Could Unpaid Estate Taxes Haunt You?

Oh that dreaded word – taxes! We all know what a pain they are while you’re alive, but a court case that the U.S. Supreme Court recently declined to review has now established how much of a pain they can be after death!

The case was decided in the 9th Circuit (which encompasses California) and is called United States v. Paulson. Since the U.S. Supreme Court declined review, it will be what everyone (including the IRS) relies on, unless and until there’s a future conflict between circuits and the U.S. Supreme Court picks it up.

So, what bad news does this case establish? Well, the upshot is that if you are a successor trustee, you can be held personally liable (meaning your possessions and funds regardless of whether they were part of any inheritance or not) for unpaid estate taxes even if those taxes were due and unpaid well before you were appointed. Read on for the scary details!

The case involves a gentleman named Allen Paulson who died with an estate valued at nearly $200 million. Most of the assets were properly placed in a revocable living trust.

One of his sons was the trustee for the trust and the executor for the estate in probate and he filed an estate tax return reporting the almost $200 million dollar estate with an estate tax liability of $4,459,051. The estate paid a portion of that upfront and elected to pay the remaining balance following a 15 year payment plan.

The tax return was audited and the estate elected to litigate with the IRS. Ultimately the tax court determined that the estate owed an additional $6,669,477 in estate taxes, which the estate also elected to pay over 15 years.

Some payments were made on the interest and the first installment payment was made. However, after obtaining a one-year extension to submit the second installment payment, no further payments were made.

The family then had internal disputes and the first son was replaced by Allen Paulson’s daughter-in-law and a different son as co-trustees.

The next year the IRS terminated the payment plan due to the unpaid installments, so the outstanding balance became immediately due.

During that time, there were more disputes and due to settlement agreements and other resolutions, various assets and cash were distributed. Due to these distributions, the trust had been “completely depleted” by that point and was unable to pay the Property Tax balance owed.

In order to collect, the government filed a lawsuit against the beneficiaries, executor, and current cotrustees. Initially, the family thought they had a win because the district court found that the successor trustees were not liable because they were not in possession of estate property at the time of Allen’s death and so it was the first son’s responsibility and failure and he (along with the beneficiaries of the estate) were the ones to be held personally liable.

However, on appeal the Ninth Circuit reversed that decision finding that the Internal Revenue Code imposes personal liability on anyone who received, possessed or had an interest in the estate’s property either on the date the estate owner died or any time thereafter, which includes beneficiaries and all successor trustees.

So, what should you do? If you are the beneficiary of a trust or the trustee, make sure you work with a (good) tax professional to ensure not only that any taxes that are owed are promptly and correctly paid, but also to get a good estimate of how much in funds to retain and not distribute until after the audit window has closed.

There are special forms to have the IRS close that audit window sooner in cases where the individual has passed away so if you work with a good tax professional, they can help you get that window closed so you’re not sitting on a reserve for 7+ years and so that you have funds in case the IRS does find (in the shortened time) some unpaid tax liability.