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Transferee Liability, Et Al
by Robert L. Moshman
here were quite a few estate-planning cases and developments that were of sufficient relevance to warrant more attention than they received over the past year. It was simply their misfortune to arrive at a most unpropitious time…all of 2001.
During the first half of the year, the attention of the estate-planning community was bent on what aspects of the estate tax repeal would be included in a tax bill. Following the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 in late May and the signing of the Act by the President in June of 2001, there was an immediate period of analysis. And after September 11, there have been other issues for everyone.
When Heirs Pay Transfer Tax
Transferee liability for transfer taxes is reported on a regular basis. As a general rule of thumb, transferees of an estate are not ordinarily liable for Federal or State estate taxes.
An estate tax is imposed on the decedent's right to transfer property and is generally paid by the executor. Routine language in virtually every will directs that "all transfer, estate, and other death taxes which become payable by reason of my death be paid out of my estate."
By comparison, an inheritance tax, such as those now imposed in several states and which more states may consider adopting, is not imposed on the property being transferred itself, but rather on the right to acquire the property.
Yet there are times when the debts and tax liabilities of a transferor can apply to a transferee. For example, a fraudulent transfer to avoid paying tax, or a specific asset that was serving as collateral or which is itself acquired by means of a loan which remains outstanding, might cause a debt to remain on the transferred property and reach a transferee, much as if the transferee were receiving property that was subject to a lien.
In, Baptiste, Jr., v. Comm'r., (CA-8), the U.S. Court of Appeals for the Eighth Circuit, No. 93-2960, 29 F3d 433, (1994), a decedent's son was personally liable for estate taxes that were not paid by his father's estate. The son's liability was limited to the value of the property that the son received from the estate and did not include interest accrued after the due date of the decedent's estate tax return. The Court relied upon a Third Circuit opinion, Poinier, 88-2.
Several cases from 2001 highlighted the types of issues that arise in transferee situations. In, Armstrong v. U.S., DC Va., 2001-1 (Jan., 2001), Decedent made several gifts of stock to his children and grandchildren just before his death. The children agreed to pay for any unforeseen gift tax that might arise if the value of the stock were found to be higher than what was reported on gift tax returns. As anticipated, the IRS valued the stock higher and assessed a gift tax deficiency. Decedent's estate then sought a refund. Although Decedent's children assumed the potential gift tax liability, the Court ruled that the amount of liability thus assumed was speculative at the time of the transfer and could not be used in adjusting the value of the gift. The fact that the children did not actually pay the additional tax was an indication that no liability was, in fact, assumed. The same reasoning applied to the potential transferee liability of the children as donees under §6324(a)(2) based on the inclusion of gift tax paid within three years of death in
the gross estate under §2035(b). A gift has to be valued at the time of the transfer.
In, U.S. v. Subklew, DC Fla., 2001-2 (June, 2001), a jurisdictional flaw enabled the transferees to avoid paying estate tax. Having failed to collect Federal estate tax of $965,257 from a decedent, the IRS pursued a judgment against a Florida-based transferee of the estate who had received the proceeds of two life insurance policies and a portion of a Cayman Islands bank account.
Although the transferee had once lived and worked in the forum state (Florida) over a 13-year period and had recently been a party to a separate judicial proceeding in the state, there had been no contact with the state for the last five years. The district court held that the transferee's contacts with the state were insufficient to establish general personal jurisdiction under Florida's long-arm statute.
In, In re Ulrich, DC La. (Bankruptcy) 2001-2, unpaid estate tax liability could not be assessed against heirs of the estate because the debt was not collected within 10 years after the assessment of the tax. Decedent's estate was administered by her surviving spouse, Husband, who filed a fraudulent Federal estate tax return (that failed to report assets) in 1981.
By 1988, Husband had remarried and filed for bankruptcy. In 1989, the IRS assessed Decedent's estate for the deficiency that resulted from the Husband's fraud. In 1994, the IRS assessed Husband based on his fiduciary liability under 31 U.S.C. §3713(b). The IRS also filed a claim in the bankruptcy proceeding.
The trustee of the bankruptcy estate denied the IRS claim arguing that the debt was the responsibility of Decedent's heirs. The Bankruptcy Court then held that the debt could no longer be imposed on either the estate or Decedent's heirs because it had not been collected within 10 years after the assessment of the tax against the estate as required by §6502(a). Only the claim against the bankruptcy estate remained pending since the assessment on that entity took place within the 10-year statutory period. But that claim was against Husband personally and the heirs had no obligation to indemnify Husband.
A Tangent: The interrelationship of tax liability and bankruptcy is capable of warping the normal linear progression of time. For example, in the recent case of Lassiter v. IRS, T.C. Memo 2002-25 (Jan., 2002), a decedent's net operating losses (NOLs) were not determined until after his death when bankruptcy proceedings were concluded.
When Things Go Wrong
The following collection of cases has a recurring theme-rules not followed, documents not executed or filed, and arguments not being applicable. Each provides an important lesson about what not to do.
Late Filing Not Excused
The cases in which a reasonable cause for the late filing of an estate tax return has been successfully demonstrated are few and far between. An executor's inexperience is not a valid excuse. Thus, where a surviving spouse serving as the executor of her husband's estate failed to file an estate tax return on time, the imposition of penalties was almost a foregone conclusion.
Although a surviving spouse filed an inventory of assets with the Court, the inventory included four items for which no value was selected. The Court considered these omissions "willful neglect."
Although there was uncertainty about how much the decedent's interest in a trust fund was worth, the Tax Court noted that neither the unavailability of information nor the existence of pending litigation constituted reasonable cause for the late filing. Based on ordinary business care and prudence, the executrix should have filed a return based on the best information then available. It was also known to the executrix that the value of the gross estate exceeded the filing threshold of $500,000 which was applicable at that time.
The one potentially useful argument that might have helped would have required a reasonable reliance on the professional advice of an attorney or accountant. This could not be established in the instant case since neither an attorney nor an accountant had advised the executrix about delaying the filing. Estate of Thomas, TC Memo, 2001-225 (Aug., 2001).
Annual Exclusions Denied For Reciprocal Trusts
Three brothers and their wives owned stock in a family business. Each of the siblings had three children. To transfer the family business to the next generation, each brother and spouse made nine annual gifts, i.e., to their own children as well as the six nephews and nieces. A total of 27 gift transfers were made. The IRS, the Tax Court, and, ultimately, the Court of Appeals for the 8th Circuit, all concurred that the gifts to the various nieces and nephews were constructive gifts that each couple was making to their own children.
The reciprocal trust doctrine was applicable because the gifts were interrelated-all were made on the same day and in the same amount. In addition, the respective donors were in the same economic position as if they had made all the gifts of stock directly to their own children. Annual gift exclusions were therefore only permitted for those gifts given directly by couples to their own children. Sather v. Comm'r., 2001 U.S. App. Lexis 11844, U.S. Court of Appeals, 8th Cir., (June, 2001).
Perpetuation of Testimony Not Warranted
Between 1951 and 1963, Leo and Marie Shaw funded trusts for each of their three children. At the present time, there are two surviving children who are 78 and 71 years of age, respectively, and their trusts are valued at $4.2 million and $5.8 million, respectively. It is their contention that they were only nominal settlers of these trusts and held only life estates. Fearing that the trusts would be included in their respective estates after their deaths, and being the only living people with direct knowledge as to the circumstances of the trusts' creation, funding, and administration, the surviving children filed an application with the Tax Court to perpetuate their testimony.
Under Rule 82 of the Tax Court Rules of Practice and Procedure (which is derived from Rule 27 of the Federal Rules of Civil Procedure), prospective litigants may "perpetuate testimony or to preserve any document or thing regarding any matter that may be cognizable" before the Tax Court. The Court must be satisfied that the perpetuation of the testimony "may prevent a failure or delay of justice."
In rejecting the application, the Tax Court concluded that Rule 82 was not intended to be invoked under abstract circumstances. Unlike, GlaxoSmithKline Holdings v. Comm'r., 117 T.C. 1 (2001), which involved an ongoing examination of a taxpayer that would reasonably be expected to take 4 or 5 more years before the case proceeded to trial, the application at bar involved the possible estate taxation of persons who are still alive and for whom no date of death can be anticipated with any certainty. It is not known what representatives of the two estates would then conclude about the estate tax liability or whether they would file estate tax returns. It is not known whether the IRS would examine or make adjustments to those conclusions. It is not known whether representatives of the estate would agree with those potential adjustments. It was all too speculative to perpetuate testimony. Shaw v. Comm'r., TC Memo.2001-287(Oct., 2001).
Unwritten Disclaimer Not Valid
He meant to do it. He talked about doing it with his son and his attorney. But Husband didn't disclaim assets from his predeceased wife's estate in writing. Executing a written document identifying the property to be disclaimed and indicating an intent to disclaim was an essential prerequisite for an effective disclaimer. The equitable doctrine of substantial compliance was of no avail because that would defeat the underlying policies of §2518, i.e., avoiding the uncertainty of trying to interpret intentions that are not set forth in writing. Thus, an unsigned handwritten property list was not useful. Nor could a probate inventory filed in the wife's estate substitute for a written disclaimer. Chamberlain v. Comm'r., U.S. Court of Appeals, 9th Cir.,2001 U.S. App. Lexis 10911 (May, 2001).
Exchange Was Not Bona Fide Transaction
Donor's revocable trust transferred property on which a restaurant and retail office plaza were located to Donor's son in exchange for a self-canceling installment note. Three monthly payments on the note were made, but once the Donor died, no more payments on the note were required. The Court concluded that this was not a valid arm's-length transaction, so the transfer was a gift to the extent that it exceeded the actual consideration paid, i.e., the three payments. Costanza v. Comm'r., TC Memo. 2001-128 (June, 2001).
Tax & Retroactive Legislation
It is said that you can't take it with you. Yet in 2001 we bore witness to a serious attempt by Congress to repeal the estate tax after 2009. In very short order, every expert worth quoting found creative ways to dismiss the repeal as never going into effect. And it is possible that the repeal will go through only to be automatically reinstated in 2011 under a sunset provision of last year's tax package. But there is another possibility as well. Congress has the ability to travel through time and change laws retroactively.
If memory serves, there was a great deal of resistance in having the 55% tax rate drop to 50% and experts predicted that Congress would step in and postpone it before the rates dropped. Only that's not what eventually happened. In 1993, Congress watched the top rates fall, on schedule, to 50% and then, as if in slow motion, finally got around to reinstating the 55% top rate retroactively-OBRA was signed on August 10, 1993. This retroactive change has been upheld previously and was again upheld just recently in NationsBank of Texas, N.A., v. United States, U.S. Court of Appeals for the Federal Circuit, No. 00-5113 (Oct., 2001).
In NationsBank, the plaintiff died in March, 1993, with an estate valued at more than $28 million when the top rate was 50%. The retroactive reinstatement of the 55% estate tax rate caused an extra $1.32 million on the plaintiff's estate. A phalanx of constitutional arguments were mobilized-separation of powers doctrine, apportionment clause, ex post facto clause, takings clause, due process clause, and equal protection clause. All failed, once again.
But the Supreme Court has said repeatedly that retroactive legislation is not preferred and as Senior Circuit Judge Plager said in his dissent in NationsBank, "Retroactive legislation is inherently offensive to the natural law of decency, to the principles of the social compact set out in the Declaration of Independence, and to the underlying tenets of the Constitution."
Could history be repeated? Suppose the repeal does take effect in 2010 and the sunset provision causes the reinstatement of the tax with a 55% top rate and a $1-million exemption on January 1, 2011.
Sometime around August of 2011, will Congress try to duplicate its retroactive maneuver of August, 1993? Will it put the repeal back into effect, or retroactively reinstate the top rate to 45% with an exemption of $3.5 million from 2009? When Congress is able to time-travel with retroactive magic, anything becomes possible.
__________
Correction: Certain editions of the January issue of this newsletter contained conflicting references to the annual gift tax exclusion. Both references should have reflected the cost-of-living adjustment that took effect in 2002. The exclusion is now $11,000
© K.S. 2002
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