Recently in Trust Administration Category

June 22, 2011
Posted by Howard Sanger

Fiduciary Liablity For Unpaid Taxes -- Part III

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?
Answer: No. Example: A decedent has unpaid taxes of $12. When the decedent died, the assets were worth, $20. The economy suffered a depression and the estate assets dropped in value to $7. The executor pays the $7 to the IRS, leaving $5 of unpaid taxes. The executor is not personally liable to the IRS for the $5 because the law (§3713) only imposes personal liability where the executor paid other creditors or made beneficiary distributions which left the estate with insufficient funds to pay the entire $12 of taxes.

June 1, 2011
Posted by Howard Sanger

Fiduciary Liability For Unpaid Taxes -- Part II

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?

Answer: Except is explained in Part III to-be-published next week, the answer is "no". The executor is not personally responsible for the decedent's unpaid taxes. The executor's duty to pay the decedent's taxes is in his representative capacity, using the decedent's estate assets, and not the executor's personal assets. Thus, if the decedent's unpaid taxes total $12, and the estate assets total $10, and the executor pays the $10 to the IRS, the executor in his personal capacity is not liable for the $2 of unpaid taxes; the executor's personal assets are not liable for the $2 of the decedent's unpaid taxes. However, a foolish or ill-advised executor could find himself personally liable and his personal assets taken by the IRS by a non-IRC provision: §3713 of 31 U.S. Code. See also Cal. Rev & Tax Code §19516.

May 23, 2011
Posted by Howard Sanger

Fiduciary Liability For Unpaid Taxes -- Part I

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?
Let's say you act as an executor for a decedent who died in 2011. The decedent died before filing his 2010 gift tax return for gifts made in 2010. Must you, as executor, file the decedent's gift tax returns? Answer: Yes. Treasury Regulation §25.6019-1(g) places the responsibility for filing the decedent's gift tax return on the executor or administrator.

3. MUST AN EXECUTOR PAY THE DECEDENT'S PRE-DEATH TAXES?
Must the executor also arrange for the payment of the decedent's pre-death income and gift taxes? Answer: Yes. California Probate Code § 11420(a) sets out the priority of payments an executor must make. California Probate Code § 11420(a) provides that debts of the United States or California have preference and the executor must pay such debts first. In the case of the gift tax, Treasury Regulation §25.2502-2 makes the executor responsible to arrange for payment of the gift tax.

May 6, 2011
Posted by Michael Brooks

Update on Form 8939

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.

March 7, 2011
Posted by Michael Brooks

The Hidden Minimum Required Distribution Rules Dangers in Drafting a See-Through Trust (Part 4)

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.

January 28, 2011
Posted by Chris Manes

"Your Account Is Wrong"

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.

This blog focuses on bridging that gap when it comes to fiduciary accountings.