Postfiling administrative expenses reduce estate tax fraud penalty.

• Author: Stein, Ronald A.

In a fully reviewed opinion with two dissents, the Tax Court recently held that, for purposes of computing the fraud penalty under Sec. 6663, an estate's underpayment of tax must take into account all deductible expenses, not merely those reported on the estate tax return (Estate of Trompeter, 111 TC No. 2 (1998) (Trompeter II)).

In Estate of Trompeter, TC Memo 1998-35 (Trompeter I), the Tax Court sustained the IRS's determination that an estate was liable for the Sec. 6663 fraud penalty. The estate had, among other things, substantially undervalued reported assets and failed to report other assets on its estate tax return.

In Trompeter II, the estate argued that in computing the underpayment subject to the penalty, it was entitled to deduct the professional fees it paid to prosecute Trompeter I, as well as deficiency interest. The Service countered that such postfiling expenses, while deductible in computing the estate tax deficiency, did not reduce the fraudulent underpayment.

The IRS relied on cases that held that a carryback does not reduce an underpayment for purposes of computing a penalty and on Sec. 6663'S reference to "any underpayment of tax required to be shown on a return" in support of the argument that the fraudulent underpayment must be measured with regard to the tax properly reported on a taxpayer's filed return.

The Service also contended that allowing postfiling deductions to reduce the fraudulent underpayment was bad tax policy. By running up administration costs through tax controversy fees, an estate could eliminate the penalty, which is supposed to reimburse the government for the costs of investigating fraud.

Judge Laro, writing for the majority, and noting that the issue was one of first impression, agreed with the estate. The carp/back cases were distinguishable; they rested on the annual accounting concept and stood for the proposition that a taxpayer may not reduce or eliminate a penalty by reason of events occurring in a later tax period. In contrast, the estate tax is not computed on an annual basis; rather, it is a one-time excise whose determination may encompass postfiling administrative expenses. The IRS's position could lead to incongruous results; for example, an estate that overpaid the estate tax could be liable for the fraud penalty.

Judge Laro also found the Service's statutory argument unpersuasive. Sec. 6663, he held, essentially constituted a recodification of old Sec. 6653(b). The court found...