A Series of Unfortunate Tax Events¹

& The Estate of Edgar Allen Poe

By Robert L. Moshman, Esq.

In a perfect world, estates and gifts would be processed as simply as any securities sale or banking deposit. Siblings and other heirs would never quarrel. Any taxes due would be modest, easily ascertained, and paid with a minimum of paperwork.

In this happy place, the tax code and regulations, all presented in plain English, would fit in a single volume that is only amended every five years. And the Internal Revenue Service, staffed by helpful and compassionate professionals, would agree to disagree about valuations and extend the benefit of the doubt to every estate, grantor, or donor.

Regrettably, those engaged in the transfer of wealth have encountered a very different experience in our not-so-perfect world, and those with delicate constitutions may want to cease reading here. As the following cases illustrate, any estate may fall afoul of the unyielding rules of our cruel tax realities.

Better Late Than Never?

Let a lesson be learned: Don't pay estate tax 32 days late! Courts may be lenient toward substantial compliance with deadlines in certain other contexts...but vis-à-vis paying estate taxes, no.

For the Estate of Oscar A. Kincaid, Jr., an additional 32 days may not have seemed like much to ask-basically, a normal grace period considering the freely granted 180-day filing extension that had already been granted and the fact that this estate paid $419,000 of tax to the government.

"Have sympathy, dear Service," the transmittal letter for that tardy return might have pleaded, "for this late-departed taxpayer won't be incurring any further exemptions in this lifetime and had the misfortune of dying before the estate tax repeal could be fully phased in."

Alas, dear reader, you can already surmise how this unfortunate tale must end. The IRS had granted the estate's request for a six-month extension until February 11, 2002, but the estate then paid $419,000 on March 15, 2002 and filed a return on December 4, 2002.

This, of course, represented two separate failures. The IRS assessed a late-filing penalty of $100,295.28, and a late-payment penalty of $16,715.88 that was later reduced to $4,178.97.

As to the late-filing penalty, it is well established that blaming one's professional adviser will not suffice. In, United States v. Boyle, 469 U.S. 241 at 245 (1985), the Supreme Court addressed the reasonable cause exception under §6651(a)(1): "To escape the penalty, the taxpayer bears the heavy burden of proving both (1) that the failure did not result from `willful neglect,' and (2) that the failure was 'due to reasonable cause.'" And the excuse that, "my accountant told me I didn't have to file," is not considered `reasonable cause.' "

Similarly, not paying the tax on time has to be based on hardship and not negligence. Under IRC §6161(a)(1), there can be an extension of time to pay estate tax for a reasonable period not to exceed 12 months. The extension is sought using Form 4768. IRC §6161(a)(2)(A) permits a reasonable period not in excess of 10 years for payment of estate tax if there is reasonable cause. These extensions are subject to IRS discretion. The longer extensions are based on undue hardship such as the estate lacking liquid assets.²

Grist for the Mill

Taxpayer, purchased 29 acres once owned by President George Washington in a historical overlay district of Virginia for $2.5 million. The lot was once used by Washington for a grist mill to produce flour and cornmeal for his nearby residence at Mount Vernon and for commercial sale along the East Coast, Portugal, and in the West Indies.

In modern times, the lot was zoned for about 30 homes, a housing plan was approved, the trees were clear-cut, and the developer built what was described as "29 monster homes."

Taxpayer then claimed that he had voluntarily not pursued a development plan for 62 homes to better serve the historic and scenic nature of the grist mill site and was entitled to a conservation easement under IRC §170(h)(1) for preservation of open space on 15 undeveloped acres. These 15 acres lie in a 100-year flood plain. Taxpayer claimed a value of $3.1 million for the 15-acre flood plain even though he'd paid less for the entire tract of land the previous year.

The IRS not only denied the charitable contribution deduction for the easement for failing to preserve any historical structure or maintain as open space any area that could have been developed, but also assessed an accuracy-related penalty under §6662(a) which the Tax Court upheld.

Note: Taxpayer is by no means the only one attempting to take advantage of conservation easements. Between 1995 and 2005, Virginia went from having 6,000 acres subject to conservation easements to 35,000 acres. The IRS is currently scrutinizing more than 500 conservation easements.³

A Glimmer of Hope?

In 2002, the estate of Edward Roski filed an estate tax return showing a balance of $32,778,000 along with a Notice of Election to defer payments under Section 6166. The IRS insisted that the estate either post a bond for twice that amount or be subject to a special lien under §6324A. The estate filed for relief under §7479 and argued that the IRS had exceeding its discretion. The IRS sought summary judgment saying its discretion was not subject to review.

The Tax Court determined that it had jurisdiction and that the IRS has no authority to impose a bond or lien requirement in every case. In the case at bar, the estate found no bond company willing to underwrite the $60-million bond. Also, the estate assets were a family business with real estate assets that provided adequate assurance against default. The statutory lien under §6324 was adequate as well. And a special lien would interfere with the cash flow of the business and violate partnership agreements.

Yes, the Commissioner had discretion…but "by adopting a bright-line rule in every case, the Commissioner has shirked his administrative duty to state findings of fact and reasons to support his decisions * * *." The case was remanded; the Court did not rule whether the bond was necessary or not.⁴

GST Grandfathering Debated

Oh, gentle reader, if would be our most ardent wish to assure you that the previous case were the rule and not the exception and that logic, reason, and clarity will swiftly guide your transactions to satisfactory conclusions. But to entirely dispel such notions, here is a case to demonstrate that the last hollow laugh always emanates from the depths of the Treasury.

The Benjamin Gerson Trust became irrevocable when Mr. Gerson died in 1973. Mr. Gerson left a $22-million estate for which $7.16 million of estate tax was owed. Marital Trust A, containing $6.24 million, was subject to a power of appointment that Mrs. Gerson exercised in her will on behalf of five grandchildren. At her death in 2000, Trust A was distributed to two of the grandchildren outright and to three others in trust until they were to turn 40.

Since Mrs. Gerson held a general power of appointment over property at death, the value of such property was includible in her gross estate for Federal estate tax purposes under section 2041.

The IRS treated the transfer to the grandchildren as direct skip transfers coming from Mrs. Gerson and therefore assessed a tax deficiency of $1.14 million based on the GST tax.

As authority the IRS relied on regulation 26.2601-1(b)(I) and Peterson Marital Trust v. Commissioner, 102 T.C. 790 (1994), affd. 78 F.3d 795 (2d Cir. 1996), in which the second circuit upheld the validity of 26.2601-1(b)(I) and found that the lapse of a general power of appointment resulted in a "constructive" addition to the trust and was therefore subject to GST tax.

The estate argued that the transfer was grandfathered as a transfer from a trust that was irrevocable prior to October 22, 1986, under section 1433(b)(2)(A) of the Tax Reform Act of 1986 (as interpreted and applied by the 8th Circuit Court of Appeals in, Simpson v. United States, 183 F.3d 812 (8th Cir. 1999), and the 9th Circuit in, Bachler v. United States, 281 F.3d 1078 (9th Cir. 2002).

The current Generation Skipping Transfer (GST) tax was enacted in 1986, at which time the former GST was revoked retroactively. In doing so, Congress tried to protect those trusts that were established prior to the specifics of the new GST being firmed up in a "mark up" session on October 22, 1986.

Based on this reason for "grandfathering," the Peterson Court reasoned that, "Mr. Peterson did not tie himself or his heirs up at all. He gave Mrs. Peterson a power over the trust that was great enough to undo any harm that stemmed from reliance on the absence of a GST at the time the trust was created. It is this fact that, in the end, not only gives additional support to the view that the Treasury regulation on constructive additions is a reasonable one, but also negates all of the taxpayer's arguments that on 'policy grounds' the exemption should apply in this case."

Simpson looked to the irrevocability of the trusts as of October 22, 1986, and concluded that the power of appointment is derived from this irrevocable trust. But the regulation in question was written specifically to counter the Simpson decision.

The case of the Gerson Trust (which is appealable to the 6th Circuit), a divided tax court sided with the IRS and noted that Congress used the transitional rule to apply to trusts involving a specific volitional generation-skipping transfer and not a general power of appointment. Also, there was congressional intent to provide uniformity in GST tax application.⁵

TECHNICAL REFERENCES

The Estate of Edgar Allen Poe

While I nodded, nearly napping, suddenly there came a tapping, as of someone gently rapping, rapping at my chamber door.

Edgar Allen Poe was a brilliant and original American talent who authored many memorable lines you may recollect. The most famous is, "Quoth the Raven, 'Nevermore,'" but you've probably heard, "Is all that we see or seem, /But a dream within a dream?" or the outrageous, "From the tintinnabulation that so musically wells, /From the bells, bells, bells, bells, bells, bells, bells." Poe rules!

And there are the classic tales of entities being walled up alive in cellars (Cask of Amontillado) or floors (Tell Tale Heart), crypts (Fall of the House of Usher) or walls (The Black Cat).

Darker thematic tales of gothic melancholia, horror, revenge, and madness reflect a life borne of tragedy and steeped in the bleakest of misfortunes.

Poe was born in 1809 to a pair of young actors. His father was an alcoholic who abandoned the family and died in 1811. His mother died that same year of consumption (tuberculosis). His younger sister, Rosalie, was mentally retarded and institutionalized.

His older brother was William Henry Poe, who was raised separately but had the same genetic imprint, and developed into a melancholy and alcoholic poet who died penniless in 1831 at the age 24. Actually, he left something for his younger brother…debt! Having signed an $80 promissory note for his brother, Edgar was arrested for the debt.

Tragedy befell everyone in the orbit of Edgar Allen Poe. At 14, Poe fell for an older woman…who suddenly went mad and died. The foster mother who had doted over him died when Poe was 20. He married a 13-year-old cousin, who burst a blood vessel while playing the harp, and then wasted away and died.

Although raised in a wealthy household and sent to a brand-new college designed by Thomas Jefferson, this was not Poe's path to success. Poe's patron benefactor, Charles Allen (the source of Poe's middle name), had never adopted Poe and gave him $100 to cover $450 of college expenses. Poe fell into debt, gambled to try to cover expenses, and fell deeper into debt. Displeased at the $2,500 gambling debt that was accrued during freshman year, Poe's patron didn't send Poe back for the sophomore year.

It was Mrs. Allen, a childless matron, who had taken Poe in and doted over him. Charles Allen, a merchant, never formally adopted Poe, had an increasingly terrible relationship with him, left him no part of his estate, and took great pains to clarify that he was not any blood relation to Poe.

Perhaps this may be due to Poe's own bad habits and behaviors. He was known to drink and after a first drink would change in behavior dramatically, go on a binge, and end up completely incapacitated for days thereafter. These binges may have included opium (this charge may not be true) laudanum (a legal opiate derivative), and absinth.

He was on the cusp of mass recognition, but held back by his own demons. The most he ever received for any literary work was $100 for "The Gold Bug," in 1843. When he died in 1949 at the age of 40, he had few assets other than the intellectual property he had produced.

Alas, even in death Poe met with misfortune. Poe had the worst executor of all time. Rufus Wilmot Griswold, an adversary and rival of Poe, insinuated himself in as self-appointed literary executor of the estate. He then exploited the estate, forged letters, and even planted a slanderous obituary of Poe in The New York Tribune that became the sole source of information about Poe for the next 25 years. Poe's literary estate languished until Griswold's death in 1857, but thereafter acquired widespread fame.

Even Poe's tombstone was afflicted by misfortune. The tablet was standing in the tablet carver's yard the week before it was to be erected, but a freight-train ran off the track, broke down the fence, and the only tablet it ruined was Poe's. -This tale is provided in the first person on website of the Edgar Allen Poe Society.

"In an aptly mysterious postscript to Poe's life, an anonymous visitor has brought three red roses and a bottle of cognac to Poe's grave at Westminster Church in Baltimore on the anniversary of the writer's birthday every year since 1949." - Quoted from NeuroticPoets.com. Alas, even that has now been revealed as a contrivance, albeit well-intentioned, to draw attention and tourism to the grave so as to maintain it with the recognition that it deserves.