The leading case on this issue seems to be Paschall (see link below), which is both pathetic and funny. The taxpayer got conned by a major accounting firm, Grant Thornton, into a scheme where he converted a $1+ million traditional IRA into a Roth IRA, without paying any tax on it. That happened in 2000. By the time IRS caught up with him, the statute for assessing income tax had expired, so he could laugh all the way to the bank on that one. But they assessed the 6% penalty for all the years from 2002 to 2006 when he did not file a Form 5329. Then they assessed the 25% late-filing penalty – are you figuring that in your calculations?

He argued that he did this on the advice of tax professionals, but the fact that he had paid $120,000 for that advice, which came with a guarantee that they would defend him if challenged, convinced the Court that the advice was not impartial.

The Tax Court agreed with IRS that the 5329 is a separate return, so filing a 1040 didn’t count. The opinion acknowledged that there was a line on the Form 1040 to report 5329 taxes, but noted that this line was blank. It didn’t even show a zero. Would that have mattered? I wouldn’t want to depend on that argument, and your client’s return probably doesn’t show a zero either.

The taxpayer didn’t even try to argue that the “excise tax” is subject to waiver provisions. He tried that on the late filing penalty, and it didn’t work.

I shudder every time someone uses the term “red flag” in connection with IRS processing of tax returns, but if there is anything that qualifies for this description, it’s a request for a waiver that draws attention to a tax that can’t be waived. So share that with your client.

https://www.leagle.com/decision/intco20110705a24