Mrs. Hake died in October of 2011 after a period of incapacitation, holding substantial assets including a closely held grocery store chain.  Her five children apparently did not agree on much, and that included the administration of her estate and the value of the assets.  Two of her five children, Ricky and Randy, were named executors, and hired the family lawyer to act as estate and tax counsel.  Normally, the estate tax return, Form 706, would have been due nine months following the date of death, in July of 2012. See Section 6075(a).  Due to the disagreements between the family, it was believed that they would not know the actual values of the estate assets at the filing deadline.

The attorney suggested filing a Form 4768 to obtain an extension of time to file the return and pay the tax due.  In June of 2012, the request for extension was filed.  An associate in the office was tasked with determining the extension, and informed the primary attorney, who in turn informed the client, that the filing deadline and the payment deadline had both been extended by a year.

But, that isn’t really a thing.  The estate had received a six month automatic filing extension, and a one year discretionary extension for payment.  This fact didn’t make it to the executors, who thought they were doing substantial good by prepaying the tax in February of 2013 ( about a month after the return was due) and in July the return was filed.  In August of 2013, the Service notified the estate that about $198k of penalties were due for failure to file a timely return under Section 6651, along with $17k in interest.  The estate took administrative steps to seek abatement, but eventually had to pay the tax due.  It then filed a refund suit in the District Court.

As the court stated, the issue was narrowly defined:

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?

The Court found that yes, it did constitute reasonable cause, which I applaud, and, as I have said repeatedly in the past, in this particular situation I do not think penalties should be imposed on the estate.  However, this is not in line with most of the case law.  The holding does follow the Third Circuit opinion in Thouron, as discussed below, but this fact pattern pushes the boundaries of the Supreme Court’s holding in Boyle further than Thouron did.

To begin the legal analysis, the court covered the general law, including that a six month extension is allowed under Reg. 20.6075-1 for filing, and that an extension to pay is allowed for up to a year under Reg. 20.6081-1(b).  Pursuant to Section 6081(a), however, the IRS is limited in allowing extensions beyond six months for failure to file (unless the taxpayer is outside of the country).

The Court characterizes this extension in an interesting way, stating:

 thus, with respect to payment and filing deadlines, the legal terrain requires subtle multi-faceted analysis. First, one must determine the initial filing and payment deadlines.  Next one must negotiate a series of deadline extensions rules.  Some of these extensions are automatic; others are discretionary.  Further, one must be alert to the fact that the application of these differing rules can lead to different deadlines for payment and filing.  Finally, one must remain mindful of the fact that the filing rules themselves change depending upon residency status of the executors.

The language is clearly framing this as a difficult issue that lay persons generally would not be capable of figuring out, which is not always how the discussions begin in cases following Boyle.    As our readers know, the failure to file penalty has an exception when such failure was due to reasonable cause and not willful neglect. Section 6651(a)(1).  SCOTUS outlined the general test for executors seeking to show reasonable cause in United States v. Boyle when relying on a tax professional.

The District Court discussed Boyle, but largely through the context of Thouron v. United States, the 2014 Third Circuit failure to pay case, which found the executor had reasonable cause for failing to timely pay estate tax because of his reliance on a tax professional regarding the extended deadline.

At the outset, it is important to note that most courts, practitioners, and commentators believe the failure to pay case law and the failure to file case law is largely interchangeable in this area, which I agree with.

The District Court noted the Third Circuit stated Boyle:

identified three distinct categories of late-filing cases. In the first category consists of cases that involve taxpayers who delegate the task of filing a return to an agent, only to have the agent file the return late or not at all…[SCOTUS] held…such…reliance…was not reasonable cause…The second category…is where a taxpayer, in reliance on the advice of an accountant or attorney, files a return after the actual due date, but within the time that the…lawyer or accountant advised the taxpayer was available.  Finally, in the third category are those cases where “an accountant or attorney advises a taxpayer on a matter of tax law.”

The District Court believed that Thouron had instructed it to construe Boyle narrowly, only clearly applying to the first set of failure above.  As to the second set, it believed Boyle did not hold on the issue leaving the lower courts to make their own determinations, and that under the third set of cases, Boyle would not apply.

The government’s contention is that the requirement for timely filing is non-delegable, and reasonable cause based on misunderstanding the deadline is never sufficient.  Such a failure is, in its mind (I am assuming), a malpractice claim between the taxpayer and its advisor.  The Service would never allow reasonable cause in the second set of cases, and would likely argue against it in most of the third set of cases.

The District Court in Hake, in the remainder of the opinion, somewhat appeared to begrudgingly agree with the Third Circuit’s analysis that reasonable cause could, and perhaps should, apply in all second and third category cases.  Towards the end, the Court stated the following not-so-ringing endorsement of its holding:

In reaching this conclusion, however, we wish to emphasize the very narrow scope of our ruling. We do not purport to stake out new or novel legal theories in this decision.  Rather, we attempt to simply and faithfully apply the law of this circuit to the facts of this case.  Moreover, our decision regarding the reasonableness of the executor’s reliance upon legal advice is strictly limited to, and bound up in the facts of this case.

The Court did then note, as a positive, the fact that the executors had overpaid the amount of tax due before the deadline for doing so (making the imposition of the penalty seem a little boorish on the part of the Service).  Finally, in foot note 6, the Court invited the government to consider taking this case up through various appeals to clarify the disparity in case law on this matter that is found in the other Circuits compared to the Third.

I have no specific knowledge of the case, but the opinion seemed to indicate that the district court judge in Hake 1)  doesn’t agree with Thouron completely, 2)  appreciated the fact that taxes were timely (over) paid, and 3)  didn’t want to be overruled on the opinion.

Thouron, however, in my mind left the door potentially open for the judge in Hake  to hold the other way, had it wanted to.  Hake doesn’t clearly state whether it falls within the second or third group of Boyle cases indicated above.  The language of the case would indicate the judge in Hake was analyzing the case under the second group, where the taxpayer files within the time frame erroneously indicated by a practitioner, not where there was clear reliance on legal advice (although the discussion of the complexity of the filing dates does drift into what I would view as a discussion more related to reliance on legal advice).

Thouron, likewise, didn’t specify whether it was a second or third group case.  It stated that Boyle only held on clerical oversight in an agent failing to file by the deadline.  “It did not rule on when taxpayers rely on the advice of an expert, whether that advice relates to a substantive question of tax law or identifying the correct deadline”.

Thouron certainly indicates a willingness of the Third Circuit to allow a reliance case in either a second (advice regarding deadline) or third (reliance on expert for tax law advice), but it does not flesh out the issue any further.

One key distinction between Thouron and Hake, in my opinion, is that Thouron seems more like reliance on an expert regarding tax advice, which happened to impact the filing deadline.  In Thouron, the estate failed to timely pay tax because the estate erroneously believed it qualified for deferral of payment under Section 6166.  That Section allows deferrals on certain closely held business interests, and is incredibly complicated, including substantial regulations, rulings, etc.  Section 6166 itself, which only deals with the extension to pay, is about 4,000 words long.  Determining whether or not an estate qualifies is clearly an expert’s job, and to attempt to penalize an estate for such reliance when the expert is wrong in the analysis is antithetical to the statutes and regulations regarding the reasonable cause exception.  Hake, instead, was just a normal extension request.

While I agree the automatic extension provisions and the discretionary extension for payment can be confusing, and arguably could be expert advice, I think the case is less clear that it would fall within group three.   Again, the holding in Thouron lumps groups two and three together, but it does not state whether Thouron was in one or both groups.  It also does not state that all cases involving an accountant or lawyer advice regarding a deadline would qualify under group two (for instance, it would be interesting to see a court have that type of holding with the same automatic extension to pay income taxes and an extension to pay income tax).  I suspect the Third Circuit would affirm Hake, and probably would have reversed it had the holding been for the government.  Its statements in Thouron were somewhat clear in stating it would find reasonable cause for reliance on determining an extension or on legal advice.

I do not believe Hake has been appealed to the Third Circuit yet, and may not be.  If it or other similar cases should continue to be affirmed by the Third Circuit, it would result in a sufficient split to allow SCOTUS to weigh in on how Boyle should be applied, or more accurately, how the underlying law should be applied in groups two and three.  I think cases in group three have to remain reasonable cause, but it would be really interesting to see what happens with group two.

All parties agree that Ms. Specht relied very heavily on Attorney Backsman to handle the administration, which largely resulted in Ms. Specht calling Attorney Backsman to get updates on the statute.  Ms. Specht asked about the returns repeatedly, and was told that an extension had been obtained for filing the return.  This was not true and the return was not filed nor were the taxes paid.  The Sixth Circuit highlighted the fact that Specht had received multiple notices that probate deadlines were missed, and that she relied on Attorney Backsman’s statement that it was being handled and extension were obtained.  The following year, Ms. Specht was contacted by a family friend who also used Backsman, and was told that Attorney Backsman was incompetent.  Ms. Specht went to see Attorney Backsman, and again accepted statements that the administration was moving forward and extensions were obtained.  She also signed “a blank paper”, which the attorney indicated would give her authority to sell the UPS stock on behalf of the estate (the attorney later claimed that paper was sent to UPS, but it never was).  From middle of August 2010 to October of 2010, the wheels really started to fall off.  Ms. Specht received multiple notices from the Ohio taxing authority indicating the return was late.  Various family members called and begged Ms. Specht to fire the lawyer due to incompetence, and Ms. Specht found out that UPS had not been contacted.  At that point, she fired Attorney Backsman.

Within a few months of hiring new counsel, the UPS stock was sold, the federal estate tax return was filed with payment of the tax and interest.  The Service imposed penalties, which the estate subsequently paid.  Somewhat interestingly, the Ohio taxing authority refunded the penalties imposed due to “hardship caused by Backsman’s representation.”   PA hardly ever imposes penalties on death tax returns, and I have rarely seen it on state death tax returns, so I am not that surprised.

Big Brother, however, decided it needed to refill the coffers of the Holding Company, and imposed substantial penalties.  The IRS imposed $1,189,261 of penalties (and interest) for failure to file and failure to pay tax under Sections 6651(a)(1) and (2).  As the Court noted, quoting US v. Boyle, the penalties are mandatory unless the taxpayer had reasonable case; the taxpayer “bears the heavy burden of proving both 1) that the failure did not result from ‘willful neglect’ and 2) that the failure was ‘due to reasonable cause’.”  469 US 241 (1985).  As Keith noted in his recent post on Kimdun, Inc., if the Court is citing Boyle heavily in a reasonable cause case, your client is probably in trouble.

In Specht, the taxpayer was clearly not sophisticated, made reasonable attempts to comply, and made the reasonable decision to hire the attorney who prepared the estate plan, was very well respected, and had decades of experience…but, under Boyle, that is not really applicable to reasonable cause in this instance.

In Boyle, the Supremes dropped what they believed to be a bright line rule, which sometimes causes reasonable people to fall outside of the reasonable cause exception.  In Boyle, the Court stated, “the time has come for a rule with as ‘bright’ a line as can be drawn…[and] Congress has placed the burden of prompt filing on the executor, not on some agent or employee of the executor.”  The Court believed this meant that Congress intended to place the burden on the executor to determine the applicable deadline and ensure filing in a timely fashion.  Further, “[t]hat the attorney…was expected to attend to the matter does not relieve the [executor] of his duty to comply with the statute.”

The Court looked to its prior holding for guidance, in Vaughn v. United States (also covered here previously).  Mo Vaughn, the rotund slugger, had a shady money manager after his retirement who was probably stealing from him and failing to keep his financial affairs and returns in order (if you wanted to argue that Mo was stealing from the Mets the final two years of his career…).  The Sixth Circuit held there that “Vaughn’s statutory duty is non-delegable and is not excused because of the felonious actions of his financial agents.”  The ultimate tax insult to financial injury.  The Court concluded by essentially stating “reasonable causes” are only something beyond the possible control and oversight of the taxpayer, and taxpayers should know the due date and make sure it is followed.

The Court concluded that Specht had agreed to be a fiduciary, which has obligations that are serious.  The Estate could not show that she met the heavy burden of showing reasonable cause in failing to file the returns before the applicable deadline.

My conclusion the first go around was as follows:

I’ve shared my frustration with this line of cases repeatedly in the past, but I do somewhat understand why the rule is crafted in this matter.  I would be interested to know how the malpractice case panned out.  The coverage may have a maximum payout amount, and if there were a bunch of these cases, the various clients could be dividing up a limited pie.  In theory, the executor could be held liable to the beneficiaries for anything not recouped.  Any result where the executor ends up responsible seem completely inequitable to me.

The estate did sue Attorney Backsman, and that case settled, although the amount is unknown.  Some amount may have been recouped, but, as I noted above, Attorney Backsman, probably had a number of claims brought against her, and it is possible that the malpractice policy limited the total payout.

My position on Boyle and reasonable cause remains the same.  I understand why the bright line is in place, as it would be too easy for executors to simply blame counsel for the mistake.  Serving as executor, however, is not a common occurrence, and, with the current estate tax thresholds, having to file a federal estate tax return is fairly uncommon.  For a sophisticated individual, it is possible to determine there is a nine month deadline.  In my view, the IRS is too aggressive in applying this rule to these type of cases.  For instance, the Service extended it to substantive advice as to when taxes had to be paid under complicated Code Sections in Thouron from the Third Circuit.  It is also drastically out of line with how lawyers and clients interact in this arena.  Every single one of my clients relies on me completely to ensure proper and timely filing.  They look to me, often bewildered, as to when the return must be filed, what the extension can be for, when the tax has to be paid and when that can be extended.  And, given how few of these returns are filed each year, it seems unlikely that John Q. Public is going to realize they cannot rely on me as protection from penalties (query if such reliance is a valid defense in a breach of fiduciary liability case).

Boyle modifies a subjective “reasonable cause” standard, and turns it into an objective line in the case where an executor relies on a preparer to timely file.  The statute, which had objective deadlines, included an exception, which is no longer allowed for receiving advice on a deadline in all deadlines.  Interestingly, the Service also recognized how colossally messed up the Code is, and that people are going to miss deadlines.  You get a free pass on the income tax side with the first time abate exception.  Income taxes are filed by essentially everyone, every single year.  Most people will never file an estate tax return.

I certainly don’t have a better solution at this point, which diminishes the usefulness of this post, but  I always feel bad for the executors.  I understand, however, why the cases are decided as they are under Boyle by the lower court judges.  If possible when bringing one of these cases, I would try to show the missed deadline was tied to substantive advice regarding the due date.  A showing that there was a general understanding, issues were raised, and incorrect advice was given.

There is one other aspect of the case that is worth noting, which was the failed argument regarding Mrs. Specht’s ability or capacity to do the job of executor.  The Sixth Circuit noted that Boyle left open the possibility that an executor’s ability level would potentially impact the reasonableness of the late filing of the return.  The Court specifically highlighted the concurrence by Justice Brennan as stating mental health or diminished capacity as reasons that could get around the bright line rule.  The Court, however, also cited to the rule that a great majority of people can determine the deadline and ensure compliance, which it found true of Mrs. Specht.  Mrs. Specht, although unfamiliar with the rules, did not suffer from a disability that would have caused her to miss the deadline.  This could be an avenue in future cases, with the right fact pattern, to claim reasonable cause when someone has relied on a preparer to ensure timely filing.