If you file an extension for an estate tax return and pay the tax before the extended due date, can the IRS impose penalties for late payment? The court addresses this in Estate of Agnes R. Skeba v. United States, No. 3:17-cv-10231 (D.N.J. 2019).
Facts & Procedural History
The taxpayer is an estate. It’s estate tax return was due in March of 2014. The estate timely-filed a Form 4768, Application for Extension of Time to File a Return and/or Pay U.S. Estate . . . Taxes. It included a partial payment with the form and a cover letter explaining the circumstances.
The estate submitted another payment to the IRS to pay off the estate tax balance. The payment was received by the IRS eight days late.
The estate’s extension was approved by the IRS in June of 2014. This extended the payment due date until September of 2014.
The estate tax return was filed in June of 2015. It reported an overpayment and a refund due to the estate.
Several months later, the IRS assessed a $450,959 late payment penalty. The estate’s CPA filed a penalty abatement request. The IRS denied the request. A protest was filed asking for an administrative appeal; however, the IRS never responded to the appeal. The estate filed suit to recoup the penalty.
The Failure to Pay Penalty
The failure to pay penalty is set out in Sec. 6651. It tops out at 25% of the amount of the tax due. The penalty is not to be imposed if the taxpayer can establish reasonable cause for not paying timely.
But what date is the tax determined? The IRS argued that the penalty could be imposed in this case as there was no tax return filed by the original unextended due date. As such, according to the IRS, the penalty applies if the full tax isn’t paid by the original unextended due date. Since it was not paid by then, the IRS imposed the penalty.
The taxpayer argued that the failure to file penalty is computed from the extended due date. It reasoned that the tax was paid before the extended due date, so there was no tax due upon which the penalty could be assessed.
The court agreed with the taxpayer. It noted that Sec. 6651 says that the extended due date is to be considered. The court noted the governments policy argument that tax administration requires timely payment in passing.
Reasonable Cause for Late Payment
The court also considered the taxpayer’s reasonable cause defense. There has been quite a lot written about reasonable cause. It is a facts and circumstances defense. The question is whether the taxpayer acted reasonably and in good faith.
In this case, the estate taxes were not paid immediately given several factors: the estate held liquid assets, there was ongoing litigation, and the estate was attempting to obtain a loan to pay the tax. The IRS dismissed these factors.
The court concluded that:
The IRS should have conducted an evidentiary hearing or undertaken some investigation before deciding the issue. At the end of the day, the curt one-line denial of the IRS is arbitrary and capricious.
Thus, the taxpayer also won on its reasonable cause defense.
The IRS often responds to penalty abatement requests by sending form letters. In some cases involving unpaid tax debts, the form letters do not provide any explanation as to why reasonable cause wasn’t established. In other cases the letters provide 1-2 sentences, as in this case.