Good News For Beneficiaries And Bad News For Fiduciaries In Regard To Transferee Liability For Estate Tax

by Charles (Chuck) Rubin

In a recent U.S. District Court case, transferee liability statutes were favorably interpreted to avoid transferee liability to trust beneficiaries. However, the fiduciaries were unable to rely on a contribution agreement from the beneficiaries to avoid personal liability for unpaid estate taxes under the federal claims statute.

FACTS: Before Anna Smith died, she created a family trust (the “Trust”). Anna died in 1991, and her last will provided for a pourover of probate assets to the Trust. The Trust provided for a residual distribution to certain named beneficiaries after all expenses and taxes of the Trust were paid (the “Beneficiaries”). A significant asset of the estate was shares of stock in a corporation. Anna’s fiduciaries elected to defer a portion of her estate taxes under Code §6166.

In 1992, the trustees of the Trust distributed assets of the Trust to the Beneficiaries. Because the estate taxes were not yet paid in full due to the deferral under §6166, the Beneficiaries agreed to bear responsibility for the unpaid estate taxes.

In 2002, the corporation went bankrupt. The Beneficiaries received nothing on their shares beyond some amounts received for covenants not to compete from the buyer of the corporation assets out of bankruptcy. In 2003, the estate defaulted on its unpaid estate taxes, after having paid only $5 million of the $6.871 million in taxes due. The IRS then sought to collect the unpaid taxes from the personal representatives of Anna’s estate (who were also trustees of the Trust), and from the Beneficiaries.

The District Court determined that the Beneficiaries were not subject to transferee liability for the residual assets distributed to them from the Trust. The personal representatives/trustees were found liable under the federal claims statute, however.


Liability as Transferees. The IRS argued that Code §6324(a)(2) imputes personal liability to the Beneficiaries as “transferees.” That provision reads:

"(2) Liability of transferees and others. If the estate tax imposed by chapter 11 is not paid when due, then the spouse, transferee, trustee ..., surviving tenant, person in possession of the property by reason of the exercise, nonexercise, or release of a power of appointment, or beneficiary, who receives, or has on the date of the decedent's death, property included in the gross estate ... to the extent of the value, at the time of the decedent's death, of such property, shall be personally liable for such tax."

Based on the language of “who receives, or has on the date of the decedent’s death,” the court narrowly interpreted who is a “transferee” under this provision to exclude the Beneficiaries since they did not receive the subject property immediately upon death. They were entitled to the property only after other Trust beneficiaries were paid and all taxes and expenses were paid.

Technically, the trustees of the Trust did not immediately receive the Trust property either, because estate administration first had to occur. Nonetheless, the court still found them as described transferees under the statute. While not discussed in the case, a fair reading might be that a named beneficiary of an asset from its owner at the time of death (whether that owner is the decedent’s estate or a trust that already owns the asset) meets the immediacy requirement, but not a beneficiary of a trust when the trust itself must first receive the asset from the decedent’s estate.

§6624(a)(2) also imposes transferee liability on a “beneficiary.” The IRS also sought to impose liability on the Beneficiaries using that term. Interestingly, however, case law generally limits that term to beneficiaries of life insurance, and does not apply a broad definition such as any recipient of property from an estate or trust. Once again, the Beneficiaries escaped transferee liability, due to this narrow use of the term. Presumably, however, even if the “beneficiary” term was broad enough to include the Beneficiaries, the above immediacy requirement may have also insulated the Beneficiaries from liability in this circumstance, too, for the same reasons it insulated them from being “transferees.” Note that the Beneficiaries did not entirely escape transferee liability since they were beneficiaries of life insurance on the decedent’s life and thus were covered by §6624(a)(2) to the extent of those assets.

The limited scope of the terms “transferee” and “beneficiary” will likely be of use to other potential indirect recipients of property who receive property under similar circumstances.

Statute of Limitations. The Beneficiaries argued that the statute of limitations for collection expired against them. However, since the Estate had extended the statute of limitations in conjunction with its §6166 election, this extension was deemed applicable to collections against estate distributees such as the trustees and the Beneficiaries as to the life insurance received.

Claims Statute Liability.

31 U.S.C. §3713(b) provides 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 Government is liable to the extent of the payment for unpaid claims of the Government.” It is this statute that should give pause to any fiduciary distributing any estate or trust assets if it has knowledge of any unpaid taxes of the estate or trust, since it can result in personal liability to the fiduciary if it retains insufficient assets to fully pay the federal liability.

In this case, the fiduciaries distributed assets to the Beneficiaries before the federal estate tax liability was fully paid. While the fiduciaries obtained a contribution agreement to obligate the Beneficiaries to pay any remaining taxes, this put the fiduciaries at personal risk for the taxes if the Beneficiaries defaulted on that obligation. While not clear from the opinion, the bankruptcy of the corporation may mean that the Beneficiaries no longer have the financial wherewithal to pay the taxes such that the fiduciaries are not going to be able to collect under the contribution agreement and thus will bear the taxes personally.

The fiduciaries argued that with the contribution agreement, the distribution to the Beneficiaries did not render the estate or Trust insolvent such that there were sufficient assets to pay the taxes at the time of the distribution. If there were sufficient assets, this could avoid claims statute liability. However, the court found that the agreement could not be used to bootstrap the estate and Trust into a solvency situation for purposes of this analysis. More particularly, the court provided:

"Were courts to excuse personal representatives from liability when they secure contribution agreements, the Government would have to bring an action in contract, prove it is a third-party beneficiary of the agreement, and then establish its right of contribution. Section 3713(b) is designed to avoid such complications. It provides a straightforward way to collect unpaid taxes from the very individuals who dispersed the estate's assets without having satisfied the tax liability. In this case, the individuals who distributed the Estate's assets accepted the risk that the Heirs may fail to pay the tax. The Personal Representative, rather than the Government, is in the best position to seek reimbursement from the individuals who accepted the assets with a deferred obligation to pay the tax."

There is a lesson here for fiduciaries undertaking a Code §6166 election to defer payment of taxes. The lesson is that with the extension, the estate or trust with the subject assets should retain those assets until after full and eventual payment of the tax liability. Distributing early, unless there are other assets in the estate or trust to fully cover the tax liability, will expose the fiduciaries to personal liability such as that imposed in the subject case. Perhaps if the fiduciaries can adequately secure the beneficiary obligations under the contribution agreement with a pledge and/or mortgage of assets that are unlikely to lose material value, the risk can be minimized.

U.S. v. Johnson, 109 AFTR 2d 2012-XXXX (05/23/12)


DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Charles (Chuck) Rubin, Gutter Chaves Josepher Rubin Forman Fleisher P.A. | Attorney Advertising

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Charles (Chuck) Rubin

Gutter Chaves Josepher Rubin Forman Fleisher P.A. on:

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