                               T.C. Memo. 2013-60



                        UNITED STATES TAX COURT



 MICHAEL L. THOMAS AND JULIE A. THOMAS, n.k.a. JULIE A. BROWNE,
                         Petitioners v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 22909-10.                         Filed February 26, 2013.



      Michael L. Thomas, pro se.

      Kelly Andrew Blaine, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      GERBER, Judge: Respondent determined income tax deficiencies of

$60,244 and $18,728 for petitioners’ 2006 and 2007 tax years, respectively.
                                         -2-

[*2] Respondent also determined accuracy-related penalties under section 6662(a)1

of $12,048.80 and $3,745.60 for 2006 and 2007, respectively. Michael L. Thomas

(petitioner) conceded the income tax deficiencies, and respondent agreed that

petitioner Julie A. Thomas, n.k.a Julie A. Browne, is not liable for the income tax

liabilities or penalties because of the application of section 6015. The sole issue

remaining for consideration is whether petitioner is liable for the accuracy-related

penalty for 2006 and/or 2007.

                                FINDINGS OF FACT

      Petitioners resided in Idaho at the time their petition was filed. In 2003

petitioner was working as the head of real estate acquisition for a group of

companies known as DBSI Group (DBSI). While there he met Don Steeves, who

managed the investor side of DBSI. Sometime later, petitioner started two

businesses, TIC Capital, LLC (TIC), and TICC Property Management, LLC

(TICC). TIC was an investment company that purchased real estate, and TICC

was a property management company supporting TIC. After purchasing real

estate, TIC would resell interests in said property to investors at a profit and TICC



      1
       Unless otherwise indicated, all section references are to the Internal Revenue
Code in effect for the years in issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure.
                                         -3-

[*3] would then manage that property. The purchase and resale of the real estate

usually occurred simultaneously.

      Steeves was a certified public accountant with a master’s degree in

accounting and seven years of specialized experience working in the real estate

investment business. Because of these qualifications, petitioner hired Steeves as an

independent contractor to act as the chief financial officer of TIC and as a managing

partner of TICC. Steeves also managed the investor and broker-dealer side of TIC.

His compensation, including accounting fees, was based on the financial success of

petitioner’s businesses.

      In addition to his duties as chief financial officer and managing partner,

Steeves prepared petitioners’ income tax returns for the years 2005, 2006, and

2007. However, he signed only the 2005 return. He oversaw and maintained all

the books, records, bank accounts, and other financial information from which the

income and expenses were derived and reported on petitioners’ returns. He

digitally maintained those records on his computer, and petitioner was not able to

readily access them. Petitioner did not see or review the books, and he relied

completely on Steeves to maintain his records and prepare their income tax

returns.
                                        -4-

[*4] The only information Steeves requested from petitioner each year was

statements of mortgage interest, petitioner wife’s Forms W-2, Wage and Tax

Statement, and interest income information, which petitioner provided.

      In September 2007 Steeves resigned from petitioner’s companies but

continued to perform the bookkeeping until March 2008 when that aspect was

turned over to an employee of petitioner. Steeves also continued to act as

petitioner’s accountant/representative until he was replaced in 2009.

      Late in 2008 respondent selected petitioners’ 2006 and 2007 income tax

returns for audit, and on December 8, 2008, petitioner executed a Form 2848,

Power of Attorney and Declaration of Representative, to enable Steeves to represent

petitioner before the Internal Revenue Service (IRS). The audit examination for

2006 and 2007 uncovered discrepancies and inadequacies in petitioner’s business

records.

      Respondent’s agent was unable to understand how the amounts on the 2006

and 2007 returns comported with petitioner’s business records. The books were

maintained on a cash basis, and Steeves had not properly recognized income. For

example, Steeves had not recognized as income certain amounts deposited during

2006 and 2007. The IRS seized on these discrepancies, which triggered the
                                        -5-

[*5] examination and generated the income differences that resulted in the income

tax deficiencies.

      Once petitioner had discovered the problems with Steeves’ accounting

practices he brought his concerns to Steeves’ attention in a letter dated December

12, 2008. In that letter petitioner admonished Steeves to “produce accounting

records to verify proper use of [company] funds.” Steeves resisted petitioner’s

requests to produce the companies’ records.

      In 2009 petitioner hired David R. Stewart to replace Steeves as his

representative in the audit examination. Stewart was a certified public accountant

with 34 years of experience working with small businesses and individual financial,

accounting, and tax matters. Stewart’s involvement with petitioner’s books and the

audit examination caused him to conclude that Steeves had done a “poor” job of

maintaining the records. Stewart worked with respondent’s agent to reconstruct

accounts and balance sheets to determine the actual amounts of income for the

taxable years. Stewart and respondent’s agent arrived at agreed-upon amounts of

reportable income, and, ultimately, income tax deficiencies for 2006 and 2007.

      Additionally, in a letter dated August 17, 2011, petitioner provided the City of

Boise Police Department with a lengthy list of criminal allegations against
                                          -6-

[*6] Steeves. The particulars of this list attempted to show that Steeves had

committed theft, fraud, and misappropriation of petitioner’s funds. Ultimately

petitioner filed a civil case against Steeves in the Fourth Judicial District Court for

Ada County. The alleged losses to petitioner totaled $1,202,016.

                                       OPINION

      The sole question we consider is whether petitioner is liable for the section

6662(a) accuracy-related penalty. Petitioner agrees that the income on his returns

was underreported but contends that the penalty should not apply because he

reasonably relied on his accountant/return preparer.

      A taxpayer may be liable for a 20% penalty on any underpayment of tax

attributable to negligence or disregard of rules or regulations or a substantial

understatement of income tax. Sec. 6662(a) and (b)(1) and (2). “Negligence” is

any failure to make a reasonable attempt to comply with the provisions of the

Internal Revenue Code, and “disregard” means any careless, reckless or intentional

disregard. Sec. 6662(c). A substantial understatement of income tax is an

understatement that exceeds the greater of 10% of the tax required to be shown on

the tax return or $5,000. Sec. 6662(d)(1)(A).2 The accuracy-related penalty

      2
        Petitioner’s concession of the $60,244 and $18,728 income tax deficiencies
establishes that there were substantial understatements for the 2006 and 2007 tax
                                                                        (continued...)
                                         -7-

[*7] under section 6662(a) does not apply to any portion of an underpayment if it is

shown that there was reasonable cause for that portion and that the taxpayer acted in

good faith with respect to that portion. Sec. 6664(c)(1); sec. 1.6664-4(b), Income

Tax Regs.; see also Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 98

(2000), aff’d, 299 F.3d 221 (3d Cir. 2002); secs. 1.6662-3(a), 1.6664-4(a), Income

Tax Regs.

         Accordingly, we consider whether there was reasonable cause for the

underpayments. Petitioner contends that his failure to include the unreported

income was reasonable because he relied on his tax adviser. We look to the

pertinent facts and circumstances, including the taxpayer’s efforts to assess the

proper tax liability, the knowledge and experience of the taxpayer, and the reliance

on the advice of a professional. Sec. 1.6664-4(b)(1), Income Tax Regs. When a

taxpayer relies on the professional judgment of a competent tax adviser who has

been provided with all necessary and relevant information, the taxpayer’s behavior

may be consistent with ordinary business care and prudence. United States v.

Boyle, 469 U.S. 241, 250-251 (1985).




         2
             (...continued)
years.
                                         -8-

[*8] To establish reasonable cause through reliance on the advice of a tax adviser,

the taxpayer must meet the following three-prong test, laid out in Neonatology

Assocs., P.A. v. Commissioner, 115 T.C. at 98-99: (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

relied in good faith on the adviser’s judgment. Finally, petitioner bears the burden

of proof with respect to the defenses to the accuracy-related penalties. See Higbee

v. Commissioner, 116 T.C. 438, 447 (2001).

      Petitioner met and became familiar with Steeves, his tax preparer, during

2003 when they began working together in a real estate investment business. After

working with Steeves for some time, petitioner began his own businesses, which

involved the same type of business activity in which he had worked with Steeves.

Steeves was a certified public accountant and had seven years of experience in the

same type of businesses as petitioner. Petitioner, having worked with Steeves and

being aware of his professional background and experience, exclusively relied upon

him to maintain his records, handle his business financial matters, and prepare his

returns. Under these circumstances we find that it was reasonable for petitioner to

perceive Steeves as a competent professional and to rely on him.
                                         -9-

[*9] Petitioner was reasonable in his reliance upon Steeves to correctly and

accurately prepare his books. Petitioner understood that those books were used in

the preparation of his 2006 and 2007 income tax returns. In addition, petitioners

provided Steeves with all other information Steeves requested that was necessary to

complete their returns, including the amounts of mortgage interest and interest

income and Forms W-2. Accordingly, petitioner was satisfied that Steeves had all

necessary and accurate information needed to correctly prepare petitioners’ income

tax returns. We find that petitioner’s efforts were sufficient to ensure his return

preparer had adequate and accurate information.

      Finally, we consider whether petitioner relied in good faith upon Steeves’

judgment. In the setting of this case, there came a time when petitioner had doubts

about the accuracy and quality of Steeves’ recordkeeping. Ultimately, petitioner

believed that Steeves was guilty of theft, fraud, and misappropriation of his money.

However, his doubts about Steeves’ ability or honesty did not arise until sometime

after the 2006 and 2007 income tax returns were filed and respondent was

conducting an audit examination of the returns. At the outset of that examination,

petitioner continued to believe in and rely upon Steeves, to whom petitioner gave a

power of attorney to represent him before the IRS.
                                       - 10 -

[*10] Under these circumstances we hold that petitioner has carried his burden of

showing reasonable reliance on the advice of a professional as a defense to the

accuracy-related penalties for 2006 and 2007. Accordingly, petitioner is not liable

for an accuracy-related penalty on any underpayment for 2006 or 2007.

      To reflect the foregoing,


                                                Decision will be entered

                                       under Rule 155.
