In Liftin v. United States, 2013-5103 (June 10, 2014), the U.S. Court of Appeals for the Federal Circuit affirmed a Court of Federal Claims’ finding that a penalty for a late-filing estate tax return was mandatory. Agreeing with the lower court that an executor had no reasonable cause to rely on the advice of counsel regarding a filing deadline, the estate of Morton Liftin remained liable for penalties.
Filing the Estate Tax Return
Morton died on March 2, 2003, leaving his wife, a citizen of Bolivia, and his son, John. John, an attorney, was named the executor of Morton’s estate. John administered his father’s estate with the assistance of John’s former law partner.
The estate tax return, Form 706, was due by Dec. 2, 2003—nine months after Morton’s death. Under Internal Revenue Code Section 6075(a), the Internal Revenue Service may issue a six-month extension. On Nov. 26, 2003, John requested an extension, which the IRS granted, to June 2, 2004.
John and his former law partner were uncertain about two issues related to determining the amount of tax due. The first uncertainty was whether Morton’s wife would become a U.S. citizen. That issue was important because an executor may deduct the value of property that passes to a surviving spouse—but only if she’s a U.S. citizen or becomes a citizen before the day on which the tax return is due, and if she was a resident of the United States after her spouse’s death but before becoming a U.S. citizen. John’s former law partner advised John that the estate couldn’t take the marital deduction unless Morton’s wife became a U.S. citizen prior to filing the estate tax return. Morton’s wife agreed to become a citizen and began the naturalization process.
The second issue related to litigation that the estate was involved in, regarding the will and a prenuptial agreement that Morton’s wife had signed.
Both issues remained unresolved as of June 2, 2004, which was the extended due date for paying the estate tax and filing the return. Prior to the extended deadline, John made an estimated payment to the IRS of $877,300, which represented an amount sufficient to cover the estate tax due even if the estate couldn’t claim the marital deduction. However, John didn’t file a tax return. John’s former law partner advised him that he could file the Form 706 after the June 2 extension, because the citizenship issue was unresolved, as was the prenuptial agreement issue. Relying on this advice, John didn’t file Form 706 by June 2.
The IRS contacted the estate and John’s former law partner responded in a letter stating that the estate wasn’t filing the Form 706 until Morton’s wife obtained U.S. citizenship. There was no mention in the letter of the pending legislation surrounding the prenuptial agreement.
On Aug. 3, 2005, Morton’s wife became a U.S. citizen. John delayed filing Form 706 until May 9, 2006—23 months after the filing extension date of June 2, 2004. In the late-filed return, the estate claimed a marital deduction for the property passing to Morton’s wife and a tax liability of $678,575.25. The estate claimed a refund of $198,727.75, based on its prior estimated payment of $877,300.
The IRS assessed a $169,643,06 late-filing penalty, which it reduced to $135,714.45. It didn’t disagree with the estate’s tax liability calculation.
In September 2010, John, on behalf of his father’s estate, sought recovery in the Court of Federal Claims for the late filing penalty. The court determined that the estate’s failure to file the return during the 14 months after the extension deadline and up to the date of citizenship (Aug. 3) was due to reasonable cause. That is, it concluded that it was reasonable for John to rely on the advice that filing could wait until Morton’s wife became a citizen so that the marital deduction could become available. However, the court found it unreasonable that the estate delayed filing the tax return for nine months after Morton’s wife became a citizen. As such, the court granted summary judgment for the IRS, agreeing that the IRS correctly assessed the entire late filing penalty under IRC Section 6651(a)(1). The estate appealed to the U.S Court of Appeals for the Federal Circuit.
Under Section 6651(a)(1), for every month that a federal estate tax return is late, the IRS must impose a penalty of 5 percent of the tax due, up to a limit of 25 percent, unless it’s shown that the failure to timely file is “due to reasonable cause and not due to willful neglect.”
The Court of Appeals agreed with the lower court that the estate lacked reasonable cause for the 9-month delay after Morton’s wife became a citizen. The court stated:
Though fully able to file, he [John] simply relied on the advice of counsel that he should wait to file until the resolution of various “ancillary” matters—advice for which he obtained no explanation and that rested on the unreasonable assumption that incompleteness of information justified delay in filing.
The court further concluded that the advice given to John on the timing of the estate’s return didn’t supply reasonable cause for the post-August 2005 failure to file, because the advice made an assumption that wasn’t legally reasonable. In its discussion of U.S. v. Boyle, 469 U.S. 241 (1985), the court noted the substantial risk of weakening the threat of the late filing penalty, whose imposition was mandatory, unless there was reasonable cause. Additionally, stated the court, “one does not have to be a tax expert to know that tax returns have fixed filing dates.”
The Court of Appeals then affirmed the trial court and agreed that there was no basis in tax law for assuming that incomplete information justified delay in filing the return. This assumption, stated the Court of Appeals, was “simply unreasonable.” Accordingly, John lacked reasonable cause under Section 6651(a)(1) to rely on the filing deadline advice of his former partner, and the court granted summary judgment to the IRS.
A Dissenting Voice
Circuit Judge Pauline Newman filed a lengthy dissent, emphasizing that the estate paid estimated taxes of $877,300: “The role of the estimated tax payment is to avert the imposition of penalty,” said the judge. “It is incongruous to levy a penalty for late payment of a tax that had been timely and fully paid two years earlier, before the penalty payment accrued,” she dissented.
The dissent argued that the majority held that the 25 percent penalty should be incurred as if estimated taxes weren’t paid. And, not only did the estate overpay estate taxes, but also Morton’s spouse proceeded with the naturalization process, and there were disputes regarding her prenuptial agreement. Furthermore, noted the dissent, the estate notified the IRS about these issues in a letter.
Citing Gould v. Gould, 245 U.S. 151 (1917), the dissent argued that in the event of an ambiguity in interpreting tax law, the laws are to be construed against the government. Discussing the IRS’ position and the majority’s agreement that the full penalty is due as if no estimated tax had been paid at any time, the dissent argued that:
Such statutory interpretation renders meaningless the provisions for extension of time as well as the purpose of permitting and requiring estimated payments although the tax return is filed later. It cannot be correct to interpret the statute as imposing a penalty of 25% of the tax that was already paid.
In the instant case, the IRS not only received payment for the entire tax the estate owed, but also had an overpayment from the estate of taxes due. Citing the legislative record for Section 6651, the dissent thus concluded that Section 6651(b) bars a penalty for late filing when estimated taxes are paid.