March 13, 2017
Authored by: Kathy Sherby and Charles Lin
U.S. v. McNICOL
829 F.3d 77 (1st Cir. 2016)
(cert. denied 1/9/2017)
Trusts and Estates practitioners often focus solely on the Tax Code found in Title 26 of the United States Code and ignore other parts of the United States Code (U.S.C.). However, it is a mistake to do so as Marci McNicol learned first-hand. In this case, the Federal Priority Statute found in 31 U.S.C. § 3713 came into play to impose liability on Marci for the decedent’s unpaid Federal income tax liability.
Here, at the time of his death, the decedent owed over $300,000 in Federal income taxes. As a result of this and other liabilities, the decedent’s estate, which consisted almost entirely of interests in two closely held companies, was insolvent. Marci, the decedent’s widow, transferred decedent’s interest in one of the companies to herself even before the court had appointed her as executrix of the decedent’s estate. Once she was appointed executrix of decedent’s estate, Marci transferred the other company to herself. Both transfers were without consideration at a time when Marci knew of her husband’s unpaid tax liability.
In October of 2003, the IRS filed a formal claim against the estate for the unpaid income taxes due. By November of 2006, however, the tax bill had not been paid, and the IRS again contacted Marci seeking payment. Marci informed the IRS in 2008 that she would no longer cooperate with them in the collection effort. At that point, the IRS served Marci with a formal notice of potential liability under the Federal Priority Statute, and ultimately filed suit against Marci in her capacity as executrix of the decedent’s estate to collect the decedent’s liability and also against her individually under the Federal Priority Statute for transferring assets to herself from the decedent’s estate without first paying the decedent’s Federal income tax liability.
The Federal Priority Statute provides that (1) a claim of the U.S. government against a decedent is to be paid first when the decedent’s estate or trust is insolvent, and (2) an executor or trustee who pays “any part of a debt” of an estate or trust prior to paying the government claim is personally liable for payment of such government claim. The trial court granted the government’s motion for summary judgment against Marci individually to the extent of the value of the property transferred to her from the estate.
Using such phrases as “it is clear beyond contradiction” and “the statute means what it says and says what it means”, the Appeals Court resoundingly affirmed the trial court’s order. The Federal Priority Statute creates a priority of payment outside the scope of the priority of payment provisions found in state probate codes, and outside the scope of Federal transferee liability provisions found in Title 26. Under the Federal Priority Statute, the executor or trustee is personally liable for the government’s claim as long as the following three requirements are present, with the burden of proof as to all three on the person seeking relief from such personal liability.
1. The executor or trustee transferred assets of the estate or trust prior to paying the government claim;
2. The estate or trust was insolvent at the time of such transfer; and
3. The executor or trustee had knowledge of the government’s claim or notice of facts that would cause “a reasonably prudent person to inquire” as to the existence of such a claim.
Interestingly, the Court did not limit personal liability to those transfers that occurred once the estate was opened and Marci was officially appointed executrix. This Court extended personal liability under the Federal Priority Statute to any person having control over the decedent’s property at the time it was transferred. Thus, this would extend personal liability under the Federal Priority Statute to any person having control over a decedent’s property that would be subject to the claims of the decedent’s creditors under applicable state law. This could include property held in any nonprobate transfer form, such as in a transfer on death account.
As a consequence of the potential personal liability under the Federal Priority Statute, an executor, trustee or person having control of the decedent’s property (referred to hereafter for convenience together as “executor”) should ascertain as quickly as possible the extent of the decedent’s debts and the value of the decedent’s property in whatever form held. If it is possible that the decedent was insolvent at the time of death, the executor should review the decedent’s income tax returns to determine whether all of the decedent’s income was reported and all the deductions were validly taken. The executor should review all of decedent’s gift tax returns and make sure that all taxable transfers were adequately disclosed on a gift tax return. Consider filing a Form 4810, Request for Prompt Assessment Under IRC § 6501(d) for all of the decedent’s open year income tax returns and gift tax returns, which will shorten the statute of limitations for such taxes to an 18 month period.
The Federal Priority Statute is not invoked to produce executor liability where estate assets were in fact used to pay expenses given priority under a state’s priority of payment provisions. If a determination is made that the decedent was insolvent at the time of death, or the estate could potentially become insolvent, close attention should be paid to the state priority of payment statute. The executor of a potentially insolvent estate should not make any disbursement or distribution, other than for those items given priority under the state priority of payment statute, until all Federal tax liabilities have been ascertained and paid.