Is there reasonable cause for late filing and late payment of estate taxes?

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An estate can avoid penalties for late filing and late payment of estate taxes if they can prove that there was reasonable cause. A recent case, Leighton v. United States, 2021 WL 3486478 (August 9, 2021) addressed a situation where the estate was unaware of a large prior gift that created an estate tax return filing requirement.

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David Leighton died on January 6, 2017, and his son, Tom, administered his estate. Tom sought guidance from an attorney. The attorney informed Tom that an estate tax return was required if the value of the estate, plus lifetime gifts, exceeded $5,490,000. Based on the information available to them, they found approximately $1-2 million of estate assets and no prior gifts. Tom used his father’s CPA to prepare the final individual income tax return and remained in communication with the CPA during the estate administration as needs arose. The CPA never disclosed the existence of a 2012 gift tax return, even though the record seems to suggest the CPA was asked about prior gifting.

Almost two years after death, the decedent’s other son mentioned that David “might have” established lifetime trusts and that an estate tax return may have been necessary. After the attorney contacted the CPA about the lifetime trusts, the CPA produced a 2012 gift tax return showing gifts totaling $5,094,000, which when combined with the $1-2 million of estate assets, created an estate tax return filing requirement.

In a little over a month, the parties gathered the information to prepare and file the estate tax return. The estate paid the estate tax and the penalties. It then filed a refund claim asking the IRS to abate the penalties for “reasonable cause” since Tom relied on the attorney’s advice that a filing was not required and was unaware of the lifetime gifts.

After the requisite six months without a response from the IRS, the estate filed suit. The issue before the court was whether the missing information could constitute reasonable cause for the delay to file the estate tax return. The IRS argued that the case should be dismissed because (1) the advice that Tom received from the attorney was objectively unreasonable; (2) Tom held sole responsibility for filing the return and could not delegate that duty; and (3) the “unavailability” of the 2012 gift tax return was unreasonable. In a motion to dismiss, the Court looks at the facts in the light most favorable to the opposing party (here the estate) to see if the case should proceed to trial; they were not deciding if there was “reasonable cause,” only if there could potentially be a claim for it.

As to argument (1), the Court found that the estate had pled sufficient facts to proceed to trial. Tom had hired an attorney, worked with a CPA and had also hired a third-party firm to coordinate tax and legal information. The third-party firm had sent a questionnaire to the CPA about the valuation of the estate and then informed Tom and the attorney that there was not any indication of lifetime gifts.

Argument (2) stems from prior court cases that concluded that a taxpayer can outsource preparation of the return, but the taxpayer remains solely responsible for filing the return on time. While that is true, the Court noted that taxpayers “may reasonably rely on advice concerning whether – but not when – a return must be filed.” The court noted that there was an open question whether reasonable cause applies in this situation, where the taxpayer and agents act on incorrect information.

As to argument (3), the Court felt the case should proceed to trial so that the estate could present evidence about why they were unaware of the 2012 gift tax return when it was in the CPA’s possession the entire time and they were in contact with the CPA. [Note: You can also request copies of prior gift tax returns directly from the IRS, but the IRS’s response is incredibly delayed, and it is difficult to get copies within nine months after death.]

The Court denied the IRS’s motion to dismiss the case and allowed the executor to proceed to trial to show that he had reasonable cause for the delayed filing. This ruling may have lasting impacts in situations where gift tax returns are unknown or unavailable to the executor despite due diligence on the executor’s behalf.

If you have any questions about late filing and late payment of estate taxes, please contact your Henry+Horne advisor.

Jennifer King, CPA