Beneficiary and Fiduciary Liability for Income, Gift and Estate Taxes

It are often either a blessing or a curse to be appointed because the representative of an estate or Trustee of a trust (collectively a “Fiduciary”). one among the foremost overlooked aspects of the work is that the incontrovertible fact that the U.S. Government features 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’s important to tell them that with the responsibility also comes the potential for private liability.

On many occasions, a Fiduciary could also be placed into an edge where assets passing outside the probate estate (life insurance, jointly held property, retirement accounts, and pension plans) or trust, over which they need no control, constitute a considerable portion of the assets (real property, stocks, cash, etc.) subject to estate taxation. Without the power to direct or assume control of the assets, the Fiduciary may have both a liquidity problem and lack of means to satisfy the estates’ tax (income or estate) obligation. For this reason alone, a Fiduciary should be very reluctant to distribute any funds to a beneficiary before all statute of limitation periods expire for the interior Revenue Service (“IRS”) to assess a tax deficiency.

Liability for Income and Estate Taxes:

Internal Revenue Code (“IRC”) §6012(b) holds a Fiduciary liable for filing the decedent’s final income and inheritance tax returns. IRC §6903(a) further establishes a Fiduciary’s responsibility for representing the estate altogether tax matters upon filing the specified Notice Concerning Fiduciary Relationship (IRS Form 56). Under IRC §6321, when the tax isn’t 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 the other debt (31 U.S.C. §3713 and IRC §2002).

A Fiduciary who fails to abide by this requirement will subject themselves to personal liability for the quantity of the unpaid tax deficiency (31 U.S.C. §3713(b)). An exception arises when a private has obtained an interest within the property that might prevail over the federal 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 results of the Fiduciary’s actions, the IRS may collect the tax obligation directly from the Fiduciary without reference to transferee liability (United States v. Whitney, 654 F.2d 607 (9th Cir. 1981)). If the IRS determines a Fiduciary to be personally responsible for the tax deficiency it’ll be required to follow normal deficiency procedures in assessing and collecting the tax (IRC §6212).

Prerequisites for Fiduciary Liability:

Under IRC §3713, a Fiduciary are going to be held personally responsible for federal liabilities if the subsequent conditions precedent are satisfied: (I) the U.S. Government must have a claim for taxes; (ii) the Fiduciary must have: (a) knowledge of the government’s claim or be placed on inquiry notice of the claim, and (b) paid a “debt” of the decedent or distributed assets to a beneficiary; (iii) the “debt” or distribution must are paid at a time when the estate or trust was insolvent or the distribution created the insolvency; and (iv) 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 the payment of: (I) hospital and medical bills; (ii) unsecured creditors; (iii) 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)); (iv) a beneficiary’s distributive share of an estate or trust; and (v) the satisfaction of an elective share. In contrast, the term “debt” specifically excludes the payment of: (I) a creditor with a security interest; (ii) funeral expenses (Rev. Rul. 80-112, 1980-1 C.B. 306); (iii) administration expenses (court costs and reasonable fiduciary and attorney compensation) (In Re Estate of Funk, 849 N.E.2d 366 (2006)); (iv) family allowance (Schwartz v. Commissioner, 560 F.2d 311 (8th Cir. 1977)); and (v) a “homestead” interest (Estate of lgoe v. IRS, 717 S.W. 2d 524 (Mo. 1986)).

In order to gather the federal tax deficiency, the IRS possesses the choice to either file a lawsuit against the Fiduciary in administrative district court, pursuant to IRC. §7402(a), or issue a notice of fiduciary liability under IRC § 6901(a)(1)(B and commence collection efforts. The statute of limitations for issuing a notice of fiduciary liability is that the latter of 1 year after the fiduciary liability arises or the expiration of the statute of limitations for collecting the underlying liabilities (IRC § 6901(c)(3)).

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