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District Court of Appeal, Second District, Division 3, California.


Civ. 18177.

Decided: August 31, 1951

Sheppard, Mullin, Richter & Balthis, Gordon F. Hampton and E. Talbot Callister, of Los Angeles, for appellant. Walter G. Danielson and H. Spencer, St. Clair, Los Angeles, for respondent.

Defendant Mitchell, a certified public accountant, appeals from a judgment for plaintiff in the amount of $17,428.83 rendered after a trial to the court.

The complaint, filed December 7, 1948, alleged defendant was specially employed to prepare plaintiff's tax returns for the calendar years 1943 and 1944, that defendant failed to prepare and file these returns until 1946, and as a result plaintiff was damaged in having to pay interest and late filing penalties for federal taxes, as well as counsel fees for negotiations with the Treasury Department. These grievances are stated in the form of five causes of action: (1) For interest and penalties resulting from late filing of 1943 federal returns; (2) for interest resulting from late filing of the 1943 State return; (3) for interest and penalties resulting from late filing of 1944 federal returns; (4) for interest resulting from late filing of the 1944 State return; (5) for counsel fees incurred in negotiating a settlement with the Treasury Department. In the discussion which follows we break the five into (1) causes of action arising because of interest payments, and (2) causes of action arising because of penalties, thus taking part of the first and third causes of action together with the fifth.

Defendant is a certified public accountant who has conducted his own practice in Los Angeles since 1935. He held himself out as a specialist in tax matters and had prepared returns for plaintiff in 1941 and 1942. On February 7, 1944, defendant wrote a letter to plaintiff agreeing to conduct an income tax review of plaintiff's books and prepare state and federal tax returns for the year 1943. A similar agreement was made in January, 1945, covering the 1944 tax returns. On March 15, 1944, defendant filed ‘tenative‘ 1943 returns which consisted of entries of $20,000 for ‘net income’ and $5,300 for income tax due, which amount was paid by plaintiff at that time. These entries were estimates based on the corresponding figures on the corporation's 1942 tax return. Mitchell asked for and was granted an extension of time until May 15, 1944, to file an amended or completed return. A second extension was granted until June 15, 1944, at which time he filed another return which was identical with the ‘tentative’ return previously filed. Thus in 1944 no 1943 return fully listing income and deductions was filed but the estimate tax was paid on time. In 1945 the same ‘tentative’ and ‘completed’ procedure was followed, with the indicated tax being paid. Finally, in March, 1946, defendant filed ‘amended’ returns for 1943 and 1944 which clearly contained the necessary information. The additional indicated tax was paid by plaintiff at the time the ‘amended’ returns were filed. A similar procedure was followed with respect to the California franchise returns for 1943 and 1944. In the margin we have set out the estimates and payments made over the two-year period as well as the figures composing the damages as found by the trial court.1

On January 9, 1947, after the ‘amended’ returns were filed, an Internal Revenue agent made an audit of plaintiff's books and determined that there should be an assessment for additional taxes and penalties in the amount of $52,386.46. A portion of Mrs. Olson's salary for each year was disallowed. The agent stated to defendant that since the Olsons owned all the stock excessive salary might be, in part, regarded as dividends, and as such, not deductible from the corporation income. The agent also informed defendant there would probably be a late filing penalty unless reasonable cause for such delay in filing completed returns were shown. Defendant prepared a comprehensive affidavit stating that the late filing was not due to an intent to evade the law, and that the final returns were late because the corporation relied on defendant and he was unable to do the work because of insufficient accounting assistance due to the manpower shortage. Olson, president of the plaintiff corporation, refused to sign the affidavit. His reason was that it presented the Swedish officers of the corporation in an unfavorable light. Defendant later prepared and filed his own late filing affidavit. On behalf of plaintiff a protest was filed by defendant to the proposed additional assessment of $52,386.46, and he later met with the Conference Section of the Technical Staff, Pacific Division, Bureau of Internal Revenue. The protest was denied and in June, 1947, defendant requested a hearing before the complete staff. The hearing was set for March 15, 1948, and when notified defendant informed Mr. Olson who immediately called his attorney, Mr. Danielson. They dismissed defendant and turned the negotiations over to Alva Baird, an attorney and tax practitioner. A compromise settlement was reached regarding penalties and the proposed deficiency assessments, and plaintiff paid the amount agreed upon. See Note 1. It is this compromise sum which is the major element of damage in this action.

Defendant pleaded the statute of limitations. The first issue for our determination is whether any of the claims are barred in whole or in part. Plaintiff claims the action to be one for damages resulting from breach of a written contract of employment and that the four-year statute applies. If so, none of the claims is barred. Code Civ.Proc., sec. 337(1). Defendant claims the gravamen of the action is negligent performance of the contract, that is, failure to use the skill of the profession, and thus the two-year tort statute applies to bar all causes of action. Code Civ.Proc., sec. 339(1). We conclude that the action is for negligence and not breach of contract, and that the two year statute applies. This would bar the claims based on interest payments, March 22, 1946, but not the claims based on the settlement. Penalties and counsel fees, November 23, 1948.

In support of its contention that the action is for breach of contract, plaintiff claims complete failure of performance on the part of defendant. It contends that the tentative returns were nullities and that their preparation and filing amounted to not even partial performance by defendant. The court found that they were nullities and of no force or effect whatever. We will agree that if this were true and if there was complete failure of performance on defendant's part, recovery would necessarily have to be for breach of contract. But we think the finding was in error and agree with defendant that the filing of the tentative returns constituted partial performance, that the filing of the completed returns constituted full performance except for the delay, and that the incompleteness of the tentative returns, and the delay in filing completed returns are elements of performance which go to the question of negligence. Plaintiff filed returns and paid taxes, although the returns were incorrect and incomplete. It now says, in effect, that it was in the position of one who had filed no returns. The two defaults and their consequences are dissimilar. The incomplete returns were recognized by the Bureau of Internal Revenue and plaintiff was not, and could not have been, accused of having wilfully failed to file returns. If defendant was guilty of breach of duty it was because his imperfect performance constituted negligence.

The courts have uniformly based recovery upon principles of negligence where there is failure to employ the knowledge, skill and judgment which is engaged to be rendered in professional employment, or other employment of a highly specialized nature. A member of the learned professions, and for that matter any one who undertakes employment because of his possession of exceptional skill, impliedly represents that he possesses and will employ the degree of learning and skill usually possessed by those in good standing practicing their specialties in the same locality. He impliedly agrees to use his best judgment but does not guarantee results. Roberts v. Parker, 121 Cal.App. 264, 8 P.2d 908. ‘In all those employments where peculiar skill is requisite, if one offers his services, he is understood as holding himself out to the public as possessing the degree of skill commonly possessed by others in the same employment, and if his pretentions are unfounded, he commits a species of fraud upon every man who employs him in reliance on his public profession. But no man, whether skilled or unskilled, undertakes that the task he assumes shall be performed successfully, and without fault or error; he undertakes for good faith and integrity, but not for infallibility, and he is liable to his employer for negligence, bad faith, or dishonesty, but not for losses consequent upon mere errors of judgment.’ (Cooley on Torts (4th Ed.), Vol. 3, p. 335.) Lawyers are in this category. Hays v. Ewing, 70 Cal. 127, 11 P. 602; Gambert v. Hart, 44 Cal. 542; 3 Cal.Jur. 670. The rule has been applied to abstractors, architects and financial agents, Cooley, supra, p. 336; also to engineers, Cowles v. City of Minneapolis, 1915, 128 Minn. 452, 151 N.W. 184; explosive experts, Jackson v. Central Torpedo Co., 1926, 117 Okl. 245, 246 P. 426, 46 A.L.R. 338; oculists, Price v. Ga Nun, 1895, 11 Misc. 74, 32 N.Y.S. 801, 802; river pilots, The Tom Lysle, D.C.Pa.1891, 48 F. 690, 693; threshers, Van Nortwick v. Holbine, 1901, 62 Neb. 147, 86 N.W. 1057; and accountants, Smith v. London Assur. Corp., 1905, 109 App.Div. 882, 96 N.Y.S. 820; see also, In Re Kingston Cotton Mill Co., 1896, 2 Ch. 279, 288.

While the failure to achieve a guaranteed result is actionable, independently of negligence, this is not true where there is no guaranty of the result. Where the undertaking is to employ special skill there is no breach of duty if such skill and the operator's best judgment are put forth. Under such circumstances, mere errors of judgment are not actionable. Where the duty is breached by negligent performance the cause of action is for negligence alone. In Harding v. Liberty Hospital Corp., 177 Cal. 520, 524, 171 P. 98, 100, after reviewing the California cases the court said: ‘Notwithstanding the conflict of authority from other jurisdictions, we are satisfied that it has become the settled rule in California that actions for injuries caused by the negligent acts of another or his agent must be commenced within the period of one year from the date of the alleged injury, and that the fact that the parties stand in contractual relation to each other does not operate to change the rule or extend the time for the commencement of such actions.’ See Denning v. State, 123 Cal. 316, 55 P. 1000; Basler v. Sacramento, etc., Ry. Co., 166 Cal. 33, 134 P. 993; Krebenios v. Lindauer, 175 Cal. 431, 166 P. 17; Marty v. Somers, 35 Cal.App. 182, 169 P. 411. In the Denning case the theory of the action was breach of contract on the part of the employer to furnish a safe place for work, and in holding the action was in tort, the court said, 123 Cal. at page 323, 55 P. at poge 1002: ‘Here the contract of employment has nothing whatever to do with the liability, except to create a duty on the part of the employer—a duty not expressed in the contract, and for the violation of which the contract of employment furnishes no rule or standard for the estimation of damages. Nor is the action grounded upon the contract, but upon the duty springing from the relation created by it, viz. that of employer and employe, and under the old system of pleading was always classed as an action ex delicto.’

Plaintiff's right to recovery depended upon its ability to prove defendant was negligent within the foregoing rules. If negligence had been proved, no cause of action would have arisen until plaintiff paid additional sums which it would not have been required to pay if defendant's services had been properly rendered. If defendant were liable for negligence, section 339(1), Code of Civil Procedure would apply, Jensen v. Sprigg, 84 Cal.App. 519, 258 P. 683, and any action based upon the interest payments made on March 22, 1946, would have been barred in two years. It is unnecessary to consider the point raised that since plaintiff has the use of its money while the interest charge was accumulating, no detriment was suffered. The trial court found that the statute of limitations was tolled as to all five causes of action. The finding was irrelevant as to the sums paid in the 1948 settlement, and without support in the evidence as to the sums paid in March, 1946. Plaintiff, of course, cannot claim concealment by defendant of the fact that the interest payments were made more than two years before their action was commenced.

The court found that defendant had been negligent in failing to prepare and file proper returns on time. The most important question in the case is whether this finding of negligence has support in the evidence. Since the cause of action was for negligence it was necessary that negligence be proved by competent evidence, or such evidence as the law requires to establish breach of professional duty. If it can be said to be of common knowledge, under the facts in evidence, that defendant did not employ the learning, skill and care usually employed by those in the same profession in like matters, and that defendant's dereliction involved an unreasonable risk of loss to his client, the finding is supported. Upon the other hand, if the question was one as to which expert evidence was required, the finding is without support, inasmuch as there was no expert testimony introduced by plaintiff. In the inquiry whether defendant was negligent, numerous factual elements were to be taken into consideration. Defendant's work was handicapped by the absence of his four men accountants who were in military service, and defendant was unable to fill their positions. The account books of plaintiff were inaccurate, showing for the year 1943 a profit of $30,554.37, which was later shown by defendant's audit to be $41,526.73. As soon as defendant obtained additional help in December, 1945, he made an audit of the books, which took six weeks of continuous work. The failure to file completed returns on the due date, or within the time extended, would not necessarily have resulted in the imposition of penalties. The matter rested largely within the discretion of the personnel of the taxing authorities. This was an important fact bearing upon the question whether the matter of delay was, under the circumstances of the case, a material departure from standard practice.

Section 291(a) of the Internal Revenue Code, 26 U.S.C.A. § 291(a), provides that the penalty shall be exacted ‘In case of any failure to make and file [a] return required by this chapter, within the time prescribed by law or prescribed by the Commissioner in pursuance of law, unless it is shown that such failure is due to resonable cause and not due to willful neglect, * * *.’ The Commissioner's general interpretation of the exception in the statute is that if the delinquency occurs notwithstanding the exercise of ordinary care and caution, the penalty will not be charged. Many cases under this section hold that no penalties will be imposed where a taxpayer in good faith relies on the advice of a tax expert. See, Orient Investment & Finance Co. v. Commissioner, 1948, 83 U.S.App.D.C. 74, 166 F.2d 601, 3 A.L.R.2d 612. It would have been material to inquire whether Mitchell had reasonable cause for believing that the facts stated in the affidavit which he prepared for the signature of Olson would be accepted as sufficient to relieve plaintiff from the payment of penalties, and if so, whether such belief and reliance would accord with standard practice of accountants, under the same or similar circumstances. In this connection Mitchell testified that he informed Olson that it was his opinion the filing of tentative returns under the circumstances would be accepted as evidence of good faith and that a sufficient showing could be made to secure a waiver of penalties. He testified that he so believed. He filed returns for Taylor Soap & Chemical Company, Inc., a subsidiary of plaintiff, for 1944. The accounts of the subsidiary were confused with those of plaintiff. Tentative, and later completed, returns were filed for the subsidiary in the identical manner followed in filing plaintiff's returns. Mitchell represented the company when the circumstances of the case were reviewed and no late filing penalties were assessed. It was in evidence that Mitchell had likewise filed tentative and later completed returns for another corporation, and that although a penalty had been recommended, it was eventually waived. This testimony, if believed, indicated that he was exercising his best judgment and believed he was following a safe practice. The answers to these several questions are not within the common experience and knowledge of the nonexpert.

It is not enough to say that defendant failed to file sufficient returns on time, that this was the basis of the claim for penalties, and that plaintiff compromised the claim, yet in final analysis no more than this was proved. It cannot be denied that the dereliction involved some risk of harm to plaintiff through the imposition of penalties. That would be true of any default for which no acceptable excuse was given under the penalty provisions. But it is clear that it cannot be held, as a matter of law, that every failure of an agent to file completed income tax returns on time is a negligent breach of duty. The inquiry here was whether defendant realized or should have realized that there was an unreasonable risk.

‘When an act is negligent if done without reasonable skill, the skill which the actor is required to exercise to avoid being negligent in the doing of the act is that which he, as a reasonable man, should recognize as necessary to prevent the act from creating an unreasonable risk of harm to another.’ Rest., Torts, sec. 299, p. 803. The intricacies of income tax laws, regulations, policies and practices, are not within common knowledge. Only those versed and experienced in that field would be qualified to judge whether defendant's conduct failed to measure up to standard practices, or, in other words, whether among competent accountants and tax specialists it would be deemed to involve unreasonable risk. Expert testimony was required for the reasons that it is required in malpractice cases where resort must be had to technical knowledge in order to pass judgment on the questioned conduct. Perkins v. Trueblood, 180 Cal. 437, 443, 181 P. 642; Engelking v. Carlson, 13 Cal.2d 216, 221, 88 P.2d 695. In the absence of evidence which would support a finding of negligence under the rules stated, a reversal of the judgment is demanded.

The complaint alleged that defendant ‘negligently and carelessly prepared said tax returns in that he failed to properly set forth therein all items of income and deduction,’ and that ‘as a direct and proximate result of the negligence and carelessness of the defendant’ plaintiff was damaged, etc. The answer denied negligence and alleged that any loss suffered by plaintiff was due to its own negligence and carelessness as a direct and proximate cause thereof, and that plaintiff voluntarily attempted the course that led to its alleged losses. Upon the trial plaintiff changed from its theory of negligence to one of breach of contract, and its counsel stated: ‘I do not yield to the suggestion that this is a negligence case. And I might here respond that the reason I didn't ask Mr. Marsh as to what was the standard, whether the returns were prepared in accordance with the degree of skill and care practiced by other certified public accountants in this community, is that that question would have imported an action in tort, malpractice, and I am not suing on malpractice.’ Plaintiff still maintains this position. Defendant forcefully complains that plaintiff's switch from the theory of negligence to one of breach of contract took him by surprise, inasmuch as he was prepared to defend against the charge of negligence and had not anticipated or prepared to meet the claim that the action was for breach of contract alone. It is clear that plaintiff pleaded one theory of recovery and recovered on another. It abandoned the theory upon which recovery could have been had if negligence had been proved for an untenable theory of breach of contract. Nothing in the complaint would justify the elimination of the charges of negligence, leaving the cause of action for simple breach of contract. The court found that defendant breached his contract and that his failure to comply therewith was due to his carelessness and negligence, thus attempting to embrace both theories and to determine that if plaintiff was not entitled to recover on one theory it could recover on the other. We do not doubt that defendant was taken by surprise at the trial but find it unnecessary to determine whether he was prejudiced to an extent that would require a retrial upon that ground.

There was another issue in the case that appears to have been given scant consideration at the trial, although it is argued strenously by the appellant. The salary of Olson, as president of plaintiff corporation, was $33,686.44 in 1943. The net income of the corporation was $41,526.73. In 1944 Olson's salary was $44,705.12, and the net profits of the company before taxes amounted to $76,122.77. Some question had been raised on behalf of the government whether the amounts paid to Olson as salary should be disallowed in part, thus increasing the amounts of profits which would be subject to excess profits tax. If, for example, the 1944 salary had been disallowed to the extent of its increase of $11,018.68 over 1943, the additional tax due from the corporation would have amounted to 85 1/2 per cent, or $9,420.98. (We accept appellant's figures, which are not questioned by respondent.) In the settlement that was made, the Treasury Department waived objection to the large salary paid to Olson in each year, although approximately one-half of the salary paid to Mrs. Olson was disallowed. The settlement was nominally a compromise of the penalties claimed, approximately 50 per cent of the claimed penalties being accepted in settlement. The entire matter of plaintiff's liability was an open one and an element of the proposed assessment of penalty may have been the waiver of a claim for additional tax. An important question in the case will be whether the settlement represented a compromise of a liability for additional taxes, as well as the claim for penalties. In no event should defendant be held liable for any loss sustained by plaintiff for more than the amount paid in compromise of the penalties, as distinquished from the amount, if any, paid for the release of liability for additional taxes. Since the settlement was negotiated entirely by plaintiff, and was made without defendant's consent, the burden should be on plaintiff to establish what, if any, amount was paid in settlement of penalties alone. If there was an overall settlement incapable of segregation as between additional liability for excess profits and liability by way of penalty, we do not see how plaintiff could recover. Counsel fees in negotiating the settlement should be considered on the same basis.

The judgment is reversed.


1.  The various tax figures involved in this case are as follows:12345678Paid at time tentative return filedIndicated tax March 22 1946Paid at time amended return filed 3–22–46Interest paid March 22 1946Additional taxes due after Treasury AuditTotal taxes paidStatutory Penalties ProposedCompromise payments in addition to deficienciesFEDERALIncome: 19435300.004908.55(391.45)0.00(refund)4908.551227.21613.61 19445300.006255.29955.2958.8869.936325.221581.30790.65Decl ValExcessProfits 19430. 19440.001064.101064.1065.69415.531479.63369.91184.95ExcessProfits 19430.0018606.1418606.142352.745265.4723871.615967.902983.95 19440.0044047.2444047.242715.075066.2249113.4612278.366139.18STATE 1943766.121324.99558.8767.710.001324.990.000.00 1944705.042433.111727.07106.500.002433.110.000.005366.5910817.1521424.6810712.34(4)(5)(7)(8)The judgment awarded by the court below is composed of:The interest paid (column 4)$ 5366.59The compromise payment (col. 8)10712.34Counsel fees (not shown above)1350.00 Total$17428.93The amounts listed in column 5 were paid by plaintiff at the time of the settlement and are not directly involved in this lawsuit.The total of column 7 is the statutory penalty which was not imposed but rather a compromise sum as indicated by the total of column 8 was paid by plaintiff.

SHINN, Presiding Justice.

WOOD and VALLÉE, JJ., concur.

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