I had lunch with a friend recently. He is executor for an estate and was telling me about some … questionable third-party behavior and document discoveries. I left the conversation underwhelmed with his attorney and recommending a replacement as soon as possible. There are two other beneficiaries to this estate, and he has a fiduciary responsibility as executor.
Granted, all are family and get along. The risk - it seems to me - is minimal.
It is not always that way. I have a client whose family was ripped apart by an inheritance. I shake my head, as there was not enough money there (methinks) to spat over, much less exact lifelong grudges. However, he was executor and so-and-so received such-and-such back when Carter first started making liver pills and he should have offset someone for … oh, who knows.
Being executor can be a thankless job.
It can also get one into trouble.
Let’s take a look at the Lee estate.
Kwang Lee died testate in September, 2001.
COMMENT: Testate means someone died with a will.
A municipal court judge was named executor.
The judge filed the estate return in May, 2003.
COMMENT: The return was late, but there was some complexity as both spouses died within six months. There was language in the will about a-spouse-is-considered-to-survive-if that created some confusion.
COMMENT: It doesn’t matter. You know the IRS is coming in with penalties.
The IRS audited the return.
In April 2006 the IRS issued a Notice of Deficiency for over $1,000,000.
COMMENT: The IRS also wanted a penalty over $255 grand for late filing.
The executor filed with the Tax Court.
In February, 2007 the executor distributed $640,000 to the beneficiaries.
COMMENT: Pause on what happened here. The IRS wanted additional tax and penalties. The executor was contesting this in Tax Court. The issue was live when the executor distributed the money.
Is there a risk?
What if the estate lost its case and did not have enough money left to pay the tax and penalties?
The Tax Court gave the executor a partial win: the estate owed closer to a half million dollars than a million. The Court also waived the penalties.
The estate did not have a half million dollars. It did have $182,941.
The estate submitted an offer in compromise to the IRS for $182,941.
The IRS looked at the offer and said: are you kidding me? What about that $640,000 you distributed before its time?
The IRS pointed out this bad boy:
31 U.S. Code § 3713.Priority of Government claims
(1) A claim of the United States Government shall be paid first when—
(b) A representative of a person or an estate (except a trustee acting under title 11) paying any part of a debt of the person or estate before paying a claim of the Government is liable to the extent of the payment for unpaid claims of the Government.
The effect of Section 3713 is to make the executor personally liable for a debt to the U.S. when:
o The estate was rendered insolvent by a distribution, and
o The executor had knowledge or notice of the government’s claim at the time of the distribution.
The judge/executor did the only thing he could do: he challenged the charge that he had actual knowledge of a deficiency when he distributed the $640,000.
The executor was hosed. I am not sure what more of a wake-up-call the executor needed than an IRS Notice of Deficiency. For goodness’ sake, he filed a petition with the Tax Court in response.
Maybe he thought that he would win in Tax Court.
He did, by the way, but partially. The tax was cut in half, and the penalties were waived.
Notice that the estate would not have had enough money had it lost the case in full. The tax would have been over a million, with additional penalties of a quarter million. Under the best of circumstances, the estate would have had cash of approximately $822 thousand and unable to pay in full.
In that case I doubt Section 3713 would have applied. The estate would have conserved its cash upon receiving a Notice of Deficiency.
But the estate did not conserve its cash upon receiving a Notice of Deficiency.
The executor became personally liable.
Mind you, this may work out. Perhaps the beneficiaries return the cash; perhaps there is a claim under a performance bond.
Still, why would an executor – especially a skilled attorney and municipal judge – go there?
Our case this time was Estate of Lee v Commissioner, T.C. Memo 2021-92.