If a tax return is filed late or taxes are paid late, penalties may be imposed by the IRS. However, there are exceptions to these penalties if the taxpayer can prove that the failure was due to reasonable cause and not due to willful neglect. One might think that brain cancel might fit the bill for this type of relief.
In a recent case, Specht v. United States, No. 1:13-cv-00705 (S.D. Ohio 2015), the court held that a tax attorney’s brain cancer was not sufficient to avoid penalties for failing to file an estate tax return and pay taxes on time. This case helps explain when and how one can get out of penalties for filing tax returns and paying taxes late.
Facts & Procedural History
This case involves a malpractice suit filed by an executor against an estate tax attorney seeking to recover $1,198,261.38 in penalties and interest imposed by the IRS due to the estate’s failure to timely file its tax return and pay the estate tax owing. Not only did the IRS impose penalties, it refused to abate or remove them. Litigation ensued.
The estate was worth $12.5 million. The executor had no experience in this role and was deceived by the decedent’s attorney, who had over 50 years of experience but was privately battling brain cancer. The attorney’s malpractice led to the settlement of claims and the voluntary relinquishment of her law license. The court did not disclose the settlement amount.
The legal question was whether the failure was due to reasonable cause or willful neglect to justify not imposing penalties.
About the Late Filing Penalty
When a taxpayer fails to timely file their tax return or pay the taxes owed, the IRS may impose penalties. Failure to file and failure to pay penalties are two of the most common types of penalties that the IRS imposes.
The failure-to-file penalty under Section 6651(a)(1) can be assessed by the IRS when a taxpayer fails to file their tax return by the due date, including extensions. The penalty is calculated as a percentage of the unpaid taxes owed and is generally 5% of the unpaid taxes for each month or part of a month that the return is late, up to a maximum of 25% of the unpaid taxes.
The failure-to-pay penalty under Section 6651(a)(2) can also be assessed when a taxpayer fails to pay the taxes owed by the due date, including extensions. This penalty is also calculated as a percentage of the unpaid taxes owed and is generally 0.5% of the unpaid taxes for each month or part of a month that the tax remains unpaid, up to a maximum of 25% of the unpaid taxes.
About Reasonable Cause
The tax code provides an exception to these penalties if the taxpayer can establish that the failure to file or pay was “due to reasonable cause and not due to willful neglect.”
In general, the reasonable cause exception requires the taxpayer to show that they exercised ordinary business care and prudence but nevertheless could not file or pay on time due to circumstances beyond their control, such as illness, death in the family, or natural disasters. Willful neglect, on the other hand, involves a conscious, intentional failure to file or pay taxes owed.
This is a high burden for the taxpayer to meet, as the Supreme Court in the leading case Boyle v. United States.
Boyle v. United States
In Boyle v. United States, the taxpayer, Boyle, was the executor of his father’s estate. Boyle hired an attorney to handle the estate tax return, but the attorney failed to file the return on time. The IRS assessed a penalty against the estate for the late filing, which Boyle paid. Boyle then sued the attorney for malpractice, and the attorney agreed to reimburse Boyle for the penalty payment.
Boyle then filed a claim for a refund of the penalty payment with the IRS, arguing that the penalty should not have been imposed because the failure to file the return on time was due to reasonable cause and not willful neglect. The IRS denied the claim, and Boyle brought a lawsuit seeking a refund.
The Supreme Court ultimately ruled against Boyle, holding that the failure to file the return on time was not due to reasonable cause. The Court reasoned that Boyle had delegated the responsibility for filing the return to a third party, and had not exercised due diligence in ensuring that the return was filed on time. The Court also rejected Boyle’s argument that the attorney’s negligence constituted reasonable cause, noting that taxpayers are generally held responsible for the acts of their agents, including attorneys.
Evidence of Willful Neglect
The court in the present case focused on the willful neglect element. The court noted that the taxpayer has to show the absence of willful neglect. There was evidence of careless, reckless, or intentional not filing in this case. This included evidence that the executor of the estate was aware of the federal tax return deadline, the amount of tax owed, and the consequences of missing the deadline. She received multiple notices from the probate court before and after the deadline, warning her of missed deadlines and delinquent tax returns. Additionally, she was informed that the attorney had become incompetent, and she was warned by another lawyer to hire a new attorney.
The IRS can impose a penalty on a tax return preparer, but it does not do this very often. Instead, it will assess various penalties on the taxpayer.
To avoid penalties under Section 6651 for missing a filing deadline, the taxpayer must demonstrate that the failure to file was not due to willful neglect, which requires a high burden of proof. Evidence such as the attorney’s hospitalization or medication affecting their awareness of the deadlines could be used to support the argument that the failure was not willful neglect. However, if there is no such evidence and instead evidence of willful neglect on the part of the taxpayer, the courts are unlikely to remove the penalties for late filing.