No Lady Doctor Exception to Late File Penalty

Originally published on Passive Activities and Other Oxymorons on June 10th, 2011.
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Pamela B. Russell v. Commissioner, TC Memo 2011-81

I've mentioned from time to time why I am ill qualified to work for the IRS.  One of the reasons is my tendency to decide that people deserve a break for reasons not supported by any statute or regulations.  I think Dr. Russell who cares for sick babies all day long deserved a break here.  While doing this she had to put up with the indiginity of having a husband who called his waterproofing endeavors the Basement Doctor.  (Apparently its a common name in the industry so maybe it didn't bother her).  Here are some of the basic facts :

Petitioner is a medical doctor in the neonatology unit at the Children's Hospital of Philadelphia, where she worked as an employee for all relevant periods. Petitioner is and was married to Bertram Royce Russell (Mr. Russell) at all relevant times. Petitioner and Mr. Russell (hereinafter sometimes referred to as the couple) maintained separate finances and separate checking accounts. Petitioner was responsible for handling the family's day-to-day living expenses, and Mr. Russell took primary responsibility for their children's tuition and college savings, the couple's retirement savings, and all tax matters. During the periods in issue Mr. Russell owned an interest in Basement Doctor, Inc. (Basement Doctor), a business that waterproofed basements.

It turned out that leaving long term finances and tax compliance to her husband might not have been the optimal family division of labor. Mr.Russell found Mr. Bagdis to help them with some of those issues.  Mr. Bagdis made a bang up first impression:

The Internal Revenue Service (IRS) examined the couple's returns  at some point after Mr. Bagdis had assumed his role as their financial adviser and tax attorney. Mr. Bagdis and his law firm represented petitioner and Mr. Russell during that examination. The examination was resolved in the couple's favor, and they received a refund from the IRS. The successful resolution of the IRS examination by Mr. Bagdis and his firm gave petitioner confidence in Mr. Bagdis, leading her to believe that he was extremely competent. Petitioner relied on Mr. Bagdis for tax advice.

It turns out that the masterful audit representation was the high point of the relationship.

Mr. Bagdis advised petitioner during early 1999 that she should submit a Form W-4, Employee's Withholding AllowanceCertificate, to Children's Hospital claiming that she was exempt from income tax withholding for 1999. In accordance with Mr. Bagdis' advice, petitioner signed a Form W-4 claiming the exemption on January 27, 1999. Mr. Bagdis' law firm submitted the Form W-4 to Children's Hospital, accompanied by a letter from the firm.

Petitioner was required to file a Federal income tax return for 1999. However, petitioner did not timely file her 1999 return because Mr. Bagdis advised her that her husband's business, Basement Doctor, had sustained significant losses during 1999 that would offset the couple's income from petitioner's salary, but that those losses needed to be calculated exactly before the couple filed their return. Petitioner followed Mr. Bagdis' advice and did not timely file her 1999 tax return. On February 21, 2001, respondent sent a delinquency notice to petitioner, informing her that respondent's records showed she had not filed a tax return for 1999 and asking her to file that return. The couple filed a joint tax return for their 1999 tax year on October 31, 2001. On their 1999 return, the couple reported $153,786 in wages and salary income, but the couple reported a loss of $100,000 from Mr. Russell's business. The couple reported an overpayment of $16,289 for 1999, and they received a refund of $16,417.57 on December 24, 2001.

Petitioner likewise was required to file a return for 2001, the year in issue, but was again advised by Mr. Bagdis not to file her return until he had calculated the exact losses from her husband's business. Petitioner understood that Basement Doctor was divided into three “parts” by State, one part each in Delaware, Pennsylvania, and New Jersey. Mr. Bagdis explained to petitioner that Basement Doctor's 1999 losses were from the Pennsylvania business, the 2000 losses were from the Delaware business, and the 2001 losses would be from the New Jersey business. Mr. Bagdis told petitioner that the losses from Basement Doctor's New Jersey business would be even greater than the losses from Pennsylvania and Delaware. Petitioner knew that her 2001 return was due on April 15, 2002, but, in accordance with Mr. Bagdis' instructions, petitioner did not file her 2001 return when it was due.

At some point during October 2004, IRS agents visited petitioner while she was working at Children's Hospital to serve her with a subpoena for records.

There you go with why I am not working for the IRS.  Who wants to be the guy who serves the subpoena on the lady doctor taking care of the sick babies ? Surely I would have pleaded that I needed to go drown some puppies or something.

Around the same time, petitioner understood that the IRS had also seized files from Mr. Bagdis' offices. After she received a subpoena from the IRS and learned of the IRS raid on Mr. Bagdis' offices, she became very concerned and asked to meet with Mr. Bagdis as soon as possible. When petitioner met with Mr. Bagdis, she received the same explanation from him: he expected that large losses from Basement Doctor would offset her salary income from 2001 and that she should wait to file her return until Mr. Bagdis could calculate the exact numbers. Petitioner continued to rely on Mr. Bagdis' advice.

This is the point where my sympathy for Dr. Russell starts turning into impatience.  I hate to state the obvious but figuring out the Schedule C loss of a small service business is not rocket science or brain surgery.  It's not even neonatology.  It's also not something to be entrusted to a lawyer particularly one who after telling you you have to wait for an exact number comes up with exactly $100,000.  Here is another little piece of advice.  When your attorney tax preparer can't get it done because the feds have seized the records you need to call another attorney.

On or about April 6, 2005, Mr. Bagdis sent petitioner and her husband a letter regarding their 2001, 2002, and 2003 taxes. In the letter, Mr. Bagdis informed the couple that he no longer had access to many of the couple's records because his files had been seized by Federal agents. However, he told the couple that he had nevertheless attached “pro forma” Forms 1040, U.S. Individual Income Tax Return, for the couple as married, filing separately. In the letter, Mr. Bagdis explained that the “pro forma” returns were based on “limited historical data” available in some computer files to which he still had access, as well as some new information supplied by the couple. Mr. Bagdis informed the couple that although the “pro forma” returns he had prepared were for the couple filing separately, they probably would have a lower tax liability if they filed a joint return. Specifically, he told the couple that if they filed a joint return for 2001, the Basement Doctor losses would offset petitioner's salary income and result in a tax liability of close to zero.

Mr. Bagdis reassured her that there was no problem with the return being late since there would be a refund.

On or about April 25, 2005, respondent sent petitioner a letter informing her that respondent still had not received her income tax return for 2001 and providing petitioner with respondent's calculation of petitioner's income tax liability for 2001. Upon receipt, petitioner or Mr. Russell delivered the letter to Mr. Bagdis. At that time Mr. Bagdis again explained to petitioner that he was waiting until all of the losses from Basement Doctor had been captured.

Can't you just picture these squirrely little creatures called "losses" racing around an enormous basement while someone who looks like Marcus Welby chases them with a butterfly net.

Mr. Bagdis wrote a letter responding to the IRS' letter for petitioner, which petitioner then typed on her stationery and sent to respondent on or about May 24, 2005. The letter petitioner signed reported that most of her records had been seized by Federal agents when they raided Mr. Bagdis' offices. The letter explained that petitioner was therefore unable to access the records related to her 2001 tax year and that “there is no further action that can be taken at this time.”

Petitioner apparently received at least one more letter from the IRS, dated August 30, 2005, which also included a proposed tax return for 2001. Petitioner again responded to the IRS with a letter drafted by Mr. Bagdis and stating that petitioner did not have access to the records she needed to prepare her 2001 tax return since those records had been seized. The letter objected to the IRS' proposed tax return because it did not include the losses from Basement Doctor, which the letter stated were expected to offset petitioner's remaining income and reduce her tax obligation to “near zero.”

Sometime during December 2005, petitioner received a call from John Pease, an attorney involved in the investigation of Mr. Bagdis, who advised her that she should retain separate counsel and should not be relying on Mr. Bagdis.  As a result of the conversation with John Pease, petitioner began to doubt Mr. Bagdis' advice, and she did retain separate counsel, Thomas Bergstrom (Mr. Bergstrom). From the time around December 2005 when she first spoke with Mr. Bergstrom, petitioner had no further interactions with Mr. Bagdis except to request that he withdraw as her attorney.

Petitioner first met with Mr. Bergstrom, a criminal defense attorney, during January 2006. At the time petitioner retained Mr. Bergstrom, both Mr. Bagdis and Mr. Russell were under criminal investigation by the U.S. Attorney's Office for the Eastern District of Pennsylvania. Mr. Bergstrom was concerned that the investigation might also expand to include petitioner. Over the next 11 months, Mr. Bergstrom met with the U.S. Attorney's Office on several occasions, and he hired a certified public accountant to prepare a tax return for petitioner's 2001 tax year. It took 11 months for Mr. Bergstrom, the certified public accountant, and petitioner to calculate and pay petitioner's 2001 tax liability.

Dr. Russell was in Tax Court over late file / late pay penalties.  Those squirrly little losses in the basement turned out to be on the elusive side so it did matter that she filed and paid late.  I would have let her go but the Tax Court apparently didn't go for the lady doctor sick baby exception.

We find it more plausible to conclude that petitioner was relying on Mr. Bagdis' advice that no tax would be due for 2001. She had relied on his advice when filing late tax returns for the 2 prior years, and she had received a refund both times, as Mr. Bagdis had said she would. Petitioner was, in effect, relying on a scenario that she would also be entitled to a refund for 2001. Unfortunately for petitioner, her hoped-for scenario did not materialize, and she owed tax for 2001. As the Court of Appeals stated in Jackson v. Commissioner, 864 F.2d 1521, 1527 [63 AFTR 2d 89-539] (10th Cir. 1989), affg. 86 T.C. 492 (1986): “a presumed expert's advice concerning the amount of tax owed can be erroneous, and the taxpayer must bear the risk of that error when he fails to comply with a known duty to file a return.” See also Estate of Hollo v. Commissioner, T.C. Memo. 1990-449 [¶90,449 PH Memo TC], affd. without published opinion 945 F.2d 404 (6th Cir. 1991); Gore v. Commissioner, T.C. Memo. 1987-425 [¶87,425 PH Memo TC]. As a matter of law, it was unreasonable for petitioner to file her tax return late on the basis of Mr. Bagdis' advice that no additions would be due because she would owe no tax.

Whether Petitioner's Reliance on Her Adviser's Advice That It Was Necessary To Have Accurate Information Constitutes Reasonable Cause Petitioner's reliance claim includes the contention that Mr. Bagdis advised her that she should wait until she had complete information about Mr. Russell's business losses before filing her return.  We have held that reliance on an attorney's advice that it was necessary to wait for complete information before filing a return does not constitute reasonable cause for a delay in filing.

It turns out that getting nailed for some late file/late pay penalties was pretty mild given the maelstorm that Dr. Russell had found herself on the edge of.  Last year after trial and a six year investigation Mr. Bagdis was sentenced to 10 years in prison.  There was radioligist convicted along with him.  Dr. Betram Russell was sentenced to 66 months.  I stick pretty much with tax research so I leave it to an ambitious reader to trace whether there is a family connection.