Death of a Parent
In the context of a family-owned business, it is often the case that the matriarch or patriarch of the family is also the chief executive of the business. They may have founded the business, or they may have been at its helm for longer than most can remember. This individual’s strength of character, knowledge of the business, reputation in the industry, and experience, are resources that are nearly impossible to replace anywhere near as quickly as the family and the business would like. In other words, their passing may turn out to be the most disruptive event in the history of the business.
Unfortunately, the business is only one victim of the elder’s demise. The absence of their steadying presence and the loss of their moderating influence over various members of the family will often mark the beginning of fierce competition among these individuals for leadership in the business; it may also spur infighting within the family, generally, for control over the family’s wealth.
In the midst of this drama, and sometimes overlooked in the bloodshed, lurks the ravenous federal estate tax. As the members of one affluent family recently learned, the IRS does not discriminate among the beneficiaries of the elder’s estate in seeking to collect the tax that is owed.[i]
The Estate Tax
Decedent died survived by his third wife (Wife-3), three sons from a prior marriage, and several grandchildren (the “Heirs”). At the time of Decedent’s death, nearly all his assets, which included real estate, stocks, bonds, cash, and receivables, were held in a so-called “living trust” (the “Trust”).[ii] The Trust was revocable during Decedent’s lifetime and, according to its terms, was to pay any estate taxes imposed upon Decedent’s taxable estate regardless of where the assets comprising the gross estate (for tax purposes) resided.
The trustees of the Trust filed a federal estate tax return with the IRS, on Form 706, which reported a gross estate of almost $188 million, a taxable estate of approximately $9 million, and an estate tax liability of about $4.5 million.
Decedent’s estate paid over $700,000 with the return and elected to defer the balance of the estate tax of approximately $3.75 million – attributable to the Decedent’s closely held business interests – to be paid in installments over a 14-year period.[iii]
The IRS audited the estate tax return and asserted a deficiency in the estate tax reported on the return, which the estate challenged in Tax Court. The Tax Court entered a stipulated decision and determined that the estate owed an additional $6.67 million in estate taxes. The IRS assessed the additional liability and the estate elected to pay this amount through the remainder of the installment period.
The estate made the first estate tax and interest payments but failed to make any subsequent installment payments.
Can’t We Just Get Along?
Meanwhile, various disputes arose between Wife-3 and the other Heirs. In settlement thereof, Wife-3 received assets from the Trust that the government asserted were worth approximately $19 million. The other Heirs asserted those assets were worth over $42 million. The Trust also distributed at least $7.26 million in cash to the other Heirs.
Shortly thereafter, the probate court removed the then-trustee of the Trust for misconduct and appointed other Heirs as co-trustees. The government asserted that, at that time, the Trust contained assets worth more than $13.7 million, which exceeded the estate tax liability. The newly appointed trustees, however, claimed that the Trust was insolvent, with $10.8 million in assets, but $28.3 million in liabilities, including the federal estate tax liability.
Following the missed installment payments, the IRS terminated the above-described installment election. The Trust challenged the IRS’s termination of the election in Tax Court, but the Court sustained the IRS’s decision.
At that point, according to the government, the Trust held assets worth at least $8.8 million. The IRS recorded notices of federal tax liens against the estate.[iv]
In the meantime, various other disputes arose among the Heirs, which they settled through an agreement by which one of the Heirs (a former trustee) received certain assets from the Trust. The trustees asserted that, by the time of this agreement, the Trust was “completely depleted.”
The government filed an action in federal district court against the Heirs in their individual and representative capacities. The complaint sought a judgment against Decedent’s estate and the Trust for the outstanding balance of Decedent’s estate tax liability, which then exceeded $10 million, as well as judgments against the individual defendants.[v]
The Heirs filed motions to dismiss and argued that they were not personally liable for the estate taxes as trustees, beneficiaries, or transferees of the Trust.
The district court concluded that Wife-3 was not liable for the unpaid estate taxes as a beneficiary of the Trust . The district court further concluded that the other Heirs were not liable for the unpaid estate taxes as transferees or trustees because they were not in possession of estate property at the time of Decedent’s death. The IRS appealed this decision to the Court of Appeals for the Ninth Circuit, which reversed the lower court.
Before reviewing the Circuit’s opinion, let’s briefly consider how the estate tax is collected.
Collecting the Estate Tax – A Quickie[vi]
The Code imposes a tax on a decedent’s taxable estate, which the executor is required to pay.[vii]
The “executor” of an estate means the executor or administrator of the estate. If none is appointed, qualified, and acting, then any person in actual or constructive possession of any property of the decedent is considered an executor for this purpose.[viii] This may include, among others, the decedent’s agents, custodians of the decedent’s property, and even debtors of the decedent.[ix]
To protect the government’s ability to collect the estate tax, the Code imposes a lien on the decedent’s gross estate for the unpaid estate tax.[x] This lien attaches at the date of the decedent’s death to every part of the gross estate, whether or not the property comes into the possession of the executor. The lien attaches to the extent of the tax shown to be due on the estate tax return and of any deficiency in tax found to be due upon audit.[xi] Such a lien attaches for a period of ten years from the date of the decedent’s death.[xii]
The Code also imposes personal liability for the estate tax on those who receive or have estate property if the estate tax is not paid when due.[xiii] Specifically, it provides:
If the estate tax imposed [under the Code] is not paid when due, then the spouse, transferee, trustee . . . , surviving tenant, person in possession of the property by reason of the exercise, nonexercise, or release of a power of appointment, or beneficiary, who receives, or has on the date of the decedent’s death, property included in the gross estate under sections 2034 to 2042, inclusive, to the extent of the value, at the time of decedent’s death, of such property, shall be personally liable for such tax.[xiv]
It is important to note that this personal liability is not limited to the estate tax that is attributable to the property in the transferee’s possession; rather, it extends to the entire estate tax, capped at the date of death fair market value of the property received by the transferee.
Query, however, what this means in the case of a transferee described in the above provision who receives property from a decedent that has decreased in value since the date of death.
The Ninth Circuit
As framed by the Court, the question before it was whether the phrase “on the date of the decedent’s death,” set forth in the above-quoted provision, modifies only the immediately preceding verb “has,” or if it also modifies the more remote verb, “receives.”[xv]
The IRS argued that the limiting phrase “on the date of decedent’s death” modifies only the immediately preceding verb “has,” and not the more remote verb “receives.” Therefore, in its view, the Code imposes personal liability on those persons listed in the statute who (1) receive estate property at any time on or after the date of the decedent’s death, or (2) have estate property on the date of the decedent’s death.
Thus, the IRS contended, the Code imposed personal liability for the Decedent’s unpaid estate taxes on the successor trustees and beneficiaries of the Trust, including those who had or received estate property after the Decedent’s death.
The Heirs, in contrast, argued that the limiting phrase “on the date of the decedent’s death” modifies both the immediately preceding verb “has,” and the more remote verb “receives.”
Under the Heirs’ interpretation, the Code imposed personal liability for the Decedent’s unpaid estate taxes only on those who received or had property included in the gross estate on the date of the Decedent’s death. Those who received property from the estate at any point after the date of the Decedent’s death had no personal liability for the unpaid estate taxes.
The Court concluded that “the most natural reading” of the statutory text,[xvi] and other indicia of its meaning,[xvii] supported the IRS’s interpretation. Therefore, the Court held that the Code imposes personal liability for unpaid estate taxes on the categories of persons listed in the Code who have or receive estate property, either on the date of the decedent’s death or at any time thereafter, subject to the applicable statute of limitations.
The Court observed that the statutory text at issue states that a person (who fits within one of the categories of persons listed in the statute) “who receives, or has on the date of the decedent’s death, property included in the gross estate … shall be personally liable” for the unpaid estate tax.[xviii]
The Court then launched into a lengthy discussion on statutory construction – including a “canon of statutory construction known as ‘the rule of the last antecedent’” and “the canon against absurdity” – the placement of commas, the separation of clauses, and the placement of conjunctions in the statutory text, the likes of which I have before seen.[xix]
Having set forth the basis for its interpretation of the statute, the Court explained that the Code attaches personal liability for unpaid estate taxes to assets that are receivable from the decedent’s estate by any of the identified persons. Thus, the Court continued, the statute anticipates that at the time of the decedent’s death, the categories of persons listed in the statute may receive the “expectation of the right to receive” certain estate property. In other words, they may have a “receivable interest” on the date of the decedent’s death but not actually receive property on that date.
Next, the Court dismissed the Heirs’ remaining contentions,[xx] adding that, while it was “not our job to find reasons for what Congress has plainly done, . . . Congress rationally could have concluded that such risk is acceptable or is effectively mitigated by other provisions of the tax code, and thus is outweighed by the benefit of ensuring the collection of estate taxes. This is not an irrational tax policy.” Moreover, even if the Court “were to conclude that such a policy is ‘odd,’ or ‘not wise,’ or simply unfair, we cannot rewrite the statute to advance a different policy. . . If Congress determines that its tax policy leads to unintended or unfair results, it is for Congress, not the courts, to rewrite the tax code.”
With that, the Court concluded that the Code imposes personal liability for unpaid estate taxes on the categories of persons listed in the statute who (1) receive estate property on or after the date of the decedent’s death, or (2) have estate property on the date of the decedent’s death. Therefore, the Code imposes personal liability for unpaid estate taxes on trustees, transferees, beneficiaries, and others listed in the statute, who receive or have estate property on or after the date of the decedent’s death.
The Court then determined that the Heirs were within the categories of persons listed in the statute when they received or had estate property and, so, were liable for the unpaid estate taxes as trustees and beneficiaries.
The Court’s (and the IRS’s) reading of the Code provision described above may result in allowing the government to impose personal liability for unpaid estate taxes on the beneficiaries of an estate or trust in excess of the value of the assets received; for example, if estate’s properties had high values at the time of the decedent’s death but decreased by the time they were received by the estate’s beneficiaries years later. In such a case, a beneficiary would nevertheless be personally liable for the unpaid estate taxes based on the value of the property on the date of death, even if the property were worth much less when received by the beneficiary.
Did Congress intend such an outcome?
Or was the taxpayers’ reading of the Code more logical because it would allow the IRS to impose personal liability for estate taxes only on a person who receives (or holds) estate property on the date of the decedent’s death?
The weight-challenged female[xxi] hasn’t sung yet.
Sign up to receive my blog at www.TaxSlaw.com.
The opinions expressed herein are solely those of the author(s) and do not necessarily represent the views of the Firm.
[i] U.S. v. James D. Paulson, 68 F.4th 528 U.S. Court of Appeals, Ninth Circuit.
[ii] The only asset that was not held by the living trust was an ownership interest in a hotel and casino corporation, which was not relevant to this case.
[iii] Under IRC Sec. 6166, an executor may pay a portion of the estate taxes in installments when more than 35% of the estate’s value consists of interest in a closely held business. IRC Sec. 6166(a)(1), (3). This election is limited to the portion of the estate tax attributable to the interest in the closely held business. Sec. 6166(a)(2). Section 6166 allows the executor to make only interest payments for five years and then pay the taxes (plus interest) over ten years. IRC Sec. 6166(a)(3), (f).
[iv] Under IRC Sec. 6321, 6322, and 6323.
[v] Under IRC Sec. 6324(a)(2) and 31 U.S.C. Sec. 3713.
According to Sec. 3713, the executor of an estate who pays any part of a debt of the estate before paying a tax liability owing by the estate to the government is liable to the extent of the payment for the unpaid taxes. For purposes of this rule, a distribution to a beneficiary of the estate is treated as the payment of a debt.
[vi] Remember the 1979 vampire spoof, “Love At First Bite,” in which Dracula (played by George Hamilton) says to Cindy Sondheim, “With you, never a quickie”?
[vii] IRC Sec. 2001 and Sec. 2002.
[viii] IRC Sec. 2203.
[ix] Reg. Sec. 20.2203-1.
[x] IRC Sec. 6324(a)(1).
[xi] Reg. Sec. 301.6324-1(a).
[xii] The estate tax lien expires after ten years. What if the executor of a qualifying estate elects to pay estate tax payments in installments over a period of fourteen years? The government’s interest in the last installments is not fully secured by the ten-year tax lien under IRC Sec. 6324(a)(1). Not to worry – the Code provides the government with various options to protect its interests beyond the ten-year period, including the option to require a surety bond pursuant to IRC Sec. 6165 and Sec. 6166(k)(1), and the option to require a special lien pursuant to IRC Sec. 6324A.
[xiii] IRC Sec. 6324(a)(2). This provision affords the IRS a separate remedy against the beneficiaries of an estate when the estate divests itself of the assets necessary to satisfy its tax obligations.
[xiv] IRC Sec. 2034 through 2042 refer to persons who, in effect, receive or hold property of a transfer that was made “in contemplation of,” or taking effect at, the decedent transferor’s demise.
[xv] As in, “receives on the date of death.”
[xvi] “Statutory construction must begin with the language employed by Congress and the assumption that the ordinary meaning of that language accurately expresses the legislative purpose.”
[xvii] Too lengthy to include here. Count your blessings.
[xviii] IRC Sec. 6324(a)(2).
[xix] I must admit that I struggled through this discussion.
[xx] Including one based on the definition of the term “beneficiary”!
[xxi] I’m guessing I can still say that, right? Should I have said “was assigned” instead? Oh well. I’m a simpleton in such matters.