Estate Tax / A Trap for the Unwary ... Extended Filing Deadlines for Estate Taxes

Joseph J. Ecuyer for Bloomberg BNA writes: In the normal income tax setting, applying for an extension of time to file your income taxes means that you must also estimate and pay your tax liability by the original due date (typically April 15th).  If the taxpayer pays at least the amount that will ultimately be calculated as due, in the event that the taxpayer cannot file his/her return by the extended due date (typically October 15th), the taxpayer need not worry about the failure to file penalty or the failure to pay penalty as those penalties are calculated with reference to the amount of the late payment.

As the recent case of Young Est. v. U.S., No. 1:11-cv-11829-RWZ (D. Mass. 12/17/12) illustrates, however, taxpayers and their representatives must exercise more care when dealing with meeting the extended estate tax filing deadline, if the taxpayer also requested and extension to pay the estate tax.

In Young Est., the decedent died on August 14, 2008.  The estate's tax return and tax payment were originally due on May 14, 2009. However, the estate submitted timely requests for extension of time to file and extension of time to pay; those requests were granted, which made the estate's tax return due by November 14, 2009, and the Estate's tax payment due by May 14, 2010.  The estate made a partial payment of $760,000 towards its tax liability on May 14, 2009, before the original payment deadline expired. It made a second payment of $2,200,000 on August 31, 2009, after the original payment deadline but before the extended deadline. That second payment satisfied the balance of the Estate's tax liability as estimated when the request for extension of time to file was made.

During 2009, the real market crashed and property values plummeted.  During this period, the estate obtained appraisals of its properties, but believed that the appraisers' estimated values were substantially higher than the fair market value at the time.  Instead of filing its return on the extended filing date of November 14, 2009, upon advise from its tax advisers, the estate decided to wait until the properties were sold, and then file a single late return. The estate's tax advisers believed that, because the estate had already paid more than its eventual tax liability, there would be no penalty for filing late. They therefore advised the estate to ignore the filing deadline and just file a single late return, because they believed filing a timely but inaccurate return and then an amended return would be better than filing a single late return—especially since it would simplify any subsequent audit.

Unfortunately, the estate's tax advisers were wrong. Filing its return after the extended filing due date had the effect of voiding the extension to make the estate tax payment.  And, therefore, even though the estate had paid the full balance on August 14, 2009 (nine months before the extended payment date), the estate owed a late-filing penalty calculated from the original due date of the return.  The IRS assessed a late-filing penalty of $259,325.85 plus $20,774.30 interest.

The estate paid the penalty and filed a request for refund with the IRS, on the ground that the estate had reasonable cause for filing late because it relied on expert tax advice. The IRS denied the refund request. The estate then filed a penalty appeal with the IRS, but again failed to obtain relief. Finally, it brought this suit in district court.  However, the district court held that estate was liable.  According to the district court, relying on substantive tax advise (as opposed to relying on an adviser to perform a ministerial act, such as actually filing a return) does not constitute reasonable cause for which a taxpayer would be excused from the penalty.

The lesson here is that tax advisers should be extremely careful when advising their clients that they do not have to meet certain deadline.  In all likelihood, the adviser was thinking about the effect of filing a late return (when full payment has already been made) in the income tax context.  In the estate tax context, the same rules do not apply when the taxpayer has also filed for and been granted a request to extend its payment obligation.  This is true even where the estate pays the full amount of the tax prior to the extended filing date, as the Young Est. case illustrates.