Unqualified Estate Planner Leads to Estate Taxes & Litigation

Reliance on Self-Titled Estate Planner Leads to Estate Taxes & Litigation

I commented last week on a recent matter I handled that involved a self-titled estate planner without legitimate credentials.  I ran across a Federal tax case recently that drives this point home.  That case involved an “enrolled agent” who held himself out as an estate planner.  The result?  $380,000 in unpaid taxes and a $76,000 penalty that the taxpayer had to litigate in Tax Court.

The case involved the estate of Ralph Robinson.  Ralph was a self-made man.  Although he worked as a lumber mill saw filer, he had amassed an estate worth more than $1 million.  But later in his life, Ralph suffered from Alzheimer’s disease.  In 1999, he executed a durable power of attorney naming his daughter Carol as attorney-in-fact.  Carol began working with Ralph’s son James to arrange Ralph’s final affairs prior his death.

Like most people, James was not a tax guru.  He was a computer programmer without a college degree.  He had only completed a basic accounting course and had not taken any tax courses.  At the recommendation of a friend, James had hired John Schlabach to handle his own taxes.  James made this decision partly because Schlabach was an “enrolled agent.”  In the IRS’s language, an enrolled agent is:

An applicant who demonstrates special competence in tax matters by written examination administered by, or administered under the oversight of, the Director of the Office of Professional Responsibility and who has not engaged in any conduct that would justify the censure, suspension, or disbarment of the practitioner.

Between 1997 and 2007, Schlabach handled James’ personal income tax returns.  During that time, James noticed that Schlabach had added “estate planning” to his advertising.  When James asked about this, Schlabach told him that he was a “certified” estate planner who knew “how to file each and every return that the IRS has.”  Schlabach said that he routinely performed these services and could cite the Internal Revenue Code.  So when it came time to plan Ralph’s estate, James thought of Schlabach.

Ralph had wanted to minimize his estate tax liability and avoid probate (Ralph had went through a difficult probate with his brother’s estate and wanted to avoid the same in his own estate).  These objectives were conveyed to Schlabach, who recommended a living trust-based estate plan.  On Schlabach’s advice, the Ralph Kitson Robinson Living Trust was established in 2002. James and Carol served as co-trustees.

The purposes of the trust were typical of a trust-based estate plan: the trust was to receive and manage Ralph’s assets for his benefit during his lifetime and distribute the assets to his children (after paying expenses) upon his death.  Ralph’s primary residence and brokerage account were transferred into the trust.  James understood that this would not remove these assets from Ralph’s taxable estate, but that it could avoid the need to probate these assets.

Schlabach also advised James to transfer some real estate to the Alden Granville Trust.  Schlabach incorrectly informed James that doing so would remove those assets from Ralph’s taxable estate (Ralph had a retained interest in the Granville trust that triggered inclusion under Section 2036 of the Internal Revenue Code).

Ralph died in 2003 at the age of 91.  James was named as executor of his estate.  Schlabach informed James that Ralph’s estate exceeded the applicable exclusion amount (then $1 million).  To avoid estate taxes, Schlabach suggested that James transfer assets of the living trust to the Robinson Foundation, a non-exempt charitable trust that had been formed on Schlabach’s advice.  Based on this advice, James transferred $941,000 to the Robinson Foundation.

When all of this got to the IRS, the IRS issued disallowed the $941,000 for property transferred to the Robinson Foundation and included the value of the real estate transferred to the Granville trust in Ralph’s estate.  Apparently James didn’t even have a good argument to the IRS’s claims.  He conceded these issues to the IRS, resulting in an estate tax deficiency of $380,514.

But the IRS also charged an accuracy-related penalty of $76,103.  This penalty generally does not apply to the extent that there is reasonable cause and good faith on behalf of the taxpayer.  Good faith reliance on the advice of an independent, competent professional as to the tax treatment of an item may constitute reasonable cause.  James disputed the accuracy-related penalty, claiming that his reliance on Schlabach’s advice was evidence of reasonable cause and good faith.

The case reached the United States Tax Court, which ad to decide whether James really owed the accuracy-related penalty.  Lucky for James, the Court held that he did not.  The Court felt that James’ reliance on Schlabach’s advice was reasonable based on Schlabach’s representations of his own ability to James.  Accordingly, the $76,103 accuracy-related penalty did not apply.   But you have to wonder how much he spent in attorneys’ fees and court costs to reach that result.

Estate of Robinson, T.C. Memo 2010-168 (August 2, 2010).