On August 17, 2020, the Tax Court issued a Memorandum Opinion in the case of Babu v. Commissioner (T.C. Memo. 2020-121). The sole issue before the court in Babu v. Commissioner was whether the petitioner was liable for the substantial understatement accuracy-related penalty under IRC § 6662(a), IRC § 6662(b)(2), IRC § 6662(d)(2).
Background to Babu v. Commissioner
After earning a B.A. degree in finance, Mr. Babu attended law school at the University of Baltimore, graduating in 2005. During law school he took courses in tax law, participated in a tax clinic that assisted low-income taxpayers, and finished “with a pretty good understanding of tax.” Not only that, he worked for a tax mill during law school, and general counsel for five years after graduation. The petitioner held franchises for 19 separate tax mill locations. Business was good, until the DOJ dropped the hammer on the tax mill and its owner for “engaging in and facilitating extensive and pervasive tax fraud.” Mr. Babu was spared from actual prosecution, he was “singled out” during trial as having been complicit with the illegal behavior, including hiding $5m in a secret bank account. Nevertheless, after trial, Mr. Babu founded another tax preparation firm and engaged in similar shenanigans. Then the IRS stepped in and found millions in unreported income.
Babu Hires a Puppy to Defend Him
We all started somewhere, but generally our first case out of law school was not a multi-million-dollar tax fraud case. At least, mine wasn’t. It turns out that the puppy attorney that Mr. Babu hired was a “friend,” who became the only other partner in his law firm.
The IRC § 6662 penalty does not apply to any portion of an underpayment “if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith.” IRC § 6664(c)(1). The decision as to whether the taxpayer acted with reasonable cause and in good faith is made on a case-by-case basis, taking into account all pertinent facts and circumstances. Treas. Reg. § 1.6664-4(b)(1). Circumstances that may signal reasonable cause and good faith “include an honest misunderstanding of fact or law that is reasonable in light of all of the facts and circumstances, including the experience, knowledge, and education of the taxpayer.” Id.
Reasonable cause can be shown by good-faith reliance on the advice of a qualified tax professional. Treas. Reg. § 1.6664-4(b)(1), (c). To establish this defense the taxpayer must prove that: (1) the adviser was a competent professional who had sufficient expertise to justify reliance, (2) the taxpayer fully disclosed all relevant facts to the adviser, and (3) the taxpayer actually relied in good faith on the adviser’s judgment. Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002). Mr. Babu does not contend (and could not plausibly contend) that he relied on advice from his accountant regarding the proper reporting of the tax mill’s gross receipts, because the accountant performed no independent evaluation of this question; he simply reported the figures that Mr. Babu gave him. Mr. Babu did not inform the accountant that the tax mill had processed almost 30,000 returns for another mill during 2014, that it charged a fee of $100.95 per return, or that he had withdrawn well over $3 million from the other mill’s bank accounts during 2014. Thus, Mr. Babu did not fully disclose all relevant facts to Mr. Accountant.
Mr. Babu contends that he relied on advice from the puppy-attorney regarding the reporting of the mill’s gross receipts. We find this argument deficient for a number of reasons. On the whole, the puppy-lawyer was not a credible witness, and her “financial entanglements with [Babu]” raised “serious questions” about her objectivity. See 106 Ltd. v. Commissioner, 136 T.C. 67, 79 (2011) (holding that “advice must generally be from a competent and independent advisor unburdened with a conflict of interest”), aff’d, 684 F.3d 84 (D.C. Cir. 2012).
As a consequence, Mr. Babu was found very much liable for the penalties.
Bad Mr. Babu.
(T.C. Memo. 2020-121) Babu v. CommissionerAdd to favorites