One of the more challenging issues courts and the IRS consider is when taxpayers can rely on a tax professional to avoid the imposition of penalties. In the last few years, courts have addressed many situations involving executors who have relied on accountants or attorneys to advise on estate return filing and payment obligations. The rules for estate tax payment and return filing are sometimes very straightforward, but at other times are complex, and advisors make mistakes, potentially triggering substantial late filing and late payment penalties if the estate cannot establish that the error was attributable to reasonable cause.
This will be the first of a two part post, which will start with a discussion of the reasonable cause exception as applied to failure to file cases, including the recent denial of certiorari in Knappe v. United States, and the second will move into the extension of the case law into the failure to pay cases, including some critical commentary on another recent case, Estate of Thouron v. United States, which should be heard by the Third Circuit in the near future.
Filing Deadlines: Sometimes Advice Can Insulate; Sometimes Not
Although an exhaustive discussion of the delinquency penalties and exceptions would be a tad much for this blog post, some background is needed to frame the recent cases. Section 6651(a) imposes a penalty for the failure to file a tax return and for the failure to pay the tax due. Both of these penalties are imposed “unless it is shown that such failure is due to reasonable cause and not due to willful neglect.” Treasury Regulation § 301.6651-1 and the Manual at 20.1.1.3 provide some background information. Saltzman and Book ¶7B.07 was recently rewritten by Les, and has a comprehensive discussion of this point, for those interested in more background.
One of the most common reasonable cause defenses is passing the figurative buck (as the actual buck was probably not passed if the penalty was imposed). Hiring (then blaming for the error) a return preparer or tax advisor, may, in some circumstances, show the taxpayer used reasonable business care and prudence to correctly ascertain the tax due, file the appropriate return and pay the tax. United States v. Boyle is the starting point in most reasonable cause discussions, and in Boyle the Supreme Court stated it is reasonable for a taxpayer to rely on its tax advisor on substantive matters, but filing a timely return is not a delegable duty, and it is not excused by reliance on an agent. See United States v. Boyle, 469 US 241 (1985). But, what if filing the return was based on somewhat substantive advice? In cases where the tax adviser indicates a return is not due or will be extended, and it is not a simple procedure matter, “courts have found that reliance on an expert was reasonable cause for failing to file timely a return because the taxpayers made full disclosure to the expert, relied in good faith on the expert’s advice, and did not otherwise know that the return was due.” See Russell v. Comm’r, TC Memo. 2011-81 (2011). The thrust of the remainder of this post and the follow up post will be a discussion of how that has been applied in recent failure to file and failure to pay cases.
One such case that attempts to fit within the above exception is Knappe v. Commissioner, where the Ninth Circuit has held the Service was correct in not abating penalties for a failure to file an estate’s federal estate tax return (Form 706) upon the advice of an accountant who indicated the extension provided twelve additional months to file the Form 706. The executor of the estate requested review from the Supreme Court, but certiorari was denied.
ScotusBlog has coverage of Knappe, including links to the briefs. The facts are straightforward, which I’ve taken from the Ninth Circuit holding found here. Ingeborg Pattee died in November of 2005, leaving a somewhat substantial estate and naming her friend Peter Knappe as executor. Mr. Knappe was a businessman, and not an expert in the federal estate tax, so he hired an accountant to assist with the estate administration. The accountant directed that the estate tax return would be due August 30, 2006, the correct date. As that date approached, more time was needed to prepare the return, so Knappe directed the accountant to file for an extension. The accountant requested the automatic six month extension for filing and a completely discretionary extension to pay the tax due, which, if granted, extended the payment date by one year. The automatic extension to file applied, and the discretionary extension was granted by the Service, which indicated the extension to pay was valid until the following year. The accountant told Knappe that he had until the extended payment date to file the return. Neither Knappe nor the accountant realized that the accountant’s guidance regarding the filing deadline was incorrect. Knappe filed the Form 706 a few months prior to what he thought was the extended deadline. The Service promptly imposed a penalty for late filing of close to $200k, at which point the accountant realized his error, and admitted to making a mistake.
As the Ninth Circuit states, the question is when can you trust your accountant, lawyer or other preparer? The answer can be fairly complicated, but for Knappe the writing was on the wall. Knappe requested that the Service excuse the penalties due to reasonable cause and not willful neglect under Section 6651(a)(1), and tried to shift the burden to his paid preparer, arguing reliance on the accountant’s erroneous advice. The IRS denied the claim, and eventually Knappe filed a refund suit in the District Court based on the same argument.
A policy side note before I get back to the case, I understand why this is the rule, but I feel it is fairly unforgiving in the estate return context in many cases. The vast majority of people will never have to consider an estate tax return. Further, the Service has provided a wonderful first time abate program (see our post here), which allows people to ask for forgiveness in situations where they screw up initial returns, among other situations. This does not extend, however, to event specific returns, like the estate tax return. This return is also due at strange times (nine months from date of death), and does have some complex rules relating to some types of extensions (for example, the extension to pay under Section 6166, which I will discuss in the follow up post). Executors should be careful in accepting the duty, and in handling the estate, but I think the policy and procedure around penalty imposition in this context may also deserve review.
In Knappe, the penalty also creates an interesting situation where the Service had agreed to take the funds a year later, but because it did not have the return after six months, penalties were imposed. The Service gets a windfall and isn’t harmed, and the executor probably has a fiduciary duty to sue the accountant for the bad advice. The accountant likely has some type of professional insurance that then reimburses the estate. The accountant was at fault, and eventually is punished, but the burden is placed on the taxpayer.
Back to Knappe, where the court made three controlling determinations: (1) the executor’s duty to ascertain the due correct filing deadline, and the date was non-delegable; (2) the determination of the due date following the request for an automatic extension was not substantive advice about the due date; and (3) the extended due date was set out in the correspondence from the IRS, which the executor could ascertain. The executor did have some additional minor facts, which evidenced reason for confusion, but the court did not seem interested. The Ninth Circuit upheld the District Court, and SCOTUS declined to review. Although I think this policy needs to be revisited, I think the case properly follows Boyle (also an estate tax case).
In the next post, I will discuss another recently decided estate tax case that indicates when advice regarding an extension is substantive, and then how the failure to file cases overlap with the failure to pay reasonable cause cases. Finally, I’ll cover a recent failure to pay estate tax case that I believe is wrongly decided and will hopefully be reversed on appeal.