In Carlson v. United States, Case No. 12-13736 (decided June 13, 2014), the United States Court of Appeals for the Eleventh Circuit addressed several important issues regarding when a tax return preparer is liable for penalties for preparing returns that understate a client’s tax liability.

Ms. Carlson worked as a tax return preparer for two different companies. The IRS conducted audits of hundreds of tax returns she had prepared for clients and determined that 40 contained deductions that could not be substantiated. The IRS assessed a 15 percent penalty against Ms. Carlson for aiding and abetting the understatement of tax liability. Ms. Carlson paid the penalty and filed a civil action seeking a refund. Ms. Carlson lost at trial, but the Eleventh Circuit reversed the judgment against her.

On appeal, the Court addressed two significant issues. First, the Court held that of the imposition of a penalty required the Government to prove that the tax preparer have actual knowledge that the return contained an understatement of tax liability. Therefore, the imposition of penalties was a claim of fraud and fraud needed be proven by clear and convincing evidence. The burden of proof was higher than the traditional civil burden of proof of preponderance of the evidence.

Second, the Court held that, for a number of the returns at issue, the Government had failed to produce any evidence that Ms. Carlson had engaged in fraud. For a number of returns, the Government presented evidence only that the return was erroneous, not that Ms. Carlson knew that the returns understated the tax liability. That the returns contained understatements was not circumstantial evidence that Ms. Carlson knew that those returns contained the understatement. Opinion, p. 15.

This decision is an important precedent for return preparers involved in disputes over penalties for erroneous returns. It establishes a high threshold for imposing such penalties.

For more information on the United States Court of Appeals rulings on tax liabilities, contact your Appellate Counsel at Smith, Gambrell & Russell.