One issue that always is in the back of my mind when working with owners of a closely held business is:  what happens if the value of a family business, art collection, or legacy real estate suddenly loses its value once the estate is settled?

In U.S. v Mary Carol S. Johnson Estate (DC UT 05/23/2012) 109 AFTR 2d 2012-804, a Federal District Court case out of Utah, a trust was funded in 1995 with $15 million worth of stock in a closely held company operating a hotel.  The IRS challenged the valuation of the stock, and in 1997 the estate agreed to a total estate tax due of $6.87 million, in ten annual installments.  The Trust made distributions of income to the beneficiaries until 2002, when the Company filed for Chapter 11 Bankruptcy and the company was liquidated; the trust and the beneficiaries received nothing for the stock in the company.  The Trust had paid $5 Million of the estate tax due, and the IRS sued the Trust, the Trust’s beneficiaries and the personal representatives of the estate personally for the shortfall.

The implications of this decision are that:

  1. Using family members as personal representatives (or fiduciaries) in estates or trusts that hold closely held assets contains unintended liabilities long after the estate appears to be “settled”;
  2. Passing the closely held business, or other hard to value assets, through a trust can provide some protection to the beneficiaries;
  3. You should be aware that just because you have agreed to a settlement with the government, it does not prevent them from suing you later; and
  4. A good succession plan for the leadership of the closely held company, art collection or other unique asset to prevent a collapse in value in the first place should be a key priority for the estate plan.

Here is a short summary:

The Federal District Court came down with mixed, but interesting, results:

  1. Beneficiaries of a trust funded from an estate are liable for unpaid estate taxes when the estate and trust assets subsequently lose value due to bankruptcy.
  2. The statute of limitations on collecting unpaid estate taxes is tolled by the opening of an action to collect estate taxes.
  3. Does a distribution agreement with the personal representatives of the estate and the trust beneficiary absolve the personal representatives of their statutory liability for the estate tax deficiency?

The Court held that in order for a person to be a transferee under Code Sec. 6234(a)(2), the person must have or receive property from the gross estate immediately upon the date of decedent’s death rather than at some later point.  Under this interpretation, personal liability for estate tax does not typically extend to trust beneficiaries because it is the trustee who receives the property on the date of a decedent’s death.  The court further concluded that the first sentence of Code Sec. 6234(a)(2) does not apply to subsequent transferees who receive property from a Distributee following a decedent’s death. Accordingly, heirs were not transferees under Code Sec. 6234(a)(2).

Under precedent of the Tenth Circuit (to which this case is appealable), as long as the period of time is open for collecting against an estate, it is open for collecting against a Code Sec. 6324(a)(2) Distributee.

The government also argued that Johnson and Smith, as personal representatives of the estate, were liable under 31 USC 3713(b), which provides that a representative of an estate that pays any part of a debt of the estate before paying a claim of the government is liable to the extent of the payment for unpaid claims of the government.

Johnson and Smith admitted that they distributed assets from the estate prior to satisfying the government’s tax claim.  They contended, however, that they were not personally liable because the estate had a sufficient asset to pay the tax at the time the distributions were made — the Distribution Agreement under which heirs agreed to pay the estate tax as it became due.  The district court found that section 3713 does not recognize such shifts in liability.  In other words, personal representatives cannot divest themselves of statutory liability through a contract with others.  It therefore would not dismiss the government’s cause of action under this provision.

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