Earlier in the week, I wrote about the primary holding in the Liftin case here. There were portions of the primary holding that I found interesting and potentially taxpayer unfriendly. The majority in dicta, and the dissent, touched on a separate issue, which was why the failure to file penalty was imposed when the taxpayer had made a full timely payment of all tax due, since full payment of tax due usually protects a taxpayer from the imposition of the penalty amount. We found this surprising, and found the dissent persuasive that the penalty should not have been imposed. The same sentiment seems to be shared by various other practitioners. The issue is discussed below.
Wait, a timely payment was made –Why a penalty?
The Facts
The dissent, and the majority in footnote 1, addressed the imposition of the failure to file penalty when the taxpayer had made a timely payment of all tax due. As discussed in the prior post, the estate requested an extension to pay the tax due, which was granted. Prior to the expiration of the extension, the estate overpaid the actual amount due by around $200,000. Many months after the expiration of the extension deadline, the estate filed the federal estate tax return, and requested a refund of the overpaid amount. The IRS issued a refund, but reduced the refunded amount after assessing the failure to file penalty. The estate then challenged the imposition of the penalty based on reasonable cause by reliance on advisor. The estate did not raise the prepayment issue with the lower courts. The Federal Circuit requested briefing on the matter, sua sponte.
The Law
Under Section 6651(a)(1), a penalty is imposed for failure to “file any return…on the date prescribed therefor (determined with regard to any extension of time for filing)…” The penalty is based on the amount of tax due. In calculating the penalty, Section 6651(b)(1) directs the IRS, however, to reduce the tax amount “by the amount of any part of the tax which is paid on or before the date prescribed for payment of the tax.” Section 6651(b)(1) does not have the same parenthetical found in (a)(1) referencing extensions. The language of Section 6651(a)(2), which is the imposition of the failure to pay penalty, is very similar to (a)(1) and has the parenthetical indicating the timeframe for determining whether the failure to pay penalty applies includes the period of extensions to pay– meaning no failure to pay penalty can be imposed if a timely payment is made within the original payment period plus any extended period. But, can the failure to file penalty be imposed if a timely payment was made after the original due date???
The Positions
I didn’t pull the taxpayer’s brief, so I’m not sure of its position, but I suspect it is similar to the dissent’s discussion below.
The Service position for the imposition of the penalty, taken from footnote 1 in the opinion, is that the exception portion of the statute found under (b)(1) does not make any reference to extensions to pay tax, unlike in the parentheticals found in (a)(1) and (a)(2). The subsections in (a)(1) and (a)(2) are not identical though, with (a)(1) stating no failure to file penalty is imposed if a return is filed within the extension period, and (a)(2) stating no failure to pay penalty is imposed if tax is paid within the extension period. Subsection (b)(1), directing the calculation of the failure to file penalty, states payments received within the prescribed time to pay reduce the gross tax due, but there is no reference to extensions. The Service determined that only payments before the original due date are counted. To bolster this position, the Service looked to Section 6151(c), which states that the date for payment should be read to refer to the last day fixed for such payment determined without regard to extensions to pay. Section 6151 is the general statute regarding the time and location for the filing of tax returns. Section 6161 allowing for the extension is found in the following subchapter (a somewhat important part, because Section 6151 states the date can only be modified by language in that subchapter).
Discussion
Although the Court requested supplemental briefing on the matter, the majority declined to address the matter, stating “ [w]e see insufficient reason, in the circumstances here, to depart from the important rules requiring timely presentation and development of issues.” This statement and the majority’s discussion of the matter appeared in foot note 1 of the majority’s opinion. The discussion was largely just the initial Service position, and then the majority’s conclusion that it would not review the matter. Initially, I took this to be a sign that the majority would not have ruled in favor of the taxpayer (coupled with the first sentence of the majority “Discussion” section that stated the penalty regime was imposed even when there has been payment), but I’m not sure that is correct, and I think the request for briefing and the footnote statement indicate taxpayers in similar situations as the taxpayer in Liftin should make this argument earlier in the process and before the Courts.
I am somewhat disappointed that the Court did not hold on the matter, because it now allows for this holding (perhaps the only one) with little explanation and guidance on this very interesting issue that caught so many folks off guard. I believe the Court would have been within its discretion to make a determination, even if the taxpayer failed to raise the issue. I think doing so would have been better overall for tax administration.
The dissent disagreed with the majority, and felt the Court should address the issue and hold for the taxpayer. In reviewing the matter, the dissent looked to the statute, noting the failure to pay penalty is housed immediately following the failure to file penalty, and language is very similar. The interpretation by the Service creates an anomaly where the failure to pay penalty cannot be imposed (because extensions are considered), while the failure to file penalty, which is based on amounts that have not been timely paid, can be imposed because extensions would not be filed. The dissent reasoned it made little sense to impose one penalty and not the other on a “timely” made payment.
It also attacked the interpretation of Section 6651 not including validly extended periods of time, noting the interpretation was contrary to both the House and Senate reports, which stated:
Subsection (b) of [6651] provides that the addition to the tax will be computed on the net amount due on the return rather than on the gross amount of the tax required to be shown on the return. This provision is important in the case of income tax where a large part of the amount of the tax shown on the return may have been prepaid through declaration of the estimated tax or through income tax withholdings. [emph. added]
The dissent also walked through various failure to file cases that stated explicitly that no penalty can be imposed when the amount has been paid in full, and twice emphasized that the Supreme Court has held statute levying taxes, especially penalties, are construed most strongly against the government.
I find the dissent’s position more compelling than the Service position on this matter. If you read the entire statute, you see that penalties are imposed when payments are not timely made, and timely payments or filing take into account extensions. This seems a bit like a reverse tax shelter argument, where the Service was able to create a cute explanation based on a very specific reading of unconnected statutes.
If the penalty is not clearly zero, then I think the statute is ambiguous. There is clearly a valid position that the reference in (b)(1) to “paid on or before the date prescribed for payment of the tax” could reference the extended dates discussed within the same statute. In looking at other evidence, it would seem the heavy weight of the evidence would be in favor of no penalty imposition.
In this case and related cases, the Service had access to the money in a time frame it approved, and the statute of limitations was tolled. Holding otherwise would also undermine the extension provisions, rendering one aspect useless. If the taxpayer knows he or she will not timely file the return after the extension, there is no benefit to making a payment during the extended payment period. The same 25% total penalty will be imposed, and the taxpayer might as well benefit from the use of the money (assuming fraud is not then an issue). The holding would also appear to be contrary to the intent of the penalty statute itself, based on the legislative history and overall statute.