Executrix Personally Liable for Decedent's Income Tax Debt
In McNicol, 1 the First Circuit affirmed a decision of a district court and held that an executrix was personally liable for the unpaid federal income tax debt of the decedent when she distributed property from the insolvent estate with knowledge of the tax liabilities.
Robert Reitano died in July 2002 survived by his wife, Marci McNicol, and four minor children. At the time of his death, Robert owed over $340,000 in unpaid federal income tax liabilities. Robert's estate was insolvent at the time of his death because the tax liabilities exceed the value of the assets of his estate. The assets of the estate consisted almost entirely of stock in two corporations, one was owned 100% by the estate, and the other was owned 50% by the estate (and the other 50% by Marci). Each corporation owed a fishing vessel as its sole asset.
On 7/30/2002, Marci, without consideration, transferred ownership of the stock of the first corporation to herself. Marci was appointed executrix of the estate in January 2003, and in April of that year she transferred, without consideration, ownership of the stock of the second corporation to herself. At the time of these two stock transfers, Marci was aware of Robert's unpaid federal tax liabilities. In October 2003, the IRS formally submitted a probate claim for the unpaid tax liabilities.
Nothing was paid on the claim, and the IRS served Marci with a formal notice of potential liability under the federal priority statute of 31 U.S.C. section 3713(b)31 U.S.C. section 3713(b) and shortly thereafter brought suit in federal district court. On summary judgment, the district court held that Marci was liable under the federal priority statute in an amount equal to the value of the assets transferred from the estate (which was equal to the selling price of the vessels less a lien that encumbered one of the vessels). Marci appealed the decision of the district court.
The relevant statute, 31 U.S.C. section 3713(a)(1)(B)31 U.S.C. section 3713(a)(1)(B), provides "a claim of the United States Government shall be paid first when the estate of a deceased debtor, in the custody of the executor or administrator, is not enough to pay all debts of the debtor." Pursuant to Section 3713(b), the personal representative of a debtor's estate is personally liable for failure to honor the priority claim of the federal government if the government is able to establish that the following three requirements have been met:
(1) The fiduciary distributed assets of the estate.
(2) The estate was insolvent at the time of the distribution or the distribution rendered the estate insolvent (i.e., with liabilities in excess of assets).
(3) The distribution took place after the fiduciary had actual or constructive knowledge of the liability for unpaid taxes.
The second and third requirements-insolvency and notice-do not appear in the text of section 3713(b). Nevertheless, courts have routinely read these requirements into the statutes to soften what would otherwise be a strict liability regime. 2
The court found that the record supported the district court's decision [pg. 43] that all three requirements were satisfied. The court held that the facts demonstrated that Marci effected asset transfers by distributing virtually all of the assets of Robert's estate to herself; that the estate was insolvent at the time of these transfers because its unpaid federal income tax liabilities far exceeded the value of the estate's assets; and that Marci was aware of the unpaid tax liabilities when she effected the transfers.
Marci argued that certain types of expenses associated with administering an estate should be entitled to precedence over the government's tax claims. Marci insisted that she used the transferred assets to pay administrative expenses and, therefore, she was entitled to an equitable exception. While not ruling on this issue, the court stated that a personal representative of an estate that is indebted to the U.S. for unpaid taxes may nonetheless use estate assets to defray certain types of expenses without contravening the statutory priority. The court noted that the IRS acknowledges in the Internal Revenue Manual that there are exceptions to the priority created by section 3713(a) for family allowances and administrative expenses (such as "expenses incurred for the general welfare of creditors," "expenses incurred to collect and preserve assets," court costs, and funeral expenses). 3
The court, however, rejected Marci's claim to an equitable exception because the district court record in the case established that Marci deliberately chose not to have the estate sell the two fishing vessels in order to pay the tax debts of the estate. Instead, she wanted to maintain the lucrative income that the vessels had been generating and to use that income to fund her family's lifestyle. The record of the district court established that Marci hoped that the IRS would not seek to collect the liabilities and that the statute of limitations period would expire. In addition, the court noted that Marci failed to adequately substantiate that any administrative expenses were in fact paid.
The record of the district court firmly established that Marci was attempting to avoid paying the federal tax liabilities of her husband. Marci's actions were clearly in violation of section 3713. It is important to note that the court in this case did not rule on whether administrative expenses, including attorney's fees and personal representative commissions, have priority over federal government claims. The court did not need to address that issue directly because the record of the district court established that Marci did not use the assets of the estate to pay administrative expenses. As is often the case in situations such as this, outside factors indirectly come into play. The fact that Marci was living off the income from the fishing boats certainly did not generate any sympathy from the court.
1 829 F.3d 77 118 AFTR 2d 2016-5150 (CA-1, 2016).
2 See, e.g., Renda, 709 F.3d 472 (CA-5, 2013).
3 See Internal Revenue Manual, 22.214.171.124 (8/11/2004)
Frank Baldino is an estate planning attorney who co-chairs Lerch, Early & Brewer’s Estate Planning & Probate group in Bethesda, Maryland. His focus is on protecting the assets his clients have accumulated and minimizing federal and state tax liability. These clients range from homeowners whose property has appreciated to people with significant investment, retirement, business, and real estate holdings. For more on constructive income when an insurance policy with a loan is terminated, contact Frank at (301) 657-0175 or firstname.lastname@example.org.
This article originally appeared in the December 2016 edition of Estate Planning, a monthly periodical directed to estate planning professionals that offers readers the newest and most innovative strategies for saving taxes, building wealth, and managing assets.