Minimizing a personal representative's personal liability to pay taxes: part 1 describes tax returns, tax payment obligations, and ways in which a PR can be held personally liable for failing to adhere to the applicable federal and state requirements.

JurisdictionUnited States
AuthorCarroll, William C.
Date01 November 2004

A Personal representative ("PR") of a Florida probate estate must be fully cognizant of his or her obligations to file tax returns and pay taxes on behalf of the decedent and the decedent's estate. These obligations are numerous and include returns for income, estate, generation-skipping, gift and intangible taxes. A failure to file these tax returns and to pay these taxes could result in the PR being personally liable to the Internal Revenue Service or to the Florida Department of Revenue for any unpaid taxes, penalties, and interest. This personal liability can be asserted and collected by the federal and state government many years after the estate is closed. Additionally, the Florida Probate Rules specify that, before making complete distribution of estate assets to beneficiaries, the PR is obligated to settle all creditor claims and to pay or make provision for taxes and expenses of administration. (1) Even if the PR is not personally liable to the IRS or the FDOR, the PR could be personally liable to the beneficiaries through a surcharge action based on a loss suffered because of a failure to pay taxes when due.

Part I of this article describes these tax returns and tax payment obligations and discusses the ways in which a PR can be held personally liable for failing to adhere to the applicable federal and state requirements. Part II suggests a course of action for a PR to minimize the risk of being personally liable for these taxes.

Federal Tax Obligations in General

Federal law requires the PR to file the decedent's outstanding federal income and gift tax returns. (2) Depending on the size of the estate and the amount of the decedent's lifetime gifts, the PR may also be required to file a federal estate tax return. (3) The PR is responsible for paying the federal estate tax, even if a part of the tax liability is attributable to assets which are not in the possession of the PR. (4) With respect to the generation-skipping tax, the PR is required to report on the estate tax return any testamentary direct skips and is liable to pay the related generation-skipping tax. (5) The PR must also report on the estate tax return, and pay, any direct skip generation-skipping tax resulting from a "trust arrangement" involving less than $250,000, such as a life insurance policy with a grandchild as the beneficiary. (6)

Federal Mechanism for Holding the PR Personally Liable for Taxes

If a PR fails to pay the decedent's or the estate's federal tax liabilities, he or she can be held personally liable for these taxes. 31 U.S.C. [section] 3713(a) provides in part that a claim of the United States Government must be paid first when the assets in the estate of a deceased debtor are not enough to pay all debts of the debtor. 31 U.S.C. [section] 3713(b) states that a representative of a person or an estate paying any part of a "debt" of the person or estate before paying a claim of the U.S. Government is personally liable to the extent of the payment for unpaid claims of the U. S. Government. Thus, a PR can be held personally liable to the U.S. Government if the PR pays a "debt" of the estate before satisfying the U.S. Government's claims. A trustee of a trust which was revocable until the decedent's death can also be personally liable for the decedent's and the estate's taxes. (7)

In addition to holding the PR personally liable pursuant to [section] 3713(b), the IRS has other methods available for collecting unpaid taxes. The U.S. Government has a lien on all property of the taxpayer for assessed and unpaid taxes. (8) This lien is commonly referred to as the general tax lien. The general tax lien does not arise until the tax is assessed. Additionally, the estate tax becomes a lien on the gross estate. (9) This lien is a special tax lien. This special tax lien, unlike the general tax lien, attaches immediately upon the decedent's death. (10) Thus, in addition to, or in lieu of, holding a PR personally liable, the IRS can attach the property subject to any general or special lien. Additionally, the IRS can hold a transferee liable for any assessed tax deficiency of a taxpayer, decedent, or donor. (11) This is known as "transferee liability." The term "transferee" includes an heir, legatee, devisee, and distributee of an estate of a deceased person and a donee of any gift. (12)

Thus, holding a PR personally liable for unpaid taxes pursuant to [section] 3713(b) is but one of several mechanisms available to the IRS for the collection of unpaid taxes. One commentator noted that [section] 3713(b) is usually used by the IRS as a last resort in that, as discussed below, the Service cannot use [section] 3713(b) unless it has satisfied certain conditions precedent. (13) This same commentator, however, goes on to state that holding the PR personally liable may be the only effective weapon available because:

1) the general tax lien may not be effective due to a distribution of assets from the estate before the tax was assessed;

2) many types of transfers defeat the government's security interest under the special tax lien statute (i.e., purchasers and secured creditors in certain instances); and

3) a transferee may dissipate assets he or she received from the decedent's estate. (14)

* Conditions Precedent to Personal Liability under [section] 3713(b).

In order for a PR to be held personally liable under [section] 3713(b) the following conditions precedent must be satisfied:

(1) the U.S. Government must have a claim;

(2) the PR must have knowledge of the government's claim or be placed on inquiry notice of the claim;

(3) the PR must have paid a "debt";

(4) the "debt" must have been paid at a time when the estate is insolvent or the "debt" must create the insolvency; (I5) and

(5) the IRS must have filed a timely assessment against the PR individually, or there must have been a timely filing of a court action against the PR personally.

Following is more detail on some of these conditions precedent:

* U.S. Government Claims

U.S. Government claims include taxes owed (even unassessed taxes) to the U. S. Government, and interest and penalties attributable to unpaid taxes. (16)

* PR's Knowledge of Unpaid U.S. Government Claim

In general, a PR cannot be held personally liable for any unpaid tax of a decedent unless he or she has knowledge of the tax liability or knowledge of facts which would cause a reasonable person to inquire as to the existence of such tax liability. (17) A PR who relies on the erroneous advice of legal counsel might avoid personal liability if the fiduciary can demonstrate limited experience in estate matters. (18)

* "Debt" Defined

To be held personally liable for federal taxes, one condition precedent is that the PR must have paid a "debt" of the decedent or the estate prior to satisfying the claim of the U.S. Government. What type of payments constitute the payment of a "debt"?

* Payments Which Do Not Constitute Payments of a Debt

Payment of amounts owed to a creditor with a security interest perfected prior to any federal tax lien does not constitute a "debt" payment under [section] 3713(b). (19) Payment of funeral expenses, administration expenses, including court costs and reasonable compensation for the fiduciary and his or her attorney, and payment of family allowances, do not constitute payment of "debts" under [section] 3713(b). (20) The IRS characterizes these amounts as charges against the property of the decedent to be deducted before the payment of "debts." (21) According to U.S. v. Blakeman, a Texas case, a surviving spouse's homestead interest in a decedent's property was not subject to the IRS lien against the decedent's estate. Therefore, based on the court's holding, a PR's "distribution" of the life estate to the surviving spouse should not constitute the payment of a "debt" under [section] 3713(b). (22)

* Payments Which Constitute Payments of a Debt

Payment of expenses of the decedent"s last illness are debt payments. (23) A payment to an unsecured creditor constitutes a "debt" payment under [section] 3713(b)...

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