In a recent federal district court case, the beneficiaries of a decedent's revocable trust and individual retirement account were held to be personally liable for more than $3 million in unpaid estate taxes, even though no assessment or collection action against the beneficiaries had been commenced until more than ten years after the decedent's death. According to the recent US District Court decision in US v. Mangiardi (Southern District of Florida, July 19, 2013), a beneficiary's exposure for transferee liability for federal estate taxes can last for more than a decade after the decedent's death. In fact, the Court concluded that the limitations period for collecting the tax from a beneficiary is no different from that for collecting it from the estate, regardless of whether a separate assessment against the beneficiary is timely made.
In Mangiardi, the defendant's mother died on April 5, 2000, leaving an estate that primarily consisted of marketable securities in a revocable trust and an IRA. The defendant was a co-personal representative of the decedent's estate and a co-trustee of the revocable trust. She also was a beneficiary under the revocable trust and the IRA.
The estate tax return was filed on July 5, 2001, fifteen months after the decedent's date of death. The Internal Revenue Service selected the return for examination and, on Dec. 22, 2003, assessed an estate tax of $2,478,658. (This was actually less than the estate tax liability reported on the estate-tax return.)
The estate requested, and the IRS granted, six extensions for payment of the estate tax. The estate based its request on the ground that the estate tax would have to be paid with proceeds from the sale of marketable securities, but due to depressed market and economic conditions, the marketable securities could not be sold without incurring a substantial loss. The estate represented that the marketable securities would be held until they returned to value, and then they would be sold to pay the estate tax. In truth, however, the marketable securities weren’t simply held as planned. Rather, the co-trustees, including the defendant, actively traded the portfolio, while they paid themselves hundreds of thousands of dollars in fees.
By July 13, 2006, the estate had paid only $250,000 in estate taxes. The IRS served a levy notice for the balance (plus interest), but the estate requested an administrative hearing. The IRS Office of Appeals sustained the levy. The United States Tax Court affirmed the Office of Appeals' decision, and, on or about Oct. 12, 2011, the Court of Appeals for the Eleventh Circuit affirmed the Tax Court's decision.
By that time, the estate was insolvent and couldn’t pay the remaining estate tax liability, which had ballooned to more than $3 million. The IRS brought an action in Federal District Court to collect the outstanding balance from the beneficiaries of the decedent's revocable trust and IRA, including the defendant. The defendant moved to dismiss, arguing that the limitations period for assessing the tax against the beneficiaries had long since expired; therefore, the IRS couldn’t collect the tax from the beneficiaries. The Court disagreed.
The defendant's primary argument for dismissal was that the IRS had not timely assessed transferee liability under IRC Section 6901, which allows the IRS to assess transferee liability within four years after the federal estate tax return is filed. The Court acknowledged that the statute of limitations for transferee liability under Section 6901 is the normal three-year statute laid out in IRC Section 6501 for assessments against the estate, plus one additional year. However, the Court held that Section 6901 is not the exclusive source of transferee liability for estate taxes. According to the Court, the IRS also may seek payment of estate taxes from transferees under IRC Section 6503, even if they are time-barred under Section6901, as long as they aren’t time-barred from proceeding against the estate.
Here is how the Court explained it:
Under IRC Section 6501(a), the IRS must assess estate taxes within three years after the return is filed. Then, under IRC Section 6303(1), the IRS must serve notice and demand payment within 60 days after assessment. Under IRC Section 6502(a)(1), if the IRS has made notice and demand but the tax has not been paid, the IRS can collect by levy or commence a proceeding in court for collection within 10 years after the tax is assessed. In addition, under IRC Section 6324(a)(1), a tax lien in favor of the US automatically attaches to a decedent's gross estate at death and lasts for 10 years.
A corollary to that last point is that, under Section 6324(a)(2), if estate assets are distributed, the transferee takes the assets subject to the lien and the transferee assumes personal liability to the extent of the value of such property at the time of the decedent's death. According to the Court, the transferee liability arises under these circumstances, even if the IRS has not assessed transferee liability under IRC Section 6901.
More Than a Decade
The Court then explained how transferee liability can continue for more than ten years:
Under IRC Section 6161(a)(2), the IRS can extend the time for payment of estate taxes for a period of up to ten years, but under IRC Section 6503(d), any such extension tolls the statute of limitations for collections of the tax.
In Mangiardi, the IRS granted the estate six extensions to pay, which had the corresponding effect of pushing the collection period out to July 20, 2015; 13 years and 11 months after the tax was assessed. The defendant argued that the extensions were granted to the estate, not the transferees; therefore, they shouldn’t extend the period of transferee liability. The Court, however, held that transferee liability derives out of donor liability; therefore, if a collection action would be timely against the estate, it would be timely against the transferees. In other words, the limitations period to collect the estate tax from the transferees is no different from the limitations period to collect the same from the estate.
The Court's explanation seems to make sense based on the legal authority it cites, but it nevertheless would surprise most beneficiaries to learn that they could be held personally liable for estate taxes many years after the decedent's death, even though the tax was not assessed against them immediately after the estate failed to pay it. To be safe, beneficiaries should be advised to assume that transferee liability is always a risk, until the estate tax has been paid in full.