Estate Notches Rare Win over IRS in Penalty Refund Suit by SANDRA BROWN and TENZING TUNDEN
Enforcement and compliance is a top priority of the Internal Revenue Service (“IRS”). The IRS has 150 penalties at its disposal to assist in its stated goals of enforcement and obtaining compliance with the tax laws of the United States. Many of these penalties can be assessed not only against taxpayers but also against tax professionals and related parties such as accountants preparing returns and consultants advising on tax issues.
A frequently utilized penalty is the delinquency penalty. This penalty can be imposed in addition to a tax deficiency assessed by the IRS. Moreover, this penalty can be stacked with accuracy penalties, fraud penalties, or listed transaction penalties against noncompliant taxpayers.
While challenging the IRS’s imposition of a deficiency penalty is more often than not an uphill battle, recently the court in Estate of Agnes R. Skeba v. United States, found that the taxpayer should not be held liable for the delinquency penalty based upon both a legal statutory grounds as well as a factual reasonable cause grounds.
The Internal Revenue Code (“IRC”) §6651(a) imposes a penalty assessed against a taxpayer for failing to either file their tax return by the due date or pay a tax due by the due date. In case of a failure to timely file a tax return, the penalty is 5 percent (5%) of the amount of such tax required to be shown on the return if the failure is for not more than 1 month, with an additional 5 percent (5%) for each additional month or fraction thereof during which such failure continues, not exceeding 25% in the aggregate. Pursuant to IRC §6651(b)(1), such penalty is imposed on the “net amount due,” which is the amount of tax required to be shown reduced by any credit and any payment on or before the return due date.
If a taxpayer fails to pay the tax shown on the return by the due date, there is a penalty of .05% of the amount of such tax if the failure is for not more than 1 month, with an additional 0.5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25% in the aggregate. The failure to pay penalty is imposed on the unpaid balance of the tax shown due on the return. There is a similar penalty for failing to pay a tax deficiency assessment after notice and demand. The failure to file and failure to pay penalties do not apply if the failure is due to reasonable cause, and not due to willful neglect. Reasonable cause exists when a taxpayer exercises ordinary business care and prudence but is unable to file a return.
Estate of Agnes R. Skeva v. United States
In Estate of Agnes R. Skeba, the executor filed a suit for a refund of the failure to file penalty assessed by the IRS. The Estate consisted mostly of farmland and equipment, was valued at $14,500,000, and owed federal estate taxes in excess of $2.5 million, as well as $575,000 to the State of New Jersey and $250,000 to the State of Pennsylvania, but only had liquid assets of $1,475,000. The Estate could not obtain a loan to pay off all tax debts in full by the due date of the return as a result of valuation issues; was also involved in litigation contesting the will. Nonetheless, the Estate timely satisfied its State tax debts and paid the remainder ($725,000) to the IRS towards its federal estate tax liability and timely submitted a Form 4768 requesting an extension for time to file the federal estate tax return. The IRS granted the taxpayer’s request and the due date for filing the return was extended to September 10, 2014. The Estate then, a week and a half after the original due date for filing the return, made a second estimated payment of $2,745,000, resulting in the timely “payment” of the tax due per the extension granted by the IRS. However, it was not until June 30, 2015, which was 9 months past the extended due date of September 10, 2014, that the Estate filed the return. The IRS then assessed the full 25% penalty failure to file penalty under §6651(a)(1) on the $2,745,000 paid just after the original due date.
Penalty Assessed and the Government’s Argument
The issue for the Court was on what amount did the 25% “late filing” penalty apply? The government took the position that since the tax return was not filed timely then all payments ($2,745,000) made after the return’s original due date of March 10, 2014, were delinquent and the taxpayer was only entitled to a reduction under §6651(b) for the amount ($750,000) paid before the original due date, despite the fact that the IRS had granted the taxpayer an extension to file the return, factually rendering both payments timely under the “new” due date of the return.
Penalty Assessed and the Estate’s Argument
The Estate argued that IRC §6651(b) should be read in conjunction with §6651(a). In reading these sections together, the Estate argued that the late filing penalty is calculated by using the formula set forth in subsection (a)(1) incorporating the “net amount due” on the “date prescribed for payment” as set forth in (b)(1).
Since the extension ran until September 10, 2014 there was no net amount due on the extended due date; hence, the Estate asserted, no penalty may be imposed under the applicable statute.
The Court’s Decision
In determining which interpretation of §6651 should be applied to calculate the delinquency penalty, the court relied on the Supreme Court’s decision in Gould, which held that it “is the established rule not to extend their [tax] provisions, by implication, beyond the clear import of the language used, or to enlarge their operations so as to embrace matters not specifically pointed out” and that, even in the event of ambiguity, the Court’s interpretation should be “construed most strongly against the government, and in favor of the citizen.”
The court then found that there was no ambiguity; rather, the government’s position that the extension of the due date of the return should be read out of the statute was inconsistent with the clear language set forth in §§6651(a)(1) and (a)(2), both of which designate the specific day on which penalties will be assessed whether for the late filing of the estate tax return or the late payment of the estate tax debt to be “determined with regard to any extension of time for filing”. As such, the court ruled that as a matter of statutory interpretation, the calculation of the delinquency penalty required the estate to be credited with the payments made before the new date extended for the filing of the return, resulting in the appropriate penalty calculation being zero.
In addition to the statutory argument, the Estate also asserted that the failure to file timely was based upon “reasonable cause” and not due to willful neglect and thus, IRC §6651 (a)(1) protected the taxpayer from the imposition of the delinquency penalty. Interestingly, perhaps anticipating a government appeal on the statutory issue above, the court addressed this alternative, factual issue in its ruling.
The court, cited the Supreme Court’s decision in United States v. Boyle,  which in ruling in the government’s favor, reasoned that there is an administrative need for strict filing requirements, and also cited to Treas. Reg. §301.6651-1(c)(1), which sets forth that to avoid the delinquency penalty, it must be shown that, given all facts and circumstances, the taxpayer exercised ordinary business care and prudence and was nevertheless unable to file the return within the prescribed time.
The court then found that in this case, the Estate had presented sufficient evidence, including factors outside of the taxpayer’s control both due to the nature of the estate’s assets, third-party litigation and serious health issues of the estate’s attorney, as well as evidence of due diligence, to satisfy its burden of establishing the taxpayer’s exercise of ordinary business care and prudence in the face of its inability to file the return on time and therefore the Estate was entitled to a finding of “reasonable cause” as an alternative basis for granting a full refund of the delinquency penalty.
Sandra R. Brown is a Principal at Hochman Salkin Toscher Perez P.C., and specializes in representing individuals and organizations who are involved in criminal tax investigations, including related grand jury matters, court litigation and appeals, as well as representing and advising taxpayers involved in complex and sophisticated civil tax controversies, including representing and advising taxpayers in sensitive-issue audits and administrative appeals, as well as civil litigation in federal, state and tax court. Prior to joining the firm, Ms. Brown served as the Acting United States Attorney, the First Assistant United States Attorney and the Chief of the Tax Division of the Office of the U.S. Attorney (C.D. Cal).
Tenzing Tunden is a Tax Associate at Hochman Salkin Toscher Perez P.C. Mr. Tunden recently graduated from the Graduate Tax Program at NYU School of Law and the J.D. Program at UC Davis School of Law. During law school, Mr. Tunden served as an intern at the Franchise Tax Board Legal Division and at the Tax Division of the U.S. Attorney’s Office (N.D. Cal).
 Estate of Agnes R. Skeba v. United States, No. 3:17-cv-10231 (D. N.J. 2020).
 IRC §6651(a)(1).
 IRC §6651(a)(2), (b)(2).
 IRC §6651(a)(3).
 Treasury Regulation § 301.6651-1(c).
 Gould v. Gould, 245 U.S. 151, 153 (1917).
 United States v. Boyle, 469 U.S. 241, 246 (1985).