John R. Bullis: Paying unpaid federal taxes
The surviving spouse who also was Executrix of her husband’s estate had to pay his income tax liabilities. Mr. Robert Reitano died in July of 2002.
Ms. McNicol, the surviving spouse, distributed the assets of his estate to herself for no consideration. She knew of his unpaid income taxes of prior years of about $340,000, but transferred the assets to herself and did not pay IRS for his debts first.
The assets were mainly 100 percent of a corporation that owned a fishing vessel and 50 percent of a corporation that owned another fishing vessel (she owned the other 50 percent of the second corporation).
The District Court record indicates the selling price of both vessels, less a lien (debt) on one of them was about $125,938. She testified she wanted the lucrative income that the vessels had been generating.
The federal priority statue requires the government be paid first if the estate does not have enough assets to pay all of its debts. The government has to be paid first if the Executrix (person in charge of the estate) distributed assets; the estate had more debts than assets (was insolvent) at the time of the distributions; and the Executrix knew of the liability for unpaid taxes.
In 2003 IRS finished the assessment of taxes, penalties and interest owed by Mr. Reitano. The total owed to the government was $342,539. IRS contacted the Executrix (surviving spouse), Ms. McNicol about the debt but nothing was paid to IRS. So IRS sued her under the federal priority statute.
The District Court decision that she had to pay the government was appealed. But the Court of Appeals upheld the decision and she had to pay the estimated net selling price of the vessels, $125,938. It appears the rest of what he owed was written off as a bad debt.
This is just another example of the complexities of administering an estate or trust. Since she failed to document and substantiate any administrative expenses, the ‘equitable exception’ to the federal priority statute did not apply. The fiduciary (Executor, Trustee etc.) has the potential of personal liability for unpaid taxes. That goes back to the times of George Washington!
The lesson is if the decedent owed federal taxes at death, the estate is supposed to pay those taxes or at least as much of the assets, first. Distributions to the beneficiaries come after that. If the estate (or trust) has to pay all of its assets to clear the debt to the government, the beneficiaries will get nothing.
Did you hear? “Ignorance is never better than knowledge,” by Enrico Fermi.
John Bullis is a certified public accountant, personal financial specialist and certified senior adviser who has served Carson City for 45 years. He is founder emeritus of Bullis and Company CPAs.