document to another, transpositions often occur. If a computer-based software program is being used in the process, the limitations and requirements of a software program might not be fully appreciated by the user. Any number of situations could cause an "honest" mistake to be made when amounts are incorrectly reported on a Federal income tax return. But petitioners' focus on the erroneous entry as the "mistake", and their explanation describing how the mistake occurred, misses the point. The mistaken entry is not the real problem. Their mistake was failing to review the return carefully enough to have recognized the erroneous entry before the return was filed. After all, it should go without saying, that a taxpayer's obligation to prepare and file a Federal income tax return includes the duty to review that return to ensure that the information reported or shown on the return is accurate before the return is filed.

The deduction for mortgage interest shown on the return occupies at least two additional columns to the left of any other number shown on the page of the return where the deduction is claimed. Looking up and down the columns showing other items reported on the return, the mortgage interest deduction sticks out, as the saying goes, "like a sore thumb". A careful review of the return after it was prepared would most certainly have caught the error; actually, even as little as a quick glance at the return probably would have done so.

At trial petitioners more or less acknowledge that they failed to carefully review the return before it was forwarded to the Internal Revenue Service. It was a mistake for petitioners not to review the return carefully, or as recollected by one of them, not to review it at all after it was prepared. Their failure to review the return carefully was a careless mistake that completely undermines their claim that they acted with reasonable cause and in good faith with respect to the underpayment of tax that, as it turned out, resulted from that failure.

It follows and we find that petitioners are liable for a section 6662(a) accuracy-related penalty for 2017.

To reflect the foregoing, decision will be entered for respondent. This concludes the Court's bench opinion in this case.

(Whereupon, at 10:15 a.m., the above-entitled matter was concluded.)