Missing Estate Tax Info Might Provide Reasonable Cause for Late Return

(Parker Tax Publishing August 2021)

The Court of Federal Claims denied the government's motion to dismiss a lawsuit brought by the executor of an estate for a refund of penalties the IRS assessed for the late filing of the estate's tax return. The court held that the executor presented a plausible claim for reasonable cause based on his reliance on tax advisors who determined, based on the information available at the time, that the estate was not required to file an estate tax return, even though it was later determined that a return was required due to the decedent's lifetime gifts. Leighton v. U.S., 2021 PTC 247 (Fed. Cl. 2021).

Background

David Leighton passed away in January of 2017 leaving behind two sons, Frank Leighton and David Leighton, Jr. Frank was the executor of Leighton's estate. The administration of the estate involved three key actors: Freshwater Consultants of Alexandria, VA (Freshwater), JDJ Family Office Services (JDJ Services), and Richard Allen. Prior to his death, Leighton utilized Freshwater for tax preparation services for several years. After he died, Leighton's heirs contacted JDJ Services to learn of the next steps that each needed to take. Frank then hired Allen, an attorney with Fraser & Allen, LLC, to assist with administration of the estate, and authorized Allen to communicate with JDJ Services on Frank's behalf.

In March of 2017, Allen informed Frank that an estate tax return needed to be filed only if the value of the estate exceeded $5,490,000. Based on readily available information, Allen, Frank, and JDJ Services all operated under the assumption that the estate was worth around $1-2 million. Had that valuation been correct, an estate tax return would be unnecessary under Code Sec. 2010. Freshwater worked in conjunction with JDJ Services and Allen to file Leighton's 2016 individual income tax return, but the matter of possible lifetime gifts was apparently not discussed. Various steps were taken in the fact-gathering process to effectively fulfill the estate's tax obligations. As part of that process, a representative of JDJ Services responded to a questionnaire sent by Allen which asked for details of any gifts in excess of the annual exclusion amounts and any gift tax returns previously filed. These efforts did not result in any indication of lifetime gifts by Leighton.

David Leighton, Jr. had not been involved in the estate administration until February of 2019 - almost two years after his father's death - when he indicated that his father "might have" established and funded various trusts during his lifetime and that an estate tax return may have been necessary. Allen inquired about those trusts with Freshwater, to which Freshwater responded with a copy of Leighton's 2012 gift tax return confirming the existence of lifetime gifts. This was new information to Frank, Allen, and JDJ Services. That form showed gifts totaling $5,094,000 - an amount that would put the value of the estate over the threshold for an estate tax return. Under Code Sec. 6075(a), that return was due within nine months of Leighton's death, i.e., not later than October 6, 2017 - a deadline long passed.

In April of 2019, after coordinating with JDJ Services, Freshwater, and Frank, Allen prepared and filed Leighton's belated estate tax return, and the estate paid the taxes plus estimated penalties and interest. After processing the return, the IRS assessed a late filing penalty, a late payment penalty, and interest. Those amounts were paid and Frank filed a refund claim with the IRS, insisting that it was improper to impose penalties resulting from the untimely filing of the estate tax return because he reasonably relied on Allen's advice and was unaware of Leighton's lifetime gifts. After more than six months passed without the IRS acting on his refund claim, Frank brought a lawsuit for the refund in the Court of Federal Claims.

Under Code Sec. 6651, penalties will not be imposed if the failure to timely file a return is due to reasonable cause and not willful neglect. Reg. Sec. 301.6651-1(c)(1) provides that, if the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return or pay the tax within the prescribed time, then the delay is due to a reasonable cause. Reg. Sec. 1.6664-4(b)(1) states that reasonable cause may include an honest misunderstanding of fact or law that is reasonable in light of all of the facts and circumstances, including the experience, knowledge, and education of the taxpayer. That regulation also states that reliance on the advice of a professional tax advisor does not necessarily demonstrate reasonable cause and good faith unless, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith.

The government, citing the Supreme Court's decision in Boyle v. U.S., 469 U.S. 241 (S. Ct. 1985), argued that, because the executor of an estate is the sole party responsible for belated estate tax filings, he therefore cannot demonstrate reasonable reliance on the advice of his agent. Taxpayers are free to hire an agent of their choosing in the preparation of their taxes, the government noted, but that does not relieve the taxpayer of its legal obligations under the tax code, and any carelessness, reckless indifference, or intentional failure by the taxpayer's agent or employee is attributable to the taxpayer under the standards set forth in Boyle. Reliance on advisors, the government said, is generally an insufficient excuse for relief from the late-filing and late-payment penalties because filing and payment deadlines are unambiguous. According to the government, Allen's advice was objectively unreasonable because it did not account for the 2012 gifts made by Leighton and therefore was not based on all of the pertinent facts and circumstances. The government also contended that blind faith in JDJ Services regarding Leighton's lifetime gifts did not constitute due diligence. The government asserted that Frank was the sole party responsible for the belated filings and he therefore could not demonstrate reasonable reliance on the advice of his agent. As a result, the government filed a motion to dismiss Frank's complaint for failure to state a claim on which relief could be granted.

Analysis

The Court of Federal Claims denied the government's motion to dismiss after finding that Frank's complaint stated a plausible claim upon which relief could be granted. The court found that, while the government's motion was predicated on the assertion that someone, somewhere, should have known about Leighton's 2012 gift tax return, the court was not able to make that decision at this early stage of the litigation.

The court reasoned that if it found for the government on the issue of the reasonableness of Allen's advice, then missing information could never constitute reasonable cause because the advice would necessarily not be based on all pertinent facts and circumstances. On the issue of due diligence, the court contrasted this case with the facts of Russian Recovery Fund Ltd. v. U.S., 2017 PTC 112 (Fed. Cir. 2017), where the Federal Circuit found that a failure to perform due diligence amounts to unreasonable reliance on the statements of others. In that case, the Federal Circuit found that the taxpayer's accounting firm did no independent investigation into the factual accuracy of the information supplied by a related individual. The Court of Federal Claims noted that in this case, the complaint laid out various steps taken in coordinating the estate, including an exchange of a questionnaire about the valuation of the estate. The court said that at this stage of the case, it had to accept as true that the steps outlined in the pleadings were taken to their most reasonable extent. The court reasoned that tax advisors cannot reasonably give advice on unavailable information and that, without more evidence, it could not discern whether Allen's factual investigation constituted reasonable due diligence.

The court also rejected the government's argument that Frank was the sole person responsible for the late return. The court noted that in Boyle, the Supreme Court held that taxpayers may reasonably rely on advice concerning whether - but not when - a return must be filed. However, the court found that that Boyle does not address the issue of whether reasonable cause can be established when, as in this case, the taxpayer and its agents act on incorrect information. The court observed that it is a pillar of the tax code that a taxpayer is expected to file a timely return based on the best information available and then file an amended return if necessary. In addition, the court said that as a general rule, a taxpayer is not obliged to share details with a tax preparer that a reasonably prudent taxpayer would not know; neither is the taxpayer required to share details that he himself would neither know nor reasonably should know are relevant.

The court said there was no dispute that Leighton's lifetime gifts impacted whether an estate tax return was required and that Allen acted promptly once he obtained a copy of the 2012 gift tax return. Thus, the court concluded that the inquiry as to whether Frank acted reasonably largely depended on the availability of the missing 2012 gift tax return. Whether that return was in Freshwater's possession, as the government asserted, was a factual inquiry that the court said was beyond the record before it. The court observed that the missing 2012 gift tax return could have been misfiled, intentionally hidden, or willfully ignored, and it was unclear at what point the availability of the document and exhaustive searching becomes enough to rise to the level of reasonable cause for a late filing. The court noted that the specific details surrounding the inquiries to Freshwater were not pled before the court, nor were they required at this stage. Whether those inquiries were actually diligent presented a question of fact not suitable at the dismissal stage. The court concluded that there was simply not enough information to answer the question of whether Frank and his advisors should have known about Leighton's funded trusts prior to their unveiling in 2019.

For a discussion of abatement of penalties due to reasonable cause, see Parker Tax ¶262,127.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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