Wednesday, May 8, 2019
In recent months, several court decisions have involved the issues of executors and beneficiaries of an estate being held personally liable for the unpaid taxes of the estate. Sometimes a statute of limitations defense can be raised to fend off personal liability. Sometimes it cannot be raised. The matter can also be complicated when the estate makes an election to pay the estate tax in installment over (essentially) 15 years rather than filing the return and paying the federal estate tax nine months after the decedent’s death.
Personal liability of heirs for unpaid federal estate tax – that’s the topic of today’s post
Family trust. In United States v. Johnson, No. 17-4083, 2019 U.S. App. LEXIS 9317 (10th Cir. Mar. 29, 2019), the decedent died in 1991, survived by her four children. Before death, the decedent had established a trust that named two of her children as the successor trustees of her trust and the personal representatives of her estate. The decedent funded the trust with stock in a closely-held corporation that operated a hotel with a Nevada gambling license. Her will directed that the residue of her estate after payment of expenses and claims be transferred to the trust and administered in accordance with the trust’s terms. The children were also the beneficiaries of the decedent’s life insurance policies value at approximately $370,000. The decedent died on September 2, 1991.
Installment payment election. As reported on a timely filed federal estate tax return, the gross estate was valued at almost $16 million and the estate tax liability was approximately $6.9 million. The federal estate tax paid with the estate tax return was $4 million. An installment payment election was made in accordance with I.R.C. §6166 for the balance of the estate tax liability which allowed that portion of the tax to be paid in 10 annual installments starting in 1997 (after five years of interest-only payments) and ending in 2006. Upon receiving the filed estate tax return, the IRS took note of the election and assessed the estate for unpaid estate tax on July 13, 1992. In late 1992, all of the remaining trust assets (primarily hotel stock) were distributed to the children. The hotel stock was distributed to the trust beneficiaries because Nevada law governing casino ownership via trust required it. All of the children entered into a distribution agreement (governed by Utah law) acknowledging that they were equally responsible for the unpaid federal estate tax as it became due and equally liable for any additional tax that might result from an audit.
IRS lien. In 1995, the IRS took the position that the estate’s gross value had been underreported by approximately $3.5 million. Ultimately, a settlement was reached whereby the estate agreed to pay additional federal estate tax of $240,381. In 1997, shortly before the due date of the first estate tax installment, the IRS informed the personal representatives of alternatives to personal liability for unpaid deferred estate tax. As a result, the personal representatives executed an I.R.C. §6324A lien which all four children signed along with an agreement restricting the sale of stock in a hotel which comprised the largest asset of the decedent’s estate. That restriction was to be in effect while the lien was in effect. In 2002, the hotel filed bankruptcy and a sale of all hotel assets was approved. In 2003, the IRS informed the personal representatives that if they defaulted, the entire balance of estate tax would be immediately due. Shortly thereafter the estate defaulted on its federal estate tax liability after having paid a total of $5 million of the amount due. After attempting to collect via levies against the estate, trust and the children, and learned of the distribution agreements in mid-2005. The IRS filed suit in 2011 naming all of the children as defendants and seeking to recover over $1.5 million in unpaid federal estate tax from them personally.
Litigation. The trial court held that the heirs who received trust distributions were not liable as beneficiaries or transferees under I.R.C. §6324(a)(2). However, the trial court also determined that the personal representatives could be liable under 31 U.S.C. §3713 and I.R.C. §2036(a) as successor trustees up to the value of the trust assets that were included in the decedent’s gross estate via I.R.C. §2034-2042. The personal representatives claimed that the assets were included in the estate via I.R.C. §2033. The trial court determined that the assets were included in the estate via I.R.C. §2033 because the decedent never lost the beneficial ownership of them during her lifetime (i.e., the assets had not been transferred as required by I.R.C. §2036). Thus, the personal representatives were not personally liable for the unpaid estate tax as trustees. In addition, the court determined that the personal representatives were not liable under 31 U.S.C. §3713 because liability was discharged upon execution of the I.R.C. §6324 lien. The IRS also claimed it had rights as a third-party beneficiary of the 1992 distribution agreement whereby they agreed to be equally liable for any additional taxes resulting from an audit. The trial court determined this claim was untimely under Utah law (6-year statute of limitations) and rejected the IRS claim that federal law should apply.
Tenth Circuit decision. On appeal, the appellate court held that federal law applied on the contract-based claim and was governed by the 10-year statute of limitations of I.R.C. §6502. That’s because the court concluded that the government was acting in its sovereign capacity. Accordingly, the 10-year statute of limitations applied. When the federal government is enforcing its rights, it is not bound by a state’s statute of limitations even with respect to lawsuits that are brought in state courts. It makes no difference whether the claim at issue arose under federal or state statutes or the common law.
Likewise, the transferee liability claim was timely because the limitations period applicable to the I.R.C. §6324(a) transferees was the same as the limitations period that applied to the estate. Because the 10-year limitations period that normally applies to the collection of estate tax was suspended by the installment payment election, the government’s claim was timely. See, e.g., §6503(d); United States v. Botefuhr, 309 F.3d 1263 (10th Cir. 2002). The appellate court also held that the children were liable for unpaid estate tax to the extent of any life insurance proceeds they received from the estate. United States v. Johnson, No. 17-4083, 2019 U.S. App. LEXIS 9317 (10th Cir. Mar. 29, 2019). The appellate court also held, reversing the trial court, that the beneficiaries weren’t entitled to attorney fees and costs because the government’s position was “substantially justified under I.R.C. §7430(c)(4)(B). Indeed, the government received a judgment for the full amount of the estate tax liability asserted.
It’s worth noting that the decedent in Johnson died in 1991. The Tenth Circuit’s decision was in 2019. That show’s how long matters can get drawn out if an installment payment election is made and there is unpaid tax liability. The government is not simply going to go away.