Fair Market Valuation Method Does Not Include an Exception for Fraudulent or Criminal Actions Not Known to the Public

(Parker Tax Publishing August 2019)

A district court held that the personal representative of an estate could not use her diagnosis of financial disability to toll the limitations period for filing a refund claim for the estate. With respect to the overvaluation of stock held by the estate and reported on the estate's tax return, the court noted that the fair market valuation method does not include an exception for fraudulent or criminal actions not known to the public, even if those actions lower or destroy the stock's value. Carter v. U.S., 2019 PTC 298 (N.D. Ala. 2019).

Background

Elizabeth Carter is the personal representative of the Estate of Frances E. P. Roper (the Estate). Ms. Roper died on September 21, 2007. At the time of her death, Ms. Roper owned 567,092 shares of Colonial BancGroup stock, worth a market value of approximately $17,605,000. Ms. Roper bequeathed the majority of her estate, comprised primarily of Colonial BancGroup stock, to her niece, Elizabeth Carter (i.e., the personal representative), and her nephew, Randy Roper. Within six months after Ms. Roper's death, the market value of the stock had decreased to $8,549,000.

On June 19, 2008, the Estate filed a federal estate tax return. The return reported an estate valued at $6,261,530 and tendered payment of the computed tax. On April 26, 2009, the Estate filed an amended return reporting a slightly lower tax of $6,169,892. The Colonial stock represented 46.8 percent of the gross estate. In valuing the Colonial stock, the Estate used the alternative valuation date to calculate the fair market value, a method which relied upon the stock's exchange price six months after Ms. Roper's death. The IRS accepted the amended return and issued a refund.

On September 13, 2013, the Estate filed a refund claim with the IRS, alleging it overpaid its estate tax by $3,731,616, due to a criminal fraud perpetrated against Colonial by one of its customers. The Estate asserted it did not have to rely upon the stock's exchange price for valuation due to the criminal fraud involving the bank. Ms. Carter and Mr. Roper alleged that Colonial Bank and its executives urged them not to sell their shares as their value began to decrease. Instead, they obtained a loan from Colonial Bank to pay the estate tax, for which Colonial Bank required personal guarantees from Ms. Carter and Mr. Roper. They remain liable on these personal guarantees. The IRS denied the Estate's refund request.

The United States prosecuted and obtained convictions against Lee Bentley Farkas for bank, wire and securities fraud, and conspiracy to commit the same, arising from a multibillion dollar scheme to hide the financial difficulties of Taylor, Bean, & Whitaker Mortgage Corp. (TBW) during his tenure as chairman and principal owner of TBW. TBW received short-term, secured funding from Colonial Bank via a master advance account, and it also maintained an investor funding account at Colonial which housed proceeds from loan sales to investors in the secondary market. Between 2002 and 2003, Farkas and his co-conspirators disguised overdrafts of TBW's master advance account by "sweeping" funds from TBW's investor funding account into and out of the master advance account. As a result of this sweeping scheme, Colonial Bank's daily reports did not depict the overdrafts. As the deficit in TBW's account grew to well over $100 million, Farkas and his co-conspirators initiated more sophisticated schemes, including "Plan B."

Under Plan B, TBW sold sham mortgage loans and loan pools to Colonial Bank. Colonial Bank held approximately $250 million in Plan B individual loans on its books by mid-2005, and approximately $500 million by August 2009. As a result, Colonial BancGroup significantly overstated the value of its assets in its quarterly and annual reports to the U.S. Securities and Exchange Commission. A grand jury returned an indictment against Farkas on June 15, 2010, and a jury convicted Farkas on April 19, 2011. On August 14, 2009, the Alabama State Banking Department closed Colonial Bank, and the Federal Deposit Insurance Corporation (FDIC) assumed receivership over the bank. By December 17, 2010, Colonial's stock closed at $0.07 per share and could no longer be publicly traded.

The Estate filed another refund claim on August 26, 2016. A medical opinion of Carter's treating physician, Dr. William Hahn, accompanied the claim, in which he declared that Carter suffered from a medical impairment for over five years. Carter asserted that, from Fall 2008 to the end of 2013, she suffered from moderate to severe mental and emotional maladies which rendered her incapable of managing the Estate's financial affairs. She maintained that, because of this disability, Code Sec. 6511(h)'s equitable tolling provision applied so as to excuse the untimely filing of the refund claim. When the IRS failed to dispose of the claim within the statutorily required time, the Estate filed a refund suit in a district court. The Estate argued that the Colonial stock was worthless on the valuation date, based on non-public information which later became available, and that the late filing of the refund suit should be excused as a result of Carter's financial disability.

The government contended that the Estate's action had to be dismissed for lack of subject matter jurisdiction because, under Code Sec. 6511(a), its refund claim was untimely. According to the government, Carter's financial disability did not excuse the untimeliness of the Estate's refund claim.

Under Code Sec. 6511(a), a claim for credit or refund of an overpayment of tax must be filed by the taxpayer within three years from the time the return was filed or two years from the time the tax was paid, whichever is later. Code Sec. 6511(h) provides that, in the case of an individual, the running of the periods specified in Code Sec. 6511(a) is suspended during any period of such individual's life that such individual is financially disabled.

Analysis

The district court dismissed the case after holding that Carter's alleged financial disability did not extend the filing deadline for the Estate to seek a refund and, even if it did, the valuation of the Colonial stock established no entitlement to a refund.

The court found that Carter clearly violated Code Sec. 6511. When the Estate filed its 2013 and 2016 refund claims, the court said, the limitations period for submitting such a claim had lapsed because the Estate had filed its tax returns in 2008 and 2009. The court also rejected Carter's contention that the deadline to file the refund claim should be tolled due to her financial disability. Unfortunately for Carter, the court said, estates do not constitute "individuals" subject to Code Sec. 6511(h)'s provisions. Estates, while able to conduct their affairs only through personal representatives, exist separately from their personal representatives. Therefore, the court observed, Carter could not invoke her financial disability to toll the time for the Estate's refund claim, and thus, Code Sec. 6511(a) barred the Estate's refund claim because it was not timely filed.

With respect to the stock valuation, the court cited Estate of Wright v. Comm'r, 43 B.T.A. 551 (1941) in noting that the fair market valuation method does not include an exception for fraudulent or criminal actions not known to the public, even if those actions lower or destroy the stock's value. While the court expressed sympathy for Carter's plight in these circumstances, it said it could not invoke its equitable powers to fashion relief against the ravages wreaked by the criminal fraud.

For a discussion of the statute of limitations for filing refund claims and the financial disability exception that allows a suspension of the limitations period, see Parker Tax ¶261,180.

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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