Reminder to Executors and Trustees: Pay Estate Taxes First

Estate executors, personal representatives and trustees should pay the tax debts of an estate before they distribute assets, as illustrated by one recent U.S. District Court case.

The court found that an estate’s co-executors and the individuals who received distributions from the estate were personally liable — more than a decade later — for repaying more than $600,000 in unpaid federal estate taxes.

Facts of the Case

After the death of a man in 2004, his two co-executors “administered the estate informally, without court supervision, and they took actions without court approval,” according to court documents. The man’s will contained a “pour-over” clause directing residuary assets to be transferred into a family trust and distributed in accordance with its terms. The man and his wife, who died before him, were grantors and initial trustees. They were succeeded as trustees by the co-executors of the man’s estate.

The family trust directed, among other things, that upon the death of the grantors the co-trustees set aside sufficient assets to pay federal estate tax debts and obligations. The co-trustees were then to direct the disposition of the remaining assets to the named beneficiaries.

The complaint identifies real property, business assets and retirement accounts that were under the control of the co-executors/co-trustees. The Form 706 Estate Tax Return filed by the co-executors/co-executors listed the fair market value of all estate assets at $5,120,869. One of the co-executors/co-trustees filed an election to defer payment of estate taxes for five years and to pay the remaining tax liability in 10 annual installments. In the election, he stated that the estate tax liability totaled $1,586,551.00, of which the estate elected to defer $622,563.

On or about August 16, 2005, the co-executors/co-trustees requested an extension to pay federal estate taxes that had been due a month earlier. That request was granted, and the IRS continued to make timely assessments from 2006 through 2012.

Over the next few years, the estate negotiated other agreements to secure the debt to the United States, to defer payments and enter liens to assure satisfaction.

On June 14, 2012, the IRS declared the estate in default of the installment agreement and terminated it. On November 8, 2012, the agency sent a notice and demand for payment of federal estate taxes of $621,850 plus interest that continued to accrue.

What Was Distributed?

The court found that, despite the fact the tax burden wasn’t satisfied, the co-executors/co-trustees had distributed the following assets:

  1. A car valued at $35,000 and cash payments and loans of $210,922 to one defendant,
  2. A truck valued at $35,000 and cash payments and loans of $440,944 to a second defendant,
  3. A truck valued at $20,000 and $212,228 in cash payments and loans to a third defendant,
  4. Two cars valued at $80,000 and $60,000, and $755,826 in cash payments and loans to a fourth defendant,
  5. Cash payments of $33,840 to a fifth defendant,
  6. Cash payments of $27,500 to a sixth defendant,
  7. A cash loan of $120,000 and cash deposits of $170,145 to a company.

The court noted that these transfers were “made at a time when the estate didn’t have sufficient assets to pay its outstanding liabilities, including its federal estate tax liability.”

Government Sought Default Judgment

The United States sought a default judgment to recover the unpaid estate taxes, interest and penalties from the estate, co-executors/co-trustees and beneficiaries to whom assets or cash was distributed.

The court noted that the “liability of the individual non-executors is limited to the value of the assets each received from the estate as transferees, trustees, and/or beneficiaries, up to the date of judgment.” The liability of the co-executors/co-trustees is alleged to extend to the value of all estate property they distributed in violation of their fiduciary duty to pay federal estate taxes due.

The court entered the default judgment, noting that withholding it in this case, “where the facts are clear and the delay is palpable . . . would only serve to encourage other executors and beneficiaries to take distributions without regard to the tax requirements.”

Although the estate was large and there were many beneficiaries, the court added, “the law was clear — the estate taxes were to be paid before distributions were made.” The total amount due after interest and penalty is $817,944. (U.S. v. Estate of Espinor, Dist. Ct. ED Cal, 2016 WL 2880191)

The Message

This case provides a warning for all executors, personal representatives, trustees and beneficiaries: If estate taxes are due and distributions are made, it’s possible that money will have to be paid back — even years later.