United States v. MacIntyre, ___ F.Supp.2d ___, 2012 WL 2403491 (S.D. Tex. June 25, 2012)
A personal representative (“PR”) is personally liable for paying the decedent’s remaining tax bills, be they income taxes, gift taxes or estate taxes. That’s right, when you say “yes” to serving as someone’s PR, you also say “yes” to personally guaranteeing their back taxes are paid up. Not to worry though, as I previously wrote here, if you take advantage of the risk-management tools built into the tax code, this is a problem no one need lose sleep over. But get this wrong, and things can turn ugly real fast.
Is the IRS bound by your bad legal advice? NO
In 1995, J. Howard Marshall, II made a $35 million taxable gift to certain family members, including his ex-wife Eleanor Pierce Stevens (“Stevens”). For better or worse, Marshall Sr is probably best known for having been married to Anna Nicole Smith during the last 14 months of his life. If you’re a trusts and estates lawyer, you can thank the Marshall estate and Anna Nicole Smith for some of the most high profile probate litigation in years [click here, here]. The Marshall name is shaking up the probate world again: this time around it’s fiduciary liability for a decedent’s unpaid taxes.
Marshall Sr never paid the tax due on his $35 million gift, and neither did his estate. By operation of law liability for Marshall Sr’s tax liability shifted to the gift’s recipients or “donees,” including Stevens [click here for the back story]. Stevens died in April 2007, shifting her tax liability to her estate. E. Pierce Marshall, Jr. (“Marshall Jr”) became the sole executor of her estate and Finley L. Hilliard (“Hilliard”) was the trustee of her revocable trust. By its terms, Stevens’ revocable trust was liable for her estate’s taxes.
So what went wrong?
At some point Marshall Jr and Hilliard were told by their lawyers the IRS couldn’t collect on the estate’s unpaid gift-tax liability, so they went ahead and distributed estate assets without paying the tax. When the IRS came after them personally for the estate’s unpaid taxes, they claimed ignorance. Not because they didn’t know the gift-tax liability existed, but because they relied on their lawyer’s bad tax advice. Wrong answer. Legal opinions are great ways to shift risk to your lawyers, but that’s all you’re doing. Tax opinions aren’t shields against tax claims; the IRS isn’t bound by your bad legal advice.
The Tax Court has articulated the elements of § 3713 liability as (1) a fiduciary; (2) distributed the estate’s assets before paying a claim of the United State and (3) knew or should have known of the United States’ claim. Huddleston v. Comm’r, T.C. Memo.1994–131, 1994 WL 100520 at *6 (U.S. Tax Ct.1994); see also Leigh v. Comm’r, 72 T.C. 1105, 1110 (U.S. Tax Ct.1979). “[I]n order to render a fiduciary personally liable under 31 U.S.C. [§ 3713], he must first be chargeable with knowledge or notice of the debt due to the United States….” Leigh, 72 T.C. at 1109 (construing a virtually identical earlier version of the statute). “The knowledge requirement … may be satisfied by either actual knowledge of the liability or notice of such facts as would put a reasonably prudent person on inquiry as to the existence of the unpaid claim of the United States.” Id. at 1110.
As explained above, the knowledge requirement is not actual knowledge. Leigh, 72 T.C. at 1110. It is sufficient to show that the fiduciary had “notice of such facts as would put a reasonably prudent person on inquiry as to the existence of the unpaid claim.” Id. Neither Marshall nor Hilliard contend that they were never told that the IRS might try to make a claim against Stevens for the unpaid gift taxes on the Gift. In fact, they admit that they were both told that the IRS might try to assert a claim against Stevens’s Estate for donee liability on the Gift. Instead they argue that they did not believe the IRS’s claim against Stevens was valid for various reasons. But, as the government points out, Marshall and Hilliard’s belief in the validity of the government’s claim is not the test. Marshall and Hilliard had sufficient notice of the claim to put a reasonably prudent person on notice. It is regrettable that they received incorrect advice on that point, but poor legal advice is not a defense. Despite their belief that the government’s claim was not valid, Marshall and Hilliard were required by § 3713 to preserve the funds to pay the government’s claim-should it be proved valid. Accordingly, Marshall and Hilliard both meet the test for individual liability under § 3713 and are therefore personally liable for distributions made from Stevens’s Estate and Trust.
Is failing to pay taxes a breach of fiduciary duty? YES
This probably comes as a surprise to most PR’s, but a decedent’s unpaid creditors, including the IRS, have standing to sue you for breach of fiduciary duty if you screw up. And not paying taxes qualifies as a major screw up. So to make matters worse, if you muck up an estate’s taxes, not only are you personally on the hook for this mess, you may also get sued for breach of fiduciary duty. That’s what happened in this case.
The government argues that Marshall, as Executor of Stevens Estate, breached his fiduciary duty to pay the taxes due the IRS on the estate in the order and manner they were due. In effect, it urges that Marshall’s breach is coterminous with his personal liability under § 3713. The court agrees. Insofar as the court held above that Marshall was individually liable to the government pursuant to § 3713, he has also breached his fiduciary duty as an Executor under state law. See In re Tomlin, 266 B.R. 350, 354 (N.D.Tex.2001).
The question is, why would the IRS go through the trouble of suing you for breach of fiduciary duty if you’re already personally liable as a matter of federal tax law? Answer: to make sure you don’t dodge this bullet by declaring bankruptcy. As I previously wrote here, a breach-of-duty judgment against a PR (or trustee) is NOT dischargeable in bankruptcy. Why? Because under bankruptcy code section 523(a)(4) this kind of judgment is deemed the product of “fraud or defalcation while acting in a fiduciary capacity.”
Lesson learned? Forewarned is forearmed:
The best way to win a tax case is to not get sued by the IRS in the first place. You can’t do that with a legal opinion. You can do that by making the IRS tell you in advance if there are any unpaid taxes. How do you do that? Click here. Forewarned is forearmed.
“The truly wise man, we are told, can perceive things before they come to pass; how much more than those that are already manifest.”
Sun Tzu, The Art of War