Filed: Jun. 13, 2011
Latest Update: Nov. 14, 2018
Summary: STEPHEN G. WOODSUM AND ANNE R. LOVETT, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT Docket No. 18934–09. Filed June 13, 2011. In 2006 Ps received gain of $3.4 million upon the termi- nation of a ‘‘swap’’ transaction. P–H was personally involved in terminating the transaction and received from the payor a Form 1099–MISC, Miscellaneous Income, that reported the payment. Ps retained a firm with a lawyer and a certified public accountant to prepare their 2006 income tax return. Ps gav
Summary: STEPHEN G. WOODSUM AND ANNE R. LOVETT, PETITIONERS v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT Docket No. 18934–09. Filed June 13, 2011. In 2006 Ps received gain of $3.4 million upon the termi- nation of a ‘‘swap’’ transaction. P–H was personally involved in terminating the transaction and received from the payor a Form 1099–MISC, Miscellaneous Income, that reported the payment. Ps retained a firm with a lawyer and a certified public accountant to prepare their 2006 income tax return. Ps gave..
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STEPHEN G. WOODSUM AND ANNE R. LOVETT, PETITIONERS v.
COMMISSIONER OF INTERNAL REVENUE, RESPONDENT
Docket No. 18934–09. Filed June 13, 2011.
In 2006 Ps received gain of $3.4 million upon the termi-
nation of a ‘‘swap’’ transaction. P–H was personally involved
in terminating the transaction and received from the payor a
Form 1099–MISC, Miscellaneous Income, that reported the
payment. Ps retained a firm with a lawyer and a certified
public accountant to prepare their 2006 income tax return. Ps
gave to the firm all the 160-plus information returns they had
received from third-party payors, including the Form 1099–
MISC reporting the $3.4 million. The 115-page return that
the firm prepared reported $29.2 million of adjusted gross
income but omitted the $3.4 million from the swap trans-
action. Ps signed and filed the return. The IRS determined a
deficiency of tax (which Ps conceded and paid) and an
accuracy-related penalty under I.R.C. sec. 6662(a), which Ps
dispute on grounds of ‘‘reasonable cause’’ under I.R.C. sec.
6664(c)(1). Held: Ps’ reliance on their return preparer did not
constitute reasonable cause for their omission of the $3.4 mil-
lion income item.
David H. Hopfenberg, for petitioners.
Patrick F. Gallagher, for respondent.
585
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586 136 UNITED STATES TAX COURT REPORTS (585)
OPINION
GUSTAFSON, Judge: This case is before the Court pursuant
to section 6213(a) 1 for redetermination of an accuracy-
related penalty of $104,295 that the Internal Revenue
Service (IRS) determined against petitioners Stephen G.
Woodsum and Anne R. Lovett for tax year 2006, pursuant to
section 6662(a). The issue for decision is whether petitioners
had ‘‘reasonable cause’’ under section 6664(c)(1) for omitting
$3.4 million of income from their joint 2006 Federal income
tax return.
Background
The parties submitted this case fully stipulated, pursuant
to Rule 122. We incorporate by this reference the stipulation
of facts filed December 6, 2010, and the associated exhibits.
Petitioners’ backgrounds
Petitioners Stephen G. Woodsum and Anne R. Lovett are
married. At the time they filed their petition, they resided in
New Hampshire.
Ms. Lovett received a bachelor of arts degree from Yale
University in 1977, and the stipulated record shows nothing
more about her background. Mr. Woodsum received a bach-
elor of arts degree from Yale University in 1976 and a mas-
ter’s in management from the Kellogg School of Management
at Northwestern University in 1979. Mr. Woodsum is the
founding managing director of Summit Partners, a private
equity investment firm founded in 1984.
Petitioners are not tax experts. But Mr. Woodsum is finan-
cially sophisticated, and he has a basic understanding of the
taxation of interest income, dividend income, and income
from the sale of stocks and bonds.
The swap transaction
In 1998 Mr. Woodsum signed an agreement that undertook
a financial transaction that the parties describe as a ‘‘ten
year total return limited partnership linked swap’’ (and that
we refer to herein as ‘‘the swap’’). In entering into this trans-
1 Except as otherwise noted, all section references are to the Internal Revenue Code of 1986
(26 U.S.C.), as amended and in effect for the year at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
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(585) WOODSUM v. COMMISSIONER 587
action, Mr. Woodsum was advised by attorney David H.
Hopfenberg (who, as we show below, supervised the prepara-
tion of the tax return for the year at issue). Mr. Woodsum
originally entered into the swap with the London Branch of
Bankers Trust Company, but Bankers Trust was succeeded
in its interest in the swap by Deutsche Bank. The parties’
stipulation explains the swap as follows:
21. The Swap required * * * [Deutsche Bank] to pay Petitioners the
value of the Reference Fund less the Calculation Amount on the Termi-
nation Date.
22. The Reference Fund was Spring Point Partners, L.P., a Delaware
Limited Partnership.
23. According to the terms of the Swap, the Specified Interest in the Ref-
erence Fund was ‘‘a limited partnership interest in the Reference Fund
that would result from a capital contribution to such Reference Fund of
USD 2,612,156 on December 31, 1997, if one were to be made.’’
24. The Swap required Petitioners to make quarterly payments to * * *
[Deutsche Bank] based upon the product of the Notional Amount (as
adjusted) times the USD–LIBOR–BBA rate plus 1.50% (the ‘‘LIBOR Pay-
ments’’). The agreement further required the Petitioners to provide Collat-
eral to * * * [Deutsche Bank].
After the end of every calendar quarter, petitioners
received account statements with respect to the swap
showing the total appreciation or depreciation in the value of
their interest. They began receiving these quarterly reports
at least as early as December 31, 2003 (when petitioners’
interest had appreciated to $5,816,401), and until March 31,
2006 (when petitioners’ interest had appreciated to
$6,368,506). On their returns for the tax years preceding
2006, petitioners reported income and deductions relating to
the collateral and LIBOR payments in connection with the
swap.
The swap’s ten-year term was apparently scheduled to end
in early 2008, but Mr. Woodsum believed that the reference
fund was not performing as well as it should. He therefore
informed Deutsche Bank in writing on February 3, 2006, of
his intention to terminate the swap effective March 31, 2006.
The net payout to petitioners in connection with the termi-
nation of the swap was $3,367,611.50, all of which, the par-
ties agree, was taxable income to petitioners. Mr. Woodsum
discussed the termination with Mr. Hopfenberg before it took
place, and Mr. Hopfenberg advised Mr. Woodsum when the
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588 136 UNITED STATES TAX COURT REPORTS (585)
swap had been terminated. After the end of 2006, Deutsche
Bank issued to petitioners a Form 1099–MISC, Miscellaneous
Income, reporting ‘‘Other income’’ of $3,379,611 2 from the
termination of the swap, and a Form 1099–INT, Interest
Income, reporting $60,291.69 of ‘‘Interest income’’.
Petitioners’ income in 2006
In 2006 petitioners received adjusted gross income totaling
almost $33 million (including the $3.4 million from termi-
nating the swap). Petitioners’ payors reported that income to
petitioners and to the IRS on more than 160 information
returns, e.g., Schedules K–1 and Forms 1099, including the
Deutsche Bank Forms 1099–MISC and 1099–INT.
The $3.4 million reported on Deutsche Bank’s Form 1099–
MISC was not the largest amount reported on the information
returns that petitioners received for 2006. However, if the
$3.4 million from Deutsche Bank had been included on peti-
tioners’ 2006 return, it would have been the third largest
long-term capital gain amount reported as a line item on
Schedule D, Capital Gains and Losses.
Preparation of petitioners’ 2006 return
For 2006 petitioners filed 27 State income tax returns and
a joint Federal income tax return.
To prepare their 2006 Federal income tax return, peti-
tioners hired Venture Tax Services, Inc. (‘‘VTS’’), a niche firm
specializing in tax work for private equity and hedge funds
as well as such funds’ general partners. VTS employed Mr.
Hopfenberg, whom petitioners had retained for investment
and tax advice since 1996. As of 2006, Mr. Hopfenberg had
more than 20 years of tax compliance and consulting experi-
ence, including employment in the tax departments of major
accounting firms. For VTS’s preparation of petitioners’ 2006
return, Mr. Hopfenberg acted as reviewer. The VTS employee
charged with actually preparing the return was a Massachu-
setts certified public accountant (‘‘C.P.A.’’) who similarly had
more than 20 years of tax compliance experience, including
employment with major accounting firms.
2 The Deutsche Bank Form 1099–MISC shows an amount of $3,379,611, but the parties have
stipulated that the net payout (and the taxable income) was $3,367,611.50. The discrepancy is
not explained in the record. For purposes of discussion in this Opinion hereafter, we round the
number to $3.4 million.
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(585) WOODSUM v. COMMISSIONER 589
Petitioners provided to VTS all 160-plus information
returns, including the Deutsche Bank Form 1099–MISC
reporting $3.4 million from the termination of the swap and
Form 1099–INT reporting $60,291.69 of interest income. VTS
duly scanned the Form 1099–MISC into its records for use in
preparing the return.
The Form 1040, U.S. Individual Income Tax Return, that
VTS prepared for petitioners was 115 pages long. The return
did report the $60,291.69 of interest income that petitioners
received from Deutsche Bank. However, for reasons the
record does not show, 3 the return that VTS prepared did not
include the $3.4 million that Deutsche Bank paid and
reported. If the $3.4 million had been included on the return,
that amount would have appeared on Schedule D as a dis-
tinct line item in Part II, ‘‘Long-Term Capital Gains and
Losses—Assets Held More Than One Year’’. But, again, it
was not reported on the return that VTS prepared.
Review and signing of petitioners’ 2006 return
Petitioners had obtained an extension of the due date for
filing their 2006 return. As a result, the return was due
October 15, 2007. At 11 a.m. on that date, petitioners met
with Mr. Hopfenberg to discuss several subjects, including
their return. At that meeting Mr. Hopfenberg turned the 115
pages of the return and discussed various items of income
and deduction with Mr. Woodsum. Petitioners characterize
this as their ‘‘perform[ing] more than a cursory review of the
return.’’ However, the parties have stipulated that peti-
tioners do not recall—
• which specific items of income and deduction were dis-
cussed at the meeting, or
• the amount of time they spent reviewing the return, or
• the amount of time they spent reviewing the Schedule D
and the attachments and statements thereto.
During the discussion of the return, Mr. Woodsum did not
compare or match the items of income reported on the Form
1040 and its schedules with the information returns that the
third-party payors had provided. Consequently, petitioners
3 In their briefs petitioners seem to imply that the omission was the result of mistake or over-
sight by the C.P.A. who prepared the return. However, the stipulation does not state the reason
for the omission, and because petitioners chose to submit the case under Rule 122, they did not
call the C.P.A. as a witness. Thus, we do not know why the $3.4 million was omitted.
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590 136 UNITED STATES TAX COURT REPORTS (585)
failed to make sure that all their income items were reported
on the return that VTS had prepared.
Petitioners signed the return on that same day—October
15, 2007. We assume that, when they did so, petitioners were
unaware of the omission of the $3.4 million. 4
The IRS received Deutsche Bank’s Form 1099–MISC
reporting the $3.4 million, compared it with petitioners’
return, and determined a deficiency in tax of $521,473 and
an accuracy-related penalty under section 6662(a) of
$104,295. Petitioners agreed to the assessment of tax in the
amount determined by the IRS. As a result, their tax due,
which they reported as $3,719,454, was actually $4,240,927.
Petitioners paid the tax deficiency plus interest.
However, petitioners filed their petition in this Court dis-
puting the accuracy-related penalty. The parties jointly sub-
mitted the case fully stipulated under Rule 122.
Discussion
I. The relevant law
A. Accuracy-related penalty under section 6662(b)(2)
Section 6662(a) and (b)(2) imposes an ‘‘accuracy-related
penalty’’ of 20 percent of the portion of the underpayment of
tax attributable to any substantial understatement of income
tax. 5 By definition, an understatement of income tax for an
individual is substantial if it exceeds the greater of $5,000 or
10 percent of the tax required to be shown on the return.
Sec. 6662(d)(1). Under section 7491(c), the Commissioner
bears the burden of production and must produce sufficient
evidence that the imposition of the penalty is appropriate in
4 Petitioners argue in their brief that ‘‘Neither the tax advisor nor the Petitioners noticed that
the tax preparer failed to include the Deutsche Bank 1099–MISC which showed income of
$3,379,611.00 on the return’’; but no evidence in the record explicitly asserts that petitioners
were unaware of the omission. The closest assertion is the parties’ stipulation that ‘‘Petitioners
relied upon Venture Tax Services to prepare their 2006 tax return and include all of the items
relating to the over 160 information returns provided to Venture Tax Services on said return.’’
For purposes of this Opinion, we interpret this stipulation in the manner most favorable to peti-
tioners—an approach admittedly at odds with the fact that they have the burden to prove rea-
sonable cause and good faith, as we show below.
5 Under section 6662(b)(1), the accuracy-related penalty is also imposed where an under-
payment is attributable to the taxpayer’s negligence or disregard of rules or regulations; and
respondent argues that petitioners’ omission of the income reflects negligence. However, as we
show below, respondent has demonstrated that petitioners substantially understated their in-
come tax for 2006. Thus, we need not consider whether, under section 6662(b)(1), it is also true
that petitioners were negligent or disregarded rules or regulations.
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(585) WOODSUM v. COMMISSIONER 591
a given case. Higbee v. Commissioner, 116 T.C. 438, 446
(2001). Once the Commissioner meets this burden, the tax-
payer must come forward with persuasive evidence that the
Commissioner’s determination is incorrect. Rule 142(a);
Higbee v. Commissioner, supra at 447.
B. Reasonable cause under section 6664(c)(1)
A taxpayer who is otherwise liable for the accuracy-related
penalty may avoid the liability if he can show, under section
6664(c)(1), that he had reasonable cause for a portion of the
underpayment and that he acted in good faith with respect
to that portion. 6 The pertinent regulation provides:
The determination of whether a taxpayer acted with reasonable cause and
in good faith is made on a case-by-case basis, taking into account all perti-
nent facts and circumstances. * * * Generally, the most important factor
is the extent of the taxpayer’s effort to assess the taxpayer’s proper tax
liability. Circumstances that may indicate reasonable cause and good faith
include an honest misunderstanding of fact or law that is reasonable in
light of all of the facts and circumstances, including the experience, knowl-
edge, and education of the taxpayer. An isolated computational or
transcriptional error generally is not inconsistent with reasonable cause
and good faith. * * * Reliance on * * * professional advice * * * con-
stitutes reasonable cause and good faith if, under all the circumstances,
such reliance was reasonable and the taxpayer acted in good faith. * * *
[26 C.F.R. sec. 1.6664–4(b)(1), Income Tax Regs.]
Whether the taxpayer acted with reasonable cause and in
good faith thus depends on the pertinent facts and cir-
cumstances, including his efforts to assess his proper tax
liability, his knowledge and experience, and the extent to
which he relied on the advice of a tax professional.
II. Application of the law to petitioners
A. Substantial understatement
The undisputed tax deficiency attributable to petitioners’
omitted income is $521,473. That amount is obviously in
excess of $5,000. That amount is also in excess of ‘‘10 percent
6 There are other defenses to the penalty that petitioners do not invoke here; i.e., section
6662(d)(2)(B) provides that an understatement may be reduced, first, where the taxpayers had
substantial authority for their treatment of any item giving rise to the understatement or, sec-
ond, where the relevant facts affecting the item’s treatment are adequately disclosed and the
taxpayers had a reasonable basis for their treatment of that item. Neither of those defenses is
applicable here, where petitioners admit that the income was taxable and simply allege an inad-
vertent omission from the return.
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592 136 UNITED STATES TAX COURT REPORTS (585)
of the tax required to be shown on the return’’, sec.
6662(d)(1), because the correct tax liability, which petitioners
have conceded, is $4,240,927. Petitioners’ understatement of
tax was therefore ‘‘substantial’’ for purposes of section
6662(d)(1). Consequently, respondent has carried the burden
of production that section 7491(c) imposes.
The accuracy-related penalty is mandatory; the statute
provides that it ‘‘shall be added’’. Sec. 6662(a). Petitioners
bear the burden of proving the defense of reasonable cause
and good faith. See Higbee v. Commissioner, supra at 446.
B. Reasonable cause and good faith
1. Reliance on professional advice
For purposes of section 6664(c), a taxpayer may be able to
establish reasonable cause and good faith (and thereby avoid
the accuracy-related penalty of section 6662) by showing his
reliance on professional advice. 26 C.F.R. sec. 1.6664–4(b)(1).
As we stated in Neonatology Associates, P.A. v. Commis-
sioner, 115 T.C. 43, 99 (2000), affd.
299 F.3d 221 (3d Cir.
2002):
for a taxpayer to rely reasonably upon advice so as possibly to negate a
section 6662(a) accuracy-related penalty determined by the Commissioner,
the taxpayer must prove by a preponderance of the evidence that the tax-
payer meets each requirement of the following three-prong test: (1) The
adviser was a competent professional who had sufficient expertise to jus-
tify reliance, (2) the taxpayer provided necessary and accurate information
to the adviser, and (3) the taxpayer actually relied in good faith on the
adviser’s judgment. * * *
Seeking to meet these standards, petitioners assert (1) that
VTS and its attorney and C.P.A. were competent and experi-
enced professionals, (2) that petitioners provided VTS with
the necessary and accurate information, i.e., the Form 1099–
MISC reporting the $3.4 million, and (3) that petitioners
relied on VTS to prepare the return and report the $3.4 mil-
lion—all of which the parties have stipulated. However, for
purposes of proving reliance on professional advice, these
assertions miss the mark.
The IRS’s regulations define ‘‘advice’’ as follows:
(2) Advice defined.—Advice is any communication, including the opinion
of a professional tax advisor, setting forth the analysis or conclusion of a
person, other than the taxpayer, provided to (or for the benefit of) the tax-
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(585) WOODSUM v. COMMISSIONER 593
payer and on which the taxpayer relies, directly or indirectly, with respect
to the imposition of the section 6662 accuracy-related penalty. Advice does
not have to be in any particular form. [26 C.F.R. sec. 1.6664–4(c)(2).]
A premise only implicit in petitioners’ position is that their
return preparer’s unexplained omission (i.e., the omission of
what Mr. Woodsum knew to be includable as a substantial
income item on their return) constituted ‘‘advice’’ to exclude
that item. However, the fact that the regulation defines
‘‘advice’’ broadly enough to include ‘‘any communication’’,
whether or not ‘‘in any particular form’’, provides no grounds
for reliance by petitioners: In United States v. Boyle, 469 U.S.
241 (1985), where the taxpayer knew or should have known
of the applicable filing deadline, he lacked reasonable cause
for his attorney’s untimely filing of his return; similarly,
since petitioners knew their Form 1099 income should have
been included, they lack reasonable cause for their preparer’s
failure to include the income.
In order to constitute ‘‘advice’’ within the definition of the
regulation, the communication must reflect the adviser’s
‘‘analysis or conclusion’’. The taxpayer must show (in the
words of Neonatology Associates, 115 T.C. at 99 (emphasis
added)) that he ‘‘relied in good faith on the adviser’s judg-
ment.’’ Petitioners present no testimony of the preparer (nor
any other evidence) to show that the income was omitted
from the return because of any ‘‘analysis or conclusion’’ or
‘‘judgment’’ by VTS that the income was not taxable. When
the Supreme Court discussed the ‘‘reasonable cause’’ defense
in Boyle, it characterized the relevant professional role as
giving ‘‘substantive advice’’, 469 U.S. at 251, and contrasted
that professional function with things that ‘‘require[ ] no spe-
cial training’’, id. at 252. No ‘‘special training’’ was required
for Mr. Woodsum to know that the law required him to
include on that return an item of income that he had
received and that Deutsche Bank had reported on Form
1099. The including of that income on their tax return is
what petitioners say they intended when they handed over
their information returns to VTS.
Petitioners make no suggestion that VTS gave them ‘‘sub-
stantive advice’’ to omit the $3.4 million or that petitioners
relied on any such substantive advice. On the contrary, peti-
tioners stipulated that they ‘‘relied upon Venture Tax Serv-
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594 136 UNITED STATES TAX COURT REPORTS (585)
ices to prepare their 2006 tax return and include all of the
items relating to the over 160 information returns provided
to Venture Tax Services on said return’’. (Emphasis added.)
There is no evidence that when VTS instead omitted the $3.4
million, it thereby was exercising ‘‘analysis’’ or ‘‘judgment’’ or
was making a professional recommendation to petitioners;
rather, it was failing, in that specific instance, to carry out
petitioners’ general instruction. In signing the return thus
erroneously prepared, petitioners were not deliberately fol-
lowing substantive professional advice; they were instead
unwittingly (they contend) perpetuating a clerical mistake.
The defense of reliance on professional advice has no applica-
tion here.
2. Return preparer’s error
More pertinent to this case is the principle, quoted above,
that ‘‘[a]n isolated computational or transcriptional error
generally is not inconsistent with reasonable cause and good
faith.’’ 26 C.F.R. sec. 1.6664–4(b)(1). However, petitioners fail
to place their understatement within the category of ‘‘com-
putational or transcriptional error[s]’’ because they provided
no evidence to explain the nature of or the reason for VTS’s
omission of the $3.4 million. It may be (and petitioners seem
to expect the Court to assume) that the omission was the
result of the C.P.A.’s oversight of one Form 1099 amid 160
such forms, but no actual evidence supports that character-
ization. The omission is unexplained, and since petitioners
have the burden to prove reasonable cause and good faith,
this evidentiary gap works against their defense.
Even if we assume that the $3.4 million omission was an
innocent oversight by the return preparer, the reasonable
cause defense is unavailing here. Taxpayers sometimes do
avoid the accuracy-related penalty by showing that their
understatement was the result of a return preparer’s error.
See, e.g., Thrane v. Commissioner, T.C. Memo. 2006–269, 92
T.C.M. 501. 7 However, as we stated in Metra Chem
7 In Thrane,
The erroneous income figure for Windsor ($414,845) appeared only on a worksheet to the Sched-
ule E attached to petitioner’s Form 1040. That figure required a further offsetting adjustment
before being reported on the face of the Schedule E as $378,428. Thus, only a rather detailed
tracing through the Schedule E worksheet would have alerted petitioner to the error at issue.
* * * [92 T.C.M. (CCH) at 503.]
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(585) WOODSUM v. COMMISSIONER 595
Corp. v. Commissioner, 88 T.C. 654, 662 (1987) (citations
omitted):
As a general rule, the duty of filing accurate returns cannot be avoided
by placing responsibility on a tax return preparer. As the petitioners have
noted, this Court has declined to sustain the addition to tax under section
6653(a) in cases in which the taxpayer relied in good faith on the advice
of a tax expert. However, a close examination of these cases reveals that
they raised questions as to the tax treatment of complex transactions and
that the position taken on the returns with respect to such items had a
reasonable basis.
This case presents no such difficult issues. Ronald Laroche simply failed
to report over $10,000 in cash dividends which he received from corpora-
tions controlled by him. Richard Laroche similarly failed to report over
$6,800 in such dividends. The unreported dividends constituted over 21
percent of Ronald and Beverly Laroche’s gross income for 1977 and over
20 percent of Richard and Shirley Laroche’s gross income for such year.
We believe that such a substantial underreporting of income would not
have gone unnoticed if the petitioners had made even a cursory review[8]
of their returns. Under such circumstances, the petitioners may not shift
responsibility for the accuracy of their returns to their accountant.
However complex the swap may have been in its creation
and its operation, its termination resulted in Deutsche
Bank’s issuing to petitioners a standard and uncomplicated
Form 1099–MISC that, petitioners admit, should have
resulted in a distinct and identifiable entry on Schedule D of
their return. Like Metra Chem, ‘‘This case presents no such
difficult issues.’’ Id.
‘‘Even if all data is furnished to the preparer, the taxpayer
still has a duty to read the return and make sure all income
items are included.’’ Magill v. Commissioner, 70 T.C. 465,
479–480 (1978), affd. 651 F.2d 1233 (6th Cir. 1981). 9 We do
not hold that a taxpayer must duplicate the work of his
return preparer, or that any omission of an income item in
In this case, however, the facts are quite different, in that the $3.4 million figure on the Form
1099–MISC should simply have appeared as a distinct and visible entry on Schedule D.
8 We thus observed in Metra Chem that a ‘‘cursory review’’ would have disclosed the under-
reporting in that case. Petitioners attempt to construe this passage in the Metra Chem Opinion
as announcing a rule that the reasonable cause defense requires only a ‘‘more than cursory re-
view’’. Metra Chem does not state this low standard. As we explain below, what is required for
‘‘reasonable cause’’ is that the taxpayer conduct a review the purpose of which is to ‘‘make sure
all income items are included.’’ Magill v. Commissioner, 70 T.C. 465, 479–480 (1978), affd.
651
F.2d 1233 (6th Cir. 1981).
9 See also Bailey v. Commissioner, 21 T.C. 678, 687 (1954) (‘‘The duty of filing accurate returns
cannot be avoided by placing responsibility upon an agent. The fact that petitioner told the per-
son who made up the partnership return about the sale of leasehold interests totaling $83,500
cannot excuse his failure to read the return and ascertain the inclusion of this item.’’).
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596 136 UNITED STATES TAX COURT REPORTS (585)
a return prepared by a third party is necessarily fatal to a
finding of reasonable cause and good faith on the taxpayer’s
part. Rather, for purposes of this Opinion, we assume that
the reasonable cause defense may be available to a taxpayer
who conducts a review of his third-party prepared return
with the intent of ensuring that all income items are
included, and who exerts effort that is reasonable under the
circumstances, but who nonetheless fails to discover an omis-
sion of an income item.
Mr. Woodsum, however, makes no showing of a review
reasonable under the circumstances. He personally ordered
the termination that gave rise to the income; he received a
Form 1099–MISC reporting that income; that amount should
have shown up on Schedule D as a distinct item; but it was
omitted. The parties stipulated that petitioners’ ‘‘review’’ of
the defective return was of an unknown duration and that it
consisted of the preparer’s turning the pages of the return
and discussing various items. Petitioners understated their
income by $3.4 million—an amount that was substantial not
only in absolute terms but also in relative terms (i.e., it
equaled about 10 percent of petitioners’ adjusted gross
income). A review undertaken to ‘‘make sure all income items
are included’’ (in the words of Magill)—or even a review
undertaken only to make sure that the major income items
had been included—should, absent a reasonable explanation
to the contrary, have revealed an omission so straightforward
and substantial.
In evaluating reasonable cause, ‘‘the most important factor
is the extent of the taxpayer’s effort to assess the taxpayer’s
proper tax liability.’’ 26 C.F.R. sec. 1.6664–4(b)(1). But peti-
tioners do not recall how much time they spent reviewing the
return, how much time they spent reviewing Schedule D, or
which income items they reviewed; and they recall that they
did not compare or match the items of income reported on
the return with the information returns they had received.
They have thus failed to prove the ‘‘most important factor’’—
i.e., ‘‘the taxpayer’s effort’’. Petitioners did not fulfill their
duty to review the return that VTS had prepared.
Mr. Woodsum terminated the swap ahead of its set termi-
nation date because his watchful eye noted that it was not
performing satisfactorily as an investment. That is, when his
own receiving of income was in question, Mr. Woodsum was
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(585) WOODSUM v. COMMISSIONER 597
evidently alert and careful. But when he was signing his tax
return and reporting his tax liability, his routine 10 was so
casual that a half-million-dollar understatement of that
liability could slip between the cracks. We cannot hold that
this understatement was attributable to reasonable cause
and good faith.
To reflect the foregoing,
Decision will be entered for respondent.
f
10 By way of analogy, 26 C.F.R. sec. 1.6664–4(b)(1) suggests that an error on a corporate re-
turn, arising from ‘‘data compiled by the various divisions of a multidivisional corporation’’, may
result from reasonable cause ‘‘provided the corporation employed internal controls and proce-
dures, reasonable under the circumstances, that were designed to identify such factual errors.’’
Petitioners here lacked ‘‘controls and procedures, reasonable under the circumstances’’.
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