Indemnity Coverage and Penalty abatement

I have a client from the Low Income Taxpayer Clinic for which I do Pro Bono Work and he was recently assessed $12k for underreporting about $70k under an annuity 1099. He said the preparer inputted the wrong number which seems to be the only explanation based on the 1099 he showed me. On the other hand, he admitted not looking at the return carefully when he signed it because of health issues at the time (documented). He is pursuing the recovery of the penalties from the preparer in small claims court in NJ. The preparer does not want to settle.

1. Based on your experience, does my client have a reasonable chance of prevailing ?

2. My initial inclination was to submit a penalty abatement request based on reasonable cause. However, I'm concerned about the possibility of the client getting both an abatement and an indemnification, i.e., a windfall. Is there a professional SOP in these cases? I've searched extensively, but could not find any guidance on the IRS Side. It would be helpful to have something specific to take to the client besides "it's not right".

Note: This is a different set of facts than the FIRPTA case which I recently posted in the Taxation Forum.

The preparer's insurance company should be involved. Taxpayer needs reimbursement of penalties and interest, right? And that reimbursement itself is probably taxable, creating a circular calculation that results in the proper award being more than $12k. I don't know what you do if the preparer won't cooperate and notify the insurance company. Is preparer licensed?

I hadn't thought about the gross-up, thank you. I'll advise the client to adjust his claim accordingly. I know very little about the preparer; Im trying to stay out of that side of it. Separately, and I don't know why I didn't think of this earlier, as to simultaneously seeking both an abatement and the indemnity, if one comes in before the other, I'll suggest, she drop the other. What she does is up to her.

Is the 12k taxes, penalty, and interest, or just penalties and interest? Someone with $70,000 taxable annuity qualifies for LITC?

$12k in penalties/interest? Or does that include the tax, too? The TP is always responsible for the tax. The preparer may be on the hook for penalties/interest. Same time, it pisses me off because the TP admitted they did not properly look at the tax return.

I had a client where input errors caused me to leave off about $60k in income over two years. They also did not review and acknowledged their responsibility as well, so we settled on me covering 50% of the penalties/interest assessed by the IRS. This was a nice client, not one that'll just jump to a legal claim.

On the other hand, he admitted not looking at the return carefully when he signed it because of health issues at the time (documented). He is pursuing the recovery of the penalties from the preparer in small claims court in NJ.

He signed the 8879 under penalties of perjury that he examined a copy of the return and that to the best of his knowledge it is true, correct and complete. He should have caught $70k of income left off the return unless he's extraordinarily aloof.

Usually in these situations the preparer pays the penalty (if the preparer feels he's at fault). The taxpayer/client pays the tax and interest, as he/she had use of the money. If the preparer is feeling extra sorry, they can pay the interest too.

Tough spot. Sometimes people sign a return they know to be incorrect because it's in their favor to do so. Then when the s*** hits the fan, they play victim. Hard to tell months (or years) down the line if that is the case.