Originally published on Forbes.com.

I think it is a good thing that people tend to be loyal to their tax preparers.  Reilly’s Second Law Of Tax Practice, as modified for family audiences, is ” When the prospect tells you his last two accountants were jerks, it won’t be long before you are the next jerk.” Like anything else, that loyalty can be excessive.  That is one of the lessons in a recent Tax Court decision Carolyn F. Whitsett v CIR.  You will have to read on or skip to the end for the other lesson.

A Name Has Been Changed

The tax preparer is named in the case, but I feel bad for the fellow, so I will just refer to him as James, my mythical friend whose public accounting career is something of a parody of my own.  You can’t rule out that there is something off about the Tax Court’s narrative, which makes old James out to be pretty inept. Dr. Whitsett, on the other hand, is viewed quite favorably by the Tax Court and, accepting the Tax Court narrative, it seems really odd that the IRS was litigating about the accuracy penalty in her case.

It Starts With Good News

Carolyn Whitsett’s tax nightmare began with good news.  A physician specializing in blood transfusion, she and/or her ex-husband had the foresight to buy 4,000 shares of a company called Immucor in 1982 for $11,000.  In 2011 TPG Capital agreed to purchase Immucor for nearly $2 billion, which worked out to $27 per share, a premium of about a third of what the stock had been trading at.  Dr. Whitsett’s 4,000 shares had become 63,594 shares, “thanks to stock splits, among other things,” making her share $1,717,038.  In August, she told James that she would be accepting the TPG offer.  That’s a good client, one who tells you about transactions before they are cast in concrete.

James Starts To Lose It

TPG, either out of consideration for the sellers or for its own purposes, structured the deal to push the realization event into 2012.  There was however some ambiguity in the documentation:

In January 2012 TPG’s agent, Computershare Trust Co. (Computershare), sent petitioner a check, dated January 4, 2012, for $1,717,038 (63,594 shares x $27 per share). This check was accompanied by a document captioned “Corporate Action Advice” that showed the “payment date” as August 19, 2011, and the “tax year” as 2012. Computershare also enclosed a letter dated January 9, 2012, stating that petitioner’s stock redemption was “processed” as of January 4, 2012.

Somehow James took that to be a 2011 transaction.  To be fair, we can’t rule out that it might have been better for some reason for Dr. Whitsett to recognize the gain in 2011.  The time value of money, a huge concern in tax planning back in the day, has become pretty negligible.  Arguably, the transaction could be viewed as an installment sale.  I’d have to do more research than I care to in order to determine if that position would stand up, but I would probably have went with it if it was better for Dr. Whitsett to take the gain in 2011.  By putting the return on extension, you could know a lot about how 2012 worked out for her by the time you actually had to commit on whether to report the gain in 2011 or 2012.

James made another error.  He computed the basis in the stock to be $639,437 based on the notion that there had been reinvested dividends.  Apparently there had not been, so the only basis was the $11,000 paid for the original 4,000 shares. Oddly enough, this mistake probably would have gone undetected but for the other mistakes.  That is the type of error that as somebody who works for the taxpayer, I find less than tragic.

It Gets Worse

Per the instructions of James, Dr. Whittsett sent in $154,776 with the extension for her 2011 return.  Somehow, the extended due date passed by.  In February 2013, Dr. Whitsett got a copy of her 2011 return along with a 1040-V to send in the balance due of $5,393.  James told her that the return had been filed electronically.  When the 2012 return came around, James decided that he did not have to do anything about the $1,717,038 1099-B, since, as far as he was concerned, the gain had been reported on the 2011 return.  This was the most damaging error he could have made and, from a practical viewpoint, the probable root cause of a lot of Dr. Whitsett’s problems.

Most tax preparers I know will tie themselves in knots to avoid a document mismatch.  Although, given the idea that the gain had been reported in 2011, there should not have been a gain on the 2012 return, that $1,717,038 should have appeared somewhere on the 2012 return to pay homage to the computer, since more than likely no human being would otherwise ever have looked at the return. I asked my covivant what she thought the best course was.  CV is also my business partner and a much better 1040 preparer than I.  First she would have tried to get a corrected 1099-B, but failing that there is Column g on Schedule D, that allows one to make adjustments.  Would have been a big adjustment, but it is way better than doing nothing with the 1099-B.

As it turned out, at least as far as the IRS was concerned, the gain had not been reported in 2011, because no return had been filed for 2011.

In December 2013 Dr. Whittsett received a notice from the IRS indicating that they had $165,562 on her account, but no return.

This is where it gets really weird.  She brought the notice to James and asked whether she should file the 2011 return so that they would process something.  James told her there was no need as he had filed it electronically.  At trial, he was not able to produce any evidence that the return had filed electronically.

The Straw That Broke The Camel’s Back

The 2012 chickens came home to roost at the end of 2014:

On October 27, 2014, the IRS sent petitioner a CP2000 notice for her 2012 taxable year. That notice, triggered by Computershare’s Form 1099-B reporting $1,717,038 in gross proceeds from the Immucor stock sale, informed petitioner that she had a balance due of $680,086 for 2012.

Dr. Whitsett’s faith in James remained unshaken.  She gave him a power of attorney.  In a couple of email exchanges, James indicated that he would have to prepare paper amended returns, which never happened.  Things moved quickly from there.

After receiving no response to the CP2000 notice, the IRS issued petitioner a notice of deficiency for 2012 determining a deficiency of $541,552 and an accuracy-related penalty under section 6662(a) of $107,995, attributable chiefly to the unreported proceeds from the Immucor stock sale.  After receiving this notice of deficiency petitioner realized that something had gone seriously wrong. She sought new assistance and ultimately hired counsel to represent her.

What Was Left For The Tax Court?

The new advisors quickly cleaned things up, filing 2011 as a protective refund claim just in the nick of time, applying the refund to 2012 and getting the basis right.  The only thing left for the Tax Court was the 20% accuracy penalty on the 2012 return.  The IRS should really have just given that up, but they can be pretty stubborn about the accuracy penalty.  The Tax Court went strongly with Dr. Whittsett on the penalty.

Although petitioner is a highly educated person and a skilled physician, she had no knowledge of Federal income taxation. She had tendered her stock to Immucor for redemption in December 2011. Although the documents she received in January 2012 said that her redemption was “processed” on January 4 and that the “tax year” was 2012, they also stated that the “payment date” was August 19, 2011. As a lay person unfamiliar with tax law, stock redemptions, and corporate reorganizations, petitioner understandably found this documentation confusing and reasonably referred this question to her longtime tax return preparer.

Given the time value of money, it would obviously have been in petitioner’s economic interest to report her million-dollar gain on a 2012 return rather than on a 2011 return. We think that she displayed admirable “business care and prudence” by referring this question to ______________ and accepting his advice to report the gain for 2011, rather than deciding unilaterally what would be best for her pocketbook.

Comment on the penalty as it related to basis overstatement was similar.

Respondent contends that _________basis computation for the Immucor stock, $639,437, was so far from what petitioner now concedes to be the correct number, $11,000, that she could not have relied in good faith on his estimate. Again we disagree. The original 4,000 shares had been purchased in 1982; she had acquired them from her ex-husband in 1998; and they had mushroomed to 63,594 shares because of stock splits and (________ erroneously told her) reinvested dividends. Petitioner did not have records going back 30 years, and she had no knowledge of how “basis” in corporate stock should be computed under these circumstances. She reasonably left this determination to her tax adviser and reasonably relied on his advice.

About Electronic Filing

Back in the good old days, preparers prepared and taxpayers filed.  The taxpayer mailed their tax returns to the IRS (certified return receipt if they were diligent).  When electronic filing came in, I was not enthusiastic, and unlike some of the youngsters, did not encourage my clients to do it in the first couple of years.  I finally came around fully a couple of years ago, even filing my own return electronically.

This case caused me to wonder how I know that electronically filed returns have actually been filed.  If it seems to you like I should have already known that, you are right.  I can only say that my lofty status in the larger firms I was working in as this stuff evolved insulated me from familiarity with very basic stuff.  In my current minute firm, CV takes care of those details.  So in a manner similar to asking her where an obscure piece of crockery is stored (i.e. one that is not used daily), I asked her how I knew that my tax return had actually been filed, since I didn’t take it to the post office, etc.

CV showed me an email indicating that the return had been accepted.  It was]from our software company.  I’m way too cynical to trust those bastards[ so I needed more.  It was not that hard to find the right site.  It is Get Transcript on irs.gov. It is a pretty tedious process to register for an account, but if you get ahold of somebody’s phone and wallet, you will find that it is not that hard. There is a two-step confirmation process involving both a text message and an e-mail and you have to give them digits from a credit card or similar account.  Once you have gone through the procedure you can see that your returns that somebody told you were electronically filed were actually filed. You can even compare key figures.  Of course you now have one more username and password to keep track of, but so it goes.  You can also order transcripts by mail, but I did not test that option.

On Your Longtime Tax Preparer

The loyalty of clients to their tax preparers and visa versa is a thing of beauty.  It is one of the reasons that accounting practices have significant goodwill values and it can be very service-full as someone is familiar with your long-ago transactions that can become relevant.  There is this downside though that I hate to admit. Clients and their advisers grow old together. Tax preparation is clean work with no heavy lifting and not at all physically dangerous, so you can keep doing it well into old age.  There comes a point though where your mental sharpness and impatience with change can start to disqualify you.  I’m thinking that might have been the problem with old James.

Of course, if your old buddy accountant who has been doing your work for thirty years is part of a good-sized firm, you can be pretty sure he is not actually doing the work himself and you might be able to rest easy, unless it is somebody in Mumbai or Bangalore that really handles things. On the other hand, if your affairs are somewhat complex and you are using the same sole practitioner with no staff that you have had for decades, reflect on how much sharper and charged up you were twenty years ago and how you are now.  Likely your preparer has made a similar shift.  I’ll leave it at that.

Other Coverage

The only other coverage I found of the case was on Law360 – Dr. Spared Fine Over Accountant’s Stock Sale Tax Gaffes by Kyle Jahner. Taxnotes also has something, but it is behind a paywall.

Update

One of my readers William Brock CPA has suggested a better way to know your return has been filed.  It is to request Form 9325 from the preparer.  I can’t explain how the existence of this form has escaped my attention.  Nonetheless, I like my way better because it does not involve an intermediary.