I’ve recently been lecturing on tax issues in play in probate and trust litigation. After giving this lecture a couple of times I noticed a pattern: the single tax question most probate lawyers were concerned with was how to limit a personal representative’s personal tax-exposure risk, which is inherent to all probate administrations.
Here’s the problem:
A personal representative (“PR”) is personally liable for paying the decedent’s remaining tax bills, be they income taxes, gift taxes or estate taxes. See 31 U.S.C. §3713(b) and IRS Manual 126.96.36.199 (10-16-2007). That’s right, when you say “yes” to being someone’s PR, you also say “yes” to personally guaranteeing the IRS that all of their taxes are paid up. But how can a PR make sure the decedent wasn’t cheating on his or her taxes? And how can a PR make sure he’s uncovered all those skeletons in the closet before distributing any assets of the estate to the heirs?
There are three risk-management tools every probate lawyer needs to know about and incorporate into his or her practice:
- IRS Form 56 (Notice Concerning Fiduciary Relationship)
- IRS Form 4810 (Request for Prompt Assessment UnderInternal Revenue Code Section 6501(d))
- IRS Form 5495 (Request for Discharge From Personal Liability Under Internal Revenue Code Section 2204 or 6905)
Even if you’re working with a CPA who’s supposed to be taking the lead on all the tax issues, you need to know these protective measures exist and ensure your PR gets the full benefit of them. Here’s why.
IRS Form 56 [click here]
A Form 56 needs to be filed twice: when your PR first gets appoint to let the IRS know who your PR is and where to send all tax notices; and again when your PR finishes his job and is discharged. What you’re doing here is making sure that any correspondence from the IRS having to do with the decedent’s taxes gets to your PR right away; the last thing you want is your PR to get sued for failing to pay the decedent’s back taxes because the deficiency notices went to the wrong address. Also, the instructions to Form 56 state that the filing of a Form 56 when your PR is discharged will “relieve [the PR] of any further duty or liability as a fiduciary.”
IRS Form 4810 [click here]
Not only do you want to make sure the IRS knows your PR exists and that this is the person they need to contact for all matters related to the decedent, you’ll also want to “shake the bushes” to make sure there are no unpaid back taxes involving the decedent. You do this by filing a Form 4810 (Request for Prompt Assessment for Income and Gift Taxes). A cautious PR will wait for the IRS to respond to this assessment request prior to making any distributions to the estate’s beneficiaries. You don’t want all the cash to go out the door only to be surprised by some huge tax assessment that puts your PR in the uncomfortable position of having to ask heirs to give money back to pay back taxes.
IRS Form 5495 [click here]
At the same time your PR files a Form 4810, he’ll also want to simultaneously (but separately) file a Form 5495 (Request for Discharge from Personal Liability for Decedent’s Income and Gift Taxes). This is another way to make sure your PR gets the heads up on any of the decedent’s unpaid back taxes. If Form 5495 is properly filed, the IRS has nine months in which to notify the PR of any deficiency for the decedent’s applicable income or gift tax returns. If the PR pays the additional tax, or if no notice is received from the IRS within nine months from the date of filing Form 5495, the PR is then discharged from personal liability.
For an excellent in-depth explanation of all three of these forms and how they work together to minimize a PR’s personal tax-exposure risk (as well as other helpful hints), you’ll want to read Minimizing a Personal Representative’s Personal Liability to Pay Taxes, Part I & Part II, by Florida trusts and estates attorneys William C. Carroll and John “Randy” Randolph.
But what payments can you make while you’re figuring out the tax issues?
If the PR distributes any portion of the estate to the beneficiaries before all of the federal taxes are paid, he or she could be held personally liable to the extent of the distribution. Personal liability under 31 USC § 3713(b) is the “muscle” behind the federal priority under 31 USC § 3713(a).
One way to manage a PR’s personal tax-liability risk is to not pay a cent to anyone until every conceivable tax issue is identified and taken care of. But we all know this isn’t possible. In order to properly manage an estate there are certain payments that can’t wait. Primary examples include court costs, reasonable compensation for the PR and the PR’s attorney, and expenses incurred to collect and preserve assets of the estate. Fortunately PR’s don’t have to guess which payments they can and can’t make without exposing themselves to personal liability. If a PR follows 2009->Ch0733->Section%20707#0733.707″>F. S. §733.707, which lists the distribution priorities for in-solvent estates under Florida’s Probate Code, he’ll be alright. Why? Because the payment priorities under Florida law are, for the most part, consistent with the payment priorities under 31 USC § 3713(a), as construed by the IRS (see IRS Manual 188.8.131.52 (10-16-2007)).
The only discrepancy between Florida’s and the IRS’s list of priority payments has to do with the payment of a family allowance. Under 2009->Ch0733->Section%20707#0733.707″>F. S. §733.707, a family-allowance payment is considered a “Class 5” priority, below the U.S. Government “Class 3” priority, but the IRS considers a reasonable family allowance payment to have priority over its claims for payment of taxes (see IRS Manual 184.108.40.206 (10-16-2007)). In other words, the IRS approach is more lenient than Florida’s Probate Code.