Estate of Hake, 119 AFTR 2d 2017-727 (DC Pa., 2017)
In Hake,1 the U.S. District Court for the Middle District of Pennsylvania held that executors were not liable for penalties for late filing of the estate tax return, because the executors filed the return within the time their attorney had told them it was due. The district court relied on the precedents in its own Third Circuit, and noted that other circuits are split on this issue.
Esther Hake died on 10/2/2011, and two of her sons were appointed as executors of her estate. The executors hired a law firm to advise them on all tax matters and related estate administration issues, including the calculation, preparation, payment, and filing of federal taxes and tax returns. Because of ongoing family disputes regarding the valuation of estate assets, it became apparent to the executors that filing the estate tax return by the deadline would not be possible.
In order to give the executors time to resolve these issues, the lawyer advised the executors to seek extensions of time in which to file the return and pay the taxes owed. Pursuant to the executors’ direction, the lawyer filed a Form 4768 on 6/12/2012, seeking extensions of time to file the return and pay the taxes. Upon approval of the extension, the lawyer informed the executors that the deadline to pay the taxes and file the return had been extended for one year.
The lawyer, however, was incorrect. An estate tax return generally must be filed with the IRS within nine months after a decedent’s death.2 Reg. 20.6081-1(b) permits an executor to apply for an automatic six-month extension of time to file the estate tax return by filing a Form 4768 on or before the date the return is due to be filed. Executors may also apply for discretionary extension of time to pay estate taxes “for a reasonable period of time, not to exceed 12 months.”3 Therefore, under applicable statute and regulations, the estate’s deadline for filing its estate tax return was extended until 1/2/2013, and the deadline for payment of any estate taxes was extended to 7/2/2013.
The estate made a prepayment of estate taxes in the amount of $900,000 on 2/12/2013, some five months prior to the extended tax payment deadline. The estate filed its return on 7/2/2013, the date the executors were told it was due. The IRS notified the estate on 8/12/2013, that a penalty in the amount of $197,868.26, and interest in the amount of $17,202.44, had been assessed under Section 6651 for failure to file a timely return.
The lawyer attempted to seek abatement of the penalty, explaining by letter that he had understood the extension of the deadline for paying the taxes applied equally to the deadline for filing the return. When these efforts proved unsuccessful, the estate engaged in an administrative review process with the IRS, which was ultimately also unsuccessful. Having exhausted its administrative remedies, the estate filed a refund action in district court seeking recoupment of the penalty and interest paid.
The district court framed the issue in this case very narrowly. The district court stated:
When an executor relies upon inaccurate advice from legal and tax counsel regarding the extended deadline for filing an estate tax return, in a factual context where determination of filing and payment deadlines are governed by a series of mandatory and discretionary rules which may vary depending upon the residence status of the taxpayer, does that reliance upon professional advice constitute reasonable cause to avoid the assessment of late filing penalties and interest?
When a taxpayer fails to file a tax return by the due date, including any extension of time for filing, a late penalty applies “unless it is shown that such failure is due to reasonable cause and not due to willful neglect.”4 Reg. 301.6651-1(c)(1) provides that reasonable cause will excuse a failure to file timely only “[i]f the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time.” The Supreme Court, in Boyle,5 stated that in order to gain the benefit of this exception, an executor bears the heavy burden of proving that the failure to timely file the tax return was due to reasonable cause.
In the Supreme Court case of Boyle, the executor retained a lawyer on behalf of the estate to assist with tax matters. The executor relied on the lawyer’s instruction and guidance, and although he repeatedly checked with the lawyer about the status of the estate’s return, the lawyer overlooked the matter because of a clerical oversight in omitting the filing date from his master calendar. As a result, the estate’s return was filed three months late. The Supreme Court held that in such circumstances, the executor could not hide behind the oversight of his attorney because executors have a clear obligation to make sure that estate tax returns are filed timely and this obligation cannot be discharged by delegating responsibility to an attorney or accountant. The Supreme Court further found that the executor’s reliance on his tax lawyer was not for substantive tax advice, but for the administrative act of filing the return.
In Estate of Thouron,6 the Third Circuit, to which this case is appealable, read Boyle to have identified three distinct categories of late-filing cases.
The first category consists of cases, like Boyle, involving taxpayers who delegate the task of filing a return to an accountant or attorney, only to have the agent file the return late or not at all. In Boyle, the Supreme Court held that in such cases, reliance on an attorney to file a timely tax return was not reasonable cause to excuse the late filing.
The second category of cases, like Thouron (discussed below), involves a taxpayer who in reliance on the advice of an accountant or attorney files a return after the actual due date, but within the time that the taxpayer’s accountant or attorney advised the taxpayer was available.
Finally, the third category consists of cases where an accountant or attorney advises a taxpayer on a matter of tax law.
In Thouron, the executor retained an attorney to advise him. The estate requested an extension of time to file the return and requested an extension of time to pay estate taxes. As requested, the estate was granted the automatic extension of time to file the return but the IRS denied the requested extension of time to pay the estate taxes and imposed a penalty for failure to pay the tax that was owed by the deadline. The estate argued that its failure to pay was reasonable and not willful neglect, because it was based on substantive advice of counsel.
The district court granted summary judgment in the government’s favor, and the Third Circuit vacated the ruling, holding that the case was distinguishable from Boyle because Boyle involved a case of clerical oversight. This court found that the estate should be permitted to present evidence to show that it should not have been assessed the penalties because of its reasonable reliance on the legal advice of counsel.
The Third Circuit in Thouron, in reaching this determination, noted that Boyle had recognized a split of authority regarding the second category of cases, where the estate either paid or filed late, but did so by or before the deadline that its lawyer had instructed. In addition, the Third Circuit in Thouron noted that in Boyle the Supreme Court explicitly declined to resolve the split in the circuits regarding this issue. The Third Circuit in Thouron noted that the Third Circuit, in Sanderling, Inc.,7 had previously held that a taxpayer could show reasonable cause where he or she filed (or paid) before what he or she was erroneously advised was the deadline. The district court ruled in favor of the estate and disallowed the penalties stating that it was obligated to follow the precedents of the Third Circuit laid down in Thouron and Sanderling.
The district court reached a favorable result for the taxpayer. Other circuits, specifically, the Ninth Circuit,8 most likely would have reached a different result. These contrary decisions result from whether the applicable court interprets Boyle narrowly or more broadly. The Third Circuit has interpreted Boyle narrowly while the Ninth Circuit has interpreted Boyle more broadly. It will be interesting to see how other circuits decide this issue, and if the split among the circuits persists, whether the Supreme Court agrees to accept a similar case in order to resolve the issue.
1 119 AFTR 2d 2017-727 (DC Pa., 2017).
2 Section 6075.
3 Reg. 20.6161-1(a)(1).
4 Section 6651(a)(1).
5 469 U.S. 241 55 AFTR2d 85-1535 (1985).
6 752 F.3d 311 113 AFTR2d 2014-2082 (CA-3, 2014).
7 571 F.2d 174 41 AFTR2d 78-831 (CA-3, 1978).
8 See Knappe, 713 F.3d 1164 111 AFTR2d 2013-1531 (CA-9, 2013).
Frank Baldino is an estates and trusts attorney who helps people throughout the greater Washington, DC area protect assets for their families and future generations through careful estate tax planning. For more information, contact Frank at (301) 657-0175 or [email protected].
This article originally appeared in the June 2017 edition of Estate Planning, a monthly periodical directed to estate planning professionals that offers readers the newest and most innovative strategies for saving taxes, building wealth, and managing assets.