Care Must Be Taken With Closing Agreements in the Offshore Initiatives (4/13/13)

In Nance v. United States, 2013 U.S. Dist. LEXIS 52050 (WD TN 2013), here, the Nances (husband and wife), guided by an attorney who held himself out as an experienced tax attorney, undertook some "offshoring" of their assets with consequent tax underpayment and failures to file.  In the 1990s, they created two corporations in the Bahamas and a trust in Costa Rica.  They transferred assets to these entities.  In late 1999, the attorney advised them that these activities "may 'no longer' be valid from a tax standpoint."  He did not advise them, however, to liquidate the entities or take any other remedial action (such as form filings); still, the Nances ceased further deposits.

In 2003, the IRS contacted the Nances to invite them into an earlier version of a voluntary compliance initiative targeted to offshore financial accounts, called the Voluntary Compliance Initiative.  Under that initiative, the tax was required and penalties as follows:  (i) a civil fraud penalty for a major year and (ii) an accuracy related penalty for the other years.  The letter advised that (i) an FBAR penalty would be assessed for 1 year and (ii) other penalties, such as for failure to filed Form 3520 or 5471, would not be asserted if delinquent returns were filed.  The Nances, guided by new counsel, joined the program.  The communications between the IRS and the new counsel indicated some confusion as to whether the Nances would be required to filed the information forms.  Ultimately, the new counsel submitted, among other things, Forms 3520-A to the agent for the years 1997 through 2003.  Thereafter, on February 23, 2006, the Nances and the IRS entered a Closing Agreement for the years 1997 through 2002, in which they paid $1,245,396.52 in tax and $446,344.50 in penalties.  That closing agreement provided "[t]his agreement is final and conclusive except . . . if it relates to a tax period ending after the date of this agreement, it is subject to any law, enacted after the agreement date, that applies to that tax period."

On September 11, 2006, the IRS asserted a penalty of $156,478.00 based on the Nances' failure to filed Form 3520-A for 2003, a form that was due on March 15, 2004.  The Nances asked for waiver of the penalty.  The IRS denied the request.  This suit following that denial.

The odd thing is that the Form 3520-A for 2003 was in fact mailed to the agent in 2004, albeit after the date that it was due (April 15, 2004), at the agent's request.  It is unclear why the year 2003 was not included in the Closing Agreement.  Nonetheless, either I am missing something from the facts or the IRS seems to have asserted the 2003 penalty in bad faith, given the Nances' clear intent to enter the program and cooperate.  Apparently what had the Government perturbed was the fact that the Nances were notified in 2003 of their offshoring delinquences and invited into the program.  Yet, for some reason, with that full knowledge, they let the key April 15, 2004 date for filing the 2003 Form 3520-A pass without filling it, although they did later submit it to the agent.

The Government filed a motion to dismiss on the basis that the year 2003 was not part of the Closing Agreement and thus 2003 was a stand-apart year for which the IRS was entitled to assert the penalty.  The Court denied the motion, finding that the facts did not foreclose the defense of reasonable cause for late filing.  The Court's cryptic analysis is as follows:

When they received Letter 3679, Plaintiffs became aware of their obligation to make certain filings with the Service. As noted above, their subsequent counsel, Mr. Carney, met with revenue officer Cunningham in July 2004, four months after the Form 3520-A's March 2004 due date. According to the amended complaint, "Mr. Carney and Ms. Cunningham discussed the remaining returns and amended returns that would be required. Mr. Carney took notes from such meeting, noting that the Plaintiffs would need to file a Form 3520-A for the years 1997 through 2004 (stating that 2004 would be the final return)." (D.E. 20 ¶ 42.) Carney provided the form to Cunningham directly pursuant to her request in November 2004. 

"Reasonable cause may exist when a taxpayer files a return after the due date, but does so in reliance on an expert's erroneous advice." Estate of Liftin, 101 Fed. Cl. at 608. Reliance on the erroneous advice of an IRS officer or employee may also constitute reasonable cause. See McMahan, 114 F.3d at 369; Tesoriero v. Comm'r of Internal Revenue, No. 18959-10, 2012 WL 3964976, at *4 (U.S. Tax Ct., Sept. 11, 2012). Viewing the facts alleged in the light most favorable to the Plaintiffs, the Court finds they have stated a plausible claim that their failure to timely file the 2003 Form 3520-A was due to reasonable cause, based on Mr. Carney's communications with Ms. Cunningham.

My gut reaction,  like the judge's, is that there is more nuance here than meets that eye that just has to be developed by trial and not  on  motion for summary judgment.  Perhaps the judge is signaling the Government to lighten up and get this case resolved without a trial.

JAT Comments:

There are two valuable lessons here.

First, all potential issues should be resolved in these Closing Agreements.  It is unclear whether the Nances' attorney could have insisted on 2003's inclusion.  And,to be fair, it is not clear that the IRS would have included it if the Nances' attorney had requested that it be included.  From the IRS perspective, its offer was to settle past problems as of the date the Nances were notified and the Nances should have known at that time to diligently attend to future compliance.  Still, I think something is missing here.

Second, from the date the taxpayer decides to join one of the initiatives -- really from the date the taxpayer is aware of the initiative -- the taxpayer must diligently attend to all future filing requirements.

Finally, I should note that I have two recent postings on my Federal Tax Procedure Blog on reasonable cause for late filings that readers of this blog may be interested in.  They are:

1. Estate Did Not Have Reasonable Cause For Failure to Timely File Estate Tax Return (FTPB 4/11/13), here.
2. Estate Had Reasonable Cause for Failure to Timely File Estate Tax Return Based on Attorney's Advice (4/6/13), here (discussing Estate of Morton Liftin v. United States, 2013 U.S. Claims LEXIS 236 (Fed Cl. 2013), a later decision than cited by the Court above).