Ruling Involving Trustee’s Frivolous Tax Return Raises Questions

The Tax Court recently held in Stanojevich v. Commissioner that the trustee of a grantor trust could be personally liable for penalties under Section 6702(a) of the tax code. Perhaps more important than what the Tax Court said in the opinion is what it didn’t say.

It’s important to understand that Section 6702(a) imposes a civil penalty on a person who files a “frivolous” tax return. It can mean a return that “does not contain information on which the substantial correctness of the self-assessment may be judged” or that “contains information that on its face indicates that the self-assessment is substantially incorrect,” and is based on what the IRS deems frivolous under Section 6702(c). It also can be a return that “reflects a desire to delay or impede the administration of federal tax laws.”

The Tax Court in Stanojevich found that the position reflected on the trust’s returns was frivolous. But the court didn’t take into account the complicating factor that this was a grantor trust, although it’s unclear whether doing so would have impacted the court’s ultimate conclusion. If the trust were a grantor trust to one grantor, in full, then the interest income reported on the trust’s return was taxable to the grantor, not the trust.

However, in the analysis, the court cites to Section 641 in setting forth the trust’s tax and reporting obligations. The court doesn’t explain why it failed to consider the impact of Section 671 and Treas. Reg. 1.671-4 on the reporting requirements of the grantor trust at issue, or whether the trust returns failed to comply with those reporting requirements. It’s also unknown whether the grantor was reporting the interest earned by the trust on his personal income tax return, and that the fiduciary income tax returns were therefore correct in reporting the trust’s taxable income as zero.

The court also rejected petitioner’s argument that he wasn’t personally liable for the penalties because he wasn’t the taxpayer at issue—the taxpayer was the trust. From the opinion, it appears the trustee focused his argument on the fact that the fiduciary income tax return wasn’t his personal income tax return instead of which taxpayer signed the return.

The court points out that the trustee is the proper party—the person with authority—to sign a fiduciary income tax return. The IRS didn’t dispute the assertion that Stanojevich signed the trust’s federal income tax return (Form 1041) on behalf of the trust solely in his capacity as trustee of the trust (not in his individual capacity), nor did the court analyze the state law status of the trust as a juridical entity or the duties of a trustee.

Instead, the court focused on the technical language of Section 6702(a) and concluded that because the statute used the term “person” rather than the more narrow term “taxpayer,” and that the petitioner is indeed a “person,” the civil penalties found in Section 6702(a) could be applied to him.

The court further supported its conclusion by pointing out that treasury regulations require the trustee to file a Form 1041 on behalf of a trust, as evidence that Congress supports the court’s conclusion that Section 6702 can be applied against a trustee. (The court erroneously refers to the petitioner as the “taxpayer” in the course of this analysis.)

Although at points confusing, the court’s ultimate decision is in line with the evolution of Section 6702 over time. First, Congress amended Section 6702 in 2006 by changing its application from “individuals” to the broader term “persons.” Prior to this change, the interpretation of who could be assessed a penalty was narrow.

In 2012, the IRS issued a revenue procedure that in order for a person to be eligible for a reduction in the Section 6702(a) penalty, that person must have filed all valid tax returns required to be filed, including “any returns of a trust for which the person serves as trustee.”

The court only reviewed the application of Section 6702 to a trustee who signed a fiduciary income tax return. It didn’t consider any applicable state law analysis, including whether the trust could or should indemnify the trustee for the tax penalties assessed against him. Most states’ trust codes allow a trustee to be reimbursed from the trust corpus for expenses incurred in the capacity as trustee.

It now will be a state law question whether or not civil penalties assessed against a trustee would be considered to have been incurred pursuant to an unreimbursable breach of fiduciary duty—if, for example, the trustee reasonably relied upon the advice of a professional return preparer.

It’s worth noting that the petitioner appeared pro se. The court ends its opinion with the following statement: “We have considered all of petitioner’s arguments, and to the extent not discussed above, we find them to be irrelevant, incomprehensible, or without merit.” In other words, the petitioner’s arguments likely weren’t well presented to the court.

The case is: Stanojevich v. Commissioner, T.C., No. 4984-17L, 4/10/23

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Laura Walker Plunkett is a shareholder at Baker Donelson. She concentrates her practice in tax-exempt organizations and charitable giving, estate and business succession planning, administration of trusts and estates, and fiduciary litigation.

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