Accuracy Related Penalty
Negligence of Rules
Audit Techniques Guide
Chapter 7: Reasonable Cause and Good Faith – IRC
Reasonable Cause & Good Faith Exception -
Section 6664(c) provides an exception, applicable to all types
of taxpayers, to the imposition of any accuracy-related penalty if the
taxpayer shows that there was reasonable cause and the taxpayer acted in
good faith. Special rules, described below, apply to items of a
corporation attributable to a tax shelter resulting in a substantial
The determination of whether the taxpayer acted with
reasonable cause and in good faith is made on a case-by-case basis,
taking into account all relevant facts and circumstances. See
Treas. Reg. § 1.6664-4(b)(1). The most important factor is the
extent of the taxpayer’s effort to assess the taxpayer’s proper tax
liability. Other factors to consider are the taxpayer’s
experience, knowledge, sophistication and education and the taxpayer’s
reliance on the advice of a tax advisor.
All relevant facts, including the nature of the tax
investment, the complexity of the tax issues, issues of independence of
a tax advisor, the competence of a tax advisor, the sophistication of
the taxpayer, and the quality of an opinion, must be developed to
determine whether the taxpayer was reasonable and acted in good faith.
Examples of types of conduct that may, or may not,
constitute reasonable cause in this context are described in Exhibit
On December 30, 2003, Treasury and the Service amended
the IRC § 6664 regulations to provide that the failure to disclose a
reportable transaction, on Form 8886, “Reportable Transaction
Disclosure Statement,” is a strong indication that the taxpayer did
not act in good faith with respect to the portion of an underpayment
attributable to a reportable transaction, as defined under IRC § 6011.
See below for a discussion of reliance on advice, in general, and
reportable transactions, in particular. In addition, Treas. Reg.
§ 1.6664-4(c)(iii) provides that a taxpayer may not rely on an opinion
or advice that a regulation is invalid to establish that the taxpayer
acted with reasonable cause and good faith unless the taxpayer
adequately disclosed, in accordance with Treas. Reg. § 1.6662-3(c)(2),
the position that the regulation in question is invalid.
Taxpayer’s effort to assess the proper tax
Generally, the most important factor in determining whether the
taxpayer has reasonable cause and acted in good faith is the extent of
the taxpayer’s effort to assess the proper tax liability. See
Treas. Reg. § 1.6664-4(b)(1); see also Larson v. Commissioner, T.C.
Memo 2002-295. For example, reliance on erroneous information
reported on an information return indicates reasonable cause and good
faith, provided that the taxpayer did not know or have reason to know
that the information was incorrect. Similarly, an isolated
computational or transcription error may indicate reasonable cause and
Generally, there is reasonable cause and good faith if
the taxpayer relies on erroneous information inadvertently included in
data compiled by various divisions of a multidivisional corporation or
in financial books and records prepared by those divisions. The
corporation, however, must have employed internal controls and
procedures, reasonable under the circumstances, which were designed to
identify factual errors. See, e.g., Vandeyacht v. Commissioner,
T.C. Memo. 1994-148 (taxpayers not required to duplicate work done by
bookkeepers and accountants; ordinary business care and prudence require
taxpayers to take precautions to prevent inaccuracies in income tax
returns and books and records used to prepare them).
Experience, Knowledge, Sophistication and
Education of Taxpayer
Circumstances that may suggest reasonable cause and good faith
include an honest misunderstanding of fact or law that is reasonable in
light of the facts, including the experience, knowledge, sophistication
and education of the taxpayer. The taxpayer’s mental and
physical condition, as well as sophistication with respect to the tax
laws at the time the return was filed, are relevant in deciding whether
the taxpayer acted with reasonable cause. See Kees v.
Commissioner, T.C. Memo. 1999-41.
If the taxpayer is misguided, unsophisticated in tax
law, and acts in good faith, a penalty is not warranted. See
Collins v. Commissioner, 857 F.2d 1383 (9th Cir. 1988); cf. Spears v.
Commissioner, T.C. Memo. 1996-341 (court was unconvinced by the claim of
highly sophisticated, able, and successful taxpayers that they acted
reasonably in failing to inquire about their investment and simply
relying on offering circulars and accountant, despite warnings in
offering materials and explanations by accountant about limitations of
Reliance on Advice
Reliance upon a tax opinion provided by a tax advisor may serve
as a basis for the reasonable cause and good faith exception to the
accuracy-related penalty. The reliance, however, must be
objectively reasonable. For example, the taxpayer must supply the
advisor with all the necessary information to assess the tax matter.
Similarly, if the advisor suffers from a conflict of interest or lack of
expertise that the taxpayer knew or should have known, the taxpayer
might not have acted reasonably in relying on that advisor. See
Treas. Reg. § 1.6664-4(c); Neonatology Associates, P.A. v.
Commissioner, 299 F.3d 221 (3rd Cir. 2002). The advice also must
be based on all pertinent facts and circumstances and the law as it
relates to those facts and circumstances.
The advice must not be based on unreasonable factual
or legal assumptions (including assumptions as to future events) and
must not unreasonably rely on the representations, statements, findings,
or agreements of the taxpayer or any other person. For example,
the advice must not be based on a representation or assumption which the
taxpayer knows, or has reason to know, is unlikely to be true, such as
an inaccurate representation or assumption as to the taxpayer’s
purposes for entering into a transaction or for structuring a
transaction in a particular manner. See Treas. Reg. §
1.6662-4(g)(4)(ii). Similarly, the advice must not be based on an
assumption that the transaction has a business purpose other than tax
Whether a taxpayer reasonably relied on an opinion or
advice cannot be determined without reviewing the opinion(s). At
times, a taxpayer may refuse to turn over an opinion the taxpayer claims
to have relied on or the taxpayer may assert a privilege claim. If
the taxpayer does so, seek the assistance of subject matter technical
advisors or local Chief Counsel attorneys.
The failure of a taxpayer to disclose a reportable transaction
is a strong indication that the taxpayer did not act in good faith with
respect to the portion of an underpayment attributable to a reportable
transaction, as defined under IRC § 6011. A taxpayer may argue
that the failure to disclose was based on the advice of a tax advisor
concluding that the transaction was not reportable.
A taxpayer’s reliance on an opinion that a
transaction is not reportable must be reasonable and made in good faith.
An opinion providing that a transaction is not reportable, and,
therefore, need not be disclosed is subject to the same scrutiny as the
underlying tax opinion or advice. The taxpayer must demonstrate
reasonable cause and good faith as discussed in this ATG.
Where a tax benefit depends on nontax factors, the taxpayer has
a duty to investigate the underlying factors rather than simply relying
on statements of another person, such as a promoter. See Novinger
v. Commissioner, T.C. Memo. 1991-289. Further, if the tax advisor
is not versed in these nontax matters, mere reliance on the tax advisor
does not suffice. See Addington v. United States, 205 F.3d 54 (2d
Cir. 2000); Collins v. Commissioner, 857 F.2d 1383 (9th Cir. 1988).
Although a tax advisor’s lack of independence is not alone a
basis for rejecting a taxpayer's claim of reasonable cause and good
faith, the fact that a taxpayer knew or should have known of the
advisor's lack of independence is strong evidence that the taxpayer may
not have relied in good faith upon the advisor's opinion. Goldman
v. Commissioner, 39 F.3d 402 (2nd Cir. 1994); Pasternak v. Commissioner,
990 F.2d 893, 903 (6th Cir. 1993)(finding reliance on promoters or their
agents unreasonable, as “advice of such persons can hardly be
described as that of ‘independent professionals’”); Roberson v.
Commissioner, 98-1 U.S.T.C. 50,269 (6th Cir. 1998) (court dismissed
taxpayer’s purported reliance on advice of tax professional because
professional’s status as “promoter with a financial interest” in
the investment); Rybak v. Commissioner, 91 T.C. 524, 565 (1988)
(negligence penalty sustained where taxpayers relied only upon advice of
persons who were not independent of promoters); Illes v. Commissioner,
982 F.2d 163 (6th Cir. 1992) (taxpayer found negligent reliance upon
professional with personal stake in venture not reasonable); Gilmore
& Wilson Construction Co. v. Commissioner, 99-1 U.S.T.C. 50,186
(10th Cir. 1999) (taxpayer liable for negligence since reliance on
representations of the promoters and offering materials unreasonable);
Neonatology Associates, P.A. v. Commissioner, 299 F.3d 221 (3rd Cir.
2002)(reliance may be unreasonable when 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
Similarly, the fact that a taxpayer consulted an
independent tax advisor is not, standing alone, conclusive evidence of
reasonable cause and good faith if additional facts suggest that the
advice is not dependable. Edwards v. Commissioner, T.C. Memo.
2002-169; Spears v. Commissioner, T.C. Memo. 1996-341, aff’d 98-1 USTC
50,108 (2d Cir. 1997). For example, a taxpayer may not rely on an
independent tax advisor if the taxpayer knew or should have known that
the tax advisor lacked sufficient expertise, the taxpayer did not
provide the advisor with all necessary information, the information the
advisor was provided was not accurate, or the taxpayer knew or had
reason to know that the transaction was “too good to be true.”
Baldwin v. Commissioner, T.C. Memo. 2002-162; Spears v. Commissioner,
T.C. Memo. 1996-341, aff’d 98-1 USTC 50,108 (2d Cir. 1997).
Special Rules for Tax Shelter items of a
If a corporate taxpayer has a substantial understatement that
is attributable to a tax shelter item, the accuracy-related penalty
applies to that portion of the understatement unless the reasonable
cause and good faith exception applies. See Treas.
Reg. § 1.6664-4(f) at Exhibit 8. The determination of whether
a corporation acted with reasonable cause and good faith is based on all
pertinent facts and circumstances. Treas. Reg. § 1.6664-4(f)(1).
A corporation's legal justification may be taken into
account in establishing that the corporation acted with reasonable cause
and in good faith in its treatment of a tax shelter item, but only if
there is substantial authority within the meaning of Treas. Reg. §
1.6662-4(d) for the treatment of the item and the corporation reasonably
believed, when the return was filed, that the treatment was more likely
than not the proper treatment. Treas. Reg. § 1.6664-4(f)(2)(i)(B).
The reasonable belief standard is met if:
the corporation analyzed pertinent facts and
relevant authorities to conclude in good faith that there would be
a greater than 50 percent likelihood (“more likely than not”)
that the tax treatment of the item would be upheld if challenged
by the IRS; or
the corporation reasonably relied in good faith on
the opinion of a professional tax advisor who analyzed all the
pertinent facts and authorities, and who unambiguously states that
there is a greater than 50 percent likelihood that the tax
treatment of the item will be upheld if challenged by IRS.
(See Treas. Reg. § 1.6664-4(c) for requirements with respect to
the opinion of a professional tax advisor).
Satisfaction of the minimum requirements for legal
justification is an important factor in determining whether a
corporation acted with reasonable cause and in good faith, but not
necessarily dispositive. See Treas. Reg. § 1.6664-4(f)(3).
For example, the taxpayer’s participation in a tax shelter lacking a
significant business purpose or the taxpayer is claiming benefits that
are unreasonable in comparison to the taxpayer’s investment should be
considered. Failure to satisfy the minimum standards will,
however, preclude a finding of reasonable cause and good faith based (in
whole or in part) on a corporation’s legal justification. See
Treas. Reg. § 1.6664-4(f)(2)(i).
If a corporation does not claim legal justification,
then other facts and circumstances also may be taken into account
regardless of whether the minimum requirements for legal justification
are met. See Treas. Reg. § 1.6664-4(f)(4).