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Personal Representative Who Relied on Attorney Was Not Liable for Estate's Unpaid Taxes.

In 1989, C died. Because C had no close family members, his friend T agreed to act as personal representative for C's estate. T had had no prior experience in estate administration. T hired an attorney (L) to provide legal services regarding the estate's administration.

In 1989, T paid the estate's debts. Early in 1990, T received Forms W-2 and 1099, which indicated that C had income in 1989 and 1990. T forwarded these to L, who repeatedly advised T that, because of the size of the estate, no taxes were due.

In 1992 and 1993, the IRS mailed letters addressed to C, proposing income tax deficiencies for 1989 and 1990, respectively. T passed these letters on to L, who continued to advise T that the estate was not liable for any Federal taxes.

In May 1993 (prior to closing the estate), L hired a CPA (D) to review the estate's administration. D discovered that certain income tax returns had not been prepared and filed for C or his estate. D reconstructed the available information and filed the necessary returns (without payment) in September. D also informed T and L of the unpaid income tax liabilities. After this, T's only disbursements were to pay debts that had priority over those due the U.S.

In November 1993, T submitted a Form 656, Offer in Compromise, to the Service; it was not accepted. L and D then had a series of meetings with the IRS; as a result, they believed they had negotiated a final resolution. L and D informed T that the matter had been resolved with the Service. L then advised T that there was no tax liability to be paid by the estate, and that it was appropriate for T to pay out the remaining funds and close the estate. T did so.

In 1997, the IRS determined that T was liable for income taxes and additions due from C's estate, under 31 USC Section 3713(b). T challenged this assessment, and the Tax Court (opinion Ruwe, J.) holds for T.

The IRS argues that, under 31 USC Section 3713(b), T is personally liable for the estate's unpaid income tax liabilities. Title 31 USC Section 3713 provides:

Section 3713. Priority of Government claims.

(a)(1) A claim of the United States Government shall be paid first when--

(B) the estate of a deceased debtor, in the custody of the executor or administrator, is not enough to pay all debts of the debtor.

(b) A representative of a person or an estate paying any part of a debt of the person or estate before paying a claim of the Government is liable to the extent of the payment for unpaid claims of the Government.

This section appears to impose strict liability on a fiduciary who makes a disbursement that leaves the estate with insufficient funds with which to pay a debt owed to the U.S. However, it has long been held that a fiduciary is liable only if it had notice of the claim of the U.S. before making the distribution. Whether the fiduciary had notice is determined by whether the executor knew or was chargeable with knowledge of the debt (either actual knowledge of the liability or notice of such facts as would put a reasonably prudent person on inquiry). To be chargeable with knowledge of such a debt, the executor must be in possession of such facts as to "put him on inquiry."

It is clear that T had no actual knowledge of the estate's income tax liabilities at the time that he made estate disbursements and distributions. However, the Service argues that his receipt of Forms W-2 and 1099 and subsequent notices would have put a reasonably prudent person in his position on inquiry as to the existence of the debts due the U.S. for unpaid income taxes. We agree that the receipt of the tax information forms in January 1990 and 1991 was sufficient to put Ton inquiry. However, T, having been put on inquiry, acted in a prudent and reasonable manner consistent with his fiduciary duties. He forwarded the forms to L, the estate's attorney, and sought his advice. L informed T that, because of the estate's size, the estate had no income tax liabilities. L's legal advice was wrong.

T continued to receive the same advice from L after giving him other notices from the IRS that indicated there might be unpaid income taxes for which the estate might be liable. It was not until the summer of 1993 when D was brought in and prepared and filed delinquent returns that the tax liabilities in issue were discovered by L; almost all the estate's assets had already been distributed by then. As a result, T submitted an Offer in Compromise and sent a check for the balance of the estate's assets to the Service. The offer was not accepted and, several months later, the IRS returned the check to T without explanation. T immediately informed L. Thereafter, L and D met with Service representatives and (erroneously) concluded that the IRs would drop the tax claims against the estate. They informed T of this, and L advised T to make the final disbursements and to close the estate. Relying on the advice of the estate's attorney and the CPA, T closed the estate.

A fiduciary who knows of a debt due to the U.S. cannot delegate his responsibility to pay such a debt; the act of payment requires no legal expertise. If a fiduciary delegates responsibility to make payment to an attorney, he assumes the responsibility for the attorney's actions. Under such circumstances, failure to pay a debt due the U.S. gives rise to personal liability under 31 USC Section 3713(b). The question in this case is different; the question is whether T had the requisite knowledge at the time that he was disbursing funds to have knowingly disregarded debts due the U.S. It is this knowing disregard of the debts due the U.S. that gives rise to liability under 31 USC Section 3713(b).

T had no prior experience with the administration of estates when he was put on notice of potential income tax liabilities of C's estate. Had he determined on his own that there were no tax liabilities or simply ignored this notice and made no further inquiry, he would probably be chargeable with notice of the tax liabilities. However, T did not ignore the information about potential tax liabilities. T recognized that he did not have the knowledge or experience to determine whether the estate owed tax. He therefore gave the information to the estate's licensed attorney, who had been retained to advise T in the administration of the estate, and asked for advice. T's inquiry was neither haphazard nor careless; rather, it was the prudent and reasonable thing to do. Unfortunately, the attorney came up with the wrong advice when he repeatedly told T that there was no tax liability.

Regardless of L's culpability in failing to ascertain the estate's income tax liabilities, T fulfilled his duty of inquiry and was reasonable and acted in good faith in following his advice that no tax was due from the estate. T lacked knowledge of the estate's income tax liabilities at the time he made payments from the estate's assets and did not knowingly disregard debts due the U.S.; therefore, he is not liable under 31 USC Section 3713(b) for the unpaid tax liabilities in question.

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Author:Fiore, Nicholas J.
Publication:The Tax Adviser
Date:May 1, 2000
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