Taxpayers must often rely on professionals to advise them on tax matters. Estate taxation can be particularly complicated for a layman. The personal representative of an estate, responsible for administering a decedent’s financial affairs, often has no knowledge of tax issues. Fiduciaries who disregard claims of the United States (including income tax liabilities) are held personally responsible for any unpaid amounts. Frequently, these individuals need professional advice about disbursements of funds to creditors, beneficiaries and the taxing authorities.
Jerry J. Calton died intestate in 1989. His friend, William D. Little, was asked to act as personal representative. Little had no experience as a fiduciary and sought guidance about the estate’s administration. Soon after Little was appointed personal representative, the estate hired an attorney. Little promptly forwarded tax forms and tax notices he received regarding the decedent to the attorney. Notwithstanding several W-2s and 1099s the estate received on the decedent’s behalf, the attorney advised Little the estate owed no taxes due to its small size.
Based on advice from the attorney that there was no tax liability, Little disbursed most of the estate’s assets to creditors and beneficiaries. Soon after, the estate received a notice of deficiency from the IRS proposing a tax liability based on the decedent’s earnings before his death and on the estate’s income. Little forwarded the notice to the attorney, who again told him no federal taxes were due.
The attorney hired a CPA to review the administration of the estate prior to its closing. The CPA discovered the tax documents and assessments and filed the required returns. Although there was a balance due, the estate sent no money with the returns. (The estate, however, stopped disbursing funds once it became aware of a potential tax liability.) Little subsequently sent an offer in compromise to the IRS, submitting the estate’s remaining funds ($17,586.07) as full payment of the tax liability. The IRS did not accept the offer and returned the check without explanation. The attorney and the CPA met with the IRS and came away with the erroneous belief that the IRS was canceling the tax liability as a result of the meeting. They advised Little to pay out the remaining funds and close the estate.
The IRS continued to press its claim. Little received a notice from the IRS that he was personally liable for unpaid income taxes and penalties amounting to $63,734.53 plus interest. Asserting that he had no knowledge of the tax liability when he distributed the estate’s assets, Little petitioned the Tax Court for relief.
Result. For the petitioner. The IRS based its case on a federal law which says representatives of a person or an estate are liable for government claims. Courts have held a fiduciary liable if he or she has actual knowledge of the claim or is “chargeable with knowledge of the debt.” In ruling in his favor, the Tax Court determined Little was unaware of the decedent’s income tax liability when he closed the estate.
The IRS said that Little knowingly disregarded the tax liability when he closed the estate because he was aware of the debt when he received the W-2s and 1099s. However, the Tax Court found that Little sought advice before making disbursements and acted in a “prudent and reasonable manner.” He was repeatedly informed that there were no taxes due. He disbursed all funds and closed the estate on the advice of both an attorney and a CPA.
The Tax Court determined that because he “fulfilled his duty of inquiry and was reasonable and acted in good faith in following the attorney’s advice” no tax was due from the estate.” The U.S. Supreme Court, in United States v. Boyle , (469 US 241, 151 (1985)) observed that a taxpayer who relies on the advice of a professional should not be expected to seek a second opinion. The law requires fiduciaries to pay debts due to the United States before disbursing funds to creditors and beneficiaries. Those who do not have personal knowledge of the law generally seek professional advice. When a fiduciary follows such advice, even if it is incorrect, he or she is considered to have acted reasonably and in good faith and should not be held responsible for any unpaid taxes.
- William D. Little v. Commissioner , 113 TC no. 13.
Prepared by Cynthia Bolt Lee, CPA,
assistant professor of business administration,
the Citadel, Charleston, South Carolina.