Busch v Commissioner, a small tax case issued as a bench opinion, involves a couple who claimed to have made an honest mistake on their self-prepared tax return. According to the Busches, when using their tax return prep software, the software did not allow them to enter cents when recording the mortgage interest paid in a year. The Busches paid $21,201.25 in deductible mortgage interest and entered $21,201.25 line for their mortgage interest, but the software, kicking out the cents, recorded the deduction as $2,120,125 instead. The couple of million dollar difference led IRS to likely discover the error automatically via document matching.
What followed was likely mismatch virtual audit, a notice of deficiency that adjusted for the underpaid tax, and for good measure, a proposed 20 per cent substantial understatement accuracy related penalty under Section 6662(a). The Busches filed a petition, conceding the extra tax but challenging the penalty.
The issue in the case was whether the taxpayers could establish that they acted with reasonable cause and in good faith under Section 6664(c) and thus be excused from the penalty.
The brief opinion notes that the taxpayers urged the court to find that the error was an “honest” mistake, and, as such, they should not be penalized for that mistake. The opinion shows some sympathy for the taxpayers and more generally to how it is possible that taxpayers may foot fault when using software:
[The taxpayers] ask the Court to recognize, as they point out that honest mistakes are sometimes made. As a general proposition of life, we agree with petitioners on the point, and we further agree with petitioners’ suggestion that not every mistake made on a Federal income tax return should result in the imposition of an accuracy-related penalty. A person preparing a return might understandably get distracted while doing so and enter the wrong amount for an item, or if not distracted, when transferring numbers from one document to another, transpositions often occur. If a computer-based software program is being used in the process, the limitations and requirements of a software program might not be fully appreciated by the user. Any number of situations could cause an “honest” mistake to be made when amounts are incorrectly reported on a Federal income tax return.
The problem with the taxpayers’ argument though was that the taxpayers had an obligation to review the return. The two-million dollar difference between the deduction on the return and interest actually paid should have triggered greater inquiry into the matter:
But petitioners’ focus on the erroneous entry as the “mistake”, and their explanation describing how the mistake occurred, misses the point. The mistaken entry is not the real problem. Their mistake was failing to review the return carefully enough to have recognized the erroneous entry before the return was filed. After all, it should go without saying, that a taxpayer’s obligation to prepare and file a Federal income tax return includes the duty to review that return to ensure that the information reported or shown on the return is accurate before the return is filed.
The opinion notes that the “deduction for mortgage interest shown on the return occupies at least two additional columns” on the same page as where the deduction appears on the return:
Looking up and down the columns showing other items reported on the return, the mortgage interest deduction sticks out, as the saying goes, “like a sore thumb”. A careful review of the return after it was prepared would most certainly have caught the error; actually, even as little as a quick glance at the return probably would have done so.
This is another in the line of cases that holds that the use of tax software by itself is not sufficient to establish a defense to an accuracy-related penalty. As Bryan Camp noted in Lesson From The Tax Court: The Turbo-Tax Defense in Tax Prof a few years ago, there is dicta in a Tax Court opinion that suggests that the use of software can help establish reasonable cause/good faith. But hiding behind “the software made me do it” is not enough to insulate all taxpayers from penalties.
To succeed in blaming the software, taxpayers will generally achieve better results if the software issue involves a question of the proper tax treatment of the item as opposed to a clerical type mistake any taxpayer could pick up by reviewing the return. The taxpayers discussed in post by Bryan Camp were sophisticated yet the Tax Court, in dicta, expressed sympathy with their plight. Similarly, former Treasury Secretary Timothy Geithner had a problem reporting his income from the World Bank that he blamed on the tax prep program. His excuse worked to get him out of a confirmation pickle. Where the defense of the computer made me do it fails is in cases in which any reasonable taxpayer should recognize the mistake if they took care.
Taxpayers can generally rely on a paid preparer to insulate them from the penalty when taxpayers give the paid preparer all of the information necessary and the preparer makes a mistake; however, just having a paid preparer doesn’t necessarily insulate a taxpayer from the duty to review the return and catch obvious mistakes. Taxpayers could not easily escape penalty where a return contained an obvious mistake just by saying they relied on the accountant to add the numbers properly and if the accountant said 1 + 1 + 3 the taxpayer had no duty to correct the mistake.
Courts seek to build on decades of case law involving human paid preparers as they analyze situations in order to decide the appropriateness of penalizing someone relying on digital paid preparers. Taxpayers choosing the do it yourself route can put some blame on their digital preparer but must assume some responsibility to check to make sure the resulting return makes sense. Had the taxpayers here checked, they would have concluded the return did not reflect the correct tax result. The Busches bore responsibility to at least check for a return that made sense.