In Estate of Liftin, No. 10-589 (Fed. Cl., March 29, 2013), the Court of Federal Claims held that an estate was subject to a late-filing penalty due to its failure to timely file its estate tax return.  The decedent died in March 2003, and his son was appointed the Executor of his estate.  The decedent’s will provided for outright bequests to a number of people, including his surviving spouse, who was a U.S. resident and a citizen of Bolivia.  Following the decedent’s death, Mrs. Liftin also asserted various claims against the estate based on a prenuptial agreement between herself and the decedent (the “ancillary matters”).

The attorney for the estate advised that the estate could not claim a marital deduction under Internal Revenue Code Section 2056 with respect to the assets distributed to Mrs. Liftin, as she was not a U.S. citizen and the property was distributed outright to her rather than held in a qualified domestic trust (QDOT) for her benefit.  Further, the attorney advised that should Mrs. Liftin decide to become a U.S. citizen after the estate tax return was filed, the return could not be amended to reflect her change in citizenship and no marital deduction would be allowed.

The decedent’s estate tax return was due on Dec. 2, 2004.  The attorney filed for an extension through June 2, 2004, and the estate made an estimated tax payment, which would cover any amount due in the event the marital deduction was unavailable.

Thereafter, the surviving spouse applied for her U.S. citizenship.  It was determined that she would not be fully naturalized until after June 2, 2004, so discussions were had regarding the consequences of filing a late estate tax return.  Based on his interpretation of the Code and Regulations, the attorney advised the estate that there would be no penalty associated with filing a late return in order to claim the marital deduction, so long as the return was filed within a reasonable time after Mrs. Liftin became a U.S. citizen and the completion of the ancillary matters.

Mrs. Liftin became a U.S. citizen on Aug. 3, 2005, and in February 2006, the ancillary matters were settled.  The estate tax return was filed on May 9, 2006, and the estate claimed the marital deduction.  The Internal Revenue Service then issued a Notice of Adjustment on June 12, 2006, reflecting a substantial late-filing penalty.

Reasonable Cause

The Estate argued that its failure to timely file its estate tax return was due to reasonable cause and not willful neglect under IRC Section 6651(a)(1).  The Court first noted that to prove reasonable cause, the taxpayer must show that it “exercised ordinary business care and prudence” but, nonetheless, was “unable to file the return within the prescribed time.”  Further, inUnited States v. Boyle, 469 U.S. 241 (1985), the U.S. Supreme Court held that “advice from an attorney involving an interpretation of substantive tax law” may be reasonable cause, while “an attorney’s assistance in meeting the requirements of unambiguous statutes,” does not constitute reasonable cause.  In addition, a taxpayer’s reasonable reliance on an attorney’s erroneous advice regarding a return’s due date can constitute reasonable cause.  Estate of La Meres v. Commissioner, 90 T.C. 294, 320 (1992).  To prove reasonable cause in such a scenario would require the taxpayer to demonstrate that: (a) he disclosed all relevant facts to an expert, (b) the expert gave advice to the taxpayer, (c) the taxpayer relied in good faith on this advice, and (d) the taxpayer did not otherwise know that the return was due.

Here, the Court held that the estate’s failure to timely file its estate tax return was due in part to reasonable cause.  The attorney advised the estate that it would not be subject to a late-filing penalty should it wait to file until Mrs. Liftin became a U.S. citizen, and this advice was based on the attorney’s interpretation of substantive provisions of the tax law.  While the Executor knew of the various filing deadlines, he trusted the attorney’s advice and believed that these deadlines did not apply to this case.  While the attorney’s advice was erroneous, the Executor had no reason to question the attorney’s analysis of the substantive law; thus, the estate’s reliance on this advice was reasonable.  Therefore, the estate’s failure to timely file the estate tax return in order to obtain the marital deduction was due to reasonable cause, as the estate reasonably relied on the erroneous advice of the attorney.

On the other hand, the Court held that the additional nine-month delay in filing following Mrs. Liftin’s naturalization was not due to reasonable cause.  The attorney advised the estate to wait to file the estate tax return until the conclusion of the ancillary matters, as the estate would not have enough information with which to file an accurate return until these matters were finalized.  However, the Court noted that the law is clear that the need to file a complete and accurate return does not constitute reasonable cause for failure to timely file a tax return.  Further, the attorney’s advice was not based on his interpretation of substantive tax law;  instead, it related to an unambiguous provision of the tax law.  Therefore, the estate did not have reasonable cause with respect to its failure to timely file the estate tax return due to the desire to conclude the ancillary matters.  This nine-month delay without reasonable cause subjected the estate to the maximum late-filing penalty.

Lessons Learned

This decision clarifies the meaning of reasonable cause.  If an advisor provides advice to a client based on her interpretation of the substantive provisions of the tax law, then the client may reasonably rely on this advice, even if it’s erroneous.  As the court noted, it would be illogical for a client to question the advice of his advisor and get a second opinion whenever the advisor provided advice based on an analysis of the tax law.  However, if the advisor provides advice on an unambiguous provision of the tax law, such as a filing deadline, the taxpayer will not be able to show reasonable cause for failure to file on time.  Of course, the distinction between a substantive provision and an unambiguous provision of the tax law may be in the eye of the beholder at times.

The case also demonstrates the importance of early planning for non-citizen spouses.  While the court did find that the taxpayer had reasonable cause for its failure to timely file the estate tax return for purposes of waiting for Mrs. Liftin to obtain her U.S. citizenship, it would have been helpful to have discussions regarding her citizenship status well in advance of the decedent’s death.  Such discussions may have encouraged the decedent to provide for his wife in the form of a QDOT, rather than through outright bequests, so that the estate could claim the marital deduction.  Further, early planning on this issue may have enabled the estate to file a timely return and avoid the expenses of litigation.