New York State Division of Tax Appeals Holds That Software Deficiency is Reasonable Ground to Avoid Imposition of Penalties for

The New York Division of Tax Appeals considered whether a petitioner had demonstrated that a tax software error was a reasonable cause, and not willful neglect, for underestimating its tax liability, which in turn led to penalties for late filing and payment. The Petitioner in the case, RAC for Women, Inc. relied on tax software to prepare its 2000 and 2001 tax returns, and to request an extension for the filing of the 2001 taxes. The company's 2001 tax liability was eventually calculated at $5,235. The previously filed extension request required estimation and payment of this amount. To be valid, the estimation had to be either 90% of the actual 2001 liability or 100% of the previous year's tax liability (which in this case was $225). In its extension request, however, RAC for Women estimated its 2001 liability as $100. The extension was therefore invalidated since the $100 estimate was clearly erroneous (as it was neither 90% of $5235 nor $225). The company was eventually asked to pay $1,513.05 in penalties for underpaying the estimated tax in the extension request, for late filing (because the extension was invalidated), and for late payment.

The Division of Appeals held that the extension request was properly invalidated and that RAC for Women failed to file and pay its taxes on time. However, it granted the company's request to cancel the penalties for late filing and late payment because it was shown that the failures “were due to reasonable cause and not the result of willful neglect.” Namely, the tax software used was the reason why the extension request underestimated the tax liability as $100. The program did not go back to the information and amounts of the previous year's tax return, and so automatically defaulted to a $100 estimate of minimum tax due. Had the program reflected back to the year 2000 taxes, a proper estimate of $225 would have been entered. In that case, the extension request would have been valid and the tax filing and payment timely. RAC argued that it was the software that caused it to enter $100 as the estimated liability. It further argued that it would be illogical to “subject itself to late filing penalties totaling $1,513.05 to save a $125.00 payment on the extension request.” When combined with the fact that the company had an otherwise unblemished tax filing history, the court held that the software error was a “ground for delinquency which would appear to a person of ordinary prudence and intelligence as a reasonable cause for delay and which clearly indicated an absence of willful neglect.” So while the findings of late filing and payment were upheld, most of the resulting penalties were canceled: only a $154 penalty for the underpayment of the estimated tax was upheld.

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