Reasonable Cause & Reliance on Advisors

Accuracy-Related Penalty Defenses: Reasonable Cause and Reliance on Advisors After Boyle

The accuracy-related penalty attaches to "any portion of an underpayment of tax required to be shown on a return" that is attributable to negligence, disregard of rules or regulations, or a substantial understatement of income tax, and adds "an amount equal to 20 percent of the portion of the underpayment to which this section applies" 26 U.S.C. § 6662. The exception is equally portion-specific: "No penalty shall be imposed under section 6662 or 6663 with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion" 26 U.S.C. § 6664. The most frequently litigated route to that exception is reliance on a professional adviser, and the governing framework comes from two decisions: the Supreme Court’s treatment of advisor reliance in Boyle and the Tax Court’s three-prong reliance test in Neonatology Associates.

The reliance defense divides at the line Boyle drew between ministerial obligations and substantive advice. United States v. Boyle, 469 U.S. 241 (1985) held that "[t]he failure to make a timely filing of a tax return is not excused by the taxpayer’s reliance on an agent, and such reliance is not ‘reasonable cause’ for a late filing under § 6651(a)(1)," reasoning that "one does not have to be a tax expert to know that tax returns have fixed filing dates and that taxes must be paid when they are due. In short, tax returns imply deadlines." Congress "intended to place upon the taxpayer an obligation to ascertain the statutory deadline and then to meet that deadline, except in a very narrow range of situations." Substantive advice stands on different footing: "When an accountant or attorney advises a taxpayer on a matter of tax law, such as whether a liability exists, it is reasonable for the taxpayer to rely on that advice," because "[m]ost taxpayers are not competent to discern error in the substantive advice of an accountant or attorney," and requiring the taxpayer "to challenge the attorney, to seek a ‘second opinion,’ or to try to monitor counsel on the provisions of the Code himself would nullify the very purpose of seeking the advice of a presumed expert in the first place."

For accuracy-related penalties, the Tax Court has reduced Boyle’s substantive-advice principle to a conjunctive test on which the taxpayer bears the burden of proof. Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43 (2000) held that "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 taxpayer meets each requirement of the following three-prong test: (1) The adviser was a competent professional who had sufficient expertise to justify 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." The same opinion identified the recurring failure points: "Reliance may be unreasonable when it is placed upon insiders, promoters, or their offering materials, or when the person relied upon has an inherent conflict of interest that the taxpayer knew or should have known about," and "[t]he mere fact that a certified public accountant has prepared a tax return does not mean that he or she has opined on any or all of the items reported therein."

Recent Tax Court decisions apply the test in both directions. Greenblatt v. Commissioner, T.C. Memo. 2024-109 sustained the defense for taxpayers who relied on an in-house accountant with an accounting degree and prior CPA-firm experience to compute net operating loss carryforward deductions, observing that "NOL computations are complex, and the rules governing carrying them back and forward are not intuitive and are frequently altered by Congress," and concluding that "[p]etitioners reasonably relied on Mr. May’s advice and had no reason to question the position taken on the returns with respect to the NOLs." The defense failed where the record established neither the adviser’s competence nor the information supplied to him: Ataya v. Commissioner, T.C. Memo. 2025-55 sustained penalties under sections 6662(a) and (b)(1) because "[m]ere statements alone do not show a taxpayer actually relied on advice from a tax professional during the return preparation process." Reliance on the architects of the transaction fails for a different reason: Kadau v. Commissioner, T.C. Memo. 2025-81 sustained accuracy-related penalties in a microcaptive insurance case, explaining that "[a]dvice hardly qualifies as disinterested or objective if it comes from parties who actively promote or implement the transactions in question," and concluding that communication with the taxpayers’ actuary limited to "a feasibility study questionnaire ... and a single phone call to discuss the results of the questionnaire" could not carry the second prong; the relative novelty of the issues "does not excuse petitioners from penalties in the absence of any efforts on their part to ascertain their correct tax liabilities or apply well-settled principles of taxation to their situation."

Under these decisions, the penalty defense turns on what the taxpayer delegated and what the adviser actually did. A deadline missed by an agent is not excused, because the duty to ascertain and meet the statutory filing date remains with the taxpayer; a return position taken on an adviser’s substantive judgment can be, but only on proof of each Neonatology prong. The first prong is documentary in practice: the record must establish the adviser’s credentials and expertise, not merely that a preparer was used, and advice from promoters or others with a financial stake in the transaction does not qualify regardless of expertise. The second prong requires evidence of what the taxpayer actually gave the adviser — a questionnaire and a single telephone call did not suffice in Kadau, while testimony in Greenblatt that the accountant procured all the records he needed and that the taxpayers cooperated did. The third prong requires reliance during the return preparation process itself, which assertions made for the first time at trial cannot supply. Where the disputed item involves genuinely complex computations, such as net operating loss carryforwards, reliance on a competent professional is at its strongest; where the item involves the application of well-settled principles of taxation, the absence of direct precedent does not lower the taxpayer’s burden.