Burden of Proof - EA Credentials

[Snaggletooth]

This is an outgrowth of a previous thread, and a court case brought to our attention by Bees Knees.
If you wish to read the court case to verify for yourself I am not misrepresenting the facts, the link is:

http://www.ustaxcourt.gov/InOpHistoric/MillsMemo.TCM.WPD.pdf

In short, the Mills couple took an absurdly ridiculous position on their tax return, apparently prompted by their
tax preparer, who at one time was an EA. Tax returns based the position on a 15-yr. depreciable value of over
$5.2MM on the value of Mills service, as if it were a capital asset. A few years of this depreciation had already
transpired when the error was caught. Obviously, the govt rung up the cash register on this folly.

The burden of proof is "supposedly" on the IRS, however, if they want to collect the accuracy-related penalty.
We'll see how well this burden of proof actually turns out.

The Mills claimed they made a good faith reliance on their preparer, who held himself out to be an Enrolled Agent.
The facts about the preparer was that he was no longer an EA and in fact had subsequently been sent to prison
for embezzlement of investor funds.

The court denied the good faith claim of the Mills because:
1) There had been no effort to substantiate whether the preparer was an EA at the time of preparation.
2) There had been no effort to find out when the preparer actually qualified as an EA in the past.
3) There had been no effort to substantiate whether the preparer had competent credentials, even with or without
the EA designation.
4) Over a seven-year period, no effort was made to assure that the preparer had retained the EA even if he had
the EA at the beginning of the period.

I am currently an EA, by the grace of the IRS I suppose. I have the designation on my stationery and on every
signature. I don't have calling cards, but if I did they would have the EA initials after my name. Do I have a single
client that would question this? I don't think so. Do I have any clients that would even know how to research ANY
of the four expectations of the court as outlined above? I don't think so. Are these four failures something that
would have been done by any ordinary prudent man? I don't think so. And even if they had, would they continue
to do this every year for seven years? Get real.

The court opinion goes on to say that good faith reliance on a preparer is not, by itself, sufficient to absolve the
penalty, and given the ridiculous position I myself would hesistate to deny the penalty. However, this is a good
example of how the govt espouses "burden of proof". If a party doesn't really have it, they shouldn't pretend that
they do.

In your own mind, do you believe the court applied the "burden of proof" properly in setting forth conditions by
which the Mills were supposed to rely in good faith on EA credentials?

Thanks to all readers who have read this far into a lengthy post. A good writer would have known how to shorten it.

[Gary2]

I'm not a lawyer, but my guess is that "burden of proof" applies to evidence of facts, not the legal reasoning. In this case, I doubt the specific, objective facts were in dispute. I'm not sure how "state of mind" or "good faith belief" factor into the equation - are they conclusions of fact or of law?

I do recall cases where the court based the "good faith" in part on the education and background of the individuals, holding someone with a college degree to a higher standard than someone who perhaps barely graduated high school. And the amount probably factors into it as well; a $300K deduction calls for more due diligence than a $3K deduction.

It will be interesting to see if they appeal it.

Thanks to all readers who have read this far into a lengthy post. A good writer would have known how to shorten it.

Perhaps, but it's well-written and doesn't have any obvious redundancies, and a scant few phrases that could be omitted without damaging the content. I often edit posts to shrink them, but I wouldn't cut anything in yours unless there were a strict length limit somewhere.

Reading is a skill that most of us started acquiring by the time we were 6, and have been practicing for years. While poorly written, lengthy posts are tedious, I'm annoyed by the TLDR (too long, didn't read) attitude that the net has been encouraging.

[Snaggletooth]

Appeal is a mistake

Gary, thanks for the kind words. The position taken by the Mills was so far-fetched I don't think anyone in their right mind would recommend they appeal.

They might, however, have a chance (at least in my mind) to recover the portion attributable to the 20% penalty, if application of good faith reliance can be shown to a less onerous court. My entire point was how the burden of proof was supposed to be on the IRS but the court twisted it around such that the expectation to show good faith involved heroic measures that none of us laymen would think to be necessary. The IRS was deemed by the court to have somehow satisfied their burden of proof.

But as the court went further, good faith is not by itself sufficient. The accuracy-related penalty would probably have been assessed anyway because of the ridiculous position taken by the taxpayer.

[Burke]

But as the court went further, good faith is not by itself sufficient. The accuracy-related penalty would probably have been assessed anyway because of the ridiculous position taken by the taxpayer.

This is a very interesting thread, and while I agree with your reasoning on the good faith issue, I also agree with your last statement that the final outcome would probably have been the same on appeal. The wonderful effect of this position on their tax return and its resulting refund probably had a lot to do with their "blind faith" in a third party. They wanted to believe it. And were so happy that their preparer found this "loophole" that nobody else knew about. Everybody knows they are out there just waiting to be discovered.

[Golden Rocket]

Preparer really knew better

The preparer obviously had enough knowledge and intelligence at one time to pass the EA exam. So I don't think for a minute that setting up a fictitious depreciable capital asset was anything less than a deliberate attempt on his part to defraud the government. The other bonanza to be had was the shining image of a genius in the eyes of the client.

This guy was nothing better than a tax cheat. Although I disagree that the IRS really bore the burden of proof with respect to the accuracy penalty, the position taken was so outlandish that even the client should have known better. To me, this is a stronger reason for assessing the accuracy penalty than for the court to set up all those reasons why good faith was not observed.

Don't tell me the IRS has the burden of proof for disallowing good faith, and then tell me they satisfied this burden of proof by setting forth heroic conditions they would expect an ordinary man to do. But none of that changes the fact that the client tried to get away with illegitimate deductions.

[Bees Knees]

I think you might be reading too much into this “good faith” requirement. All the Court is saying is sometimes the too-good-to-be-true scenario goes too far, and the government isn’t going to let a taxpayer off the hook by claiming ignorance and relying on a pro. There has to be at least some effort to verify a ridiculous claim. In fact, when you read the case, you will see the taxpayer had doubts about the scheme. That is probably what tipped the scale in the Court’s mind as to why they felt the taxpayer did not rely “in good faith” on the advise of a pro. If the bad advise was something less ridiculous, under the same facts the Court probably would have ruled for the taxpayer.

[New York Enrolled Agent]

The burden of proof is "supposedly" on the IRS, however, if they want to collect the accuracy-related penalty.
We'll see how well this burden of proof actually turns out.

The court opinion goes on to say that good faith reliance on a preparer is not, by itself, sufficient to absolve the
penalty, and given the ridiculous position I myself would hesistate to deny the penalty. However, this is a good
example of how the govt espouses "burden of proof". If a party doesn't really have it, they shouldn't pretend that
they do.

In your own mind, do you believe the court applied the "burden of proof" properly in setting forth conditions by
which the Mills were supposed to rely in good faith on EA credentials?

Snags

I'm not sure you are interpreting the case correctly. In deficiency cases, the burden of proof is generally on the taxpayer to show the IRS proposed deficiency is incorrect. Under §7491(a) the burden can switch to be on the IRS if the taxpayer meets the conditions in that code section.

However, in the case of determining if the taxpayer should have a penalty imposed on them, the burden of proof is essentially split between the IRS and the taxpayer as per §7491(c). In penalty determinations, the IRS has only the burden of production. If the IRS can show sufficient evidence indicating that it is appropriate (basically not unreasonable) to impose the relevant penalty then the burden of production is met.

The taxpayer then must use the burden of persuasion to tell the Court why the penalty should not be imposed. Thus, the burden is now on the taxpayer to show there is reasonable cause or substantial authority or some other mitigating reason not to impose the penalty.

In the case you cite, the IRS met the burden of production. The taxpayer failed to meet the burden of persuasion. Is this making sense?

[Snaggletooth]

Overall Good Sense

NYEA, yes this makes sense all things considered, in particular I think the Mills' position was so aggrevious that they should not have been spared the penalty.

What I can't reconcile is the expectation of the court that the Mills should go to extreme measures just to establish their good faith in the preparer, and this is the only portion of the decision I question. The court suggests that the Mills would need to investigate the EA credentials of the preparer and I don't know whether the typical layman can do this outside of contacting the IRS who awards the EA designation. Also suggests that over a 7 year period the Mills should have an ongoing investigation of the preparers' credentials because at some point during this time the preparer lost his EA designation.

Losing the EA credentials either through inactivity or disbarment should require this preparer to remove the EA designation from his stationery, advertising, signage, etc. But if he doesn't do so, this shouldn't be the fault of the innocent public. In economics, we often use the term "Caveat Emptor" (Buyer Beware!) but common law also goes to great lengths to protect the holder-of-due-course for commercial paper.

Failure to meet these extreme expectations of the court should not (by itself) have switched the burden of proof from the IRS to the taxpayer with respect to good faith reliance. However, if we alternatively find that the position was so absurd that good faith reliance should not have occurred then I would have no disagreement with that.

Thank you for your response and usual keen insight - Snag

[Bees Knees]

The court suggests that the Mills would need to investigate the EA credentials of the preparer and I don't know whether the typical layman can do this outside of contacting the IRS who awards the EA designation. Also suggests that over a 7 year period the Mills should have an ongoing investigation of the preparers' credentials because at some point during this time the preparer lost his EA designation.

The Court did mention those things, but that in itself is not the reason why the Mills lost their case to abate the penalty. The ridiculous stand taken obviously was a key factor in this case.

In another recent case, the taxpayer did have the penalty abated for relying on the pro, even though the pro embezzled funds and failed to report those funds as income on the return. In that case there was no reason for the taxpayer to question the pros qualifications. The pro didn't take a ridiculous tax deduction on the return to cause the underpayment. It was merely theft by the pro. The Court never said the taxpayer needed to investigate the pro's qualifications or current professional standing because under the facts, there was no reason to question the pro's qualifications.

http://www.ustaxcourt.gov/InOpHistoric/THOMASMemo.TCM.WPD.pdf

[taxea]

The preparer obviously had enough knowledge and intelligence at one time to pass the EA exam. So I don't think for a minute that setting up a fictitious depreciable capital asset was anything less than a deliberate attempt on his part to defraud the government. The other bonanza to be had was the shining image of a genius in the eyes of the client.

This guy was nothing better than a tax cheat. Although I disagree that the IRS really bore the burden of proof with respect to the accuracy penalty, the position taken was so outlandish that even the client should have known better. To me, this is a stronger reason for assessing the accuracy penalty than for the court to set up all those reasons why good faith was not observed.

Don't tell me the IRS has the burden of proof for disallowing good faith, and then tell me they satisfied this burden of proof by setting forth heroic conditions they would expect an ordinary man to do. But none of that changes the fact that the client tried to get away with illegitimate deductions.

With one exception. IRS employees get an EA license when they retire. The ones that qualify for EA don't have to take or pass the EA test. Of these employees, many have never done returns and don't know the current rules. My brother retired from the IRS, got an EA designation and calls me whenever he has a question on other than corp returns because he was a corp. auditor while at the IRS. Once has to dig deeper than just make sure the preparer is an EA. One should also know how the pro got the EA.

[Gary2]

Of course, there are plenty of EAs who achieved the credential by being good at test taking without being good at interviewing clients, completing complex forms, or doing tax research.

I wonder what percentage of EAs routinely do C-corp returns? I'm sure some do, but my guess is that it's a small percentage.

[New York Enrolled Agent]

What I can't reconcile is the expectation of the court that the Mills should go to extreme measures just to establish their good faith in the preparer, and this is the only portion of the decision I question. The court suggests that the Mills would need to investigate the EA credentials of the preparer and I don't know whether the typical layman can do this outside of contacting the IRS who awards the EA designation. Also suggests that over a 7 year period the Mills should have an ongoing investigation of the preparers' credentials because at some point during this time the preparer lost his EA designation.

Snags

I want to make you feel better - This wasn't just because it was an EA - the Tax Court looks at this taxpayer defense of reliance on a professional with a good deal of scrunity.

In a case called Mediaworks (you can read it on the Tax Court site) the taxpayer had a certified public accountant (his name was Jung) prepare his returns for many years. But when it came to the accuracy relate penalty in §6662, this is what Judge David Laro wrote (underlines added, citations omitted):

[start] Petitioner argues that it may escape the accuracy-related penalties in that, it claims, it relied reasonably upon Jung to prepare its Federal income tax returns correctly. We disagree with petitioner's assertion that it relied reasonably upon Jung to prepare its tax returns correctly. While it is true that the reliance on the advice of a professional as to the tax treatment of an item may sometimes be enough to escape the imposition of a section 6662(a) accuracy-related penalty,... the mere fact that a taxpayer such as petitioner claims to have relied upon a professional is not enough to fall within this defense. A taxpayer such as petitioner seeking to avail itself of this defense must prove by a preponderance of evidence: (1) The professional was a competent tax adviser who had sufficient expertise to justify reliance; (2) the taxpayer provided necessary and accurate information to the adviser; and (3) the taxpayer actually relied in good faith on the adviser's judgment. ... (the reasonable reliance defense requires that the taxpayer establish the professional qualifications of a purported expert and the nature of the advice that was purportedly given).

On the basis of the credible evidence in the record, we are unable to conclude that any of these three requirements has been met. First, the mere fact that Jung is a certified public accountant does not necessarily make him a competent tax adviser. While petitioner at trial focused his examination of Jung's qualifications on establishing that he is in fact a certified public accountant, petitioner made a feeble attempt to ferret out the professional qualifications of Jung as to tax matters. ... [end]

You can see - the burden of persuasion is clearly on the taxpayer.

[Burke]

With one exception. IRS employees get an EA license when they retire. The ones that qualify for EA don't have to take or pass the EA test. Of these employees, many have never done returns and don't know the current rules. My brother retired from the IRS, got an EA designation and calls me whenever he has a question on other than corp returns because he was a corp. auditor while at the IRS. Once has to dig deeper than just make sure the preparer is an EA. One should also know how the pro got the EA.

Wow. That IS interesting.