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A personal representative cannot be held liable for an estate’s debts, including debts for unpaid taxes, if the estate does not have enough assets to satisfy all claims. This is because the personal representative’s role in closing an estate is purely administrative. For estates with tax debts, however, personal representatives need to tread carefully. Special state and federal rules can put tax debts ahead of an estate’s other creditors and whatever interests are held by beneficiaries. If ignored, these special rules can leave personal representatives and beneficiaries directly on the hook for unpaid taxes.
Tax Liens
Whenever there are unpaid taxes, the government has an automatic lien in its favor on all of the taxpayer’s assets up to the amount of the tax due, plus any accrued interest and penalties. These liens are legally enforceable regardless of whether they are publicly recorded. It is therefore critical that a personal representative not only file all required estate tax filings, but also determine whether the decedent filed all returns in prior periods and paid any taxes due. This last part is key, because a personal representative has a duty to make sure he or she performs a full accounting of all liabilities of an estate prior to the distribution of any assets to beneficiaries.
The risk for personal representatives exists whether or not an estate is solvent. Personal representatives of insolvent estates need to make sure not only that all funds are applied to pay down debts, but also that the right debts are paid in the right order. This typically requires a legal analysis of what level of priority individual debts have against the estate’s assets and against each other respectively.
A federal law can create additional risk for personal representatives. Under the Federal Claims Priority Act, the federal government has a direct cause of action against a fiduciary if payments are made to third parties when there are outstanding federal tax liabilities. Unlike with many creditor claims, the Federal Claims Priority Act will apply even if tax liens have not been formally recorded by the IRS. The scope of the Federal Claims Priority Act is broad, and it can even apply to disallow legal fees and other bona fide administrative expenses paid from an estate’s assets to the extent there are unpaid tax liabilities.
Claims Against Personal Representatives or Beneficiaries
The Federal Claims Priority Act and other laws can work to create personal liability for representatives up to the value of any distributions made to other parties ahead of the government’s interests. This liability exists whether or not the personal representative personally benefited from any problematic distributions and even if the personal representative had no knowledge of the liability.
In certain circumstances, beneficiaries can also be held liable for an estate’s unpaid taxes under a legal theory known as transferee liability. Transferee liability can create an obligation for a beneficiary to repay moneys up to the value of whatever property he or she received.
Even in cases where caution has been exercised by a personal representative, the total amount of an estate’s liabilities may change due to a subsequent audit. In cases where there is some uncertainty concerning the final accounting of an estate’s liabilities, the personal representative should consider seeking an indemnification from the beneficiaries to protect himself or herself and secure payment of taxes that may be assessed at a later date.
Implications for Estate Administration
It should be stressed that becoming a personal representative does not itself make that person liable for an estate’s tax liabilities or any other debts; a personal representative does not step into the shoes of the deceased financially. Rather, the basis for any liability against the personal representative is from his or her role as a fiduciary for the estate’s assets.
For these reasons, personal representatives need to ensure they are properly advised when they agree to administer an estate and need to perform due diligence prior to making any distributions to beneficiaries. In cases where there are significant assets in play, we would recommend obtaining counsel. This is even the case if it is clear the estate has more debts than available assets. We typically advise clients to confirm all previous tax returns have been filed with the IRS and to obtain transcripts to confirm there are no compliance problems. If you need assistance in administering an estate, our attorneys are well equipped to help you navigate.
