In a recent decision, a Massachusetts federal court upheld the Internal Revenue Service’s assessment of penalties when, based on the advice of its accountants, an estate didn’t file a timely estate tax return. 

In Estate of Young v. United States, Civ. Action No. 11-11829-RWZ (D. Mass., Dec. 17, 2012), a federal court examined the meaning of “reasonable cause” with respect to late-filing penalties.  The decedent died on Aug. 14, 2008, and the original filing deadline for her estate tax return was May 14, 2009.  The estate requested an extension of this deadline to Nov. 14, 2009, which the IRS granted.  The estate made a partial payment of its tax liability on May 14, 2009 and a second payment on Aug. 31, 2009.  As a result of these two payments, the estimated tax obligations of the estate were satisfied.

The estate struggled to obtain an accurate valuation of its real estate holdings due to the financial crisis and, therefore, determined it wouldn’t be able to submit a complete and correct return by the extended filing deadline.  It sought the advice of its accountants, who saw two options:  either the estate could file a timely, inaccurate return by the extended deadline, with an amended return to follow, or the estate could file a late, but accurate, return.  The accountants suggested that the estate pursue the second option, as they believed there would be no late-filing penalty since the estate had already overpaid its tax liability, and filing one return would ensure an easier audit.  The estate followed the accountants’ advice and filed the return on Feb. 15, 2010.

Unfortunately, the accountants got it wrong.  As the estate had paid the entirety of its estimated tax liability after the original deadline, albeit before the extended deadline, it was subject to a significant penalty of more than $250,000, plus interest.  The estate filed a refund request with the IRS, arguing that its failure to file a timely return was due to reasonable cause and not willful neglect in accordance with Internal Revenue Code Section 6651(a)(1).  However, the IRS denied the estate’s refund request, and the estate brought suit in federal court.

The U.S. District Court for the District of Massachusetts granted summary judgment for the IRS.   The court compared the case at hand to United States v. Boyle, 469 U.S. 245 (1985), in which the U.S. Supreme Court held that the late filing of an estate tax return wasn’t based on reasonable cause.  In Boyle, the return was filed late due to a clerical mistake on the part of the estate’s attorney.  The Court held that the taxpayer had a “nondelegable duty to comply with the filing deadline and could not simply rely on his attorney to do so.”  The Court also distinguished a number of cases in which other courts had found that the failure to file a return on time was due to reasonable cause, based on the taxpayers’ reliance on expert advice with respect to a matter of law.

In Young, the court determined that the late filing of the estate tax return wasn’t based on reasonable cause.  Specifically, while the estate did rely to some extent on the substantive advice of its accountants, it was nonetheless aware of its “nondelegable duty” to file the return on time.  In addition, the accountants’ advice that there would be no late-filing penalty didn’t constitute reasonable cause, as “a taxpayer cannot disregard a known duty to file a timely return just because it believes no penalty will result, any more than a pedestrian can disregard a known duty not to jaywalk because he believes no penalty will result.”  Further, the court held that the accountants’ advice that filing a late but accurate return would simplify the audit process was insufficient to provide reasonable cause, as this was a matter of strategy, not a matter of law.

The court further found that the failure to timely file the estate tax return was based on willful neglect in accordance with IRC Section 6651(a)(1).  Specifically, the estate was aware of the applicable deadline, but consciously and intentionally filed the return after this deadline.

 

Lessons Learned

This case highlights the importance of carefully adhering to the filing deadlines for tax returns.  It also illustrates that it may be better to file an inaccurate, but timely, return, with an amended return to follow once more information is available.  While this course of action may produce a more complicated audit, it’s more likely to prevent the imposition of late-filing penalties and interest.  In addition, this case provides a helpful illustration of the meaning of “reasonable cause” with respect to the imposition of penalties.  Specifically, reliance on expert opinions with respect to a matter of law constitutes “reasonable cause,” while reliance on such opinions with respect to matters of strategy and the inapplicability of the late-filing penalty doesn’t constitute “reasonable cause.”  Whether you’re preparing an estate tax return or are assisting a client with his participation in the IRS’ Offshore Voluntary Disclosure Program, it’s important to understand what constitutes “reasonable cause” for failure to timely file a tax return.