blogger visitor

Saturday, February 26, 2011


In a recent appellate case, the 9th Circuit Court of Appeals upheld the trial court in applying failure to pay penalties for late estate taxes, even though a request for extension of payment could be inferred from an extension request filed by the taxpayer.

FACTS. An estate executor hired an accountant to prepare a federal estate tax return. Due to the inability to obtain the release of liquid funds in a timely manner to pay the tax, the accountant submitted a Form 4768, Application for Extension of Time to File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer Taxes). This Form allows for an automatic extension of 6 months TO FILE, and the taxpayer can further use it to request an extension of time TO PAY of up to 12 months. The Form submitted to the IRS did not complete Part III of the Form which is entitled 'Extension of Time to Pay." It appears that the estate did not check any of the boxes in Part III, and the field labeled "Enter extension date requested" was left blank. However, the accountant did include a letter with the Form indicating that an extension of time to pay was needed and providing the reason, but again, no specific date for the extension to run to was included. Interestingly, the request estimated the tax due at $131,327 - when the return was ultimately filed the actual tax due was $1,684,408. Due to late payment, a penalty of $58,954 was imposed, along with interest of $69,801. The taxpayer raised several reasons why the penalty should be abated - principally the doctrine of substantial compliance, collateral estoppel, and reasonable cause. The court found that none of these reasons justified removing the penalty.

ANALYSIS. The estate put forth several interesting reasons why the penalty should be abated. Unfortunately, none of them carried the day.

A. DOCTRINE OF SUBSTANTIAL COMPLIANCE. The doctrine of substantial compliance is an equitable doctrine designed to avoid hardship in cases when a party has done all that can be reasonable expected to meet statutory or regulatory requirements. The estate argued that it had substantially complied with the regulations governing payment extension requests by reason of its partially complete Form and accompanying letter.

In regard to statutory prerequisites, the doctrine cannot be used to defeat the policies of the underlying statutory provisions. Sawyer v. Sonoma County, 719 F2d 1001, 1008 (9th Cir. 1983). According to the appellate court, the regulation governing payment extensions is designed to provide the IRS with the information necessary to determine whether an extension of time to pay is warranted and, if so, to determine a reasonable length for that extension. By failing to include a period for the extension request, the court found that use of the doctrine would defeat these policies and thus the doctrine could not be applied.

B. ESTOPPEL. The estate also argued that the IRS had an obligation to inform it that the payment extension was request was deficient and to provide an opportunity to amend it, or mitigate the penalty (presumably by prompt payment). By not doing so, the IRS was equitably estopped from asserting the penalty.

However, to assert equitable estoppel successfully, the taxpayer would need to show the government engaged in affirmative misconduct beyond mere negligence (among other required elements). The Court noted that the estate could not show any affirmative misconduct by the IRS, such as a deliberate lie or a pattern of false promises. Indeed, the Court noted there was no IRS conduct at all – simply inaction. Thus, that argument was rejected.

C. REASONABLE CAUSE. Code §6651(a)(2) provides that a late payment penalty will not apply if the failure to pay is “due to reasonable cause and not due to willful neglect.” The estate argued that it acted reasonably because it relied on an accountant to prepare and submit the extension request.

The appellate court noted that it found no cases addressing whether a taxpayer’s reliance on an accountant to obtain an extension of time to pay taxed owed constitutes reasonable cause under Code §6651(a)(2). However, the court noted that in United States v. Boyle, 469 US 241 (1985), the Supreme court denied a reasonable cause defense for reliance on an attorney to timely file an estate tax return when the return was filed late. The appellate court found “no reason to distinguish between reasonable cause for a failure to timely file an estate tax return and reasonable cause for a failure to timely pay an estate tax” and thus disallowed the reasonable cause claim.


A. Based on this opinion, arguments of reliance on counsel or an accountant to abate a late penalty will be as difficult to prevail upon as a penalty for late filing. Of course, a negligent attorney or the accountant may have liability to the taxpayer for the penalty – but that obviously is not as favorable as to both the taxpayer and the advisors escaping without liability.

B. If you are submitting a Form 4768, fill in all the requisite fields! If an extension for time to pay is included, at a minimum make absolutely sure that a time period is filled in.

C. One can wonder whether both the IRS and the courts came down on so hard on the taxpayer here due to the actual tax due turning out to be over 12 times the size of the estimate of the tax included on the extension form. We will never know, but it is eye-raising and thus may have had some impact on the courts and the IRS. Since interest on an allowed late payment will be based on the actual tax due and not the estimate used on an extension request, there usually is no upside to being stingy with the estimate of tax that will eventually be due other than the possibility that the IRS will be more likely to grant an extension when the estimated tax amount is small.

Baccei v. U.S., 107 AFTR2d 2011-xxxx (CA9)

Wednesday, February 23, 2011


Generally, an IRA beneficiary cannot enter into a loan transaction with the IRA. Per Code §4975(c)(1)(B), the lending of money between a plan and a disqualified person is a prohibited transaction. For this purpose, a “plan” includes an IRA. Code §4975(e)(1).

What if the IRA purchases a preexisting note and mortgage from a bank, on property owned by the beneficiary and other disqualified persons (the beneficiary’s spouse and a trust)? Is this a prohibited loan transaction?

According to the Department of Labor it is. The DOL has recently advised that the use of IRA funds to acquire such note and mortgage is as much a lending transaction as a direct loan to the beneficiary. Clearly, when the dust settles, the beneficiary will owe the IRA on the note (instead of the bank). Nothing that surprising here – just a confirmation that the IRA and its beneficiary cannot do indirectly what they cannot do directly.  Indeed, the statute itself specifically targets both direct and indirect credit transactions as problematic.

As if this wasn’t enough to dissuade the beneficiary from proceeding, the DOL further opined that the transaction would also be a prohibited transaction under Code §4975(c)(1)(D), which prohibits to a disqualified person the use or benefit of the assets of the plan.

ERISA Opinion Letter No. 2011-04A, 2011

Wednesday, February 16, 2011


Prior to the enactment of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 ("TRA 2010"), the estates of persons dying in 2010 were exempted from federal estate tax, and were subject to a restrictive basis step-up regime. TRA 2010 reversed this and reimposed federal estate taxes for such decedents, but Section 301(c) of the Act allows estates of such persons to elect out of federal estate tax with the application of the original restrictive basis step-up regime.

The deadline for making such an election has been subject to some head scratching by practitioners. Section 301(c) of the Act is fairly clear that persons making this election are not required to file a federal estate tax return or pay federal estate tax until 9 months after the enactment date of the Act (effectively, until September 17, 2011, but since that is a Saturday, then September 19, 2011). What is unclear is when the election out of estate tax needs to be filed.

Under the law in effect prior to TRA 2010, an estate of a 2010 decedent had until the due date of the decedent's income tax return (usually, April 17, 2011), to make basis allocations required or permitted under the restrictive basis step-up regime. The IRS had gone so far as to prepare and release a draft Form 8939 for such purposes prior to TRA 2010. Thus, there has been concern that this April 17, 2011 deadline may apply to the new election out of estate tax, or perhaps even a deadline relating to the normal 9 month from death deadline for filing a Form 706.

The language of Section 301(c) of the Act provides that the election out of estate tax "shall be made at such time and in such manner as the Secretary of the Treasury or the Secretary's delegate shall provide." No such pronouncements have yet been made (subject to the website information discussed below). Some practitioners have interpreted Section 301(d)(A) of the Act, by its reference to Code Section 6018, as imposing the September 19, 2011 (9 months from date of enactment) deadline for the election out of estate tax. This is because under Section 6018 as applicable to persons electing out of estate tax (that is, applying Section 6018 as it applied to 2010 decedents before the changes of the TRA 2010), Section 6018 provided for the reporting and allocation of basis under the restrictive basis step-up regime. Since Section 6018 thus applies to the Form 8939 reporting, and since the election out of estate tax is assumed to be made through the filing of a Form 8939, the theory is that the election out of estate tax is thus not due until September 19, 2011. This may be a fair interpretation, but it is not without doubt. For example, pre-TRA 2010 Section 6018 specifically only related to reporting regarding 2010 decedents - it did not address any specific election out of estate tax (since of course, no such election existed prior to TRA 2010). Thus, the reference to it in Act Section 301(d)(1)(A) may not be sufficient to trigger the September 19, 2011 date of election out of estate tax (as opposed to the deadline for information reporting regarding basis and adjustments to basis that will arise out of such an election out of estate tax).

The IRS has now published additional information on its website that somewhat resolves these issues. This information is published at and was posted on February 16, 2011. Some things are fairly clear from the website information, and some things are not.

As far as what is clear:

a. The Form 8939 for allocating basis increases is not yet finalized, nor are the instructions for the Form or Publication 4895, Tax Treatment of Property Acquired From a Decedent Dying in 2010 which will presumably also address some of these issues.

b. The due date of the Form 8939 will be at least 90 days after the Form 8939 is finalized.

c. Instructions for how to elect to have the modified carryover basis rules apply will be included with the final Form 8939 and Publication 4895.

Some reasonable extrapolations from those items are:

a. The election out of estate tax will probably be made on or by reason of filing the Form 8939. However, it is possible that some other election method or form could be required, since the website information provides only that instructions for the Section 301(c) election will be included on the Form, not that the election itself would be on the Form. That is, the Form may still be limited to reporting of information and basis, with the election itself being made in some other manner.

b. The April 17, 2011 filing deadline for election out of estate tax should be a dead issue. Since the due date of the Form 8939 is at least 90 days after the Form 8939 is finalized, and we are closer than 90 days to April 17, the April 17 deadline should not apply. One could argue that if the election out of estate tax is to be done separately from the Form 8939 reporting then the election out and the Form 8939 may have different filing deadlines and thus this 90 day minimum may not apply to the election itself but only to the Form 8939 filing - but this appears unlikely.

c. For the same reason, the earliest deadline for electing out of estate tax should be 90 days from the date the Form 8939 is finalized.

One thing that the website information does not resolve is whether the election out of estate tax deadline is being interpreted by the IRS as not arising under TRA 2010 in any event before September 19, 2011. Thus, for example, the language of the website information does not appear to preclude an IRS interpretation that if it finalizes the Form 8939 on April 1, 2011 that the filing deadline could be set on or around July 1, 2011 (i.e., 90 days after finalization). Some further guidance or refinement of the website information in this regard would be helpful to all - otherwise, practitioners will need to watch for the final Form 8939 to determine if a filing deadline prior to September 19 may still be imposed.

Sunday, February 13, 2011


About 15,000 taxpayers came forward in 2009 in an amnesty initiative that allowed taxpayers to come clean on offshore holdings and unreported offshore income. The IRS has now introduced a similar initiative that will run through August 31, 2011.

The principal benefits to taxpayers for using the program are avoiding criminal penalties, and limits on overall penalties that might otherwise apply (such as near-confiscatory FBAR penalties).

Some key points:

--A 25% penalty will be imposed on the highest balance during the unreported period in foreign bank accounts/entities or the value of unreported assets. This is compared to the 20% penalty under the prior initiative. Under limited circumstances, the 25% penalty may be reduced to 12.5% or 5%. The 25% penalty is in addition the 20% accuracy-related penalties under Code §6662(a) for any tax underpayments that occurred, Code §6651(a)(1) failure to file penalties, and Code §6651(a)(2) failure to pay penalties.

--Tax years covered are 2003-2010.

--Taxpayers will need to provide previously filed returns, and provide missing or required complete and amended returns, for 2003-2010.

--If a civil exam is already under way, the program is not available.

--Simplified PFIC reporting mechanisms are provided for.

Presumably, most taxpayers interested in this type of relief would have participated in the 2009 program. However, within several days of the new program, we have already seen new clients interested in participating in the new program in our office.

2011 Offshore Voluntary Disclosure Initiative, Frequently Asked Questions and Answers

Monday, February 07, 2011


If more than one person owns a fractional interest in property, the sum of the value of each part may be less than the whole for transfer tax purposes. For example, if Bill and Mary own a parcel of land worth $1,000,000 as 50/50 tenants in common, at Bill’s death his interest is likely to be valued at less than $500,000 to reflect Bill’s lack of control and costs of partition.

In a recent Tax Court case, a decedent during his lifetime transferred 1/5 interests in his ranch to each of his five children. HOWEVER, he retained the “full use, control, income and possession” of the ranch during his lifetime. At his death, his estate sought discounts in value for lack of marketability and control based on the children’s fractional ownership.

Not so fast, opined the Tax Court. The entire value of the ranch was included in the decedent’s estate under Section 2036, due to the decedent’s retained lifetime interest in the ranch. The Court noted that in valuing property with a retained lifetime interest, the change in ownership is deemed to occur at the decedent’s death. Thus, for this purpose, the children did not own an interest prior to death, and their interests could not give rise to a fractional interest valuation reduction to the decedent.

This is consistent with how property is usually valued that is included under Code §2036. What is valued at death is the property transferred in the proscribed manner. Fidelity-Philadelphia Trust Co. v. Rothensies, 324 US 108 (1945). “The idea here is that for tax purposes it is appropriate to treat the lifetime transfer as the equivalent of a testamentary disposition, if the decedent postponed the real effect of the transfer until death (or for a related period) by retention of the income or use or control over who else should have the property.” Stephens, Maxfield, Lind, Calfee & Smith, Federal Estate and Gift Taxation (WG&L) at Paragraph 4.08 (2011). The rights in others that are effectively created at the death of the transferor thus should be ignored for valuation purposes. Otherwise, the gross estate inclusion policy of treating the transferor as having retained ownership during life so as to treat the transferred property as still owned by him or her for estate tax purposes would be thwarted.

While not discussed by the Tax Court, to have ruled otherwise would have opened a large hole in the estate tax regime. If a fractional interest discount could otherwise be obtained under these facts, taxpayers could achieve substantial estate tax savings via the simple expedient of creating lifetime transfers to beneficiaries with a retained life estate or usage. This case did involve a 1965 gift, one that predated Code §2702. Such a gift today of similar property would likely run afoul of Code § 2702, thus resulting in a gift of 100% of the transferred property (that is, without reduction of the value of the interest retained by the transferor). This would be a disincentive to such transfers today, absent structuring to avoid Code § 2702 - so the estate tax regime risks of a contrary ruling are probably not as great as one might expect at first.

If the fractional ownership discount is desired, a transferor could instead gift a direct (and immediately applicable) undivided interest in such property, without retained rights of control or benefits over the transferred portion in the transferor. This would allow for a fractional ownership discount both at the time of conveyance for gift tax purposes, and for the estate tax valuation of the portion retained by the transferor when he or she dies. If the transferor in such circumstances desires to retain the use and benefit of the transferred portion, he could instead rent it back from the donees for fair rental value and still preserve the transfer tax fractional discounts.

Interestingly, the Tax Court did not seemed bothered by the size or types of the discounts sought by the taxpayers - a 32% marketability discount and a 16% minority interest discount. Presumably, this was because it ended up rejecting all discounts by reason of applying Code § 2036. The Tax Court has continued to show hostility to large discounts in context of fractional undivided ownership interests. For example, in 2010 the Tax Court limited such discounts to loss in value relating to time and costs to sell property (as a method of partition), and costs relating to actual partition. Andrew K. Ludwick, TC Memo 2010-104. Therefore, even if the above-described path to discounts is followed via an inter vivos gift of an undivided interest, issues of the appropriate size of the allowed discounts remain.

ESTATE OF AXEL O. ADLER, TC Memo 2011-28 (January 31, 2011)

Thursday, February 03, 2011


The health care reform act including a provision that will require business owners to report to the IRS on Form 1099 all payments in excess of $600 each year. That provision was heavily criticized by business interests for the expensive and time-consuming reporting burden it would impose. Many gold bugs were/are convinced that this was an intentional effort by the government to be able to track their bullion purchases (as a necessary first step towards confiscation in the event of fiscal emergency).

Despite strong support for repeal, the repeal was held hostage to political interests, including possible stratagems to resisting repeal as creating an open door to the repeal of other provisions of the health care act.

On February 2, the Senate voted against the bill that passed the House of Representatives to repeal the health care act. However, it did approve, by a vote of 81-17, an amendment to the FAA Air Transportation Modernization and Safety Improvement Act that repeals the new Form 1099 reporting. The provision now has to go back to the House of Representatives. Hopefully, the House will pass a similar repeal and President Obama will not veto it, so that this burdensome requirement meets its end before its 2012 effective date.

As a political aside, it is interesting to note how the Form 1099 provision was enacted as part of health care legislation, and its repeal is part of air transportation legislation – two subjects that have next to nothing to do with tax reporting. In many states, the legislature is prohibited from legislating on more than one subject at a time. This provides the social benefit of avoiding the enactment of undesirable legislation in a vote because it is paired with or buried in legislation that enjoys broader support in the legislature or to evade a governor’s veto – a common legislative tactic. There are organizations lobbying for a similar federal prohibition on combining legislative subjects in one act – for example, if you are interested,  visit


A recent Tax Court case is interesting, not because of the tax principles involved but because of its unusual subject matter.

In the case, the taxpayer worked for Blackwater Security Consulting (Blackwater), performing dangerous security work in Iraq that related to military operations. Blackwater is an organization that has garnered attention as something akin to a private army. The taxpayer sought to exclude from income his pay under Code Section 112. That provision excludes from gross income compensation received for active service as a member below the grade of commissioned officer in the Armed Forces of the United States while serving in a combat zone.

The Tax Court held that Code Section 112 did not apply since Blackwater is not part of the Armed Forces of the U.S. Prior case law had likewise held the inapplicability of Code Section 112 for a pilot employed by a private airline flying civilian aircraft under contract in support of the U.S. military in the Vietnam War, and for a merchant marine employee of a private company working on a U.S. naval ship in a combat zone.

Given the existing precedent, one would expect penalties to be applied against the taxpayer, and indeed the IRS did assess them. However, the Tax Court struck them down (other than an estimated tax underpayment penalty) since the taxpayer had reasonably relied on an IRS internal memorandum that erroneously described civilian personnel as being able to use the Code Section 112 exclusion.

Nathanial J. Holmes, TC Memo 2011-26