And, could this be heading to SCOTUS?
The District Court for the Middle District of Pennsylvania just issued a holding in Hake v. United States regarding the reasonable cause exception for the failure to file penalties for executors who failed to file due to bad advice from their lawyer. This was a fairly taxpayer friendly opinion, following somewhat closely on the heels of the Thouron case in the Third Circuit, which we covered heavily here. While Thouron could have been limited, somewhat, to its facts, the Hake opinion applied the case broadly, allowing taxpayer reliance on an advisor to eliminate penalties. Longtime PT readers will know that I dislike the framework from Boyle regarding reasonable cause for reliance on an expert in this area (but other practitioners disagree, including other PT authors). Our readers will also likely recall that I was fairly heated in my harsh words against the Eastern District’s decision in Thouron before it was reversed by the Third Circuit. Although I think allowing reasonable cause is the right thing to do for the Hakes, the case isn’t nearly as strong for reasonable cause as Thouron was, at least in my mind. So, why do I think the Hakes got lucky (or more specifically their lawyer)?
Mrs. Hake died in October of 2011 after a period of incapacitation, holding substantial assets including a closely held grocery store chain. Her five children apparently did not agree on much, and that included the administration of her estate and the value of the assets. Two of her five children, Ricky and Randy, were named executors, and hired the family lawyer to act as estate and tax counsel. Normally, the estate tax return, Form 706, would have been due nine months following the date of death, in July of 2012. See Section 6075(a). Due to the disagreements between the family, it was believed that they would not know the actual values of the estate assets at the filing deadline.
The attorney suggested filing a Form 4768 to obtain an extension of time to file the return and pay the tax due. In June of 2012, the request for extension was filed. An associate in the office was tasked with determining the extension, and informed the primary attorney, who in turn informed the client, that the filing deadline and the payment deadline had both been extended by a year.
But, that isn’t really a thing. The estate had received a six month automatic filing extension, and a one year discretionary extension for payment. This fact didn’t make it to the executors, who thought they were doing substantial good by prepaying the tax in February of 2013 ( about a month after the return was due) and in July the return was filed. In August of 2013, the Service notified the estate that about $198k of penalties were due for failure to file a timely return under Section 6651, along with $17k in interest. The estate took administrative steps to seek abatement, but eventually had to pay the tax due. It then filed a refund suit in the District Court.
As the court stated, the issue was narrowly defined:
When an executor relies upon inaccurate advice from legal and tax counsel regarding the extended deadline for filing an estate tax return, in a factual context where determination of filing and payment deadlines are governed by a series of mandatory and discretionary rules which may vary depending upon the residence status of the taxpayer, does that reliance upon professional advice constitute reasonable cause to avoid the assessment of late filing penalties and interest?
The Court found that yes, it did constitute reasonable cause, which I applaud, and, as I have said repeatedly in the past, in this particular situation I do not think penalties should be imposed on the estate. However, this is not in line with most of the case law. The holding does follow the Third Circuit opinion in Thouron, as discussed below, but this fact pattern pushes the boundaries of the Supreme Court’s holding in Boyle further than Thouron did.
To begin the legal analysis, the court covered the general law, including that a six month extension is allowed under Reg. 20.6075-1 for filing, and that an extension to pay is allowed for up to a year under Reg. 20.6081-1(b). Pursuant to Section 6081(a), however, the IRS is limited in allowing extensions beyond six months for failure to file (unless the taxpayer is outside of the country).
The Court characterizes this extension in an interesting way, stating:
thus, with respect to payment and filing deadlines, the legal terrain requires subtle multi-faceted analysis. First, one must determine the initial filing and payment deadlines. Next one must negotiate a series of deadline extensions rules. Some of these extensions are automatic; others are discretionary. Further, one must be alert to the fact that the application of these differing rules can lead to different deadlines for payment and filing. Finally, one must remain mindful of the fact that the filing rules themselves change depending upon residency status of the executors.
The language is clearly framing this as a difficult issue that lay persons generally would not be capable of figuring out, which is not always how the discussions begin in cases following Boyle. As our readers know, the failure to file penalty has an exception when such failure was due to reasonable cause and not willful neglect. Section 6651(a)(1). SCOTUS outlined the general test for executors seeking to show reasonable cause in United States v. Boyle when relying on a tax professional.
The District Court discussed Boyle, but largely through the context of Thouron v. United States, the 2014 Third Circuit failure to pay case, which found the executor had reasonable cause for failing to timely pay estate tax because of his reliance on a tax professional regarding the extended deadline.
At the outset, it is important to note that most courts, practitioners, and commentators believe the failure to pay case law and the failure to file case law is largely interchangeable in this area, which I agree with.
The District Court noted the Third Circuit stated Boyle:
identified three distinct categories of late-filing cases. In the first category consists of cases that involve taxpayers who delegate the task of filing a return to an agent, only to have the agent file the return late or not at all…[SCOTUS] held…such…reliance…was not reasonable cause…The second category…is where a taxpayer, in reliance on the advice of an accountant or attorney, files a return after the actual due date, but within the time that the…lawyer or accountant advised the taxpayer was available. Finally, in the third category are those cases where “an accountant or attorney advises a taxpayer on a matter of tax law.”
The District Court believed that Thouron had instructed it to construe Boyle narrowly, only clearly applying to the first set of failure above. As to the second set, it believed Boyle did not hold on the issue leaving the lower courts to make their own determinations, and that under the third set of cases, Boyle would not apply.
The government’s contention is that the requirement for timely filing is non-delegable, and reasonable cause based on misunderstanding the deadline is never sufficient. Such a failure is, in its mind (I am assuming), a malpractice claim between the taxpayer and its advisor. The Service would never allow reasonable cause in the second set of cases, and would likely argue against it in most of the third set of cases.
The District Court in Hake, in the remainder of the opinion, somewhat appeared to begrudgingly agree with the Third Circuit’s analysis that reasonable cause could, and perhaps should, apply in all second and third category cases. Towards the end, the Court stated the following not-so-ringing endorsement of its holding:
In reaching this conclusion, however, we wish to emphasize the very narrow scope of our ruling. We do not purport to stake out new or novel legal theories in this decision. Rather, we attempt to simply and faithfully apply the law of this circuit to the facts of this case. Moreover, our decision regarding the reasonableness of the executor’s reliance upon legal advice is strictly limited to, and bound up in the facts of this case.
The Court did then note, as a positive, the fact that the executors had overpaid the amount of tax due before the deadline for doing so (making the imposition of the penalty seem a little boorish on the part of the Service). Finally, in foot note 6, the Court invited the government to consider taking this case up through various appeals to clarify the disparity in case law on this matter that is found in the other Circuits compared to the Third.
I have no specific knowledge of the case, but the opinion seemed to indicate that the district court judge in Hake 1) doesn’t agree with Thouron completely, 2) appreciated the fact that taxes were timely (over) paid, and 3) didn’t want to be overruled on the opinion.
Thouron, however, in my mind left the door potentially open for the judge in Hake to hold the other way, had it wanted to. Hake doesn’t clearly state whether it falls within the second or third group of Boyle cases indicated above. The language of the case would indicate the judge in Hake was analyzing the case under the second group, where the taxpayer files within the time frame erroneously indicated by a practitioner, not where there was clear reliance on legal advice (although the discussion of the complexity of the filing dates does drift into what I would view as a discussion more related to reliance on legal advice).
Thouron, likewise, didn’t specify whether it was a second or third group case. It stated that Boyle only held on clerical oversight in an agent failing to file by the deadline. “It did not rule on when taxpayers rely on the advice of an expert, whether that advice relates to a substantive question of tax law or identifying the correct deadline”.
Thouron certainly indicates a willingness of the Third Circuit to allow a reliance case in either a second (advice regarding deadline) or third (reliance on expert for tax law advice), but it does not flesh out the issue any further.
One key distinction between Thouron and Hake, in my opinion, is that Thouron seems more like reliance on an expert regarding tax advice, which happened to impact the filing deadline. In Thouron, the estate failed to timely pay tax because the estate erroneously believed it qualified for deferral of payment under Section 6166. That Section allows deferrals on certain closely held business interests, and is incredibly complicated, including substantial regulations, rulings, etc. Section 6166 itself, which only deals with the extension to pay, is about 4,000 words long. Determining whether or not an estate qualifies is clearly an expert’s job, and to attempt to penalize an estate for such reliance when the expert is wrong in the analysis is antithetical to the statutes and regulations regarding the reasonable cause exception. Hake, instead, was just a normal extension request.
While I agree the automatic extension provisions and the discretionary extension for payment can be confusing, and arguably could be expert advice, I think the case is less clear that it would fall within group three. Again, the holding in Thouron lumps groups two and three together, but it does not state whether Thouron was in one or both groups. It also does not state that all cases involving an accountant or lawyer advice regarding a deadline would qualify under group two (for instance, it would be interesting to see a court have that type of holding with the same automatic extension to pay income taxes and an extension to pay income tax). I suspect the Third Circuit would affirm Hake, and probably would have reversed it had the holding been for the government. Its statements in Thouron were somewhat clear in stating it would find reasonable cause for reliance on determining an extension or on legal advice.
I do not believe Hake has been appealed to the Third Circuit yet, and may not be. If it or other similar cases should continue to be affirmed by the Third Circuit, it would result in a sufficient split to allow SCOTUS to weigh in on how Boyle should be applied, or more accurately, how the underlying law should be applied in groups two and three. I think cases in group three have to remain reasonable cause, but it would be really interesting to see what happens with group two.