When the IRS assesses accuracy-related penalties under Section 6662 for substantial understatements or negligence, taxpayers often look to the reasonable cause and good faith defense under Section 6664(c) as their primary means of relief. Among the most commonly invoked forms of reasonable cause is reliance on the advice of a tax professional. But the Tax Court has made clear through a consistent line of decisions that the defense is neither automatic nor easy to establish. Understanding the three-part test and the circumstances in which it succeeds or fails is essential for taxpayers and their advisors.

The Statutory Framework

Section 6664(c)(1) provides that accuracy-related penalties under Section 6662 shall not be imposed with respect to any portion of an underpayment if the taxpayer shows that there was reasonable cause for the position taken on the return and that the taxpayer acted in good faith. The determination is made on a case-by-case basis, taking into account all pertinent facts and circumstances.^[1]

The regulations under Section 1.6664-4 elaborate that the most important factor is the extent of the taxpayer's effort to assess the proper tax liability. Reliance on a tax professional is one factor that may indicate reasonable cause and good faith, but it is not dispositive. The taxpayer must demonstrate that the reliance was itself reasonable under the circumstances.

The Three-Part Test

The Tax Court has distilled the reasonable reliance defense into three requirements. To prevail, the taxpayer must establish each of the following elements.

The Advisor Was Competent

First, the taxpayer must show that the advice came from a competent professional who had sufficient expertise to justify the taxpayer's reliance. This means the advisor must have been a licensed attorney, certified public accountant, enrolled agent, or other professional with recognized expertise in the relevant area of tax law. A taxpayer who relies on advice from someone without specialized tax knowledge, such as a general business consultant or financial planner without tax credentials, will have difficulty establishing this element.^[2]

The Taxpayer Provided Complete and Accurate Information

Second, the taxpayer must demonstrate that all necessary and accurate information was provided to the advisor. The defense fails if the taxpayer withheld material facts, provided misleading information, or failed to disclose circumstances that would have affected the advisor's analysis. Courts have been particularly skeptical of the defense where the taxpayer had sophisticated business knowledge that should have prompted additional disclosure, or where the taxpayer cherry-picked favorable facts while omitting unfavorable ones.

The Taxpayer Actually Relied on the Advice

Third, the taxpayer must show that it actually relied in good faith on the advisor's judgment. This requires more than simply hiring an advisor and following whatever recommendation was made. The taxpayer must have genuinely sought out and considered the advice as part of its decision-making process. A taxpayer who had already decided on a course of action before consulting the advisor, or who consulted the advisor only to create the appearance of professional support, will not satisfy this element.^[3]

Common Pitfalls

Several recurring patterns in Tax Court decisions illustrate how the defense can fail. Taxpayers who rely on promoters of aggressive tax shelters rarely succeed, because the promoter's financial interest in selling the transaction undermines the independence that the defense requires. Taxpayers who sign returns without reviewing them or understanding the positions taken on them may be found to have not exercised reasonable care. Taxpayers who continue to take aggressive positions after an advisor has expressed reservations or qualified their opinion may be found to have not relied in good faith on the advice.

The Tax Court has also emphasized that reliance on an information return, such as a Form 1099 or Schedule K-1, does not by itself establish reasonable cause. While an inaccurate information return may be relevant to the reasonable cause analysis, the taxpayer still bears the burden of demonstrating that its overall effort to determine the correct tax liability was reasonable.

Building a Defensible Position

For taxpayers and their advisors, several practical steps can strengthen the reasonable cause defense if it is ever needed. Engage a qualified tax professional with specific expertise in the relevant area before the transaction or position is executed, not after the fact. Provide the advisor with complete information about the transaction, including its business purpose, the parties involved, and any potential risks. Obtain the advice in writing, documenting the analysis and the conclusions reached. Retain the written advice and all supporting documentation as part of the tax file for the relevant year.

For tax controversy purposes, contemporaneous documentation is far more persuasive than after-the-fact reconstruction. A taxpayer who can produce a detailed memorandum from a qualified advisor, issued before the return was filed, analyzing the specific issue and concluding that the position is supportable, has a significantly stronger defense than one who relies on oral recollections years after the fact.

Understanding the parameters of the reasonable cause defense empowers taxpayers to protect themselves proactively. By engaging competent counsel, providing full disclosure, and documenting their reliance, taxpayers can minimize their exposure to penalties even when the IRS ultimately disagrees with the positions taken on their returns.