Articles Posted in Trust Administration

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Summer allows us a little break in our Palm Springs law office, and it also allows us to take a break from our blogs. But as Fall is now upon us (and it is gorgeous outside, trust me), it’s time to get back to business. We get a a lot of questions about the probate process here in California (something our Firm gets involved in regularly), and how it may differ when the deceased was not a US citizen/ resident.

Before We Describe the Probate Process, Remember, Your Estate Will Save Time and Money if You Put Your House in a Trust While You’re Living

California probate is a both time consuming (think 8 months to over a year to complete…) and costly (the family of a deceased will have to pay attorneys approximately 3% of the value of the property being probated in California…plus extra costs as well associated with the estate tax return of the estate and even potentially other costs). On the other hand, property placed into a valid trust (under California law) does not have to go through probate, which generally saves the estate thousands of dollars and speeds up the process by which the heirs receive the property considerably. Sanger and Manes drafts trusts for Canadians owning Palm Springs area real estate (and all of California property generally).

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6. WHEN CAN AN EXECUTOR BE PERSONALLY LIABLE TO THE IRS FOR A DECEDENT’S UNPAID TAXES?

Answer: The government can hold the executor personally liable for taxes the decedent owed to the IRS where because the executor pays creditors and beneficiaries, the estate lacks the funds to full-pay the IRS. Example: A decedent has unpaid taxes of $12. The decedent’s estate has $10 in total assets. The executor distributes $3 to the estate beneficiary, and then pays the remaining $7 to the IRS. The law requires the executor to pay claims owed to the United States before paying most of the other of the decedent’s debts. For purposes of the law, “debts” includes distributions to beneficiaries. Because the executor blundered when he distributed $3 to the beneficiary before paying/applying all $10 of estate assets to the IRS on account of the $12 of unpaid taxes, the executor is PERSONAL LIABLE to the IRS. In our example, the executor is personally liable for the amount of $3 (the amount he paid to the beneficiaries instead of paying the IRS). Note that the executor is not liable for the $5 of taxes remaining unpaid after (i.e. $12 owed the IRS minus the $7 of estate assets paid to the IRS), because the estate only had $10 from the outset, so the government could not expect the executor to pay more than $10. Since the estate had $10, and paid $7 to the IRS, the executor is personally responsible to pay $3 to the IRS. You will find the law at Section 3713 of title 31 of US Code (note §3713 is not an Internal Revenue Code section). There exist two important caveats to the general rule of an executor’s personal liability, discussed in our next post.

7. IF THE ESTATE HAD SUFFICIENT ASSETS TO PAY ALL IRS TAXES, BUT BECAUSE THE ESTATE ASSETS’ VALUE PLUMMETED AND THE TAXES COULD NOT BE PAID, IS THE EXECUTOR PERSONALLY LIABLE?

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4. CAN A PERSON BE RESPONSIBLE TO PAY THE DECEDENT’S UNPAID TAXES IF THE PERSON IS NOT THE COURT APPOINTED EXECUTOR?

Answer: Yes. IRC §2203 defines “executor” as the duly appointed executor or administrator, or if none has been appointed, then any person in actual or constructive possession of any property of the decedent.

5. IS THE EXECUTOR PERSONAL LIABLE FOR THE UNPAID TAXES OF THE DECEDENT?

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1. MUST AN EXECUTOR FILE A DECEDENT’S FINAL INCOME TAX RETURNS?

Let’s say you act as an executor for a decedent who died in 2011. The decedent died before filing his 2010 personal income tax return. Must you, as executor, file the decedent’s 2010 personal income tax returns? Answer: Yes. IRC §6012(b)(1) provides that if a decedent dies before filing his personal income tax return, the responsibility to file the income tax return falls upon his “executor, administrator, or other person charged with the property of such decedent.”

2. MUST AN EXECUTOR FILE A DECEDENT’S GIFT TAX RETURNS?

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As discussed in previous entries, the IRS recently released a draft Form 8939, for decedents who died in 2010 and wish to elect no estate tax (which comes with no basis step-up in assets). We think that only estates of very wealthy 2010 decedents will likely wish to file a Form 8939. But where is the final Form 8939? How can we file it if it does not exist? On March 31, 2011, the IRS issued the following statement: “Form 8939 is not due on April 18, 2011, and should not be filed with the final Form 1040 of persons who died in 2010. New guidance that announces the form due date will be issued at a later date and Form 8939 will be released soon after guidance is issued.” While that provided some relief for practitioners left completely in the dark about how to file a nonexistent Form 8938 by the filing deadline, it still leaves us all waiting for the final Form 8939. We don’t have much more to add, except that we are all…still waiting.

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Granting an income beneficiary a general power of appointment is just one way practitioners can err in drafting a see-through trust. There are no shortage of ways to make a mistake in this highly technical area. What if we determine after the death of the decedent that we do indeed have a faulty see-through trust? Presumably, we now have no choice but to distribute all IRA amounts not later than the end of year of the 5th anniversary of the decedent’s death. But what if, now that we’ve identified the problem, we simply amend the trust. For example, what if we amend the trust to provide that daughter’s power of appointment may only be granted in favor of any individual not older than daughter (as described in Part #3). Well, not so fast says the IRS. PLR 201021038 states clearly that the reformation of a trust instrument is not effective to change the tax consequences of a completed transaction. In short, an amendment to the trust document after the death of decedent to reform a defective see-through trust is unlikely to be permitted by the IRS. The lesson here is learn and understand the complex see-through trust rules before you draft the see-through trust document. Without proper drafting, practitioners face unhappy beneficiaries with IRA amounts distributed (and taxed) within five years of the decedent’s death (instead of over the lifetime of a designated beneficiary), with likely no remedy available.

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This is the last thing any attorney who represents executors, trustees and conservators wants to hear. And yet after more than a quarter century of experience scrutinizing fiduciary accounts, our firm has concluded that virtually every high-net-worth fiduciary account filed with the court has fundamental flaws. This has resulted from the complex rules of California’s Principal and Income Act, and in particular the rules for allocating assets and expenses among subtrusts.

Here’s why.

Attorneys and CPAs Speak Different Languages. Even accounts prepared by qualified CPAs familiar with fiduciary tax issues almost never meet the standards of the Principal and Income Act. CPAs know how to apply accounting concepts, not legal rules; attorneys are trained in legal rules, not accounting concepts. So, like two people who speak different languages, the attorneys and CPAs involved in preparing fiduciary accounts predictably misunderstand each other.