During her lifetime, Anna Smith established the Anna Smith Family Trust, a revocable trust administered for her benefit. Initially, Anna was initially a co-trustee with two of her children, but eventually became sole trustee. A significant asset of the trust was stock of a closely held company that owned a gaming license.
Anna later died, and her estate filed an estate tax return showing $15.958 million in gross estate assets, showing $6.631 million in estate tax, and the estate paid $4 million in taxes with the return. The estate made a Section 6166 election to pay the remaining taxes in installments. The trust provided for distributions of trust assets to limited partnerships owned by the heirs, and for direct distributions to heirs, after Anna’s death.
An additional $1 million was paid in estate taxes. Eventually, the closely-held stock was distributed to the beneficiaries due to issues with state law restrictions on a gaming license being owned by a trust – at that time, $1.46 million in estate taxes remained due. In conjunction with the distribution, the beneficiaries entered into an agreement to pay all unpaid estate taxes.
After an estate tax audit and settlement, the estate taxes were increased by an additional $240,381. The following year, an IRS agent sent a letter to the executor advising her of an alternative to continued personal liability for the deferred estate tax, which would be to provide a special lien under Code §6324A. Thereafter, the estate provided the IRS with an executed Agreement to Special Lien Under Section 6324A signed by all four children of the decedent, an agreement restricting the sale of the stock while the lien on the stock was in effect, and the additional information about the stock requested by the IRS.
Thereafter, the IRS agent advised that District Counsel had informed her that closely held stock should not be accepted as collateral because the IRS cannot publicly sell it without violating securities regulations. The parties agreed to revisit the issue in two years, but the IRS never contacted the fiduciaries.
Four years later the company filed for bankruptcy. As shareholders, the heirs never received any value for their stock ownership in the bankruptcy.
A year after that the IRS sent delinquent billing notices to the fiduciaries for the deferred estate taxes. Four years later, the IRS brought suit to collect the outstanding estate taxes against the fiduciaries and beneficiaries, asserting fiduciary liability under Code §6324(a)(2), fiduciary liability under 31 U.S.C. §3713, and beneficiary liability as transferees and to enforce the obligation of the beneficiaries to pay taxes under their promise to pay all unpaid estate taxes. The District Court initially ruled in favor of the government for partial summary judgment. Upon reconsideration, the IRS lost on all of its arguments.
A review of the avenues of liability and how the U.S. lost reveals some interesting aspects to these avenues. So how did the IRS lose on all of its attempts?
Code §6324 liability of trustees. Code §6324(a)(1) imposes a ten year general lien against all assets included in the gross estate for payment of estate taxes. Code §6324(a)(2) imposes personal liability on a trustee or transferee for taxes not paid when due for “property included in the gross estate under sections 2034 to 2042.” The trustees argued that the trust property was included under Code §2033 and thus did not come within this liability provision. The IRS claimed the trust property was included under Code §2036 and/or §2038 as a transfer with a retained life estate or because of the decedent’s ability to alter, amend, revoke or terminate the revocable trust. To resolve this, the court noted it must first analyze whether the trust assets were ever "given away" such that decedent lost the beneficial ownership of them during her lifetime, or in other words, whether a "transfer" for purposes of §§2036 and 2038 did or did not occur prior to decedent's death. The court found that while legal title did transfer to the trustee, there was no change in beneficial ownership of trust assets during the decedent’s lifetime. Thus, gross estate inclusion was under §2033 and thus no fiduciary liability under Code §6324(a)(2) arose. That the decedent was also sole trustee of the trust was a helpful, but not necessarily determinative, fact.
31 U.S.C. §3713 liability of fiduciaries. The federal claims statute will impose liability for taxes on a fiduciary who distributes assets under administration while there is an outstanding tax liability if that liability goes unpaid. A discharge of liability under Code §2204 will eliminate §3713 liability. Code §2204 relieves a fiduciary from liability for estate taxes if the fiduciary makes written application and posts bond – the granting of a special lien under Code §6324A qualifies as a bond for this purpose.
The principal issue here was that the fiduciaries never formally applied to the IRS for discharge under Code §2204 – at least not in the manner most practitioners are familiar with relating to such requests for relief when the estate tax return is filed. The court found that there are no authorities or regulations requiring a specific format, form, or working to make an application for discharge. It held “the government has only identified that the application should be made to ‘the applicable internal revenue officer with whom the estate tax return is required to be filed.’ 26 C.F.R. § 20-2204-1. The purpose of the application, according to the text of the statute and regulations, is for the government to provide the fiduciary with a determination of the amount owed.” Since the parties were aware of the tax due when the special lien was filed, the court did not believe a separate written application beyond the lien paperwork was required (and even if it was, the written correspondence between the parties would meet that requirement). Thus, the fiduciaries were protected by Code §2204 in regard to federal claims statute liability even without a formal application for discharge.
Third Party Beneficiary Theory. The government was on the right track with its argument that as a third party beneficiary of the agreement by the beneficiaries to pay the estate taxes, it could enforce that agreement. The problem, however, was that it sat on its hands and allowed the six year state statute of limitations on contract claims to expire. The court did not buy into the government’s argument that the 10 year federal tax collection statute of limitation applied, and not the state statute.
United States v. Mary Carol S. Johnson et al. (U.S District Court for Utah Central Division - Case No. 2:11-cv-00087)