The Tax Court held that the executor of an estate was not liable for a portion of the estate's unpaid estate taxes, which the IRS claimed he owed as a fiduciary of the estate because he had made distributions of the estate's assets at a time when the estate was insolvent and the estate taxes were unpaid.
Background
Scott Singer was the executor of the estate of Melvin Sacks, who had, with his brother, been a partner in a successful New York law firm. When he died, Sacks was survived not only by his brother, an estranged wife, children, and grandchildren, but also by two girlfriends. In Sacks's will, many of these people were given either cash or property.
At the time of his death in August 1990, Sacks owed the IRS over $4 million in income taxes for various years in the 1980s and 1990. In November 1991, Singer filed an estate tax return showing a gross estate of almost $4 million, a taxable estate of approximately $3.2 million, and an estate tax liability of approximately $1 million. The IRS audited the return, and the estate and the IRS later settled on a liability amount of approximately $1.85 million.
In December 1990, Singer obtained a restraining order from the Surrogate's Court of the State of New York (the probate court handling Sacks's estate) over assets of more than $2 million in Sacks's brokerage account because it appeared that Sacks's testamentary estate would be insufficient to pay creditors' claims, including those of the IRS. Because the estate was insolvent, he also sought to disaffirm the transfer to one of the girlfriends of a residence that Sacks and the girlfriend had purchased months before his death as joint tenants and paid for entirely with Sacks's money. He further sought, as allowed by New York law, contributions to help pay the estate tax from several beneficiaries who received bequests under Sacks's will and his daughter and son-in-law, who had received a gift from Sacks before his death that was includible in his federal and state gross estate for estate tax purposes.
In 1994, Singer submitted, and the IRS accepted, an offer in compromise (OIC) of $1 million for all of Sacks's unpaid income tax liabilities. The surrogate's court allowed this amount to be withdrawn from Sacks's brokerage accounts to make the OIC payment. In 1999, the IRS filed an amended proof of claim with the surrogate's court, which included only the estate's outstanding estate tax liability and did not mention any income tax liability. Nonetheless, the IRS would later claim that the estate had not made the OIC payment.
Through an order of the surrogate's court on April 15, 1999, Singer obtained the release of $753,321 from the brokerage accounts to enable Sacks's estate to pay $251,107 to the estate of Alvia Sacks, his wife; $446,772 to the IRS; and $171,587 to the New York Department of Taxation. The IRS subsequently issued a notice of fiduciary liability to Singer on July 16, 2013, for $422,694, the amount of the payments to Alvia Sacks's estate and the New York Department of Taxation.
Fiduciary Liability and the Federal Priority Statute
Under 31 U.S.C. Section 3713, generally referred to as the federal priority statute, when a decedent's estate is not sufficient to pay all the decedent's debts, the estate must pay a U.S. government claim first. A representative of a person or estate who pays any part of a debt of the person or estate before paying a U.S. government claim is liable to the extent of the payment for unpaid claims of the government.
In addition, under Secs. 6901(b) and 7701(a)(6), the executor of an estate is personally liable for the unpaid claims of the United States to the extent of a distribution from the estate when (1) the executor distributed assets of the estate; (2) the estate was insolvent at the time of the distribution or the distribution rendered the estate insolvent; and (3) the executor had notice of the United States' claim.
The IRS's Argument in Tax Court
The IRS argued that Singer was liable as a fiduciary because the estate was insolvent at the time of the distributions to Alvia Sacks's estate and the New York Department of Taxation. The IRS asserted that the estate was insolvent because on the date of Sacks's death in 1990, the estate liability for his estate exceeded the probate assets of the estate and that the combined total of the estate tax liability and Sacks's income tax liability (which the IRS claimed had not been paid in 1994) exceeded the value of his combined probate and nonprobate assets. The IRS did not take the estate's contribution rights under New York law into account in calculating the nonprobate assets.
The Tax Court's Decision
The Tax Court held that Singer was not liable as a fiduciary for the estate's unpaid estate taxes. The court found that the IRS had the burden of proof on this issue and had failed to prove that the estate was insolvent at the time Singer caused the estate to make the distributions to Alvia Sacks's estate and the New York Department of Taxation.
The court noted at the outset that two of the elements for establishing fiduciary liability—the executor distributed assets of the estate and the executor had notice of the government's claim—had clearly been met, leaving at issue only the element of whether the estate was insolvent. Both Singer and the IRS claimed that the other had the burden of proof for this element. The court sided with Singer and concluded that the IRS had the burden of proof. The IRS had cited McCourt, 15 T.C. 734 (1950), and two Tax Court memorandum opinions in support of its position that Singer had the burden of proof, but the court found that the IRS had misinterpreted the McCourt opinion and that the two memorandum opinions were not decided on the burden of proof. It further found that under its own precedent and Supreme Court precedent (citing Oklahoma, 261 U.S. 253 (1923)), the government bears the burden of proof on insolvency.
The court then looked to see if the IRS had proved that the Sacks estate was insolvent. After analyzing the applicable New York law, the court determined that the law granted the estate contribution rights and, based on precedent from the Second Circuit (In re Ollag Constr. Equip. Corp., 578 F.2d 904 (2d Cir. 1978)), to which Singer's appeal of his case would lie, the court found that contribution rights must be valued as assets in determining insolvency. With regard to the measurement date for insolvency, the court concluded, relying on decisions from circuit courts (e.g., Schwartz, 560 F.2d 311 (8th Cir. 1977); Lutz, 295 F.2d 736 (5th Cir. 1961)), that the relevant point for calculating an estate's solvency is the date of the distributions in question—in this case, April 15, 1999.
With the questions of law settled, the Tax Court reviewed whether in fact the IRS had proved that the values it argued should be used for the estate's probate and nonprobate assets in the solvency calculation were correct. It found three reasons why the IRS had failed to prove that they were. First, the court determined that the assets' values were unreliable because they were measured as of the date of Melvin Sacks's death in 1990, and the IRS provided no evidence or calculations that showed these values were still correct as of the date of distributions from the estate, despite the eight years that had passed between the events.
Second, the Tax Court determined that the IRS had not properly taken into account all nonprobate assets because it did not include the value of the estate's contribution rights in calculating the value of the estate's assets. The IRS argued that it was justified in leaving the contribution rights out because there was no evidence that anyone had made contribution payments to the estate. However, the court found that there was reliable evidence that one of the claimed contribution amounts had been paid over to the IRS, although it was unclear what had occurred with respect to the other claimed contribution. Thus, the court concluded that the contribution rights had some value and should have been included as assets of the estate.
On this point, the IRS also contended, citing Coppola, 85 F.35 1015 (2d Cir. 1996), that Singer could not escape liability by entering into agreements with third parties to pay the estate tax liability, and that the contribution rights were such agreements. The Tax Court disagreed, stating that Coppola did not address whether the agreement affected the estate's solvency and did not deal with the value of contribution rights from third parties. Additionally, the court noted that Singer did not argue that the contribution rights should absolve him of liability but instead rightly argued that they should be counted as assets of the estate when calculating the estate's solvency.
Third, the court determined that the IRS had wrongfully included the full amount of Sacks's unpaid income taxes at his death in its insolvency calculations. The IRS argued that there was no documentary evidence in the record that the taxes had ever been paid or otherwise settled. The court, on the other hand, found there was evidence in the record to support that at the time of the distribution, the estate had already settled Sacks's unpaid income taxes for $1 million. Consequently, the court concluded that the taxes should not have been included in the insolvency calculations.
Because the IRS had not proved that the estate was insolvent at the time of the distributions in question, the Tax Court found that one of the three elements necessary under Sec. 6901 for fiduciary liability did not exist. Therefore the court held that Singer was not liable for any of the estate's unpaid taxes.
Reflections
Many, if not most, people who serve as executors of estates will not be aware going into the process of their potential liability under Sec. 6901 for federal estate taxes that go unpaid. Practitioners who assist clients with preparing estate tax returns should make sure that they know the very real danger they face if distributions are made from the estate before all the federal estate taxes are paid.
Singer, T.C. Memo. 2016-48
