Liability for the estate tax falls on the estate assets and is limited by the value of those assets. Executors and beneficiaries generally do not have personal liability for estate taxes although the IRS can come after the assets held by the executor and beneficiaries if the taxes are left paid.
Under IRS regulations, the executor or administrator of the estate has the duty to pay the taxes. If there is no executor or administrator appointed, any person in actual or constructive possession of the decedent’s property is required to pay the entire tax to the extent of the value of the property in that person’s possession.
All of these rules sound reasonable, so what could go wrong? A lot. When the assets are distributed or liquidated without paying the tax owed, the IRS can step in and recover the taxes from the personal assets of the executor. This scenario occurred in the recent Tax Court case of Estate of Lee v. Commissioner.
Attorney-Executor Made Distributions
Kwang Lee died with a will on September 30, 2001. A licensed attorney and municipal court judge, Mr. Frese, was named executor of the estate. The executor filed a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, on behalf of the estate on May 21, 2003. From July 2003 to February 2007, Frese made distributions to estate beneficiaries totaling $1,045,000, of which $640,000 was distributed on February 28, 2007.
The IRS audited the return and determined a $1,020,129 deficiency in estate tax, plus a $255,032 addition to tax for untimely filing and a $204,026 accuracy-related penalty. From here, the case gets procedurally complicated, involving the abatement of the addition to tax and the penalty in an earlier case and a later rejected offer in compromise. Ultimately, the estate owned a $536,151 deficiency in estate tax but had only $183,000 in a checking account.
Executor Gets Hit with Tax Liability
For the executor, the worst that could happen did happen. The Tax Court held that the IRS could consider making Frese personally liable for the estate’s unpaid tax, finding that the IRS notice of deficiency was issued to Frese before he made the February 2007 distribution. Under Treasury regulations, an executor is personally liable for the unpaid claims of the United States government if the executor distributes estate assets when the executor had knowledge of the government’s claim.
Frese’s argument that he relied on a tax adviser also failed, because the Court observed that he was not an “unsophisticated executor” but instead was an attorney and a judge with direct knowledge of the estate tax deficiency.
Lessons Learned
Key takeaways from this case are these.
- Estate executors are not just conduits. They have substantive responsibility for the financial settlement of an estate including the responsibility to see that estate taxes are paid.
- Even if the executor does not receive estate distributions as a beneficiary, the executor may be held personally liable for the taxes.
- Sophisticated executors with professional degrees will be held to a higher standard when settling estate tax liabilities.
In short, collecting from the personal assets of an executor is one option the IRS has to satisfy an unpaid estate liability, albeit in limited circumstances.