An owner of a California health care company was found liable by the Tax Court for an accuracy-related penalty for a deduction he claimed in spite of his CPA's advice against it.
Larry Wadsworth was a general partner of Gold Coast Medical Services (GCMS), which provided medical products and services to beneficiaries of the California Medical Assistance Program in 2001 and 2002. In 2003, the California Department of Health Services (CDHS) audited GCMS and found the company had engaged in "discriminatory billing." The state agency ordered the partnership to repay $2.3 million for the two years. Wadsworth and GCMS sought to amend their federal tax returns to reflect the repayment amount as a contingent liability, even though the company's appeal of the demand was still pending before the CDHS. Keith Borges, who the Tax Court noted is a CPA and member of the AICPA and California Society of Certified Public Accountants, had prepared the original tax returns for both the partnership and Wadsworth. After researching the request, Borges declined to amend the returns absent any supporting information or legal authority from Wadsworth. Instead of providing it, Wadsworth turned to an attorney representing GCMS in its appeal before the CDHS. The attorney then engaged a non-CPA preparer to amend the returns, resulting in more than $200,000 in tax refunds to Wadsworth for the two tax years. Meanwhile, CDHS granted GCMS's appeal and overturned the state's repayment demand. The IRS examined Wadsworth's amended returns and issued deficiencies in the amount of the tax refunds, plus accuracy-related penalties totaling $40,668. Wadsworth paid the deficiencies but contested the penalties.
The Tax Court ruled that the amended Schedule K-1 attached to the amended returns was not adequate disclosure to avoid the penalty, as the taxpayer argued. The court noted that it was not accompanied by Form 8275, Disclosure Statement, or other explanation of the basis of the changes. Moreover, the position lacked a reasonable basis as required by Treas. Reg. § 1.6662-4(e)(2)(i), the Tax Court said.
The taxpayer said he had elected a "modified cash" method of accounting but presented no evidence that the amount was paid. An accrual-method taxpayer would not be able to deduct a contested liability except under the conditions of IRC § 461(f), that is, having made a transfer to provide for the satisfaction of a liability that remained contested after the transfer. Moreover, the taxpayer lacked reasonable cause and did not act in good faith, the court found. "We find that Mr. Borges' refusal to amend the returns should have raised a red flag for petitioners, but petitioners disregarded that warning," the court said.