Rare “Turbo Tax Defense” Win in Tax Court

As I have blogged about before, such as in this story, the “It’s Turbo Tax’s Fault” defense rarely works when something blows up on your self-prepared tax return and the IRS comes calling. However, there was a rare victory in Tax Court last week for a taxpayer using the Turbo Tax defense.

The taxpayer, a patent attorney with the government, self-prepared his and his wife’s joint 2007 tax return. One of the tax documents his wife received was a K-1 from a trust created by her mother’s estate. The K-1 showed interest income. It was the first time the couple had received a K-1 and they were unfamiliar with the form before this.

Because of the new form, the taxpayer bought an upgraded version of do-it-yourself tax prep software. He used the interview feature in the software and thought he had entered everything correctly. Unfortunately, he made a data entry error that caused the income from the estate to not be reported properly. He reviewed the return and used the software’s diagnostics, but neither he nor the software caught the error.

The IRS did catch the error and assessed additional taxes and an $1,800 accuracy penalty. The taxpayer agreed that he owed the additional taxes but protested the penalty. The Court sided with the taxpayer on the grounds that he made an honest mistake and acted “with reasonable cause and in good faith:”

He did not bury his head in the sand and ignore his obligation to check the accuracy of his tax return. Instead, petitioner reviewed the information he entered using his tax preparation software upon completion of the software’s interview process. Despite his best efforts, however, petitioner failed to discover that the amount of the interest income did not appear on the final version of his tax return that was filed.

So, the Turbo Tax defense can work, but only if you can prove that the mistake was in good faith rather than simply saying “Turbo Tax said it was okay.”

Update 1/3/12: Robert Flach at The Wandering Tax Pro blog argues that the Tax Court got the ruling wrong. Click here to read his story.