Personal Liability for Estate Taxes

 

Here is a greeting card for a bad day:

… the Internal Revenue Service … determined that the … Estate of Georgia M. Spenlinhauer (estate) is liable for an estate tax deficiency of $3,984,344.”

In general, when I see estate tax numbers of this size, I presume that there are hard-to-value assets. The estate will argue that the assets are illiquid, near unmarketable, and that it would be fortunate to get a thousand or two thousand dollars for them. The IRS of course will argue that the real numbers approach the GDP of many small countries. The Court will often decide somewhere between and call it a day.

Let me see what was at play.

• Whether the estate timely elected an alternative valuation date;
• Whether the estate may exclude $200,000 pursuant to a qualified conservation easement; 
• Whether the value of (yada, yada) was $5.8 million or $3.9 million.

So far it looks like another valuation pay per view Friday night fight.

• Whether the petitioner is liable as transferee for the estate tax deficiency.

That was unexpected.

What happened here?

In February 2005, Georgia Spenlinhauer passed away at the age of ninety-five. She appointed her son as executor. After paying expenses and specific bequests, the son/executor received the residue of the estate. Probate was closed in March 2009.

The executor/son requested and received an extension for the estate tax return until May 2006.

The accountant cautioned the executor/son that he did not have expertise in estate taxation and did not prepare or file estate tax returns as part of his practice.

As a practitioner myself, I get it. The executor/son had to find another practitioner – attorney or CPA – who did estate work.

The executor/son decided not to file an estate return.

COMMENT: I believe we have pinpointed the genesis of the problem.

In 2013 the executor/son filed for bankruptcy.

Through the bankruptcy proceeding, the IRS learned that he had never filed a tax return on behalf of the estate.

In 2017 he finally filed that estate tax return.

The return was audited.

In January 2018, the IRS disagreed with the numbers. It wanted money. It issued a Notice of Deficiency.

Of course.

In March, the IRS made a jeopardy assessment against the estate.

COMMENT:  Whoa! A jeopardy assessment usually indicates that the IRS suspects concealed assets or otherwise anticipates that a taxpayer will make collection difficult. Jeopardy makes the tax, penalty, and interest immediately due and payable. The IRS is authorized to begin immediate collection, without the usual taxpayer safeguards baked into the system.

A jeopardy assessment is not routine, folks.

Did I mention that the IRS was also simultaneously pursuing the assessment against the executor/son personally? Why? Because he had drained the estate to zero with the distribution to himself.

This would not turn out well. There are certain elections - such as an alternate valuation date - that must be made on a timely-filed return. Filing 11 years late is not a timely filing. There were the usual valuation disputes (I can use municipal assessment amounts as asset values! No, you cannot!). There was even a self-cancelling promissory note that got added to the estate (to the tune of $850 grand).

COMMENT: I have not seen a self-cancelling note in a moment. The attorneys worked hard on this estate.

A brutal audit adjustment involved certain litigation fees on an estate asset. The Court decided that the litigation benefited the executor/son and not the estate itself, meaning the estate could not deduct the fees. There went a quick half million dollars in deductions.

Yep, up the asset values, disallow certain deductions. The estate was going to owe - a lot.

And penalties.

The executor/son protested the penalties. To be fair, he had to. His argument?

He had relied on his accountant.

The same accountant who told him that he did not do estate work.

You gotta be kidding, said the Court. They approved the penalties in a hot minute.

There were no assets left in the estate, of course. How was the IRS to collect?

Oh no.

Oh yes.

The executor/son had exhausted the estate by distributing assets to himself. He had transferee liability to the extent of the assets distributed.

Personal liability.

This was not the routine valuation case that I first expected. This instead was closer to a Greek tragedy.

But why? The estate was large enough to obtain creative legal advice. A reasonable person must have suspected that there would be tax reporting, which work was beyond the skill set of the family’s regular accountant. Heck, the accountant was clear that he did not practice in this area. Rather than seek out another accountant (or attorney) with that skill set, the executor/son did … nothing.

Granted, the tax was the tax, whether the return had been timely filed or not. The additional weight was the penalties and interest. What were the penalties? I saw them near the beginning ….

$524,520.

Wow.

Our case this time was Estate of Spenlinhauer v Commissioner, T.C. Memo 2025-134.

Electronic Signatures And The Tax Court

I had a moment of dual disbelief and laughter.

At the expense of the IRS and the Tax Court.

Electronic records, cloud computing and work from home (WFH) have and continue to revolutionize the way we practice and work. I have been working, for example, with a CPA firm sponsoring a very robust WFH policy, as well as outsourcing selected tax functions overseas. Mind you, the infrastructure protecting that data transmission and retention is formidable, but woe to the accountant - especially if over age 40 – learning it for the first time.

Let’s go back to 2020. The Tax Court was rolling-in its new electronic platform – called DAWSON - which in turn was based on PACER, used for dockets in other courts. The Court was embracing electronic records, albeit in fits and starts. For example, the initial launch included only records created by the Court itself. It did not include taxpayer-submitted documents, for example. While the intent to protect taxpayer privacy was clear, it was also clear that some compromise was required. Filings containing confidential information could be sealed. If not otherwise pertinent, any confidential information could be redacted in the filing copy.

DAWSON did allow for electronic filing of the court petition itself.               

This was a big deal.

We have spoken many times about a Notice of Deficiency (NOD) or Statutory Notice of Deficiency (SNOD). This is an IRS notice, and it is also known as the 90-Day Letter. That 90 days may well be cast in concrete, as you have 90 days to file with the Tax Court should you choose to contest the matter. The IRS is very unforgiving here: miss the deadline by one day and it is guaranteed that the IRS will move to toss out your petition.

The electronic filing provides some piece of mind, but accidents still happen.

EXAMPLE: Antawn Jaal Sanders was filing electronically with the Tax Court, but Antawn cut it close. The last day to file was December 12, 2022, and Antawn had started downloading the Court forms onto his Android shortly before 10 p.m. Unable to file from his phone, he switched to his computer at 11:56 p.m. It took him a minute to log in and several to return to where he had been. It was after midnight by the time he started uploading to DAWSON. The IRS of course moved to dismiss his petition, and the Court agreed. Antawn might challenge the IRS, but he was not doing it in Tax Court. After midnight was the next day, meaning his petition was late.

Do you wonder how the taxpayer signs that petition in DAWSON?

If it were a paper file, there would be a handwritten signature.

DAWSON does not allow (for now, at least) for a handwritten signature. What it does do is allow a block-letter facsimile of your signature.

Here is the Court:

The combination of DAWSON username (email address) and password serves as the signature of the individual filing the document.”

The Court says it will accept the facsimile as a signature, so that should be the end of it.

Except when it isn’t.

Robert and Kegan Donlan filed their petition on DAWSON, and they took advantage of the electronic signature.

The IRS immediately filed a Motion to Dismiss, arguing that the Court lacked jurisdiction to hear the case because the petition was not property signed.

The Court bounced the IRS motion, of course.

And I find myself wondering – why did the IRS go there? I suppose it simply had to test the lock, fully expecting it to be locked.

And – here is years of CPA practice speaking – whether it was a new attorney who drew the short straw to look foolish in front of the Court.

Our case this time was Donlan v Commissioner, U.S. Tax Court Docket 16579-24, Feb. 19, 2025.

The Old Three And Two

 

You will recognize the issue.

During 2017 Mary deNourie worked at a retail store. She had wages of $11,516 and social security of $7,559. She and her husband did not file an income tax return because the withholding was enough to cover any tax due.

In 2021 the IRS contacted them about not filing a 2017 tax return. The IRS was preparing a substitute for return showing the wages and social security as well as partnership income of $25,065. When you throw the partnership into the mix, they now owed tax of $4,192, plus interest and penalties.

What partnership income, they exclaimed? The partnership had not paid them anything.

COMMENT: That is not the way partnerships are taxed. For example, a 10% partner will generally be taxable on 10% of the partnership’s taxable income. This amount is reported to a partner on Schedule K-1, a copy of which goes to the IRS. Whether the partner has received cash to go with that K-1 does not matter to the IRS. That is a matter for the partner to take up with the partnership.

I then see a court order in April 2023 releasing the husband from the matter.

That is unusual. What happened?

The IRS had not sent out a Notice of Deficiency – the 90-day letter – to the husband. This is a no-no. The IRS also has rules and procedures, and each spouse (on a joint return) must receive his or her own Notice of Deficiency. Mary received hers. He did not.

Now Mary was on her own.

Coincidentally, the partnership income went away.

COMMENT: It appears the husband owned the partnership.

We are back to Mary’s W-2 and social security.

Mary and the IRS worked on an agreement. There was no tax due for 2017. In fact, there was an overpayment of $284.

Mary wanted the $284.

Can’t blame her.

The IRS said no.

Mary in response refused to sign the agreement.

In March 2024 Mary filed a tax return for 2017. She wanted her refund.

What do you think: will Mary receive that refund?

Here is the relevant law:

Sec. 6511 Limitations on credit or refund

Period of limitation on filing claim. Claim for credit or refund of an overpayment of any tax imposed by this title in respect of which tax the taxpayer is required to file a return shall be filed by the taxpayer within 3 years from the time the return was filed or 2 years from the time the tax was paid, whichever of such periods expires the later, or if no return was filed by the taxpayer, within 2 years from the time the tax was paid. Claim for credit or refund of an overpayment of any tax imposed by this title which is required to be paid by means of a stamp shall be filed by the taxpayer within 3 years from the time the tax was paid.

Right or wrong, there is a limit on how long you can wait to file for a refund. If you file a return, for example, you have three years to amend for a refund.

There is a riff on the above rule if you file now and pay later. The Code will then permit a refund until 2 years after the tax is paid if that date is after the three-year date.

Notice what this three-and-two have in common:

          You filed a return.

If you do not file a return, the rule gets grimmer:

          You have until 2 years after the tax was paid.

If you file, you start with three and might move to two – and only if two allows for more time.

Don’t file and you have two – period. You have no choice.

Let’s see what Mary did:

·       Mary’s 2017 tax return was due April 15, 2018.

·       She did not file, so the mandatory two-year rule applies.

·       There is still hope, though. If she files within three years – by April 15, 2021 – she can flip the mandatory two back to the normal three-and-two.

o   She filed 2017 in March 2024.

Nope. Too late all around.

Mary had no tax due for 2017, but she likewise had no refund for 2017.

My thought? If you have withholding, consider filing even if there is no tax due. Why? Because withholding represents tax paid, and not filing triggers the mandatory two-year rule. By filing you move to the three-and-two rule. It may save you; it may not, but it provides more breathing room than the alternative.

Today we discussed Mary deNourie v Commissioner, U.S. Tax Court, docket 18182-22.