The taxpayers received income, and distributions, from a partnership but never received a K-1. Because they did not receive the K-1, they did not report the income on their 2005 tax return. The Tax Court holds that nonreceipt of the K-1 is not a defense to the 20% accuracy-related penalty; the taxpayers have an obligation to make a good faith attempt to obtain the K-1.
This case follows a general theme from the past few days; pass-through entities can be traps for the unwary. For comparison with the holding in this case, see Jones v. Commissioner (posted here), where the taxpayers also did not receive a K-1, and they made no reasonable attempt to obtain one. Consequently, the Tax Court assessed an accuracy-related penalty.
It also came out at trial that the taxpayers provided their CPA a K-1 from the partnership in 2004 with a small amount of income. (3 fn.4). Although under no obligation under the tax code, as a matter of best practice, practitioners should make an inquiry when information provided in year 1 is missing or incomplete in year 2. Suppose, for example, in year 1 the taxpayer provided a W-2 from XYZ, Inc., but in year 2 the taxpayer did not provide a W-2 from XYZ. A practitioner should ask whether the taxpayer changed jobs, or if the W-2 is missing.
This point is even more important when you know the taxpayer has a p'ship interest. The taxpayer should receive a K-1 every year until she disposes of the interest, which is itself a taxable event that has significant implications. As applied to the Ziegelers, I do not know whether their CPA made such an inquiry, but if she had, it might have saved the Ziegelers significant time and money. Moreover, the new AICPA Statement on Standards for Tax Services, effective Jan. 1, 2010, state that practitioners should make use of prior year returns to "avoid the omission of items" on the current year return. Tax Executive Committee, Statement on Standards for Tax Services 17 (2009).
Respondent determined a $25,123 deficiency in petitioners’ 2005 Federal income tax and a $5,025 accuracy-related penalty under section 6662(a). Petitioners concede liability for the $25,123 deficiency. The issue remaining for decision is whether petitioners are liable for the section 6662(a) accuracy-related penalty. (2).
Randi Bach (Ms. Bach), a certified public accountant (C.P.A.), prepared petitioners’ 2005 Federal income tax return.
Petitioner did not provide Ms. Bach with a Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., from HealthFirst or any additional information that would have enabled her to calculate his income from HealthFirst. (3).
In order to prevail on this issue, the taxpayer must prove by a preponderance of the evidence that the taxpayer meets each requirement of the following three-prong test: (1) The adviser was a competent professional who had sufficient expertise to justify reliance; (2) the taxpayer provided all necessary and accurate information to the adviser; and (3) the taxpayer actually relied in good faith on the adviser’s judgment. Neonatology Associates, P.A. v. Commissioner, supra at 98-99. The ultimate responsibility for a correct return lies with the taxpayer, who must furnish the necessary information to the agent who prepares the return. ASAT, Inc. v. Commissioner, 108 T.C. 147, 176 (1997). (6).
Petitioners have failed to meet their burden of proving that they acted with reasonable cause and in good faith. Though petitioners never received a Schedule K-1, they never requested one, nor did they make any attempt to calculate and report the income from HealthFirst. (7).
Petitioners’ contention that nonreceipt of a Schedule K-1 constitutes reasonable cause is mistaken. See Deas v. Commissioner, T.C. Memo. 2000-204 (nonreceipt of Schedule K-1 did not constitute reasonable cause where taxpayer failed to report partnership income). (7).
Also, the fact that a C.P.A. prepared petitioners’ tax return does not establish good faith reliance on an independent, competent professional in this case. Petitioners did not provide Ms. Bach with necessary and accurate information for her to correctly determine petitioner’s income. (7)
Ms. Bach credibly testified that had petitioner informed her of the income from HealthFirst, she would have reported it. Ms. Bach was not required to perform an audit of petitioner’s books and records. (8).