Someone thought enough of you to make you a beneficiary of their estate. They’ve passed away and now you’ve received your portion. The question is, will you get to keep it? One family learned that heirs can be liable to pay estate taxes, income taxes and other obligations of the estate from which the inheritance came.
Allen Paulson, the founder of Gulfstream Aerospace Corporation, died with an estate of almost $200 million, most of it held in a living trust. His wife and surviving children were beneficiaries of the estate and trust and each had acted as trustee or executor at some point.
The estate tax return was filed and the estate owed $4.4 million in taxes. Because the estate’s main asset was a business, it was allowed to pay the taxes in installments over 15 years. With that out of the way, the estate was fully distributed to the beneficiaries.
But then, the IRS came back and said the estate was worth more than claimed on the estate tax return and that an additional $6.7 million was due in estate taxes. But because the estate had been fully distributed, the estate and trust didn’t own any assets and there was no money to pay the additional levy by the IRS.
Several estate tax payments were missed, so the IRS tried to collect the money from the heirs citing section 6324(a)(2) of the tax code.
I.R.C. § 6324(a)(2) Liability of Transferees and Others
If the estate tax imposed by chapter 11 is not paid when due, then the spouse, transferee, trustee (except the trustee of an employees’ trust which meets the requirements of section 401(a)), surviving tenant, person in possession of the property by reason of the exercise, nonexercise, or release of a power of appointment, or beneficiary, who receives, or has on the date of the decedent’s death, property included in the gross estate under sections 2034 to 2042, inclusive, to the extent of the value, at the time of the decedent’s death, of such property, shall be personally liable for such tax. Any part of such property transferred by (or transferred by a transferee of) such spouse, transferee, trustee, surviving tenant, person in possession, or beneficiary, to a purchaser or holder of a security interest shall be divested of the lien provided in paragraph (1) and a like lien shall then attach to all the property of such spouse, transferee, trustee, surviving tenant, person in possession, or beneficiary, or transferee of any such person, except any part transferred to a purchaser or a holder of a security interest.
The IRS said yes, the heirs said no, and it went to court. A district court said the heirs were not responsible for the estate’s tax obligations. The case was appealed.
In United States v. Paulson, the beneficiaries argued that they were liable only if they received property from the trust before its creator passed away or if they had control of it on the date of death.
The Ninth Circuit Court of Appeals, reversed the lower court ruling saying the tax code imposes personal liability for unpaid estate taxes on successor trustees and beneficiaries of a living trust. It also said that the law places liability on anyone who received or had an interest in the estate’s property either on the date of death or anytime thereafter. The heirs were personally liable for more than $10 million dollars in estate taxes, interest and penalties on assets they inherited from the estate.
Takeaways:
Trustees and estate executors should be careful before making final distributions of assets. They should consider holding enough assets in the estate to pay any potential taxes the IRS or states may impose until the statute of limitations passes.
Beneficiaries who receive final distributions from trusts or estates should be aware they might be personally liable for additional taxes of the trust or estate.
Disclaimer
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