Reliance on accountant's advice regarding treatment of stock options is sufficient to negate negligence penalty.

• Author: Savell, Kenneth S.

The complexity of the tax laws challenges the ability of most taxpayers. This certainly includes corporate executives, many of whom must deal with the myriad hidden consequences underlying the exercise of stock options (an increasingly common form of compensation). As a result, such taxpayers often turn to their CPAs or tax attorneys to provide tax advice and to prepare their tax returns. A recent Ninth Circuit case reaffirms the long-standing principle that taxpayers who consult their tax advisers are generally presumed to have exercised a fair degree of care and prudence, and are, therefore, entitled to rely on the advice they receive from such presumed experts.

The Henry Case

Albert Henry was the vice president-finance, chief financial officer, and director of IMED Corp. (IMED). Henry, along with other IMED officers, was granted stock options in 1979. They all filed Sec. 83(b) statements reporting the stock's fair market value as zero. Subsequently, Warner-Lambert acquired IMED and also purchased its outstanding stock options. Warner-Lambert issued a 1982 W-2 to Henry reporting only wage income. Henry received no other Form W-2 or 1099 reporting his stock option proceeds as income.

In preparing his 1982 return, Henry provided the W-2 to his accountant and indicated that he believed the stock options were structured to achieve long-term capital gain treatment. Henry also advised his accountant to contact IMED's stock option program managers if he had further questions about the options. Although aware of the fact that the options contained restrictions--and, therefore, based on Regs. Sec. 1.83-7(b)(2), might be challenged by the IRS with respect to Henry's classification as long-term capital gains--the accountant never told Henry of the risk or about the regulation, and never requested copies of the option certificates. The accountant advised Henry that both he and his practice partner believed that IMED had structured the stock options to achieve long-term capital gain treatment.

On audit, however, the Service determined that the proceeds from the options were ordinary income and imposed penalties for negligence and substantial understatement. Henry, along with three other officers who were audited for their treatment of the stock options, petitioned the Tax Court. In pursuing his case separately, Henry stipulated that he would be bound by the court's decision as to the other three IMED officers (see Cramer, 101 TC 225 (1993), aff'd, 64...