For a multitude of reasons, the late-filing penalty has remained a priority of the IRS. First, the late-filing penalty is easy for the IRS to police through the use of modern computer systems which automatically identity and impose the penalty after a return has been filed late. Second, the amount of the penalty, or 25% of the net tax due after only five months, represents an easy windfall of revenue to the Government. Third, imposition of the late-filing penalty naturally deters taxpayers from filing their returns late and promotes compliance with the tax system. Fourth, attempts by taxpayers to have the penalty waived or abated—termed “reasonable cause” in tax parlance—require an affirmative showing of relief upon which the taxpayer bears the burden of proof.
In 1985, the Supreme Court made it more difficult for taxpayers to argue reasonable cause when they rely on a tax professional to timely file their return. In Boyle, an executor retained an attorney to assist with the preparation and filing of the estate’s tax return. Although the executor remained diligent in following up with the attorney to check on the status of the return, the attorney filed the return three months after the filing deadline, which resulted in a late-filing penalty. At trial, the executor argued that he had reasonable cause for abatement of the penalty because he had relied on an attorney to file the return. However, the Supreme Court disagreed, and held that the executor was unable to delegate his responsibility to a tax professional “for the administrative act of filing the return.”
Given the IRS’ success in Boyle, it should come as no surprise that the IRS utilizes the Boyle decision often where a taxpayer has filed a return late and the taxpayer argues that such tardiness was on account of a tax professional. Many courts have agreed with the IRS, as a matter of law, that the Boyle decision precludes such a defense. See Knappe v. United States, 713 F.3d 1164 (9th Cir. 2013); McMahan v. Commissioner, 114 F.3d 366 (2d Cir. 1997); Estate of Kerber v. United States, 717 F.2d 454 (8th Cir. 1983). However, a recent decision in the United States District Court for the Middle District of Pennsylvania reminds us that this reasonable cause defense, at least under the right circumstances, and in the proper court, may still bear some fruit. See Estate of Hake v. U.S., No. 1:15-CV-1382 (M.D. Pa. 2/10/17).
In Hake, two co-executors sought the advice of a tax attorney to assist them in the preparation and submission of the estate’s tax return. Recognizing that the return could not be timely filed by the initial deadline, the co-executors asked the attorney to request an extension of time to both file the return and pay any associated estate tax. On their instructions, the attorney filed for an extension with the IRS, which he believed provided the co-executors with a one-year extension to do both. After the extension was filed, the attorney communicated this belief to the co-executors.
However, unbeknownst to the attorney, applicable law only permitted the co-executors a six-month automatic extension of time to file the return and a one-year discretionary extension of time to pay the tax, the latter of which the IRS granted. On the basis of the advice they received from their attorney, the co-executors filed the estate tax return on the date they had been told it was due. In addition, the co-executors paid the estate’s tax five months prior to the extended tax payment deadline. Shortly after the estate’s tax return was filed, the IRS imposed a $200,000 late-filing penalty against the estate.
During the court proceedings, the co-executors argued that they had reasonably relied on the advice of a tax professional with respect to the applicable deadline to file the return and that they had, in fact, filed the return on that date. Conversely, the IRS argued that the decision in Boyle required the Court to hold, as a matter of law, that the estate was liable for the late-filing penalty. In concluding that the co-executors had successfully shown reasonable cause for the late-filing of the estate’s return, the Court noted that the Court of Appeals for the Third Circuit, to which any appeal would lie, had read Boyle narrowly in Estate of Thouron v. United States, 752 F.3d 311 (3d Cir. 2014) to identify three separate categories of late-filing penalty scenarios, two of which Boyle had not opined on:
- First Category: Similar to the facts in Boyle, a taxpayer assigns or delegates the task of filing a return to a tax professional and the tax professional fails to file the return;
- Second Category: A taxpayer relies on the erroneous advice of a tax professional to file a return after the correct filing deadline but the taxpayer files the return within the time advised by the tax professional;
- Third Category: A taxpayer relies on a tax professional on a matter of tax law.
On the facts before it, the Court reasoned that the co-executors had not “wholly delegated a clerical or ministerial duty to some third party” and had not tried to “hide behind the third party’s failure to perform the administrative task of filing a return.” Rather, the Court found that the co-executors, who both lacked a familiarity and understanding of tax law, sought tax advice related to a deadline, which itself was difficult to ascertain under the IRS’ Regulations. The Court also found significant that the co-executors were attempting to comply with the tax law, which was evidenced by their payment of tax prior to the extended payment deadline and the filing of the return on the date they reasonably believed it was due. On these “unique facts,” the Court concluded that reasonable cause had been shown, i.e., that the particular facts did not fall under the first category as in Boyle.
Significantly, the Court went to great lengths in its opinion to note that it felt bound under the doctrine of stare decisis to follow the Court of Appeals’ prior decision in Thouron. Given the developing area of the law, the circuit split that remains, and the easy to administer bright-line rule the IRS will undoubtedly seek to argue applies under Boyle, taxpayers can expect many more fights with the IRS on this particular issue.
Based on the different categories and the availability of relief only with the presence of “unique facts,” utmost care must be exercised in preparing the original penalty abatement request to not inadvertently fall into one of the Boyle traps based on a general inaccurate description of these facts.
For any questions on this blog post or any other tax-related matter, please feel free to contact me at (214) 749-2409 or firstname.lastname@example.org.