Taxpayer Both Properly Discloses a Position and Fails on Another When Dealing with §6662 Penalty

The Tax Court took a look at what represents adequate disclosure and a reasonable basis for a position in the case of Campbell v. Commissioner, 134 TC No. 3.

Albert Campbell filed suit against Lockheed Martin under the False Claims Act alleging that Lockheed defrauded the United States.  Under the provisions of that Act, a private citizen can bring a claim on behalf of the US Government and, depending on whether or not the government chooses to intervene can receive from 15 to 30 percent of the proceeds, as well as be awarded attorney’s costs.

In this case the claim was eventually settled and Albert received  $8.75 million of which $3.54 million was withheld by his attorney in payment of legal fees, for a net of $5.25 million.  Albert reported the $5.25 million on Line 21 of the Form 1040 he prepared without professional assistance, but did not include that amount is his computation of taxable income which ended up being shown as only $793.  He also included a Form 8275, Disclosure Statement, in which he argued that the $3.5 million attorney’s fee payment should not be taxable income.

The Tax Court first ruled that the entire $8.5 million was taxable income to Albert.  It disagreed with Albert’s claim that the since the payment represented a reimbursement of an overpayment to the United States government, he should be taxed in the same fashion as a taxpayer receiving a reimbursement as an assignee.  The Tax Court held, rather, that the payment was a reward to Albert and that the statutory definition of income at §61 would include such a payment.  However, Albert is allowed an itemized deduction for the $3.5 million in attorney’s fees.

The Court then moved to the substantial understatement penalty.  The amount of excluded income easily met the minimum requirements to invoke the substantial understatement penalty of §6662(a).  The taxpayer claimed since he had fully disclosed the payment on his return, there was reasonable cause for his omission from income and he acted in good faith he should not be subject to the penalty.  Alternatively, he argued he had substantial authority for his position.  Either would be sufficient to eliminate the penalty.

The Court first ruled that his citation of a case where the Court indicated it was not deciding whether reimbursement claims under FCA were taxable was not substantial authority for concluding they were not taxable.  Pursuant to the then effective Revenue Procedure 2003-77, adequate disclosure in this case would have involved filing an 8275.

The Court found he could not exclude the portion of the deficiency applicable to the $$5.25 million net amount for which he did not make a disclosure on Form 8275 and, even if it had been properly disclosed, his position would not have meet the reasonable basis test necessary either.  He also failed to act in good faith, as he was a trained accountant and he failed to seek out competent professional advice on the matter.

However, the $3.5 million payment was disclosed on a Form 8275 and at the time the return was filed the Supreme had not yet decided such payments were includable in income in the Banks case and he had reasonably relied on the 11^th Circuit’s Foster case in concluding such payments were not includable in income.

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