“When can you trust your accountant’s advice about when your taxes are due?”
That was the question posed by Circuit Judge Richard A. Paez at the onset of his decision last week in Knappe v. United States, No. 10-56904, D.C. No.2:09-cv-07328-DMG-PJW (9th Cir. April 4, 2013).
Hiring an Accountant
Ingeborg Pattee died on Nov. 30, 2005, leaving behind a large estate. She named her longtime friend Peter Knappe, as her executor. Although Peter was a successful businessman, he lacked experience serving as an executor or preparing estate tax returns. To help him out, he asked his corporate tax accountant, Francis Burns, CPA, for assistance. Francis had worked for Peter’s company for many years, and Peter had always found Francis’ work satisfactory.
After reviewing Ingeborg’s estate, Francis told Peter that the estate needed to file an estate tax return, Form 706. He correctly told Peter that the deadline to file was Aug. 30, 2006—nine months from the date of Ingeborg’s death.
Prior to the deadline, Peter realized that he needed real estate appraisals for the return. He asked Francis about the procedure regarding an extension; Francis told him he could get an extension of both the filing and the payment deadlines, and the same extension would apply to both. Peter asked Francis to file Form 4768 (“Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes”).
Extension to File vs. Extension to Pay
Taxpayers have three options under Form 4768: They can: 1) seek an extension of the filing deadline; 2) seek an extension of the time to pay any estate tax due; 3) or seek both. Form 4768 provides instructions regarding the difference between choices (1) and (2). Notably, the instructions state that an “executor may apply for an automatic 6-month extension of time to file Form 706.” An executor who’s out of the country may apply for an additional extension beyond the six months—but an executor can’t combine an application for an automatic extension and an additional extension on the same Form 4768. The instructions further note that an executor who fails timely to apply for the automatic six-month extension may apply for an “extension for cause.” The instructions warn that unless the executor is out of the country, extensions for cause are limited to “6 months from the original due date of the Form706.”
With regard to an extension to pay, the instructions provide that such an extension may not exceed 12 months and is granted at the Internal Revenue Service’s discretion. And, the IRS may grant up to 10 consecutive extensions of the payment deadline—one year at a time—so long as a taxpayer shows why it’s impossible or impracticable to pay the full amount of the estate tax by the estate tax return due date.
Francis filed Form 4786 on Aug. 30, 2006 and applied for the six-month automatic filing extension and a one-year discretionary payment extension. Francis sent a copy to Peter, who briefly reviewed the form. Peter paid most attention to the filing extension date Francis requested (Aug. 30, 2007) and the estimate of $1.1 million as taxes being due. The IRS approved the automatic six-month filing extension and sent the form back to Peter, along with a handwritten notation “2/28/07” next to the box Francis checked off for the automatic six-month filing extension. The IRS also sent Peter a “Notice to Applicant” (Notice), which contained two sections. The first section related to the application to extend the filing deadline; the second related to the application to extend the payment deadline. Both sections contained three checkboxes: “Approved,” “Not approved because,” and “Other.” No boxes were checked in the section relating to extending the filing deadline. In the section relating to extending the payment deadline, the IRS checked off “Approved” and had typed “TO 8/30/2007 only.”
The Accountant’s Mistake
When Francis prepared Form 4768, he erroneously thought that he could request a 12-month extension of the filing deadline—even though he’d read the relevant statutes, Treasury regulations and form instructions. He explicitly conveyed this mistaken interpretation to Peter, telling him that he could get a 12-month extension to Aug. 30, 2007, of both the filing and the payment deadline. Peter relied completely on Francis’ advice and made no independent effort to confirm whether what Peter was telling him was correct. Neither Peter nor Francis realized that the IRS was approving an automatic six-month filing deadline extension and a discretionary one-year payment deadline extension.
Erroneously believing that he had a one-year filing extension, Peter waited until May 2007 to file the estate tax return. With Francis’ help, Peter filed the return on May 29, 2007. Peter also included a cover letter prepared by Francis that stated: “Enclosed for filing is United States Estate Tax Return Form 706 for the above referenced decedent. The extended payment date/due date of this return is August 30, 2007 as shown on the IRS Form 4768 attached to this return.” Peter enclosed a check for the balance of the estate tax.
In 2008, the IRS noticed the late filing of the return and assessed a 20 percent late filing penalty for a four-month delinquency, excluding interest, in the amount of $196,414.60. When Francis reviewed the regulations, he noticed his error.
Peter asked the IRS to abate the penalty, arguing that his reliance on his accountant and subsequent failure to file was due to “reasonable cause and not due to willful neglect” under Internal Revenue Code Section 6651(a)(1). The IRS rejected Peter’s argument and denied the abatement. Peter appealed the IRS’ decision; the appeal was denied. As such, Peter paid the full amount due and filed a Claim for Refund with the IRS—again, the IRS rejected his claim for refund. Peter then brought an action before the Ninth Circuit.
In determining what’s “reasonable,” the court stated that a taxpayer must prove that he “exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time.” Peter argued that his reliance on his expert accountant’s advice about the filing deadline extension constituted “ordinary business care and prudence,” and he thus had reasonable cause for filing the return three months late.
The Ninth Circuit looked at two streams of cases addressing reasonable cause in similar contexts. The first line of cases involved taxpayers who delegated the filing of the return to an expert agent—and then the expert agent filed the return late or not at all. These types of cases are “non-substantive cases,” and under U.S. v. Boyle, 469 U.S. 241 (1985), it’s a taxpayer’s “fixed and clear duty” to ascertain statutory deadlines and then meet those deadlines, except in very limited situations. In the second line of cases (substantive cases), taxpayers relied on their agents’ erroneous advice that no return was due. In those instances, reliance on agents can constitute reasonable cause for delay.
Peter’s situation fell in between both lines of cases, because he neither delegated the task of filing the return to a neglectful agent, nor obtained mistaken advice that taxes weren’t due. Peter filed the return himself, but within the timeframe Francis erroneously told him was correct. However, Peter’s circumstance regarding when an estate tax return was due once an extension was obtained was aligned more closely with non-substantive cases. Thus, Peter didn’t exercise ordinary business care and prudence when he relied unquestioningly on Francis’ advice. The court concluded Peter “unreasonably abdicated his duty to ascertain the filing deadline and comply with it.”
Peter tried to convince the Ninth Circuit that his late filing was due to relying on “substantive” advice about an issue of tax law and as such, was reasonable. But the court wasn’t to be swayed. “We disagree that the issue here is substantive,” it said. Noting the unambiguous instructions to Form 4768 and the unambiguous relevant section of the IRC (IRC Section 6081), the court concluded that the question of when a return is due—even when an executor has sought an extension—is non-substantive. Thus, Peter couldn’t demonstrate reasonable cause to excuse his late filing.
Acknowledging that its decision imposes a heavy burden on executors—who now will affirmatively have to ensure that their agents’ interpretations of filing and payment deadlines are accurate if they want to avoid penalties—the court justified the burden by the government’s substantial interest in ensuring that returns are timely filed.
Not mincing words, the Ninth Circuit stated:
As to deadlines, a responsible executor will not allow himself to be misled. When an attorney or accountant tells an executor, ‘This is the deadline,’ the executor bears the risk that the advice is wrong. The rule is the same regardless of whether the payment deadline or the filing deadline is at
issue, and regardless of whether the agent’s erroneous advice results from his misunderstanding of the relevant rules or his negligence in seeking the appropriate extension. Reliance on erroneous advice about nonsubstantive tax law issues cannot constitute reasonable cause for an executor’s failure to file a timely return [citations omitted].
Tough luck for Peter… and for all those (at least in the Ninth Circuit) who think that relying on an expert accountant’s advice will help them to avoid a penalty.