Tax Malpractice: Areas in Which It Occurs and the Measure of Damages-An Update
Todres, Jacob L., St. John's Law Review
About five years ago, I published an article exploring the areas in which reported tax malpractice cases arose.1 As a secondary inquiry, that article, hereinafter referred to as Malpractice I, also focused on the measure of damages awarded in such cases. The result of that study indicated that many of those cases involved general malpractice in a tax context, as opposed to "tax malpractice." Many of the errors involved missing time deadlines, such as late-filing and non-filing of tax returns. Other errors included "ignoring or overlooking some simple, clearly mandated requirement such as making an election or obtaining consent" when necessary.2 Apart from a large number of tax shelter-related cases, which arose from the tax shelter frenzy of the late 1970s and early 1980s, and cases in the estate planning/estate and gift tax area, Malpractice I was unable to identify or predict any area or areas of tax practice more likely than others to spawn tax malpractice litigation.3 Malpractice I did allay my worst fear that due to the complexity of the tax law there would be innumerable instances of tax malpractice involving virtually every section of the Internal Revenue Code (I.R.C.).4
In the years since the publication of Malpractice I, I have received a number of calls and e-mails from practitioners inquiring as to whether, in the course of my research, I had encountered a situation "on all fours" with the one they were working on. One of these inquiries even led me to explore whether issuing an incorrect federal information return, such as a W-2 form or a form 1099, could be the basis of a tort recovery similar to recoveries for tax malpractice.5 These inquiries convinced me of the continuing importance of this area. As if further encouragement were needed, the recent Internal Revenue Service (1RS) crackdown on attorneys and accountants involved in the sale of overly aggressive and likely flawed tax shelters6 following in the footsteps of a number of financial scandals-such as Enron, which had accounting and tax machinations at its core7-emphasized the importance to society of a developed and principled body of law governing when and to what extent professional advisors might be held financially responsible for their advice.
Primarily, this Article will analyze the tax malpractice cases that have been reported since Malpractice I was published from the vantage of substantive tax law to attempt to ascertain whether certain areas of tax law or certain aspects of tax practice seem to generate more malpractice claims than others. As a secondary inquiry, the Article will discuss the proper measure of damages recoverable on account of such malpractice.
This Article focuses solely on reported cases. It examines instances of claimed malpractice involving federal income, estate, gift, and generation skipping taxes. It does not focus on other federal taxes such as employment taxes. While state and local taxes are not intended to be focused upon separately, this Article discusses several cases that involve allegations of wrong advice in connection with state sales tax8 and state personal property tax.9 While I have attempted to locate and review all of the reported cases, I acknowledge the possibility, or more accurately, the likelihood, that I missed some,10 especially since tax malpractice situations continue to sometimes lurk in esoteric venues. For instance, I will discuss an interpleader action where the court allocated the proceeds from a tax malpractice settlement,11 and an action to set aside a divorce settlement that refers to a previous tax malpractice litigation arising from the same divorce.12
Both tax attorneys and accountants are focused on in this study. While, from a purely theoretical standpoint, it might be desirable to analyze these professions separately, the pragmatic truth is that the dividing line between the work of the tax attorney and the accountant, at best, has always been murky. …