Originally Published on forbes.com on November 24th, 2011
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This is the first instance I have noted of the “Turbo-tax” defense working against penalties. Kurt Olsen was a patent attorneyworking for the Department of Energy. He had been preparing the joint return for himself and his wife using commercial software. 2007 was a special year:
In 2007, petitioner’s wife received interest income from a trust created by her mother’s estate. The funds were attributable to litigation resolved in favor of the estate. As a beneficiary of the trust, petitioner’s wife received a Schedule K-1, Beneficiary’s Share of Income, Deductions, Credits, etc., reporting the interest income. Prior to this instance, the couple had never received a Schedule K-1 and were unfamiliar with the form.
Mr. Olsen took steps:
Because he had never dealt with a Schedule K-1 in the past, petitioner upgraded his tax preparation software to a more sophisticated version as a precaution to ensure proper treatment of the unfamiliar form.
It did not quite do the trick though:
Using the upgraded software’s interview process, petitioner correctly entered the name and tax identification number of the trust, properly reporting the source of income. While transcribing the remaining information, however, he made a data entry error that prevented the amount of interest income from being correctly displayed on Schedule E, Supplemental Income and Loss, of his Federal tax return. Petitioner reviewed the Federal tax return before filing, including using the verificationfeatures in his tax preparation software, but did not discover the error.
Just goes to show you do not have to be an ace tax preparer to be a tax court judge. When you have interest income from a trust (or a partnership or an S corporation), it ends up on Schedule B. At any rate the judge had some sympathy for Mr. Olsen’s plight.
The most important factor in deciding whether a taxpayer acted with reasonable cause and in good faith is the extent of the taxpayer’s effort to assess the proper tax liability. Sec. 1.6664-4(b)(1), Income Tax Regs. Prior to 2007, petitioner never received a Schedule K-1. The interest income reported on the Schedule K-1 was not associated with any of petitioner’s investments. Instead, the income was derived from litigation proceeds received by his mother-in-law’s estate. Petitioner acted reasonably in upgrading his tax preparation software to a more sophisticated version in order to aid in properly reporting the income on the unfamiliar Schedule K-1 that his wife received. See Thompson v. Commissioner, T.C. Memo. 2007-174 . Petitioner correctly identified the trust as the source of the interest income. Petitioner also correctly entered the trust’s tax identification number into the software program. He did not bury his head in the sand and ignore his obligation to check the accuracy of his tax return. Instead, petitioner reviewed the information he entered using his tax preparation software upon completion of the software’s interview process. Despite his best efforts, however, petitioner failed to discover that the amount of the interest income did not appear on the final version of his tax return that was filed.
The tax deficiency in the case was just short of $10,000 so there must have been on the order of $30,000 in interest income involved. It is kind of hard to see how you could look at the return and not realize it was not there. Regardless, Mr. Olsen did a better job of representing himself in tax court than he did in preparing his return so the penalty of $1,859 was not upheld. Maybe drawing a judge that would have trouble preparing returns helped.