Fiduciaries (trustees, executors, personal representatives) normally are not personally liable for the obligations of the trusts and estates they administer. As mentioned here previously, a major exception to this is the federal priority statute (a/k/a the federal claims statute) under 31 USC §3713(b)/Code § 6901(a)(1)(B). This little gem can create personal liability for a fiduciary that pays out estate or trust assets (including by reason of a distribution to beneficiaries) with knowledge that there are existing federal liabilities (such as taxes) that are unpaid, if the estate or trust is unable to later satisfy those liabilities.
This is not an abstract risk, but a very real liability for fiduciaries, as two fiduciaries learned in a recent case in Texas. In that case, the IRS asserted that a decedent did not pay gift taxes during lifetime, attributable to gifts indirectly made to the decedent. That is, the original donor did not pay the gift taxes on gifts to the decedent, so the decedent was liable for the gift taxes as a transferee. Both the executor of the decedent’s estate, and the trustee of his revocable trust, were knowledgeable of the IRS’ claim but nonetheless paid out funds without making provision for the payment of the gift taxes.
The case is illustrative of various aspects of the statute.
A. The executor was liable for personal property that was distributed to beneficiaries. This is a common problem since by the time the family gets to the lawyers, they have often already made these distributions. This can be a problem under the claim statute, and also state statutes regarding priority of expenses and distributions.
B. The executor was liable for rent payments made by the estate. Such payments are subordinate in priority to the federal claim for taxes.
C. The executor was NOT liable for funeral and last illness expenses. While the federal statute does not on its face allow an exception for these items and other administrative expenses, case law exceptions to these payments exist to the extent they have a priority for payment under state law.
D. The trustee of a revocable trust got caught up in the statute because the trustee was deemed to be the equivalent of a representative of the estate due to the obligation of the trust to pay the decedents debts.
E. The fiduciaries had taken income tax charitable deductions for over $1.1 million that had been set aside to fund charitable bequests. Such bequests were subordinate to the federal claim, so the fiduciaries were held personally liable for those set-aside amounts because the court found that the funds were beyond the reach of the IRS. Presumably, since those set-aside amounts were still held in the trust, the fiduciaries will have direct access to those funds to pay the liability, but perhaps the charities can somehow block that in the same fashion that the IRS and the court found that the IRS did not have access to those funds. In the case, the amount of the other expenditures that created liability for the fiduciaries was minuscule compared to this potential $1.1 million exposure.
F. The fiduciaries were liable for legal and other expenses they paid for the charities. The court noted that payment of legal fees of the estate and trust for administrative purposes are generally not subject to the claim statute, but since these were obligations of third parties then they were not exempt under the statute.
G. The fiduciaries do not have to receive formal notice or a claim from the IRS, to be on notice for purpose of the statute. The court provided:
the knowledge requirement is not actual knowledge. Leigh, 72 T.C. at 1110. It is sufficient to show that the fiduciary had “notice of such facts as would put a reasonably prudent person on inquiry as to the existence of the unpaid claim.” Id. Neither Marshall nor Hilliard contend that they were never told that the IRS might try to make a claim against Stevens for the unpaid gift taxes on the Gift. In fact, they admit that they were both told that the IRS might try to assert a claim against Stevens's Estate for donee liability on the Gift.
H. The fact that the fiduciaries did not believe the IRS’ claim was valid, or that they relied on their professionals, did not relieve them of liability. The court noted:
[T]hey argue that they did not believe the IRS's claim against Stevens was valid for various reasons. But, as the government points out, Marshall and Hilliard's belief in the validity of the government's claim is not the test. Marshall and Hilliard had sufficient notice of the claim to put a reasonably prudent person on notice. It is regrettable that they received incorrect advice on that point, but poor legal advice is not a defense. Despite their belief that the government's claim was not valid, Marshall and Hilliard were required by § 3713 to preserve the funds to pay the government's claim—should it be proved valid.
U.S. v. MACINTYRE, 109 AFTR 2d 2012-XXXX, (DC TX), 06/25/2012