United States District Court, Northern District of Illinois, E.D
May 18, 1983
JOHN BROCKHOUSE, PLAINTIFF,
UNITED STATES OF AMERICA, DEFENDANT.
The opinion of the court was delivered by: Decker, District Judge.
MEMORANDUM OPINION AND ORDER
Plaintiff, John Brockhouse ("Brockhouse"), has brought this pro
se action against the United States of America ("United States")
seeking a refund of $15.00 paid toward the satisfaction of a
$100.00 tax preparer penalty assessed against him by the Internal
Revenue Service ("IRS"). The penalty was imposed on Brockhouse, a
Certified Public Accountant, under 26 U.S.C. § 6694(a) ("section
6694(a)") for his alleged "negligent or intentional disregard of
rules and regulations" regarding the preparation of the 1978
individual income tax return of Robert and Sarah Busch. The
jurisdiction of this court is invoked pursuant to
28 U.S.C. § 1346(a)(1).*fn1 Currently pending are the parties'
cross-motions for summary judgment.
The facts giving rise to this action have been stipulated by
the parties, and may be briefly summarized. Plaintiff Brockhouse
became an Illinois Certified Public Accountant on March 18, 1964,
and has practiced public accounting in Chicago since June, 1965.
In January, 1979, he was hired by the CPA firm of Goldman, Weiss,
Gelman & Sered ("Goldman, Weiss"). For several years, Goldman,
Weiss had prepared the income tax returns of Rubert-Busch, M.D.,
S.C. ("Rubert-Busch"), an Illinois professional corporation
engaged in forensic medicine, and those of Dr. Robert Busch, the
corporation's sole shareholder. Plaintiff's first contacts with
the tax affairs of these clients, however, was not until March,
According to the stipulation, Goldman, Weiss had "adopted the
practice" (¶ 10) of sending a data questionnaire to its
individual income tax clients which was to be completed by the
client and returned to the firm or used by the client as a guide
in collecting the information necessary for the firm to prepare
the returns. Such a questionnaire was not utilized, however, in
preparing the 1978 return of Dr. and Mrs. Busch. Instead, the
information necessary to prepare the return was supplied to
Brockhouse by Rubert-Busch's bookkeeper. The information was then
entered on input sheets of an outside computer service bureau.
These sheets were reviewed by Brockhouse, who compared the
entries with the data submitted by the client and the information
shown on the prior year's return. There were no items shown on
the prior year's return which were not accounted for in the
preparation of the 1978 individual return. The 1978 returns were
eventually signed by Brockhouse, delivered to the bookkeeper and
then given to Dr. Busch.
The corporate return of Rubert-Busch for the fiscal year ending
February 29, 1979, was the first such return prepared by
Brockhouse. For this return, the bookkeeper completed a trial
balance sheet, which was then submitted to Goldman, Weiss. This
trial balance sheet showed payments for interest expense by
Rubert-Busch, but did not indicate to whom these payments were
submitted. Since it was not necessary to list the names of the
recipients of the interest payments in the corporate return,
plaintiff did not make any such inquiries. According to the
stipulation, the interest expenses incurred by Rubert-Busch arose
from the company's periodic need to borrow funds, which in turn
stemmed from the fact that expenses were often paid several years
prior to the collection of revenues. While the necessary funds
were usually secured from the Michigan Avenue National Bank,
Rubert-Busch had begun to borrow from Dr. Busch as interest rates
rose in the late 1970's.
In May, 1980, Jolynn Cogdill ("Cogdill"), an IRS agent, began
an examination of the corporate return of Rubert-Busch for the
fiscal year ending February 28, 1979. In connection with this
examination, Cogdill requested and received copies of Dr. Busch's
1978 and 1979 individual returns. The corporation's interest
expense account was one of several for which Cogdill requested an
analysis. Brockhouse proceeded to examine the general ledger and
disbursements journal, and discovered that interest had been paid
not only to Michigan Avenue National Bank but also to Dr. Busch.
The latter had received interest in the amount of $15,291.20 in
1978, and $21,396.17 in 1979, none of which had been included as
income in Dr. Busch's individual returns. Brockhouse reported
these omissions to Cogdill at their next meeting,
and explained that one of the reasons for his failing to include
the interest paid was that no similar item had appeared on Dr.
Busch's 1977 individual return.
At meetings held in December, 1980, and February, 1981, in
connection with the audit of Dr. Busch's 1978 and 1979 individual
returns, Cogdill proposed to assess Dr. Busch a 50% penalty under
26 U.S.C. § 6653(b) because of his failure to include as income
the interest paid to him during 1978 and 1979 by the corporation.
At the February meeting, Brockhouse argued against the penalty,
stating: "If anyone is negligent, I'm the one." The proposed
penalty against Dr. Busch was later dropped entirely with respect
to 1978, and reduced to a 5% penalty with respect to 1979.
On December 17, 1981, a $100.00 tax preparer penalty with
respect to the 1978 return was assessed against Brockhouse.
Pursuant to 26 U.S.C. § 6694(c), $15.00 was paid by Brockhouse.
He then filed a Claim for Refund, which was disallowed on June
15, 1982. On June 22, 1982, Brockhouse filed the instant
complaint. The United States subsequently filed a counterclaim
for the remaining unpaid balance of the 1978 penalty; it also
sought to reduce to judgment a penalty assessed against
Brockhouse on June 24, 1982, for his preparation of Dr. Busch's
1979 return. The 1979 penalty has now been paid in full, and the
United States has agreed to dismiss its counterclaim, without
prejudice, with respect to both 1978 and 1979.
The sole question presented in this action is whether
Brockhouse is entitled to have the penalty levied against him
pursuant to section 6694(a) set aside and his $15.00 refunded.
The starting point for evaluating this issue is the actual
language of section 6694(a), which provides:
"If any part of any understatement of liability with
respect to any return or claim for refund is due to
the negligent or intentional disregard of rules and
regulations by any person who is an income tax return
preparer with respect to such return or claim, such
person shall pay a penalty of $100 with respect to
such return or claim."
26 U.S.C. § 6694(a). Section 6694(e), 26 U.S.C. § 6694(e),
provides that an "understatement of liability" means any
understatement of the net amount payable with respect to any
income tax. Section 1.6694-1(a)(1) of the Income Tax Regulations,
26 C.F.R. § 1.6694-1(a)(1), provides that a preparer is not
considered to have negligently or intentionally disregarded a
rule or regulation if he exercises due diligence in an effort to
apply the rules and regulations to the information given to him
to determine the taxpayer's correct tax liability. Section
1.6694-1(a)(5) of the Regulations, 26 C.F.R. § 1.6694-1(a)(5),
provides that the preparer bears the burden of proof on the issue
of whether he has negligently or intentionally disregarded a rule
The application of section 6694(a) is further explained by
several IRS Revenue Rulings. For example, Revenue Ruling 80-28,
Rev.Rul. 80-28, 1980-1 C.B. 304, provides that negligence under
this section is lack of due care or failure to do what a
reasonable and ordinarily prudent person would do under the
circumstances. Another ruling, Rev.Proc. 80-40, 1980-2 C.B. 774,
provides that the following factors should be considered in
applying the negligence standard under section 6694(a): (1)
nature of the error causing the understatement; (2) frequency of
errors; and (3) materiality of errors. Rev.Proc. 80-40 also
explains that where the facts and circumstances suggest that the
return was negligently prepared, the penalty will not be asserted
if (1) the preparer's normal office practice, when considered
together with the other facts and circumstances, indicates that
the error in question would rarely occur, and (2) the normal
office practice was followed in preparing the return in question.
Finally, Rev.Proc. 80-40 states that while a preparer is not
required to audit or examine books, records or other evidence in
order to independently verify a taxpayer's information, he may
not ignore the implications of information furnished to him or
which was actually known by him. The preparer is instructed to
make reasonable inquiries if
the information furnished appears to be incorrect or incomplete.
Based on the language of section 6694(a) and its interpretation
in the above-noted Income Tax Regulations and Revenue Rulings,
the court concludes that entry of summary judgment in favor of
the United States is appropriate. Given the information available
to Brockhouse, the omission of interest income on Dr. Busch's
1978 return constitutes a failure to exercise due diligence.
First, the method of operation of Rubert-Busch's business
indicated that the corporation often found it necessary to borrow
funds and that, because of rising interest rates, the funds were
borrowed from Dr. Busch, the corporation's sole shareholder.
Second, the trial balance sheet utilized by Brockhouse in
computing Rubert-Busch's corporate return showed that the
corporation had made interest payments. While the balance sheet
did not reveal the recipient of those payments, it was a practice
of Rubert-Busch, as noted above, to borrow from Dr. Busch. Third,
the general ledger and disbursements journal of the corporation
— which, upon reasonable request, would have been available to
Brockhouse for inspection — specifically indicated that interest
had been paid to Dr. Busch. Under these circumstances, a
reasonable and ordinarily prudent person would have been alerted
to the fact that Rubert-Busch was paying interest to Dr. Busch.
Based on the implications of information available to him,
Brockhouse should have made the inquiries necessary to determine
the full scope of the interest payments. Indeed, Brockhouse
himself recognized the importance of making such inquiries in a
1979 article in which he stated: "This sentence [that a preparer
may not ignore the implications of information furnished to him]
seemed to place a positive burden on preparers to use competent
judgment in evaluating a taxpayer's data and to ask reasonable
questions if the information appeared to be incomplete or
incorrect." Brockhouse, IRS Is Taking a Practical Line in
Enforcing Compliance with Return Preparer Regs, The Journal of
Taxation, 172, 174 (September 1979).
Also illustrative of Brockhouse's lack of due diligence in
preparing Dr. Busch's 1978 return is his failure to follow
procedures which both Goldman, Weiss as an accounting firm and he
as an individual accountant recognized as necessary to obtain
complete information from a taxpayer. As previously noted,
Goldman, Weiss had "adopted a practice" (Stipulation, ¶ 10) of
sending a data questionnaire to its clients as a means of
collecting information, a practice not utilized in preparing Dr.
Busch's 1978 return. Brockhouse's failure to use such a
questionnaire is particularly disturbing in light of his own
emphasis on its significance. For example, in a 1981 article,
"Examples of good office procedures include a system
to promote accuracy and consistency in the
preparation of returns. The system might include a
preparation checklist, a method for obtaining the
necessary information from the taxpayer, examination
of prior returns and review procedures. . . .
"The procedures listed in Rev.Proc. 80-40 — having
a checklist and a questionnaire to insure
completeness of taxpayer information . . . would
appear to be more stringent than procedures which the
courts have applied in deciding cases involving
taxpayer negligence under Section 6653(a). However,
they appear to be reasonable steps for most tax
preparers to take."
Brockhouse, Under the New Rules, Preparer Penalties May be
Restricted to More Flagrant Violations, The Journal of Taxation,
2, 4 (January 1981). In another article, Brockhouse explained
what he referred to as "Work-flow procedures":
"[T]he start of the return preparation process is the
mailing of data questionnaires to its [an accounting
firm's] clients. . . . Checklists can be prepared for
individuals at each stage of the preparation process.
"These checklists will serve two purposes. First,
if properly used by the firm's personnel they will
assist in improving the quality of the returns
prepared and reduce penalty exposure. In addition,
they may be useful in demonstrating to IRS personnel,
in accordance with Rev.Proc. 80-40, that the firm's
procedures were not negligent."
Brockhouse, Steps that Accountants Can Take Now to Reduce
Exposure to the Return Preparer Penalties, Taxation for
Accountants, 140 (March 1981). Thus, while Brockhouse himself
clearly recognized the need to send data questionnaires to
clients for use in preparing their returns, he failed to adhere
to this procedure in the case at bar.
Finally, evaluation of the factors outlined in Rev.Proc. 80-40
plainly indicates that Brockhouse was negligent in preparing Dr.
Busch's 1978 return. First, the provisions that was misapplied or
not discovered*fn2 was not so complex, uncommon or highly
technical that a preparer might reasonably be unaware or mistaken
as to its applicability. Second, the understatement was not an
isolated error but occurred in two instances. Third, the
understatement was certainly material, as it resulted in
underpayment of taxes in 1978 in the amount of $10,538.76.*fn3
For the reasons stated above, the motion for summary judgment
of the United States is granted, and the motion for summary
judgment of Brockhouse is denied. Plaintiff failed to exercise
due diligence in preparing the 1978 return of Dr. and Mrs. Robert
Busch, and has failed to meet the burden imposed on him by
section 1.6694-1(a)(5), 26 C.F.R. § 1.6694-1(a)(5). The complaint
is hereby ordered dismissed.