This opinion is subject to section 7463(b), which means the opinion may not be treated as precedent for any other case (even though this information is in the opinion, I will provide this disclosure going forward if applicable). This, however, does not diminish its usefulness. Private letter rulings, for example, may not be used as precedent either under section 6110(k)(3), however, many practitioners use them as guidance in analyzing particular fact and law scenarios.
There are three penalty sections at play in this case: 6651(a)(1), 6651(a)(2), and 6654(a). The taxpayer concedes she is liable for a deficiency for her 2003 and 2004 tax returns. But she contests penalties imposed under 6651(a)(1) & (2), and 6654(a).
Section 6651(a)(1) imposes a penalty for failure to file a tax return. Section 6651(a)(2) imposes a penalty for failure to pay tax shown on a tax return. And Section 6654(a) imposes a penalty for failure to pay estimated income tax. To overcome a section 6651(a) penalty the taxpayer must show the failure was due to reasonable cause and not due to willful neglect – see language in same section.
To overcome a section 6654(a) penalty, in addition to reasonable cause, the taxpayer must either be disabled, or 62 and retired – see section 6654(e)(3)(B) . For the section 6654(a) penalty there is also a provision under 6654(e)(3)(A) that gives the Secretary discretion to waive the penalty because of casualty or disaster, and under circumstances which would be against equity and good conscience.
The taxpayer, Ms. Humes, was experiencing emotional problems during the years at issue. The only evidence offered by Ms. Humes at trial regarding her illness was her own testimony. She testified that she stopped working in August 2004, was hospitalized the same month, and was one year in arrears on her mortgage payments. Her house was foreclosed on in 2005. The Tax Court acknowledges that there are circumstances in which a taxpayer's illness may constitute reasonable cause for all three penalties imposed here.
Section 6654(a) Penalties
The Tax Court disposes of the 2003 section 6654(a) penalty without any reference to Ms. Humes’s illness. Under 6654(c) & (d), estimated tax payments equal to 25% of the “required annual payment” are due in four equal installments. The required annual payment is the lesser of 90% of the current year’s tax, or 100% of the prior year’s tax. The 100% prior year tax clause does not apply in cases where the tax return was not filed in the prior year.
The IRS did not introduce any evidence that Ms. Humes failed to file her 2002 tax return. If she did file it, they did not introduce evidence of the 2002 tax shown on the return. Without any indication as to Ms. Humes’s 2002 tax return, the Court must apply the formula as written without exception. Consequently, under the 6654(d) formula Ms. Humes’s required annual payment for 2003 is $0.00 (100% of the prior year = $0.00; which is always going to be less than 90% of the current year’s tax). Either the IRS was not prepared for trial, or they did not understand the law.
Since the IRS was auditing both 2003 and 2004, there was ample evidence on the record that Ms. Humes was liable for 2004 estimated tax payments. Using the 6654(d) formula for the 2004 tax year, the 100% clause applies to the 2003 tax return admitted at trial. The Court, nonetheless, agrees with Ms. Humes that her illness met the definition of a disability under 6654(e)(3)(B)(i)(II) and abates the failure to pay estimated tax penalty.
Section 6651(a)(1) and (2) Penalties
The Tax Court sustains both penalties for 2004, but finds Ms. Humes established reasonable cause for 2003 and abates the penalties for that year.
In April 2004, Ms. Humes filed for an extension, thus the 2003 tax return’s due date was August 15, 2004. She testified at trial that her illness prevented her from working after August 2004 and that she was hospitalized in the same month. The Tax Court agrees this is enough to show reasonable cause under 6651(a)(1) for failure to file a tax return. Ms. Humes also testified that she was not able to manage her finances in 2004, she was one year in arrears on her mortgage payments, and the mortgage was foreclosed in 2005. The Court agrees here as well, Ms. Humes established reasonable cause for failure to pay the tax shown on her 2003 return.
Ms. Humes loses here because she failed to introduce evidence of her illness in 2005 and its impact on her ability to file her 2004 tax return and pay the tax shown on the return. In contrast to April 2004 where Ms. Humes at least filed for an extension, there is nothing in the opinion regarding her efforts to comply with the 2004 filing requirement in April 2005. She also provided no evidence regarding her ability to pay the tax shown on her 2004 tax return. Such evidence could include her income, assets, and liabilities in 2005.
It seems the Tax Court was more than willing to help Ms. Humes, but they were not going to make her case for her. Producing evidence at trial is critical. In this case both sides lost an issue simply because they failed to produce evidence.