• U.S. district court finds estate executors’ reliance on erroneous advice on filing deadlines was reasonable—In Estate of Esther M. Hake, ____ (M.D. Pa. March 9, 2017), an estate filed an action for an abatement of penalties relating to the late filing of its federal estate tax return. The valuation of estate assets was in dispute, and the estate was unable to file its return on time. The executors retained counsel who filed the Form 4768 to extend the due date of the return and payment of tax. As a result, the estate was granted a 1-year discretionary extension of the deadline for payment. With regard to filing, the Form 4768 permits an automatic 6-month extension of the due date. However, the attorneys advised the family incorrectly that the estate had a 1-year extension to file. Based on this advice, the executors made an estimated estate tax payment of $900,000 prior to the extended payment deadline, in an amount of $100,000 more than the actual tax liability. Then, they filed the federal estate tax return on the date they thought it was due, according to advice of counsel, which was actually six months late. The Internal Revenue Service notified the estate that penalties and interest had been assessed for failure to file a timely return.
The court held that the estate executors’ reliance on their attorneys’ advice was reasonable cause to avoid the assessment of late filing penalties and interest. When a taxpayer fails to file a tax return by the due date, including any extensions of time, a late penalty applies unless it’s shown that such failure is due to reasonable cause and not due to willful neglect. The court held for the estate on its motion for summary judgment because the executors filed the return objectively late, but within the time instructed by their attorneys, and had paid the estate taxes in advance of the payment deadline. The executors exercised ordinary business care and prudence, making their reliance reasonable.
• Court upholds IRS valuation of paintings—In Estate of Eva Kollsman, T.C. Memo. 2017-40 (Feb. 23, 2017), the IRS assessed a deficiency related to the valuation of two paintings. After Eva’s death, the executor of the estate had to handle two paintings, one known as Maypole, by Pieter Brueghel the Elder, and the other known as Orpheus, the painter of which was in some dispute (it was believed to be painted by Jan Brueghel the Younger, Jan Brueghel the Elder or a Brueghel studio). Under Eva’s estate plan, the executor was also the residuary legatee and therefore due to inherit the paintings.
After Eva’s death, Sotheby’s gave an estimate of the paintings’ values in an opinion letter based on personal inspection: $500,000 for Maypole and $100,000 for Orpheus. These values were ultimately used as the estate tax values, and the opinion letter was attached to the estate tax return. At the same time, Sotheby’s and the executor entered into an agreement giving Sotheby’s the exclusive right to auction the paintings for a 5-year time period.
The executor hired a restoration company to remove layers of dirt from the paintings. The restoration company insured the artwork while it had the paintings under its custody. The amount of insurance was determined based on recommendations by the executor:
$2 million for Maypole and $500,000 for Orpheus. The cleanings were relatively low risk and very successful.
Three and a half years after the valuation date, Maypole was auctioned by Sotheby’s and sold for a hammer price of $2.1 million.
The IRS determined a deficiency, asserting a higher value for the paintings ($2.1 million for Maypole and $500,000 for Orpheus), and the estate petitioned the court for a redetermination. The estate’s expert from Sotheby’s explained the discrepancy in his valuation date value and sale price of Maypole as a result of the unexpected improvement in condition due to the cleaning and a change in market conditions that had increased demand for paintings of this type. However, the court wasn’t convinced. It found that Sotheby’s’ conflict of interest rendered its opinion unreliable and that the opinion exaggerated the risk that cleaning posed to the painting. It also was unpersuaded by the valuation report, which didn’t include analysis of any sales of comparable paintings. Instead, it accepted the government’s expert’s valuation of Maypole at the sale price and accepted the government’s expert’s value of Orpheus. It found the analysis of comparable sales and reasoning of the government’s valuations convincing and ultimately accepted its initial values, making some adjustments for the uncertainty of the artist and the paintings’ condition. The court settled on a value of $1.995 million for Maypole and $375,000 for Orpheus.
This case demonstrates the importance of a thorough, substantive and well-reasoned valuation report.
• Changes to estate tax lien release process—Practitioners have been noticing that IRS procedures relating to lien releases have changed in the last nine months. In June 2016, the IRS (without any announcement) consolidated all responsibility for processing Forms 4422 (Application for Certificate Discharging Property Subject to Estate Tax Lien) within the Estate Tax Lien Group of the Advisory department of the IRS. Form 4422 is filed when an estate wishes to transfer assets prior to filing the Form 706 if those assets are subject to the estate tax lien under IRC Section 6324. Filing the form and obtaining a lien release was previously a routine matter, but since last June, the IRS has been requiring that the entire net proceeds from the sale of the property be deposited into an escrow account or into the estate’s estate tax account with the IRS. In addition, the IRS has also required the final determination of tax to be made before releasing the escrowed proceeds.
Over the past year, the Tax Section of the ABA has been working with the IRS to address the problems. Earlier this Spring, the IRS issued a statement acknowledging that it’s reviewing its process and considering suggestions made by practitioners, and on April 5, the IRS issued a memorandum providing internal guidance on processing requests for discharging the estate tax lien. The memorandum notes that the goal of the lien discharge process is to permit the transfer of property free from the lien when it’s necessary to clear title and directs the IRS agents to consider whether the estate tax liability is adequately provided for, either through the prior receipt of estimated payments or the escrow of proceeds that are equivalent to the estate tax liability. If no tax is due, then a discharge without escrow should be permitted. This memorandum provides a more flexible approach that should facilitate the lien discharge in many situations.
Members of the Tax Section noted that the memorandum doesn’t address the release of a lien in advance of a transfer of real property. They advise that the IRS position is that it will grant the lien only to the extent necessary, and that means only after the transaction has closed, which may create some additional work for attorneys in orchestrating real estate transactions.