When dealing with a decedent’s estate, an executor of the estate may face personal liability for taxes found to be due from the estate if the executor made a distribution that rendered the estate insolvent, assuming the executor had knowledge or notice of that liability or potential liability.[1]

Treasury Reg. §20.2002-1 provides (in part):

..[I]f the executor pays a debt due by the decedent’s estate or distributes any portion of the estate before all the estate tax is paid, he is personally liable, to the extent of the payment or distribution, for so much of the estate tax as remains due and unpaid. [2]

The regulation continues to extend that potential liability to other parties, including heirs receiving the property.

In addition, section 6324(a)(2) provides that if the estate tax is not paid when due, then the spouse, transferee, trustee (except the trustee of an employee’s trust which meets the requirements of section 401(a)), 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 section 2034 through 2042, is personally liable for the tax to the extent of the value, at the time of the decedent’s death, of such property. See also the following related sections of the Internal Revenue Code: Section 2204, discharge of executor from personal liability; section 2205, reimbursement out of estate; sections 2206 and 2207, liability of life insurance beneficiaries and recipients of property over which decedent had power of appointment; sections 6321 through 6325, concerning liens for taxes; and section 6901(a)(1), concerning the liabilities of transferees and fiduciaries.[3]

In the Estate of Kwang Lee v. Commissioner [4]the application of this provision when the estate seeks an offer in compromise is considered. The key issue to be decided was whether the IRS is allowed to include the potential amounts the IRS could receive from the executor and heirs under the recovery provisions in the calculation of the reasonable collection potential.

At the time the estate sought an offer in compromise, the total assets of the estate amounted to $183,000 in a checking account. The estate offered that entire amount to settle the outstanding balance remaining on the $536,151 amount previously determined by the Tax Court[5] to be the amount due following an IRS examination of the estate tax return.

The estate argued that the provisions for recovery would not apply in this case. The Court described the test for when the executor would be personally liable as follows:

An executor is personally liable for the unpaid claims of the United States to the extent the executor makes a distribution of assets from the estate when either the estate was insolvent at the time of the distribution or the distribution rendered the estate insolvent and the executor had knowledge or notice of the Government’s claim. 31 U.S.C. sec. 3713(b); Leigh v. Commissioner, 72 T.C. 1105, 1109 (1979); sec. 20.2002-1, Estate Tax Regs.[6]

The executor (Mr. Friese, a licensed attorney and municipal court judge) made distributions of $1,045,000 from July 2003 to February 2007, which left the estate with the $138,000 in the checking account. A key issue was that $640,000 was distributed on February 28, 2007.[7]

That $640,000 distribution was the key one, since before that distribution the estate had more than enough available to pay the estate tax ultimately determined to be due, but after the distribution the estate was well short of being able to pay that amount. But did the executor have actual knowledge or notice of this claim at that time?

To answer that question, we have to look at the IRS’s examination and later Tax Court case. The Court described that as follows:

The IRS selected the estate’s return for examination and determined a $1,020,129 deficiency in estate tax, plus a $255,032 section 6651(a)(1) addition to tax for untimely filing and a $204,026 section 6662(a) accuracy-related penalty. The IRS mailed a notice of deficiency to Mr. Frese, as executor of the estate, on April 26, 2006. Mr. Frese timely filed a petition for redetermination of the deficiency with this Court. Estate of Lee v. Commissioner, T.C. docket No. 14511-06 (filed July 27, 2006). The Court entered a decision on March 24, 2010 (2010 decision), finding a $536,151 deficiency in estate tax due from the estate with no addition to tax or penalty. Id. Respondent assessed the unpaid tax against the estate on July 19, 2010.[8]

The key dates would be:

IRS issues a notice of deficiency that totaled $1,479,187 in taxes, interest and penalties on April 26, 2006 which the taxpayer disputed and took to the U.S. Tax Court;
March 24, 2010 when the U.S. Tax Court entered its decision for $536,151 in the case; and
July 19, 2010 when the IRS assessed the unpaid tax against the estate.[9]

Obviously at July 19, 2010 the executor was aware of the liability due to the U.S. government—but was the executor on notice prior to that date? More particularly, was the executor on notice before February 28, 2007 when the distribution that would eventually render the estate unable to pay the liability was made.

The IRS argued that the executor had notice when the notice of deficiency was sent on April 26, 2006, even though that amount was significantly more than was finally determined to be due. And the Tax Court decision agrees with this view:

Respondent’s notice of deficiency, issued to Mr. Frese before he made the February 2007 distribution, was sufficient to create a claim under the FPS. See Viles v. Commissioner, 233 F.2d at 379-380; Irving Trust Co. v. Commissioner, 36 B.T.A. at 148; Estate of Frost v. Commissioner, 1993 WL 75053, at *15. Furthermore, the record establishes that Mr. Frese had actual knowledge of the unpaid claim at the time of the February 2007 distribution. Respondent mailed the notice of deficiency to Mr. Frese in April 2006, and Mr. Frese was a named party in the petition filed with this Court disputing that deficiency claim in July 2006. Estate of Lee v. Commissioner, T.C. docket No. 14511-06.[10]

The executor argues that he made the distribution in February of 2007 on the advice of the estate’s tax adviser who presumably informed him that the estate would prevail before the Tax Court. Based on that or a similar assurance, he argued he decided he could proceed with the $640,000 distribution. The executor cited the case of Little v. Commissioner, 113 TC 474 (1999) where the Tax Court had “found that an executor did not have the requisite knowledge for purposes of the FPS because the executor, who did not have a college degree, was unaware of any potential or pending Government claims against the estate and reasonably relied in good faith upon multiple erroneous reassurances from counsel that the estate had no Federal tax liabilities.”[11]

But the Tax Court found that this case was clearly distinguishable from the facts in Little. First, the Court found the executor had not presented evidence to show reliance on advice from the tax adviser on making the distribution.

The estate offered no evidence to show that Mr. Frese relied upon the advice of the estate’s tax adviser as it pertained to his decision to make distributions from the estate, including the February 2007 distribution.[12]

In a footnote the Court points out that while the estate had prevailed on the “reliance on advice of a tax professional” to escape penalties in the earlier Tax Court decision, that does not mean the executor is deemed to have reasonably relied on such advice in deciding to move forward with actual distributions:

The estate points out that we found the estate not liable for an addition to tax for untimely filing in Estate of Lee v. Commissioner, T.C. Memo. 2009-84, because Mr. Frese reasonably relied upon the estate’s attorney in filing the estate’s tax return. That case neither concerned nor considered advice given by the estate’s attorney (or any other adviser) as it related to Mr. Frese’s distributions of estate assets.[13]

The Court also noted that the executor was a licensed attorney in possession of a notice of deficiency, not an unsophisticated executor without any knowledge of the estate’s potential liabilities:

…[U]nlike the unsophisticated executor in Little who had no actual or constructive knowledge of the estate’s tax liabilities at the time of the distributions, Mr. Frese, a licensed attorney and judge, made the February 2007 distribution with direct knowledge that respondent had determined an estate tax deficiency against the estate (respondent mailed him the notice of deficiency in April 2006) and that an action concerning that deficiency claim was pending before this Court.[14]

Based on the facts in this case, the Court went on to state:

Under these circumstances, Mr. Frese made the February 2007 distribution at his own peril, and any advice he may have received in this regard cannot absolve him from liability. See King v. United States, 379 U.S. 329, 339-340 (1964); New v. Commissioner, 48 T.C. at 676-677; Irving Trust Co. v. Commissioner, 36 B.T.A. at 148. Thus, Mr. Frese may be held personally liable under the FPS for the estate’s unpaid estate tax that remains due following the February 2007 distribution.[15]

Thus, the Court found that it was proper for the IRS to consider the potential collections from the executor and other parties in evaluating reasonable collection potential for offer in compromise purposes.

[1] 31 USC 3713, Treasury Reg. §20.2002-1

[2] Treasury Reg. §20-2002-1

[3] Treasury Reg. §20-2002-1

[4] Estate of Kwang Lee v. Commissioner, TC Memo 2021-92, July 20, 2021, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/reasonable-collection-potential-must-account-for-executor%2c-beneficiaries/76wsw (retrieved July 21, 2021)

[5] Estate of Lee v. Commissioner, T.C. Memo. 2009-84

[6] Estate of Kwang Lee v. Commissioner, TC Memo 2021-92

[7] Estate of Kwang Lee v. Commissioner, TC Memo 2021-92

[8] Estate of Kwang Lee v. Commissioner, TC Memo 2021-92

[9] Estate of Kwang Lee v. Commissioner, TC Memo 2021-92

[10] Estate of Kwang Lee v. Commissioner, TC Memo 2021-92

[11] Estate of Kwang Lee v. Commissioner, TC Memo 2021-92

[12] Estate of Kwang Lee v. Commissioner, TC Memo 2021-92

[13] Estate of Kwang Lee v. Commissioner, TC Memo 2021-92

[14] Estate of Kwang Lee v. Commissioner, TC Memo 2021-92

[15] Estate of Kwang Lee v. Commissioner, TC Memo 2021-92