Preparer Knappe(s) on the job: Delinquency Penalties, Advisors, and Reasonable Cause (Part 2 — I Finally Get to my point on Thouron).

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Recently, I posted the first part to this two part discussion on the reasonable cause exception to the delinquency penalty; specifically, when reliance on a tax expert may be reasonable cause for failing to file or failing to pay in a timely manner.  Even more specifically, the three cases discussed all deal with the federal estate tax, and all deal with advice regarding extension dates for either filing or payment.

In the first post, I discussed the recent Knappe case from the Ninth Circuit, which has been denied cert by SCOTUS, and also provided a very brief overview of expert or preparer reliance as reasonable case to the delinquency penalties.  Knappe and that discussion focused primarily on failure to file, and below the focus will be on failure to pay, but first I want to highlight another failure to file case, Estate of Liftin, which shows one example as to how advice on an extension date could be substantive advice.

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In Estate of Liftin v. United States, the Court of Federal Claims found it was reasonable for the executor to rely on incorrect attorney advice regarding Reg. § 20.2056A-1(b) pertaining to surviving spouses seeking citizenship after the decedent’s death.  The Regulation provides that a non-citizen spouse of a decedent may be treated as a citizen if that spouse becomes a citizen after the death of the decedent and if other requirements are met. The attorney for the estate provided guidance regarding the surviving spouse becoming a citizen, and indicated the regulations would provide a reasonable basis for late filing when waiting for citizenship so that no penalties would be imposed. The advice was wrong, seemed aggressive, but the Court held the executor was protected on relying on that advice, as it was substantive advice and not something the executor would know on his or her own.  In Liftin, although the Court indicated it was reasonable to rely on that advice, the estate was responsible for the delinquency penalties because it waited an unreasonable time to file beyond the time frame indicated in the advice.  I suppose that could make the reliance part dicta.

Before getting to the failure to pay cases, contrast Liftin with Estate of Young, where an accountant informed the executor that it would be better to wait and file a correct, late return, than an incomplete, timely return.  The accountant specifically stated there would be no penalties due, and the audit would go more smoothly.  This case is actually much like Knappe, except the executor knew the filing was late.  The Massachusetts District Court held that there was no substantive legal advice, the executor knew it was supposed to file (the estate somewhat argued against this at the hearing), and that tax filing strategy to eliminate an audit did not change the filing requirement.  The Court acknowledged substantive legal advice was given regarding the imposition of the penalty (just like Liftin), but stated that could not justify reasonable cause for not following the known deadline (there is somewhat of a split, perhaps, on this).

So, this is somewhat complex, but we do know that substantive advice regarding a deadline can be reasonable cause for failure to file—especially if it is not regarding the imposition of penalties.

 Extending Boyle to Failure to Pay Cases:

My recollection about the delinquency penalty cases where reasonable cause is claimed is that the case law often tends to intertwine failure to pay and failure to file cases.  For one, the requirements for the exception are worded almost identically, and, two, both are often present.

In another recent estate case, Estate of Baccei, the Ninth Circuit extended the rationale of the failure to file cases to the failure to pay cases, stating “[t]here is no reason to distinguish between [them]”, which seems to be what was occurring, but not helpful if your client is trying to get out from under a harsh failure to file rule.  In Baccei, the executor was told by the accountant that the accountant filed for an extension of time to file and to pay, but the accountant failed to check the box requesting an extension to pay when he sent in the form.  The Court held that by failing to confirm that the extension had been requested and granted, the executor failed to exercise ordinary care and prudence, and this was not a substantive legal determination.  I understood this holding, but I had the same policy concerns.  How easy is it to confirm that the extension request was made and granted, and should the burden be on the executor to sue the accountant?  I really have not thought this through (the beauty of a blog, compared to a scholarly article), but it seems somewhat unfair.

When Procedure is Clearly Substance – This Case was Wrong and Should Win on Appeal:

Another case from last year is right out of my back yard in Chester County, Pennsylvania, the Estate of Thouron v. United States, found here.  I was not involved in this case, and do not know much about the specifics outside of what was in the holding.  I do know attorneys at the firm appealing this case (and suing prior counsel), but I have not discussed the case with them.

Thouron involved a failure to pay case with counsel’s advice to the executor that it did not have to separately file an extension of time to pay the estate tax when it timely filed an extension of time to file the estate tax return. It is clear to see how Boyle might apply, as it is a simple procedural matter that many taxpayers know that an extension to file is not an extension to pay.  That is what the Court held.

However, the case is not that straightforward.  At the time the executor made the extension to file request, the attorney advised the executor regarding the estate’s use of Section 6166. Section 6166 allows for an election to extend paying estate tax on closely held business interests over time, including a set period of non-payment of multiple years. This election is made on a timely filed Form 706, which includes the automatic six month extension. See Section 6166(d). The estate paid the other tax it thought due, and requested the automatic extension for the time to file.

The rules in this area are not straightforward.  I’ve made Section 6166 elections before, and every time I have to go back through, research, write myself a memo, and double check myself.  The Form 4768 is not clear in this area.  There is a box for requesting an extension to pay tax, which you do not necessarily have to check when requesting the automatic six month extension.  Further, there is a box for Section 6166 installments, which again does not have to be checked at that time under the statute.  Further, a failed Section 6166 election, if timely, may be treated as a timely extension request under Section 6161 for an extension to pay.  In addition, qualifying under Section 6166 is complex, substantive law.   In Thouron, had the taxpayer been entitled to the Section 6166 election, it would have been timely made on the Form 706, and the tax deferred.

Unfortunately, the estate apparently did not make a Section 6166 election when filing the return (presumably, it did not qualify), and instead made its first election for a Section 6161 extension to pay, which was not timely.  As I said, I do not know the specifics of this case, so perhaps I am missing something, but given the substantive legal advice regarding Section 6166 qualification, and the fact that the election could have been made on the extended Form 706 if appropriate, I have a hard time seeing how this could not be substantive legal advice relied upon in the payment of tax.  As I’ve stated above, I think Thouron should be able to win this appeal, as I think there is a strong chance of prevailing (with the caveat that I have not really looked at the 3rd Circuit’s position on this yet).  I hope the estate does prevail, as I do not like this holding being on the books for the Eastern District of Pennsylvania.

I’m not sure there is much else to glean from these posts except that it might make sense to revisit the imposition of this penalty and the exception to the penalty.  These cases can be hard to cobble together for a clear view of the legal landscape, and, under the statute and Boyle, many probably decided correctly, even if the holding can seem unfair.

Stephen Olsen About Stephen Olsen

Stephen J. Olsen’s practice includes tax planning and controversy matters for individuals, businesses and exempt entities for the law firm Gawthrop Greenwood, PC.

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