US Court of Appeals for the Eighth Circuit Archives

Eighth Circuit Applies Subjective Standard to Reasonable Basis Penalty Defense

On April 24, 2020, the US Court of Appeals for the Eighth Circuit published its opinion in Wells Fargo & Co. v. United States, No. 17-3578, affirming a district court’s holdings that the taxpayer was not entitled to certain foreign tax credits and was liable for the negligence penalty for claiming the credits. Much has been written about the substantive issue, which we will not discuss here. Instead, we focus on the Eighth Circuit’s divided analysis relating to the reasonable basis defense to the negligence penalty.

In Wells Fargo, the taxpayer relied solely on the reasonable basis defense to the government’s assertion of penalties. Under Internal Revenue Code (IRC) section 6662(b)(1), a taxpayer is liable for penalty of 20% of an underpayment of its taxes attributable to its “negligence.” Various defenses are potentially applicable to the negligence penalty, which we recently discussed in detail here. One such defense is if the taxpayer can show it had a “reasonable basis” for its position. Under Treas. Reg. § 1.6662-3(b), this defense applies if the taxpayer’s return position was “reasonably based on” certain authorities specified in the regulations.

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Kovel Protections Upheld | Government Loses Aggressive Arguments for Waiver of Privilege for Controversy Advice

On October 27, the US District Court for the District of Minnesota issued an opinion in United States v. Adams, No. 0:17-cr-00064-DWF-KMM (D. Minn. Oct. 27, 2018), addressing attorney-client privilege issues relevant to accountants working alongside tax attorneys. The court adopted a narrow, nuanced view of the waiver that applies when the taxpayer discloses an accountant’s work to the Internal Revenue Service (IRS) by filing an amended return.

In Adams, the taxpayer is facing a 17 count superseding indictment in which the government alleges he spearheaded a scheme to defraud investors in two companies and to embezzle corporate funds for his personal benefit. In late 2017, the government added three counts of tax evasion to the indictment, alleging that amended returns the taxpayer filed in late 2011 for the 2008, 2009 and 2010 tax years were willfully false under IRC § 7206(1).

The addition of the tax evasion charges is significant for the government’s arguments for waiver of privilege and work-product protection. It appears that the taxpayer filed the amended returns at issue in late 2011 under advice of counsel, working with the taxpayer’s accountant under a Kovel arrangement. (We have previously discussed the scope of Kovel protections here.) In our experience, filing of amended returns in advance of a criminal investigation or trial is one potential strategy to demonstrate good faith and lack of criminal intent and, if combined with payment, amended returns may have the added benefit of reducing the tax loss at issue in a criminal case. Of course, every case is different, but it appears this may have been the strategy at work in Adams. (more…)