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It can be either a blessing or a curse to be appointed as the Personal Representative of an estate or Trustee of a trust (collectively a “Fiduciary”).

One of the most over looked aspects of the job is the fact that the U.S. Government has a “general tax lien” on all estate and trust property when a decedent leaves assessed and unpaid taxes and a “special tax lien” for estate taxes on a decedent’s death. As a result, when advising a Fiduciary on the estate and trust administration process it is important to inform them that with the responsibility also comes the potential for personal liability.

Liability for Income and Estate Taxes:

Internal Revenue Code (“IRC”) §6012(b) holds a Fiduciary responsible for filing the decedent’s final income and estate tax returns. IRC §6903(a) further establishes a Fiduciary’s responsibility for representing the estate in all tax matters upon filing the required Notice Concerning Fiduciary Relationship (IRS Form 56). Under IRC §6321, when the tax is not paid an IRS lien will spring into being. When an estate or trust possesses insufficient assets to pay all its debts, federal law requires the Fiduciary to first satisfy any federal tax deficiencies before any other debt (31 U.S.C. §3713 and IRC §2002).

A Fiduciary who fails to abide by this requirement will subject themselves to personally liability for the amount of the unpaid tax deficiency (31 U.S.C. §3713(b)). An exception arises when an individual has obtained an interest in the property that would prevail over the federal tax lien under IRC §6323 (United States v. Estate of Romani, 523 U.S. 517 (1998)). When there are insufficient estate or trust assets to pay a federal tax obligation, as a result of the Fiduciary’s actions, the IRS may collect the tax obligation directly from the Fiduciary without regard to transferee liability (United States v. Whitney, 654 F.2d 607 (9th Cir. 1981)). If the IRS determines a Fiduciary to be personally liable for the tax deficiency it will be required to follow normal deficiency procedures in assessing and collecting the tax (IRC §6212).

Prerequisites for Fiduciary Liability:

Under IRC §3713, a Fiduciary will be held personally liable for a federal tax liability if the following conditions precedent are satisfied:

1. The U.S. Government must have a claim for taxes;
2. The Fiduciary must have:
   1. knowledge of the government’s claim or be placed on inquiry notice of the claim, and
   2. paid a “debt” of the decedent or distributed assets to a beneficiary;
3. The “debt” or distribution must have been paid at a time when the estate or trust was insolvent or the distribution created the insolvency;
4. The IRS must have filed a timely assessment against the fiduciary personally (United States v. Coppola, 85 F.3d 1015 (2d Cir. 1996)).

For purposes of IRC §3713, the term “debt” includes:

1. hospital and medical bills;
2. unsecured creditors;
3. state income and inheritance taxes (conflict between U.S. Blakeman, 750 F. Supp. 216, 224 (N.D. Tex. 1990) and In Re Schmuckler’s Estate, 296 N.Y. 2d 202, 58 Misc. 2d 418 (1968));
4. a beneficiary’s distributive share of an estate or trust;
5. the satisfaction of an elective share.

In contrast, the term “debt” specifically excludes:

1. a creditor with a security interest;
2. funeral expenses (Rev. Rul. 80-112, 1980-1 C.B. 306);
3. administration expenses (court costs and reasonable fiduciary and attorney compensation) (In Re Estate of Funk, 849 N.E.2d 366 (2006));
4. family allowance (Schwartz v. Commissioner, 560 F.2d 311 (8th Cir. 1977));
5. a “homestead” interest (Estate of lgoe v. IRS, 717 S.W. 2d 524 (Mo. 1986)).

Preference Requirement and Knowledge of Outstanding Tax Obligations:

While the IRS may pursue collection of an estate tax deficiency from the beneficiaries, the Fiduciary will only retain a right of subrogation if the IRS elects to pursue collection of the tax deficiency against them. Under IRC §6324, the IRS may seek collection of the federal tax deficiency from the Fiduciary in possession of the assets on which the tax applied, not to exceed the value of the assets transferred to any beneficiary. However, if the Fiduciary had no knowledge of the debt, they will not be liable for more than the amount distributed to the beneficiaries or other creditors, or for taxes discovered subsequent to any distributions (Rev. Rul. 66-43, 1966-1 C.B. 291). Regardless of the circumstances, a Fiduciary’s failure to file a federal tax return will subject them to personal liability for the unpaid tax.

The burden of proof will then rest with the Fiduciary to prove their lack of knowledge of the unpaid tax (U.S. v. Bartlett, 2002-1 USTC ¶60,429. (C.D. Ill. 2002)). Once this element is established the burden will shift back to the IRS (Villes v. Comr., 233 F.2d 376 (6th Cir. 1956); Estate of Frost v. Commissioner, T.C. Memo. 1993-94). If the liability pertains to income or gift taxes relating to years before the decedent’s death, a court may require the Fiduciary to have actual or constructive knowledge of the liability before holding them personally liable for the unpaid tax (U.S. v. Coppola, 85 F.3d 1015 (2d Cir. 1996)).

Statutes of Limitation:

Under IRC §6901 and §6501 the statutory period for assessing personal liability against a Fiduciary tracks the same as the underlying tax. The limitation period is:

1. three years from the date of a tax returns filing or the date the tax return is due (if filed early);
2. six years if there is a substantial omission (25% or more) of gross income, gift or estate assets;
3. no limit if the IRS can prove fraud.

Under IRC §6502(a), once the IRS makes a tax assessment it has ten (10) years to collect the tax.

Methods for Reducing Fiduciary Liability:

A Fiduciary may only make a partial distribution to beneficiaries or creditors without concern of personal liability for estate tax deficiencies if sufficient assets are retained to pay all tax liabilities (including potential interest and penalties).

Income and Gift Taxes:

The first step requires the Fiduciary to file IRS Form 4506, Request for Copy or Transcript of Tax Form, with the IRS. The response received from the IRS will educate the Fiduciary as to which tax returns (income, gift, etc.), if any, were filed by the decedent prior to his or her death. The request should include the Fiduciary’s letters of administration, if applicable, and a Power of Attorney (IRS Form 2848).

To expedite the process, IRC § 6501(d) authorizes a Fiduciary to file IRS Form 4810, Request for Prompt Assessment, to request a prompt assessment and review of all tax returns filed…

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Ihab Salloum