Fiduciary & Transferee Tax Liability for Decedents' Estates
May 18, 2012
The United States can hold parties to asset transfers, both transferors and transferees, personally liable for outstanding debts owed to the United States by a debtor. One type of such debt has the potential to affect many: federal tax and tax-related debts owed by decedents' estates. However, the basis and scope of liability associated with transfers from decedents' estates vary significantly depending upon whether the party is a fiduciary or transferee.
Executors, administrators, personal representatives, and others that control and distribute the assets of a decedent’s estate are called fiduciaries. Such fiduciaries are required to respect the creditors’ priorities set forth in 31 U.S.C. §3713(b) when handling estate matters and if not, they may be held personally liable for the debts of the estate owed to the United States.
The imposition of personal liability is subject to the following three (3) conditions set forth in 31 U.S.C. §3713 and case law as made by courts:
- The creditor priority set forth in 31 U.S.C. §3713(a) must apply;
- The fiduciary’s liability cannot exceed the amount of debts paid before those owing to the United States are paid; and
- The fiduciary must have notice of such debts.
Although the first two conditions are somewhat straightforward, the third condition is more complicated because it does not exist in statutory form but has been consistently added by courts in such cases. “[I]t has long been held that a fiduciary is liable only if it had notice of the Claim of the United States before making the distribution.” Want v. Comm’r, 280 F.2d 777, 783 (2nd Cir. 1960).
What constitutes notice is usually dependent upon the facts and circumstances of a particular case but, in general, the requirement may be “satisfied by either actual knowledge of the liability or notice of such facts as would put a reasonably prudent person on inquiry as to the existence of the unpaid claim of the United States.” Leigh v. Comm’r, 72 T.C. 1105 (U.S.T.C. 1979). Inquiry is not required unless there are circumstances that would suggest to a reasonably prudent person that an inquiry be made. Rev. Rul. 66-43. Further, it is the burden of the IRS to prove that the fiduciary had notice of such debts.
When calculating and imposing personal liability for unfiled tax returns, IRS personnel are advised to take into account the notice that a particular fiduciary had regarding unfiled returns. Specifically, the IRS manual states that an IRS agent should “determine if and when the fiduciary had knowledge of the balance due or unfiled returns.” Internal Revenue Manual 22.214.171.124(3).
As a result of the three (3) aforementioned conditions, the basis and scope of personal liability as they pertain to fiduciaries is much more limited than such basis and scope as they pertain to transferees, discussed below.
Transferees of assets from a decedent’s estate owing estate, gift, or income taxes to the United States, whether they are heirs, devisees, or others, may be held personally liable for such debts through a summary procedure set forth in 26 U.S.C. §6901 whereby the IRS can seek to impose personal liability upon transferees depending upon the type of tax obligation if a transfer, or series of transfers, rendered the decedent’s estate insolvent. However, §6901 does not impose personal liability; rather, the legal authority to impose personal liability is different for each type of tax.
A) Federal Estate Tax
Section 6324(a)(2) provides that transferees of property included in the gross estate of a decedent are personally liable for unpaid estate taxes associated with such property. However, the courts are split as to whether the IRS must follow the procedures set forth in §6901 to assess the tax against the transferee if the tax has been assessed against the estate.
In U.S. v. Russell, the Tenth Circuit Court of Appeals held that the collection procedures set forth in §6901 are cumulative and alternative, and therefore the IRS was not required to follow the procedures set forth in §6901. 461 F.2d 605 (10th Cir. 1972). In U.S. v. Schneider, however, a district court held that assessment against the estate provided insufficient notice to the transferee. 92-2 USTC 60, 119 (N.D. 1992).
B) Federal Gift Tax
Unlike federal estate tax obligations, however, the courts agree that federal gift taxes need not be assessed against a transferee before the IRS can collect the tax.
Section 6324(b) imposes a lien “upon all gifts made during the period for which the return was filed, for 10 years from the date the gifts are made.” Section 6324(b) subsequently addresses the liability that will result from non-payment of taxes, in particular: “If the tax is not paid when due, the donee of any gift shall be personally liable for such tax to the extent of the value of such gift.”
C) Federal Income Tax
Determining the authority by which the IRS can impose personal liability for unsatisfied federal income tax obligations is much more complicated than for federal estate or gift tax obligations because there is no basis in the Internal Revenue Code (IRC) to do so; rather, the IRS must look to other legal authority, including: i) state fraudulent transfer statutes, ii) federal fraudulent transfer statutes, or iii) equitable principles.
i) State Fraudulent Transfer Statutes
Although a discussion of each state's fraudulent transfer laws is not within the scope of this post, each state has enacted statutes whereby transfers that are made for less than a fair valuation while a debtor is insolvent can be “avoided” by the courts. The basis for many of these fraudulent transfer staatutes is the Uniform Fraudulent Transfer Act (UFTA). Although the specific provisions of each state's particular codification of the UFTA may vary, the relevant provisions of the UFTA define “insolvent” as applicable to decedents' estates as follows:
- A debtor is insolvent if the sum of the debtor’s debts is greater than all of the debtor’s assets, at a fair valuation.
- A debtor who is generally not paying his [or her] debts as they become due is presumed to be insolvent.
The U.S. Supreme Court has held that the IRS can leverage these state statutes to collect federal income tax obligations from transferees. Comr. v. Stern, 357 U.S. 39 (1958). The effect of these statutes is to return the transferred assets back to the transferor whereafter creditors of the transferor can attach those assets and use them to satisfy claims against the transferor.
Various federal tax courts have held that the IRS need not “assess” the tax in order for it to affect the insolvency of a debtor; rather the “the tax is ascertainable when the tax period ends” and must be factored into insolvency calculations from that point forward. 67 T.C.M. 1968, 1970 (U.S.T.C. 1994). In making such insolvency calculations, courts have further held “that the transferee is liable irrespective of the particular moment at which the transferor lapsed into insolvency, if such results no later than at the end of a series of transfers.” Id. at 1970.
ii) Federal Fraudulent Transfer Statutes
The Federal Debt Collections Procedures Act of 1990 (FDCPA), 28 U.S.C. §§3001-3308, enables the IRS to seek three types of remedies against transferees of insolvent estates for federal income tax obligations if the transfers were for less than “reasonably equivalent value”:
- avoidance of the transfer or obligation to the extent necessary to satisfy the debt to the United States;
- a remedy under this chapter against the asset transferred or other property of the transferee; or
- any other relief the circumstances may require.
28 U.S.C. §3306(a).
The definition of “insolvent” set forth §3302(a) of the FDCPA is very similar to the aforementioned definition in the UFTA. In particular, the FDCPA specifies that “a debtor is insolvent if the sum of the debtor’s debts is greater than all of the debtor’s assets at a fair valuation.” Section 3302(b) also sets in place a presumption that “[a] debtor who is generally not paying debts as they become due is presumed to be insolvent.”
Although there remain a number equitable principles, e.g. the trust fund doctrine or the concept of alter ego, through which the IRS can seek to recover an estate's unpaid federal income tax obligations from a transferee, the IRS uses such causes sparingly since the enactment of 26 U.S.C. §6901.
Creditors' Claims Period
Although the various implementations of the Uniform Probate Code as codified by the individual states can generally bar creditors' claims if such claims are not asserted during a specific period of time, often four (4) months, following the proper publication of notice of probate, the collectability of such federal tax debts is generally not affected because the Uniform Probate Code specifically allows creditors' claims based upon fraudulent transfers after that expiration of such period. UPC §1-106.
This brief overview of some important considerations associated with tax liabilities for estates, fiduciaries, and transferees is by no means comprehensive. Always seek the advice of a competent professional when making important financial and legal decisions.