Court Finds that Penalty for Late Filing of Estate Tax Return Was Arbitrary and Capricious

Seasoned trusts and estates practitioners know certain truths, such as:

• Stuff happens.
• Some estate tax disputes should not be litigated, but they are anyway.
• Sometimes justice is done.

The recent case of Estate of Skeba (Civil Action No 17-cv-10231, D NJ Oct 3, 2019)) in the District Court of New Jersey reflects all of the above.

In Skeba, the decedent died on June 10, 2013.  The estate was valued at approximately $13.1 million and was largely illiquid, as $10.2 million of value was real estate.  On March 6, 2014, a few days before the due date of the estate tax return, the executor filed for a six month extension of time to file the return and pay the estate taxes.  The executor included a payment of $725,000, and explained that the estate was illiquid, they were working to complete a mortgage on a substantial commercial property in the estate, there had been delays in getting valuations and contested estate litigation, and that they expected the mortgage would be complete in 14 days.  Stuff happens.

About two weeks later on March 18, 2014, the refinance was completed and the estate made a second tax payment of $2.745 million.

On June 25, 2014, the IRS approved the estate’s application for an extension of time to file the estate tax return, granting a six month extension.

On July 8, 2014, the IRS approved the estate’s application for an extension of time to pay the estate tax, granting a six month extension (even though the estate tax had already been paid).

The estate didn’t file the estate tax return for another year.  There was an ongoing Will contest, so the executor did not know if he had authority to act for the estate.  There were postponements due to illnesses of the litigants and one of the lawyers.  The executor was told several times by IRS officials that there would be no penalty as long as the tax was paid.  Stuff happens.

On June 30, 2015, the estate filed the estate tax return, reporting an overpayment of $941,000.

The IRS agreed with the overpayment of tax, but also found that the estate was subject to a “failure to file” penalty of $451,000, equal to 25% of the unpaid tax because the return was filed late.  The IRS calculated the unpaid tax as the amount of tax due less the $725,000 that had been paid on the original due date of the return.

The estate filed for an abatement of the penalty due to reasonable cause.  This was rejected in November, 2015.  The IRS said the estate did not establish reasonable cause or show due diligence.  On these facts?  Really?

The estate filed an appeal with IRS Appeals.  Appeals never responded.

In the litigation that followed, the IRS ignored that it had granted extensions of time to file and pay, and that its representatives had told the executor there would be no penalty as long as the tax was paid. The IRS ignored that the estate had overpaid the tax due by $941,000 eight days after the original due date of the return.  Instead, the IRS instead argued that the return was filed late, the tax had not been paid in full on the original due date, and therefore, the failure to file penalty should apply.  Some disputes should not be litigated, but they are anyway.

Judge Sheridan of the District Court imposed some sense on the government, finding for the estate, and holding that the IRS’ denial of the request for abatement of penalties was arbitrary and capricious.  Sometimes justice prevails.