Failure to Carefully Review Tax Return Results in Costly Mistake for Taxpayers
Whether you prepare your tax return yourself with tax preparation software or rely on an accountant to prepare your return, it is important to remember to meticulously review your returns before filing. The cost of such failure to review could potentially lead to substantial penalties, including a twenty (20%) percent accuracy related penalty.
The taxpayers in Busch v. Commissioner[1] failed to review their 2017 tax return before filing it and were assessed a substantial understatement penalty related to their overstated mortgage interest deduction. The taxpayer, Candice Busch, used a popular return preparation software to prepare her and her husband’s 2017 tax return. The software program only allowed the taxpayer to enter whole dollar amounts (i.e., it did not allow for the entry of cents). In 2017, the taxpayers paid $21,201.25 in mortgage interest and were entitled to a mortgage interest deduction in that amount. When Mrs. Busch entered in the mortgage interest amount, she did not round down for the cents included but instead entered $21,201.25. Since the software program did not allow for cents, it inadvertently reflected the number entered as more than $2,000,000! The program inadvertently listed a $21,000 deduction as $2,120,125 instead! This overstated mortgage interest deduction resulted in the taxpayer’s owing no Federal income tax for 2017, which in turn resulted in the taxpayers’ being refunded all of the Federal income tax withheld from their wages during 2017.
The taxpayers did not adequately review the 2017 tax return before they submitted it and did not question the fact that all of their 2017 Federal income tax withholding was refunded. Unfortunately for the taxpayers, the Internal Revenue Service (“IRS”) noticed that the Form 1098 reporting the mortgage interest paid did not match the amount of mortgage interest deducted on the taxpayers’ 2017 tax return. The IRS issued a notice of deficiency which included a twenty (20%) percent accuracy related penalty. Internal Revenue Code Section 6662(a) imposes a twenty (20%) percent penalty on the portion of an underpayment of tax attributable to the taxpayer’s substantial understatement of income tax. Generally, when a taxpayer is assessed a failure to file, failure to pay or accuracy related penalty, the taxpayer must demonstrate reasonable cause for such failure to avoid payment of the penalty.
While the taxpayers’ did not argue the amount of federal income tax that they owed due to the error, they did argue that the overstatement of their home mortgage interest deduction was due to the return preparation software resulting in an unnoticed error. Since this error was an honest mistake and due to the software, the taxpayers’, in representing themselves, argued that they should not be liable for the substantial understatement penalty. While courts have recognized that honest mistakes can be made, these mistakes do not constitute reasonable cause if the error should have been noticed by the taxpayer upon a review of the taxpayer’s tax return before signing it. In this case, the Tax Court held the amount of mortgage interest deduction produced by the software was absurdly overstated such that upon review, the taxpayers should have immediately noticed the mistake. In fact, the Tax Court stated that the mortgage interest deduction sticks out “like a sore thumb” on the tax return that even a quick glance should have caught the mistake. The taxpayers basically admitted that they had failed to carefully review the 2017 tax return before signing it and forwarding it to the IRS. Failing to review the tax return undermined the taxpayers’ reasonable cause claim as such failure demonstrated carelessness on the part of the taxpayers. Given the lack of reasonable cause, the substantial understatement penalty was upheld by the Tax Court.
Although this Tax Court opinion is a bench opinion and therefore not precedential, it is a good reminder to all taxpayers that whether the taxpayers prepare their own tax return or engage a tax professional, it is imperative to review the tax return before signing and submitting to the IRS. As the taxpayers in Busch v. Commissioner demonstrated, such failure to review can be costly
[1] Tax Court Docket No. 14085-20S (Bench Opinion), February 25, 2022.