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Estate Tax and Penalty Relief: Thouron v. US (3rd Cir.) -Substantive Issues in Extension Requests

Posted on May 15, 2014

We have previously discussed the penalty relief case of Thouron v. US in a two part post using the Knappe case from the Ninth Circuit as a springboard for the discussion.  Those posts can be found here and here.  In the posts, we indicated that Thouron was argued in January of this year before the Third Circuit, and that we thought the Eastern District of PA had misapplied the reasonable cause exception for reliance on professional advice.  Earlier this week, the Third Circuit in Thouron v US issued its opinion reversing the decision of the district court.

The two prior posts provide substantial coverage of the applicable case law, and the issue in Thouron issue, so we will only briefly outline the case below. We have also provided the meat of the holding at the end of this post.  On appeal, Thouron essentially presented two questions to the Third Circuit.  First, did the extensive body of failure to file case law apply to failure to pay cases (most assumed that it would).  Second, assuming that the failure to file case law applied, could the estate demonstrate reasonable cause for failing to timely pay tax based on the advice of its expert tax counsel regarding the special estate tax election for payment available under Section 6166. The lower court in granting the government’s summary judgment motion held that under Boyle the expert’s advice could not excuse the estate’s failure to pay.

As stated above, the Third Circuit reversed the district court. The district court, as other courts have, applied Boyle in the failure to pay context, which the circuit court agreed with, but the circuit court felt the district court failed to appreciate Boyle’s contours. Thouron brings into sharp focus how courts are struggling with precisely when advice of an expert will insulate a taxpayer from penalties in the context of estate tax filing or paying obligations.

Before getting to the specific holding, a brief review of the facts and Section 6166 is probably helpful.  In Thouron, the estate was clearly going to have an estate tax obligation.  The estate contended that at the time of the filing of the extension requesting additional time to file, counsel for the estate told the fiduciary that the estate would qualify for a deferral of the estate tax and an installment payment plan under Section 6166 of the Code for a portion of the tax due.  Section 6166 allows for an election to extend the estate tax due on closely held business interests if a certain percentage of the estate’s value results from the closely held business interests. This election is made on a timely filed Form 706.  For purposes of the election, a timely filed return includes a return filed within the extension period if an extension was properly requested.  If the taxpayer is to be believed, it paid all tax the estate thought was due, and was going to make the Section 6166 election on the timely filed return; however, upon filing, no Section 6166 election was made –presumably because the estate did not qualify.

As outlined below, the Third Circuit’s key question is whether this was a clerical or ministerial act that cannot be delegated to the advisor (the first category of cases outlined in Boyle), or did the estate receive legal advice that it was reasonably allowed to rely upon (more similar to the second and third categories under Boyle).

Just about every aspect of the application of Section 6166 can be confusing.  This starts with how to request the relief, what happens if it is denied, how to calculate the value of the closely held assets compared to the estate’s value, how long the deferral payment applies, and how long the installment agreement can last.  For instance, if you review the definition of “interest in a closely held business” found under Section 6166(b)(1), it is not surprising that an attorney could misapply the standard, or that a taxpayer would have no idea if an estate qualified.

The definition includes sole proprietorships, partnerships or corporations (and LLCs, although not stated) in a trade or business.  Trade or business is also defined, but certain assets are removed for the overall calculation.  “Passive assets” are among the assets removed from the overall calculation which makes the calculation for holding companies or entities holding real estate quite complicated.  The calculation becomes especially complicated if an operating company held by the estate leases real estate from another entity owned by the estate.  The estate must also own 20% or more of the capital interests or voting shares of each entity it hopes to defer the tax on, and there are various rules regarding ownership attribution and how to treat jointly held interests.  The vast majority of taxpayers would have to hire a second expert to check the first expert in order to determine if the advice was correct, and this is only one aspect of a multifaceted analysis.

The Third Circuit held there was at a minimum a material question as to whether or not the estate relied upon the advice of counsel in not paying the tax due with the extension request and remanded to the lower court for a factual determination.  If the estate did receive guidance from an attorney regarding its ability to qualify for Section 6166, and how and when that election should be made, that advice is a legal analysis that the Service and courts should allow a taxpayer to rely upon, and not the delegation of a ministerial act.

Below is the heart of the Third Circuit’s analysis of Boyle and its brief application to Thouron’s facts:

While Boyle was a late-filing case, the District Court adopted the reasoning of the Ninth Circuit Court in Baccei v. United States, 632 F.3d 1140 (9th Cir. 2011), to conclude that “the holding in Boyle applies with equal force to a failure to pay a tax because the ‘reasonable cause’ excuse for failing to file a return or pay a tax timely in both subsections is the same.”1 Dist. Ct. Op. at 11 (citing 26 U.S.C. § 6651(a)(1)- (2)). We agree that Boyle is relevant to failure-to-pay cases. See E. Wind Indus., Inc. v. United States, 196 F.3d 499, 504 n.5 (3d Cir. 1999). The District Court, however, applied Boyle more bluntly than would we.

As we read it, Boyle identifies three distinct categories of late-filing or, by extension, late-payment cases. In the first category, a taxpayer relies on an agent for the ministerial task of filing or paying. See Boyle, 469 U.S. at 249-50. In the second, “in reliance on the advice of his [or her] accountant or attorney, the taxpayer files a return after the actual due date but within the time the adviser erroneously told him [or her] was available.” Id. at 251 n.9. In the third, “an accountant or attorney advises a taxpayer on a matter of tax law[.]” Id. at 251 (emphasis in original)

[Boyle] noted a split of authority as to the second category, citing, inter alia, our decision in Sanderling, Inc. v. Commissioner, 571 F.2d 174, 178-79 (3d Cir. 1978), as among those holding that a taxpayer could show reasonable cause where he or she filed (or paid) before what he or she was erroneously advised was the deadline. Boyle, 469 U.S. at 251 n.9. The Court explicitly declined to resolve this dispute. Id. (“We need not and do not address ourselves to this issue.”).

As to the third category, Boyle stated that “[t]his case is not one in which a taxpayer has relied on the erroneous advice of counsel concerning a question of law.” Id. at 250. In such cases, “[c]ourts have frequently held that ‘reasonable cause’ is established when a taxpayer shows that he reasonably relied on the advice of an accountant or attorney that it was unnecessary to file a return, even when such advice turned out to have been mistaken.” Id. (citing cases). The Court identified our opinions in Hatfried, Inc. v. Commissioner, 162 F.2d 628, 633-35 (3d Cir. 1947), and  Girard Investment Co. v. Commissioner, 122 F.2d 843, 848 (3d Cir. 1941), as among those so holding.

The Court drew a distinction between relying an expert’s clerical action, as in the first category, and relying on expert’s advice, as in the second and third categories. Resolving questions of tax law is difficult, and “[m]ost taxpayers are not competent to discern error in the substantive advice of an accountant or attorney.” Boyle, 469 U.S. at 251. “By contrast, one does not have to be a tax expert to know that tax returns have fixed filing dates and that taxes must be paid when they are due.” Id. As the Court noted, lay people can and often do file or pay themselves. Id. at 251-52. For this reason, taxpayers may rely on the advice of an expert but may not, for purposes of completing their statutory duty, rely on an agent to perform the task of filing or paying.

Therefore, we read Boyle as reaching only the first category of cases and requiring only that reliance on another to perform the ministerial task of filing or paying cannot be reasonable cause for failure to file or pay by the deadline. By any account, much less interpreting the facts in the light most favorable to the non-movant, that is not what occurred here. Hence we hold that a taxpayer’s reliance on the advice of a tax expert may be reasonable cause for failure to pay by the deadline if the taxpayer can also show either an inability to pay or undue hardship from paying at the deadline. Because there is at least a genuine dispute of material fact as to whether that reliance occurred here, it remains for the District Court, after further fact finding, to apply the law in light of this holding.

As a final thought, an attorney should be very certain that an estate qualifies for Section 6166 before advising no payment has to occur, and may want to consider making a Section 6161 extension to pay request in addition to the Section 6166 request if there is uncertainty.  If a practitioner finds him or herself in the Thouron situation, it may actually be worth considering making the Section 6166 request, knowing a denial will occur.  This is because under Treas. Reg. 20.6161-1(b), the Service will consider a Section 6161 extension to pay request after the filing date if it is in response to a Section 6166 denial as timely if it is done within a reasonable amount of time following the denial.

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