Can an Employee’s Illness be a Reasonable Cause for a Delayed Business Tax Filing?

Small businesses, and even large ones, depend on their top employees to do everything from interfacing with customers to filing company tax returns. When a key employee has a serious physical or mental illness at tax time, it can create problems for the company with the IRS. But as a recent Fifth Circuit Court of Appeals case shows, an employee’s illness alone may not be reasonable cause to excuse a delayed business tax filing.

Employee’s Severe Depression Leads to Missed Tax Notices

RSBCO was required to file more than 21,000 annual information returns for its employees in 2012. The company’s operations manager (whose name is omitted for privacy) submitted the filings on the last day, March 31, 2013, but some of them contained errors. The IRS’s Filing Information Returns Electronically (FIRE) system sent the manager notices that those delayed business tax filings would need to be resubmitted, along with two additional reminders. Corrected returns were filed on July 16 and 17, 2023.

A year later, the IRS issued a notice of proposed penalties for the delays. RSBCO says it was unaware of the notice until the manager was terminated in November 2014, and the notices were found while cleaning out the manager’s office. The IRS assessed penalties in October 2015, holding RSBCO accountable for $510,700 in late fees and penalties for filing returns with incorrect information.

In January 2018, the IRS issued a notice of intent to levy to collect the assessment. RSBCO requested a hearing, asserting that it had a reasonable cause defense for the delayed business tax filings. The manager had been suffering from clinical depression, was suicidal, and had struggled focusing and completing tasks at work. RSBCO said that the manager’s mental illness was a reasonable cause for the filings’ delays. Following a hearing where no settlement was reached, RSBCO paid the penalties and interest in full and filed an administrative refund claim using the same defense. After the IRS failed to act on the request, RSBCO sued and the matter ended up before a jury, which awarded the company a complete refund.

Mitigation and Impediments Create Reasonable Cause for Tax Filing Delays

On appeal, the question was whether the manager’s illness was sufficient reasonable cause to excuse the delayed business tax filings. A filer is not liable for penalties if the taxpayer or company’s filing was “due to reasonable cause and not willful neglect.” This reasonable cause can be shown one of two ways:

• Significant mitigating factors related to the failure
• That the failure arose from events beyond the filer’s control (an impediment)

The Treasury Regulations say that “mitigating factors include, but are not limited to”:

• The fact that the filer has never been required to file that particular type of return or statement before
• Whether the filer has a history of complying with the reporting requirement in question
• Whether there had been any past penalties imposed
• If there had been past penalties, to what extent the filer had reduced its error rate since that time

The second factor, impediments may “include but are not limited to”:

• Unavailability of business records
• Undue economic hardship “relating to filing on magnetic media”
• Certain IRS actions
• Certain actions by the agent (in this case, the employee)
• Certain actions of the payee or person providing information related to the return

The Treasury Regulations also define actions of an agent can create reasonable cause for a delayed filing, which can include a employee’s unavoidable absence due to death or serious illness, but only if that employee had the sole responsibility for filing the return, and their absence resulted in the unavailability of business records long enough to interfere with timely compliance with the return (usually at least 2 weeks). This is called a “supervening event.” So while an Employee’s illness can be a reasonable cause for a delayed business tax filing, it won’t always be enough to meet the regulations’ criteria.

Jury Instructions Excluded Access to Records from Reasonable Cause Instructions

As is often true following a jury trial, the key issue on appeal was the language of the instructions the jury was given in reaching its verdict. Here, the jury instructions defined “mitigators” as “something that lessens the gravity of an offense or mistake.” The IRS’s appeal said this language was too broad because it didn’t provide any information about the reasonable cause being tied to the company’s filing history. The Court of Appeals said that was close enough, since the regulations defining mitigators included the language “include, but are not limited to,” suggesting other reasons for mitigation may exist.

However, in instructing the jury on impediments, the Court of Appeals said the Trial Court was too lax. The jury instruction defined an impediment as “a hindrance or obstruction in doing something” and provided examples allowing a refund such as “Actions of the filer’s agent” and “The death, serious illness, or unavoidable absence of the filer.” The Court of Appeals said that this instruction was “overbroad and oversimplified” since “plainly not every action of a filer’s agent excuses improper filing.” The jury instruction could have allowed the jury to find an impediment based solely on the manager’s illness, without considering the company’s access to business records, so it was invalid. Because the jury verdict form did not distinguish between a verdict based on mitigation and one based on an impediment, the Court of Appeals had to vacate the verdict and remand the case for a new trial.

Anytime a tax case goes before a jury it comes with uncertainty. But this case shows that the language of jury instructions can be crucial to the certainty and finality of the verdict, especially when a company is trying to assert that an employee’s illness was a reasonable cause for delayed business tax filings.