While the IRS may pursue collection of an estate tax deficiency from the beneficiaries, the Fiduciary will only retain a right of subrogation if the IRS elects to pursue collection of the tax deficiency against them. Under IRC §6324, the IRS may seek collection of the federal tax deficiency from the Fiduciary in possession of the assets on which the tax applied, not to exceed the value of the assets transferred to any beneficiary. However, if the Fiduciary had no knowledge of the debt, they will not be liable for more than the amount distributed to the beneficiaries or other creditors, or for taxes discovered subsequent to any distributions (Rev. Rul. 66-43, 1966-1 C.B. 291). Regardless of the circumstances, a Fiduciary’s failure to file a federal tax return will subject them to personal liability for the unpaid tax.
The burden of proof will then rest with the Fiduciary to prove their lack of knowledge of the unpaid tax (U.S. v. Bartlett, 2002-1 USTC ¶60,429. (C.D. Ill. 2002)). Once this element is established the burden will shift back to the IRS (Villes v. Comr., 233 F.2d 376 (6th Cir. 1956); Estate of Frost v. Commissioner, T.C. Memo. 1993-94). If the liability pertains to income or gift taxes relating to years before the decedent's death, a court may require the Fiduciary to have actual or constructive knowledge of the liability before holding them personally liable for the unpaid tax (U.S. v. Coppola, 85 F.3d 1015 (2d Cir. 1996)).
Statutes of Limitation:
Under IRC §6901 and §6501 the statutory period for assessing personal liability against a Fiduciary tracks the same as the underlying tax. The limitation period is: (i) three years from the date of a tax returns filing or the date the tax return is due (if filed early); (ii) six years if there is a substantial omission (25% or more) of gross income, gift or estate assets; or (iii) no limit if the IRS can prove fraud. Under IRC §6502(a), once the IRS makes a tax assessment it has ten (10) years to collect the tax.
METHODS FOR REDUCING FIDUCIARY LIABILITY
A Fiduciary may only make a partial distribution to beneficiaries or creditors without concern of personal liability for estate tax deficiencies if sufficient assets are retained to pay all tax liabilities (including potential interest and penalties).
Income and Gift Taxes:
The first step requires the Fiduciary to file IRS Form 4506, Request for Copy or Transcript of Tax Form, with the IRS. The response received from the IRS will educate the Fiduciary as to which tax returns (income, gift, etc.), if any, were filed by the decedent prior to his or her death. The request should include the Fiduciary’s letters of administration, if applicable, and a Power of Attorney (IRS Form 2848).
To expedite the process, IRC § 6501(d) authorizes a Fiduciary to file IRS Form 4810, Request for Prompt Assessment, to request a prompt assessment and review of all tax returns filed by the decedent with the IRS. The Form 4810 must detail the following: (i) type of tax; (ii) tax periods covered; (iii) name, social security or EIN on each return; (iv) date the returns were filed; and (v) letters of administration or comparable authority to act on behalf of the estate or trust. Filing Form 4810 will shorten the statute of limitations period for the tax return from three years from the date of filing or due date of the return to eighteen (18) months from the date of its filing with the IRS. It is important to note that the shortened statute of limitations period will not apply to: (i) fraudulent tax returns; (ii) unfiled tax returns (IRC §6501(c)); (iii) any tax return with “substantial omissions” (IRC §6501(e)); or (iv) any tax assessment described in IRC §6501(c).
Once the decedent’s federal income tax return(s) has been filed with the IRS the Fiduciary may file a written application requesting release from personal liability for income and gift taxes. The IRS will then be limited to nine (9) months (the “notification period”) to notify the Fiduciary of any tax due. Under IRC §6905, upon expiration of the notification period, the Fiduciary will be discharged from personal liability for any tax deficiency thereafter found to be due and owing. The application should be filed with the IRS officer with whom the estate tax return was filed (or, if no estate tax return was required, to the IRS office where the decedent’s final income tax return was filed).
A Fiduciary administering an insolvent estate or trust may also consider filing, pursuant to 28 U.S.C. §2410(a), a federal district court quiet title action against the U.S. Government. The District Court will only have jurisdiction to address procedural challenges and not the underlying IRS tax liability (Walker v. U.S. (N.J. 2-29-2008) and Robinson v. United States, 920 F.2d 1157 (3d Cir. 1990)). In Estate of Johnson v. U.S., 836 F.2d. 940 (5th Cir. 1988), a Texas fiduciary argued that he had a right to a quiet title action to determine if administration and funeral expenses had priority over federal tax liens. However, the Fiduciary should be cognizant that any quiet title court order may not protect them from an IRS assertion of personal liability under §3713(b).
DISCHARGE FROM PERSONAL LIABILITY
IRC §2204 authorizes a Fiduciary to submit a written request for discharge from personal liability from the federal estate tax. The IRS has nine months from the filing of the request, when filed after the estate tax return, to notify the Fiduciary of any estate tax due. Upon payment of the tax (the IRS will issue form 7990) and expiration of the nine-month period the Fiduciary will be discharged from personal liability for any estate tax deficiency. It is important to recognize that IRC §2204 only discharges the Fiduciary from personal liability and will not shorten the time for assessment of tax against the estate or any transferee of estate assets.
IRC §6903 provides that a judicial discharge is insufficient to relieve a Fiduciary of subsequent estate tax liabilities. Only the filing of IRS Form 56, Notice Concerning Fiduciary Relationship, informing the IRS of judicial discharge or other legal termination will terminate the Fiduciary duties. As a protective measure, most Fiduciary’s require beneficiaries to enter into separate agreements guaranteeing indemnification for any subsequent tax deficiencies in exchange for the distribution of the estate or trust's assets to them.
Income and Gift Taxes:
IRC §6905 provides the method for a Fiduciary to be discharged from personal liability for income and gift taxes of a decedent. The Fiduciary will be required to make written application (filed after the tax return with respect to such tax is made) on IRS Form 5495 for release from personal liability. Upon payment of the tax or expiration of a nine-month period (if no notification is made by the Secretary during this period) after delivery of the application for release the Fiduciary will be: (i) discharged from personal liability for any deficiency in such tax thereafter found to be due; and (ii) entitled to a written acknowledgment (IRS Form 7990A for gift taxes) of such discharge.
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