McNeely v. United States and Adell v. Commissioner (2014)

Two recent cases deal with the question whether an overpayment of non-deferred tax in a section 6166 election can be refunded before the estate tax has been paid in full. The consistent answer is that, if the overpayment was voluntary, it cannot be refunded to the estate or be applied to another tax debt of the decedent's until the estate tax has been paid in full. Section 6402 authorizes the IRS to credit an overpayment against any Internal Revenue tax liability of the decedent's. Section 6403 provides that any overpayment of a tax payable in installments must be applied first to any unpaid installments. The two cases are:

Estate of Franklin Z. Adell v. Commissioner, T.C. Memo 2014-89, released May 16, 2014, and

Estate of Donald McNeely v. United States, No. 0:12-cv-01973 (U.S. District Court for the District of Minnesota), released June 16, 2014.

    Background – Overpayments of Non-Deferred Tax

An overpayment of non-deferred tax can arise under the following circumstances.

1. An estate files a request under section 6081 for an automatic 6-month extension of time to file the estate tax return. Form 4768 is utilized to make this request. It is filed on or before the regular estate tax return due date 9 months after the date of death.

2. Form 4768 is also used to request an extension of time under section 6161 to pay the tax. This requires a separate extension request on Form 4768. A request to extend the time to file under section 6081 does not constitute a request to extend the time to pay under section 6161. (Form 4768 is not designed to show estimated payments of non-deferred tax for a contemplated section 6166 election, so a protective election is usually made under section 6161 for the entire unpaid balance of tax in the event the section 6166 election is not approved.)

3. The 6166 election can only be filed with the return. The return is usually filed 6 months after Form 4768 has been filed. To stop the running of interest, estates will pay with the Form 4768 filing the estimated amount of tax that will not be deferred under the 6166 election. However, the actual amount of non-deferred tax cannot be known until the return and 6166 election statement are filed. When they are filed, it often happens that an estate will have overpaid the non-deferred tax. This overpayment represents money that would have been retained by the estate had it known the correct numbers 6 months earlier. Some estates have tried to recover the overpayment so it can be repaid in installments under the 6166 election (McNeely) or be applied against another tax liability of the decedent's (Adell).

4. An overpayment of non-deferred tax can also arise when an amended (supplemental) estate tax return is filed reporting a decrease in the non-deferred tax so it is less than the amount paid with Form 4768 or with the return filing.

5. Finally, an overpayment of non-deferred tax can arise when IRS examination changes or Cincinnati Campus math error corrections also result in a decrease in the non-deferred tax so it is less than the non-deferred tax paid.

   The Adell Cases

There are three Tax Court decisions for the Adell estate. 

Estate of Franklin Z. Adell v. Commissioner, TC Memo 2013-228, September 30, 2013. (Petition to Tax Court for a declaratory judgment under section 7479. The IRS terminated the section 6166 deferral pursuant to section 6166(g)(3) for failure to pay "installments" on the 2010, 2011, and 2012 anniversary dates. The Tax Court upheld the termination, finding that the unresolved estate tax valuation issues had no bearing on this termination.)

Estate of Franklin Z. Adell v. Commissioner, T.C. Memo 2014-89, May 16, 2014. The IRS was pursuing collection of the decedent's unpaid 2006 gift tax liability from the estate. The estate filed for a Collection Due Process hearing. The result of the hearing was adverse to the estate. The estate appealed the determination to the Tax Court. The estate sought to apply the overpayment of non-deferred estate tax to the decedent's 2006 gift tax liability. The Tax Court held that the overpayment could not be applied against the gift tax liability because the estate tax liability had not yet been paid in full. Furthermore, the gift tax liability arose more than one year after the overpayment of non-deferred tax. The estate re-characterized a "loan receivable" from the decedent's son that had been included in the gross estate as a taxable gift. The "loan" represented the decedent's $6,667,018 payment shortly before death of a judgment that had entered against the son. The estate filed a gift tax return for the decedent a year after the overpayment of non-deferred tax. The IRS did not assess the gift tax until nearly two years after the gift tax filing. 

Estate of Franklin Z. Adell v. Commissioner, T.C. Memo 2014-155, August 4, 2014. This is the Tax Court opinion on the valuation issues. The Court held that the section 6662 undervaluation penalty does not apply to the closely held stock valuation. This is the apparent culmination of the issues raised in Estate of Franklin Z. Adell, Kevin R. Adell, Temporary Co-Personal Representative v. Commissioner, Tax Court Docket 1188-11..

Summary of facts:

Aug-13-2006 - Date of death

May-13-2007 - Estate tax return due date. Form 4768 was filed and the return filing due date was extended to Nov-13-2007. No payment was made with the Form 4768 filing.

Nov-13-2007 - Estate tax return and section 6166 election were filed. Non-deferred tax of $8,094,557 was paid with the return, but no interest was paid. Cincinnati Campus tentatively allowed the section 6166 election and sent a bill for 6 months' interest accrued on the non-deferred tax. The estate argued that it did not owe the interest and requested a section 6161 extension of time to pay. (These are usually granted in one-year increments and a new 6161 extension request is to be filed before the previously granted extension expires.)

Nov-17-2008 - First amended estate tax return filed. The non-deferred tax was recalculated as $5,205,499, creating an overpayment of $2,889,108. The estate also filed a 2006 gift tax return for the decedent reporting $2,889,108 of gift tax due, along with a request that the overpayment of non-deferred estate tax be applied against the gift tax liability. 

Interest on the deferred tax was timely paid on May-13-2008 and May-13-2009, but was not paid on the May 13,  2010 and May 13, 2011 anniversary dates. Meanwhile, Cincinnati's bills for interest on the non-deferred tax were not paid. A series of section 6161 extension requests were granted through the 4th anniversary date of May-13-2011. No further section 6161 extensions of time to pay were granted.

From May 13, 2011 forward, with regard to all of the accrued but unpaid interest the estate was in "underpaid status." Because there were no additional extensions of time to pay in effect for these amounts, the section 6166(g)(3) termination procedures were initiated with regard to the unpaid 2010 and 2011 section 6166 anniversary date interest payments and the interest accrued thereon. (The 6166(g)(3) penalty is calculated only on the past-due amount of interest and tax relating to the section 6166 deferral; it is not calculated on unpaid non-deferred tax or unpaid interest on the non-deferred tax. The section 6651(a)(2) failure to pay penalty is calculated on unpaid non-deferred tax.) Meanwhile, the section 6166 deferral continued in effect throughout the 6166(g)(3) termination procedure.

A section 6166(g)(3) termination is a strictly choreographed procedure. See IRM sections and  (failure to pay 6166 interest and failure to pay 6166 installment, respectively). It cannot be completed in less than 6 months. If the IRS does not adhere to the time frame for each procedural step, the termination procedure continues running but is suspended in the background until the next step is taken. Before estate tax return filing was centralized at Cincinnati in 2001, there were cases in some of the other service centers where 6166(g)(3) termination procedures took up to two years before reaching a conclusion, and the 6166 deferral accounts remained in effect with the beneficial interest rates during that extended period.

Within this 6-month window an estate has an opportunity to save the section 6166 deferral. To save it, the estate must pay the past-due amounts plus a penalty of 5% per month or any part thereof on the past-due balance. The maximum penalty is therefore 30% (5% times 6 months). In Adell the penalty was $15,256.81 per month. 

In November 2011 the IRS issued a preliminary determination letter advising the estate of their intent to terminate the section 6166 election within 30 days for failure to pay an installment within 6 months of its due date (section 6161 extensions of time to pay had previously been granted), and a demand for payment of the entire balance of tax and interest was included. The estate filed a protest and requested a hearing with IRS Appeals. This was a necessary step, for the estate first had to exhaust its administrative remedies within the IRS before it could petition the Tax Court for a review of the termination proceedings. See Revenue Procedure 2005-33

In August 2012 the IRS issued a notice of final determination under section 7479 that the section 6166 election and extension of time for payment had been terminated pursuant to section 6166(g)(3). The estate then petitioned the Tax Court for a declaratory judgment under section 7479 whether the section 6166 election should be terminated under section 6166(g)(3).

     Estate of Donald McNeely

McNeely v. United States - Computation Example 1

Summary of facts:

Mar-09-2009 – Date of death.

Dec-09-2009 – Estate tax return due date.

Dec-08-2009 – Form 4768 was filed requesting an extension of time to file the return until Jun-09-2010. Payment of $2,492,088 accompanied this request (Note: The court opinion contains typos in the first two references to this payment, stating it was $2,494,088. The third reference correctly states it was $2,492,088, which the reported IRS section 6166 calculation confirms.) Accompanying the Form 4768 was a statement that this payment represented the estimated tax that would not be eligible for deferral under a contemplated section 6166 election.

Jun-09-2010 – The estate tax return filing date. The section 6166 election statement attached to the return calculated the non-deferred tax to be $512,223, which meant that the estate had overpaid $1,979,865 with the Form 4768 filing. The estate requested that this overpayment be refunded so it could be repaid in installments as part of the entire amount of tax deferred under section 6166.

The IRS at Cincinnati Campus denied the refund request, stating that the non-deferred tax was $512,226.41 and section 6403 requires that the overpayment of non-deferred tax of $1,979,861.59 be applied against the installments of deferred tax as they came due beginning Dec-09-2014. 

 The estate appealed Cincinnati’s denial of its request for a refund, arguing:

1. It designated in its Dec-08-2009 letter that the entire payment was to be applied to non-deferred tax only; and,

2. Section 6403 is inapplicable to the non-deferred portion of estate tax because it applies only to overpayments of taxes payable in installments.

In its final determination letter IRS Appeals denied the appeal, stating “ . . .we have determined that under I.R.C. sections 6402 and 6403, any overpayment must be applied to reduce the balance of remaining estate tax due and cannot be refunded.” It advised the estate that it could appeal the IRS determination by filing suit in the United States District Court or the United States Court of Federal Claims.

On Aug-13-2012 the estate filed suit in the United States District Court for the District of Minnesota under section 7422(j), which permits suits by estates that have made section 6166 elections even though the tax has not been paid in full.

The estate argued that its designation of the entire $2,492,088 payment as non-deferred tax, and the IRS’s acceptance of that designated payment, binds the IRS to its categorization as non-deferred tax and creates an “overpayment” of $1,979,861.59 described in section 6402 that should be refunded. Further, section 6403 does not apply to this overpayment because it was tendered before the section 6166 election had been filed, and thus cannot be considered a payment of a tax payable in installments. Finally, section 6402 requires that this overpayment be refunded, rather than be applied as a credit against the unpaid tax, because of the estate’s special rights to defer payment of tax under section 6166.

The IRS contended that the estate was not entitled to a refund because there was no overpayment of the estate tax, but even if there was an overpayment, the IRS properly exercised its discretion under section 6402 to credit the refund against unpaid estate tax rather than refund it.