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ROBERT E. MCKENZIE, ESQ.

ARNSTEIN & LEHR LLP


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Robert E. McKenzie, Esq.

: Heirs and fiduciaries can be held personally liable for unpaid taxes of an estate. The potential
liability arises when the estate fails to pay its estate taxes or it fails to pay taxes which were owed by the
decedent. The unwary fiduciary may end up indemnifying an estate obligation to the government. She must
take steps to assure that all taxes are paid by the estate each time she participates in administration.

Transferee liability for taxes of an estate can arise in several ways. Under state law where a creditor transfers
property in fraud of creditors, the Service has all the rights of a private credit or to collect a claim for taxes.
The rights of the Service and a creditor are defined in such bodies of laws as:

(1) The law of Fraudulent Conveyances;

(2) Rights of creditors in Life Insurance Benefits.

Under the Internal Revenue laws, IRC §6324 makes transferees and donees liable for estate and Gift taxes of
a decedent or donor. Transferee liabilities are also imposed by other federal laws. For example, a fiduciary
may be held personally liable if he pays the debts of an estate before taxes under 31 U.S.C. §192. The IRS
may seek tax of a transferor from a transferee by:

(1) Instituting a civil action against the transferee under state law, for example, to set aside a conveyance as
fraudulent under the laws of the state; or

(2) Proceeding to collect the tax of the transferor from the transferee in the same manner as that of a
delinquent taxpayer pursuant to the provisions of IRC §6901, for example, by sending the transferee a Notice
of Deficiency asserting her liability under the applicable state laws. Typically, the IRS uses the transferee
liability provisions of IRC §6901, but the use of the procedure itself will depend on state law.
IRC §6901 provides a method of collecting the unpaid tax liability "at law or in equity" of a transferee of
property. As a general rule, the liability of the transferee "at law and in equity" is a question of state, not
federal law, Commissioner v. Stern, 357 U.S. 39 (1958), Kathy P. Enters., Inc. v. U.S., 84-2 USTC
¶9620(D.C. Az. 1984), aff'd on other issues, 779 F.2d 1143 (9th Cir. 1986). State law normally governs
whether there is a transferee liability and the extent of liability, but this general principle is subject to certain
qualifications. First, state law may not answer all questions relating to a transferee's liability, and second,
where a question is not definitively answered by state law, federal law is consulted. Third, certain transferee
liability issues are not controlled by state law because the supremacy of the federal government prevents the
application of state law. For example, IRC §6901(c) establishes a Statute of Limitations for the assertion of
transferee liability. The Statute of Limitation applies to a claim by the Service, instead of the shorter state
Statute of Limitations required of other creditors to proceed under the state's law. Finally, the government
need not proceed under state law to assert statutory transferee liability in all situations.

Example, if the Service wished to collect an estate and gift tax liability, it can proceed under Section 6324,
which creates its own transferee liability, rather than state law. Similarly, where a fraudulent conveyance by a
bankrupt taxpayer is at issue, the Bankruptcy Code would be applicable.

: THE ELEMENTS OF TRANSFEREE LIABILITY

In most jurisdictions before a transaction may be tagged as fraudulent, prejudice to the rights of creditors must
result therefrom. Two types of fraud in conveyancing are recognized:

(1) FRAUD IN FACT - Where actual fraudulent intent to hinder or delay creditors exists;

(2) FRAUD IN LAW OR IN EQUITY - Where the terms of any agreement or the nature of the transaction
itself evidence a conclusive presumption in law that the conveyance is fraudulent.

If there is insufficient consideration for the Debtor's transfer of property (which exists in any transfer to a
beneficiary from an estate) even though there is no proof of intent to defraud, it is presumed "fraud in law or
in equity," which is fraud that is presumed from the circumstances. Even if there is apparent sufficient
consideration for the transfer, "fraud in fact" may be established if there is a specific intent to defraud
creditors.

Generally the elements of fraud in law or in equity which constitute a fraudulent conveyance are:

(a) A gift or sale for less than fair market value;

(b) A then-existing or contemplated indebtedness against the transferor (i.e. accrual of a liability, not an
assessment); and

(c) A retention of insufficient property by the transferor to pay his indebtedness (insolvency).

There is no need for the Service to establish an evil motive to assert fraud in law. The Service is not required
to prove intent but merely the three elements. The transferee may, in fact, have been an innocent recipient via
a bequest in a will, but if the three elements exist, the IRS will prevail. An example would be a father who
transfers most of his assets to a trust for his children and is later audited and assessed with a large deficiency
for taxes which had accrued prior to transfer. In such an instance, the IRS could attack the trust because the
transfer meets the three tests, even though the father has no intent to defraud the IRS. Obviously, this could
occur in many estate situations where the decedent had used aggressive estate planning techniques to avoid
estate taxes.
In a case where a husband and wife, after tax assessments had been made against them, gratuitously
conveyed certain real estate to a trust company as trustee and named the wife the beneficial owner, after
which the wife transferred her beneficial interest to their son, the transfer was found void and was set aside
against the United States, U.S. v. Mitchel, 271 F. Supp. 858 (N.D. Ill. 1967).

When relying upon fraud in fact, the IRS must prove an actual intent to defraud in order to set aside a
conveyance. Courts will look for "badges of fraud" in making their determination with respect to fraud in fact.
Although the badges of fraud may amount to little more than suspicious circumstances, they may be used by a
court to infer a fraudulent conveyance. A transfer may be fraudulent if it is made with actual intent to defraud
creditors (Actual Fraud), even if the transferor is solvent. The conveyance is fraudulent where it is made with
actual intent, distinguished from intent presumed in law, to hinder, delay or defraud either present or future
creditors. This actual intent to defraud is established with the same evidence that constitutes badges of fraud.

Although states vary in badges of fraud which are recognized the following is a list which have been used by
various courts to infer fraudulent conveyance:

(1) An inadequate or fictitious consideration or a false recital as to consideration;

(2) The fact that property is transferred by a debtor in anticipation of or during a pending suit;

(3) Transactions which are not in the usual course or method of doing business;

(4) The giving of an absolute conveyance which is intended only as security;

(5) The failure to record the conveyance or an unusual delay in recording the payment;

(6) Secrecy and haste are ordinarily regarded as badges of fraud but are not in themselves conclusive of
fraud;

(7) Insolvency or substantial indebtedness of the grantor;

(8) The transfer of all the Debtor's property, especially when she is insolvent or greatly financially
embarrassed;

(9) An excessive effort to clothe a transition with the appearance of fairness;

(10) The failure of parties charged with fraudulent conveyance to produce available evidence or to testify
with sufficient preciseness as to the pertinent details, at least in cases where the circumstances under which
the fraud, transfer took place are suspicious;

(11) The unexplained retention of possession of property transferred by Grantor after conveyance;

(12) The buyer's employment of the seller to manage the business as before, selling the goods which were the
subject of the transfer;

(13) The failure to examine or to take an inventory of the goods bought or the presence of looseness or
incorrectness in determining the value of property;

(14) The reservations of a trust for the benefit of the grantor and the property conveyed;

(15) The existence of a blood or other close relationship between the parties to the transfer.

In addition to the particular badges of fraud set out above, various other circumstances, singly or collectively
may constitute badges of fraud, such as the concealment of an alteration in the attestation clause of the
conveyance; the transferee's failure to keep a record of the dates and amounts of the loans, or advances made
by him to the transferor; failure to demand repayment; misdescription or insufficient description of the
property transferred; sending the money received from the transferee out of the country; assignment of the
property to the seller rather than to the purchaser; and the fact that the purchaser, soon after transfer, offered
to resell the property at a much higher price.

: PROCESS OF LAW

A transferee includes, by judicial interpretation, "one who takes property of another without full, fair and
adequate consideration to the prejudice of creditors." By way of illustration, Section 6901 states the term
transferee includes:

(1) Donees;

(2) Heirs;

(3) Legatees;

(4) Devisees; and

(5) Distributees.

The regulations expand the classes of transferees by adding:

(6) Distributees of a decedent's estate;

(7) Shareholders of a dissolved corporation;

(8) Assignees or donees of an insolvent person;

(9) Successors of a Corporation;

(10) A party to a reorganization as defined

in Section 368 in the Internal Revenue Code; and

(11) All other classes of distributees.

The most important class of transferees are successors of or distributees from corporations and those having
dealings with an estate as fiduciary or beneficiary.

: FIDUCIARIES AND BENEFICIARIES

The liability of a fiduciary for any tax owed to the United States is based upon Sections 3713(a) and 3713(b)
of the Revised Statutes. Fiduciary liability is entirely distinct from transferee liability, although §6901
provides summary assessment and collection procedure against both the transferee and the fiduciary. In
general, the liability of a fiduciary arises from the fiduciary's payment on behalf of an estate of debts that do
not have priority over the debts to the United States. On the other hand, transferee liability is asserted where
the transferee takes property of the transferor, without full, fair and adequate consideration to the prejudice
of the United States as a creditor. Both an estate and the executor or the administrator of the estate in his
representative capacity can be liable as transferees of the assets of the deceased under §6901, Estate of Harry
Miller, 42 TC 593 (1964); Estate of Robert Harrison, 16 TC 727 (1951); Estate of Irving Smith, 16 TC 807
(1951); Estate of L.A. McKnight, 8 TC 871 (1947); Ewart v. Commissioner, 84 TC 912 (1985), aff'd 814 F.2d
321 (6th Cir. 1987); (co-executor who received the property from the estate was held liable as transferee
under Ohio law because transfer rendered the estate insolvent). The estate and its executors are relieved only
where notice of transferee liability has not been received before the assets have been distributed and the
executor or administrator dismissed under local law. The executor may apply for release from personal
liability by written application and payment of the amount of tax determined under this provision of IRC
§6905(a).

Transferees who receive property includable in the gross estate of decedent are personally liable for unpaid
estate taxes and donees of property are personally liable for gift taxes pursuant to the provisions of IRC
§6324. One method of enforcing this personal liability is by advising the transferee of the assessment
procedures of §6901, although these procedures are not exclusive. Where the tax involved is decedent's
unpaid income taxes, a transferee liability may be asserted against beneficiaries of an estate if the estate is
insolvent or has been completely distributed. (If an executor fails to pay taxes and allows distributions to be
made to the beneficiaries which result in an assertion of a transferee liability against the beneficiaries by the
IRS, that executor can be assured that the beneficiaries will probably seek to sue the executor for violating his
fiduciary duties.) The basis of liability is that a beneficiary is a transferee of a transferee, that is, the decedent
has transferred property to the estate, which in turn, has transferred property to the beneficiary. Under these
circumstances, if either the decedent or the estate was insolvent and the property was distributed to the
beneficiaries, the transfer would be a fraudulent conveyance and the executor or administrator would be
personally liable under Section 3713(b) for paying a legacy or devise before a debt to the United States.

A cotenant in jointly owned property who acquires the entire property upon the death of a deceased taxpayer
has generally been held not to be a transferee for purposes of Section 6901. Since the surviving joint tenant or
tenant by entirety takes the full estate by virtue of the creation of the tenancy not on the death of the
cotenant, the survivor is not a transferee and is not liable for unpaid income taxes of a decedent, Tully v.
Commissioner, 121 F.2d 350 (9th Cir. 1941). But that cotenant may become liable for estate taxes via IRC
§6324. However, where individual partners transferred property to their partnership, although the partnership
was a separate entity and the property became partnership property, the individual partners were held to be
transferees, Commissioner v. Kuckenberg, 305 F.2d 202 (9th Cir. 1962).

: INSURANCE PROCEEDS

Where a beneficiary receives life insurance proceeds under a policy owned by the deceased taxpayer, he is
liable as a transferee at law for unpaid estate taxes by virtue of the provisions of Section 6324. The liability of
a life insurance beneficiary for the decedent's income taxes depends upon whether or not the taxes have been
assessed before the death of the decedent. If there has been a tax assessment and a lien has attached to all
property and rights of property of the decedent before his death, then the beneficiary merely takes the
proceeds of the policy subject to the lien. However, only the amount of the proceeds equivalent to the cash
surrender value of the policy at the time of the decedent's death is subject to the lien. The balance does not
constitute property or rights of property of the insured, to which the tax lien would have attached at the time
of his death, United States v. Best, 357 U.S. 51 (1958). Where there is no prior federal tax lien, state law
determines the existence and extent of the beneficiary's liability. Where state law exempts the beneficiary of
a life insurance policy from the claims of the insured's creditors, the beneficiary is not subject to transferee
liability, Commissioner v. Stern, 357 U.S. 39 (1958). However, if under state fraudulent conveyance law, it
can be shown that the deceased taxpayer paid premiums with the intent to defraud creditors, the beneficiary
is liable as a transferee for the amount of the premiums paid plus interest, but not the balance of proceeds of
the policy, United States v. Truax, 223 F.2d 229 (5th Cir. 1955). In Stern, the beneficiary of the insurance
policy was the wife of the decedent. Where decedent's estate is the beneficiary of the policy and the proceeds
are paid to the estate, which in turn pays them to the widow, the widow is the transferee of the estate and not
a beneficiary of the life insurance policy. Accordingly, the widow would be liable for transferee in equity if
the estate were insolvent, Kieferdorf v. Commissioner, 142 F.2d 723 (9th Cir. 1944) cert. denied, 323 U.S.
733 (1944).

: SECTION 6324 - THE SPECIAL ESTATE TAX LIEN

A general tax lien attaches to all property belonging to the taxpayer after assessment, demand and
non-payment of the tax and secures payment of all types of federal taxes, including estate taxes. To secure
payment of estate taxes, a second type of lien called the "special estate tax lien," also exists in favor of the
government without assessment or notice and demand, the special estate tax lien comes into existence
automatically on the date of death. It continues for ten years unless, before the end of the ten-year period, the
estate tax is paid in full or becomes unenforceable by expiration of the Statute of Limitations for collection,
IRC §6324(a).

The Supreme Court held in Detroit Bank v. United States, 317 U.S. 329, 337 (1943) that the special estate tax
lien was based upon Congress' belief that there is a greater need of a lien in advance of assessment and
demand for payment of estate tax and property passing at or distributed in consequence of death than for
other types of taxes. The Court also said that there was less need to protect third parties by way of a recorded
notice of lien because the property passing at death is normally dealt with by probate and estate tax
proceedings of public notoriety. Purchasers of property from an estate must exercise extreme caution because
a special estate tax lien encumbers the property if an estate does not pay estate tax subsequently found to be
due. Careful practitioners representing buyers take such precautions as asking the estate representative for
evidence that all estate taxes have been paid, seeking the discharge of the special estate tax lien on the
property being purchased, and securing indemnity from the estate, should any estate tax liability arise.
However, the assurance of obtaining a discharge of property from an estate tax lien or a release of lien from
the Service is no longer available in every situation because the estate may not be (at least initially) subject to
estate tax. Absent evidence that the Service has been paid, reliance in some form of an indemnity from the
estate seems to be the method left to protect purchasers of estate property.

The special estate tax lien attaches to the property includable in the gross estate of decedent. The term gross
estate is a creation of the estate tax provisions of the Code, IRC §§2031-2044. Since a general lien attaches
only to property and rights to property owned by decedent at the time of death and thus passing to probate,
the special lien is far broader than the general lien. Therefore, where probate property is sold by an estate
owing estate tax, the purchaser has bought property encumbered by the special lien. Even if the executor of
the estate asks for a discharge from personal liability under §2204 and has been discharged from personal
liability, the special lien is not extinguished. It continues, but shifts from the property transferred to the
consideration received by the heirs, legatees, devisees and distributees provided that the property has been
transferred to a purchaser or holder of a security interest. The shifting lien comes into play under IRC
§6324(a)(3) only where the executor or other fiduciary has been discharged from personal liability, by
complying with §2204. If there has been no application and discharge, the special lien continues to encumber
the transferred property. The special lien attached to such non-probate property as dower or curtesy interest,
property transferred in contemplation of a death, transfers with a retained life estate, transfers taking effect at
death, revocable transfers, annuities, joint interests, powers of appointment and the proceeds of life insurance.
Property may be discharged or divested from the effects of a specialized tax lien but circumstances of
discharge are dependent on whether the property is probated or not probated. Where probated property is
involved a special tax lien is divested automatically from property included in the gross estate that the probate
or other court having jurisdiction of the estate allows it to be used to pay charges against the estate and
administration expenses, U.S. v. Security First National Bank, 30 F.2d 113 (S.D. Cal. 1939). Although this
approval need not be obtained prior to payment of an expenditure, the automatic divesture provision only
applies where the expenditures are allowed by a court of competent jurisdiction.

There is another discharge provision peculiar to the special tax lien called the "shifting lien." Certain third
parties are protected against the effects of the general lien by the requirement that the lien be publicly filed in
order to be valid against them. The special lien, on the other hand, does not require a notice to be filed for it
to be effective. Rather, property sold or transferred to a purchaser or holder of security interest is
automatically discharged or divested from the effect of the lien, but the lien shifts to the consideration
received from the purchaser or the secured lender. The shifting lien attaches to the consideration received,
even if the fiduciary obtains a discharge from personal liability after audit of the estate tax return.

IRC §6325(c) allows the estate to apply for discharge upon the sale of property. The application for discharge
may be made on Form 4422 (Application For Certificate to Discharging Property Subject to estate Tax Lien).

A lien may be foreclosed against the property that it encumbers in a judicial proceeding. Payment of the
estate tax secured by the special lien is also insured by the imposition of personal liability. There are six
categories of persons who have received property subject to the special lien and are personally liable for the
amount of the estate tax:

(1) The decedent's spouse;

(2) The decedent's transferee;

(3) A Trustee;

(4) A surviving tenant;

(5) A person in possession of the property by reason of the exercise or non-exercise and release of power of
appointment; or

(6) Beneficiary (IRC §6324(a)(2)).

Each of the categories of persons are jointly and severally liable as transferees of property includable in the
gross estate.

The categories of persons personally liable for the unpaid estate tax seem broad enough to include any person
having received property includable in the gross estate. A trustee is specifically named as a person having
personal liability; thus, it has been held that the trustee of an inter vivos trust, not the beneficiaries, is
personally liable under Section 6324(a)(2), Higley v. Commissioner, 69 F.2d 160 (8th Cir. 1934).

Personal liability imposed by Section 6324 is transferee liability. The term "transferee" includes with respect
to estate taxes "any person who, under §6324(a)(2), is liable for any part of such (estate) tax," IRC §6901(h).
Transferee liability is enforced by two methods:

(1) legal action without assessment; or

(2) assessment under the general transferee provision, §6901.


: THE SPECIAL LIEN FOR ESTATE TAX

WHERE PAYMENT IS DEFERRED

Section 6324A provides for a special tax lien in lieu of the special tax lien of §6324 where payment of the
estate tax has been deferred under Section 6166. If the executor: (1) makes an election under §6324A and (2)
files a lien agreement signed by each person has an interest in property designated in the agreement as
collateral for the payment of the deferred amount, a lien arises for the deferred amount. The lien agreement is
a written agreement signed by each person who has an interest in the property designated in the agreement in
which the signing person: (1) consents to the creation of a lien against the property; and (2) designates a
responsible person as the agent for the beneficiaries of the estate and signatories in dealings with the Service
on matters arising under Sections 6166 or 6324A.

: SUMMARY

Estate and trust administration contain many traps for the unwary which might lead to personal liability. A
fiduciary who distributes the estate prior to completion of the estate tax audit could become personally liable.
The fiduciary also can become liable as a result of his or her failure to secure a discharge from the IRS upon
conclusion of the IRS examination. Because of the extensive nature of the estate tax lien, a person acting in a
fiduciary capacity could incur liability when liquidating property of the estate.

Another risk which was not developed within this discussion is the fact that if a beneficiary or distribute of an
estate becomes the subject of a transferee liability investigation by the IRS, there is a great probability that
that beneficiary will sue the executor for errors and omissions in her fiduciary capacity. Congress has given
the IRS great power to pursue tax obligations due from the decedent and the estate and the unwary fiduciary
might become the target of that power. Therefore, it is incumbent upon each fiduciary to fully review each
estate for all tax obligations, both apparent and hidden. Upon completion of the IRS examination, the
fiduciary should seek discharge of her obligation. Even that may not prevent later litigation by the
beneficiaries of the estate if they should become the subject of an IRS investigation.

THE DISAPPEARING ASSET

ESTATE

ARISES

ESTATE CONSISTS OF A
$6 MILLION SECURED NOTE AND

$2 MILLION IN LIQUID ASSETS

ESTATE PAYS PART OF

ESTATE TAX - RECEIVES

§ 6161 EXTENSION

ESTATE DISTRIBUTES

REMAINDER OF

LIQUID ASSETS

TO BENEFICIARIES

DAUGHTER DEFAULTS ON NOTE

ESTATE FORECLOSES

COLLATERAL

IRS SEIZES COLLATERAL

AND SELLS FOR SMALL PERCENT

OF VALUE

IRS PURSUES HEIRS

HEIRS AND EXECUTOR FOR SUE


THE MISSING TAX RESEARCH BALANCE OF TAXES EXECUTOR

TAXPAYER
OWES

TAXES

TAXPAYER DIES

OWING

TAXES
ESTATE COMMENCES

EXECUTOR IS UNAWARE OF

TAX LIABILITY

EXECUTOR FAILS

TO CHECK WITH IRS

REGARDING PRIOR TAXES

ESTATE DISTRIBUTES

ALL ASSETS TO

HEIRS

IRS PURSUES
HEIRS
HEIRS
SUE
THE POST ESTATE AUDIT OF AND
DECEDENT EXECUTOR
EXECUTOR

1992

ESTATE ARISES

WITH MORE THAN

$600,000

1992

ESTATE

DISTRIBUTES

TO

HEIRS

1993

IRS AUDITS
DECEDENT'S

PERSONAL INCOME

TAX RETURNS

AND ASSERTS

LARGE DEFICIENCY

1994

IRS PURSUES

HEIRS FOR

TRANSFEREE

THE PREMATURE DISTRIBUTION

ESTATE

ARISES

706 FILED

WITH FULL

PAYMENTS

ESTATE

DISTRIBUTES

ASSETS

TO HEIRS

IRS AUDITS

ASSERTS LARGE

DEFICIENCY

TAX COURT
FINDS FOR IRS

IRS

PURSUES

HEIRS AND

EXECUTORS

THE THWARTED ESTATE PLAN

1992

TAXPAYER CREATES TRUST FOR


CHILDREN AND CONVEYS MOST
ASSETS

1993

IRS AUDITS

1990, 1991 & 1992

INCOME TAX RETURNS AND


ASSERTS A LARGE LIABILITY

1994

IRS PURSUES TAXPAYER

AND IS UNABLE TO COLLECT


BECAUSE HE IS INSOLVENT

1994

IRS PURSUES TRUST

AND BENEFICIARIES WHO HAVE


RECEIVED DISTRIBUTIONS
mckenzi7@ix.netcom.com

2/12/2007