Steps an Executor Take to Avoid Personal Liability for Federal Taxes of Estate or Decedent.
Defensive steps can and should be used by the executor to avoid potential for personal liability relating to the decedent’s or estate’s federal tax liability. This article addresses those measures.
Personal liability can be imposed on the executor if: 1) the estate is insolvent; and 2) the executor pays creditors other than the IRS. I.R.C. § 6901(a); 31 U.S.C. § 3713(b). This is because if the estate is insolvent, the federal insolvency statute applies. Under this statute, the federal government’s claim for IRS taxes becomes the highest priority. If the executor pays other creditors over the higher priority claim of the IRS, the executor is liable to the extent of payments to these other creditors.
File Notice of Fiduciary Relationship (IRS Form 56)
This must be filed to notify the IRS that the fiduciary relationship has been created. Importantly, in doing so, the IRS will send any relevant notices, including legal notices serving as procedural requirements for establishing tax liability and tax collection, directly to the executor. If the notice 56 is not filed and the decedent owes taxes, the notice of deficiency will likely get sent to decedent’s last known address, which would be sufficient for collection purposes even if the executor did not receive such notice.
Moreover, Form 56 should be filed at the end of the fiduciary relationship (such as when the probate estate is closed). Doing so may allow the executor to avoid liability for actions that occur post-termination of the fiduciary relationship.
Obtain All Relevant Tax Information
While a federal estate or gift tax return may not be required, the executor must file decedent’s final year income tax return, as well as any individual returns for prior years that were not filed by decedent despite the requirement to file. Therefore, the executor should, in addition to going through decedent’s correspondence and financial records, obtain a tax transcript and/or copies of prior year returns of decedent. Here is a link to get this information.
Request Discharge from Personal Liability
Internal Revenue Code § 6905(a) provides that once all applicable returns of decedent have been filed:
“if the executor makes written application … for release of personal liability for such taxes, the Secretary may notify the executor of the amount of such taxes. The executor, upon payment of that amount of which he is notified, or 9 months after receipt of the application if no notification is made before such date, shall be discharged from personal liability for any deficiency in such tax thereafter found due…”.
This says that once decedent’s remaining returns have been filed (mostly likely income, but possible gift tax returns may need to be filed) and any tax liability paid, the executor may request discharge from personal liability. If the executor hears nothing from the IRS within 9 months then he/she will be discharged from personal liability for such tax.
Pursuant to IRC § 2204, the executor can apply for discharge of personal liability for estate taxes. Similar rules apply.
Request for Prompt Assessment of Tax Liability
If such request is made, then the applicable statute of limitations shrinks from 3 years from the date the return is filed to 18 months after written request for prompt assessment and return has been filed. I.R.C. § 6501(d). Prompt assessment can’t be made for estate tax (can be made for decedent’s income tax). Failure make the prompt assessment request so could leave the door open to potential tax liability even after the estate has closed. Estate of Walker v. C.I.R., 90 T.C. 253 (1988).
In Estate of Walker, the executor in the probate case gave notice to creditors consistent with applicable Oregon law, directing all creditors with claims against the estate to file claims within 4 months from the date of publication of April 18, 1984. The IRS did not file a claim despite that decedent under-reported income of $75,847 on his timely filed 1982 federal tax return. On December 12, 1984, pursuant to a probate court order, the executor made estate asset distributions. That same day, the probate case closed and the executor was discharged of her duties in that case.
The executor did not file a written request for prompt assessment by the IRS.
On October 4, 1985, the IRS mailed a notice of deficiency (statutory precursor to tax assessment) within the 3 years after decedent filed his 1982 tax return. The tax liability was upheld, even though the estate previously closed, because the applicable 3-year statute of limitations had not expired.
“Petitioner cites us to no case which has held that where respondent sends a notice of deficiency to an estate within the 3- year period, the notice is untimely or invalid, because prior to the date the notice is mailed, the administrator, executor or personal representative, has been discharged or the assets of the estate have been distributed.” Estate of Walker, 90 T.C. 253, 257 (1988).
In sum, personal liability can be easily avoided by taking the correct measures. The executor should gather all available info via tax transcript, not prefer other creditors over the federal government when the estate is insolvent , file a notice 56 when the fiduciary relationship ends, and when it makes sense, request prompt assessment of tax and discharge of personal liability. Consult an attorney no matter what.
Attorney, Chris Chicoine
Estate Planning and Probate
Christopher R. Chicoine, PLLC