Personal Liability of Executors for Tax Liabilities of the Estate Under the Federal Priority Statute, 31 U.S.C. 3713

United States v. McNicol

829 F.3d 77, (1st Cir. July 15, 2016)

aff’g 2014 WL 4384486, 114 A.F.T.R. 2,d 2014-5919 (D. Mass., 2014)

Summary

This is an appeal of summary judgment by the personal representative (the “PR”) of an estate. The lower court found the PR to be personally liable under the federal priority statute, Section 3713, for tax liabilities due from an insolvent estate. Under the federal priority statute, if an insolvent debtor or estate has an outstanding tax liability, the Government has priority on the payment of their claim. The PR can be held personally liable if they transfer the assets of an estate before paying the tax liability to the Government.

The Appeals Court affirmed the lower court’s prior ruling that the federal priority statute claim was valid. The Appeals Court also found that the PR’s argument for equitable exceptions was fatally flawed and, therefore, failed. The estate, the appellant as PR of the estate, and the appellant, individually, were held liable for the Government’s claims.

Facts

Special Note: The facts of the case are based on the material facts statement filed by the Government because McNicol didn’t file a statement of materials facts with the lower court.

The decedent, McNicol’s husband, died on July 25, 2002 leaving significant federal income tax liabilities in excess of $340,000. The assets of the estate were interests in two closely-held corporations which each owned a fishing boat. Their values were insufficient to cover the federal income tax liabilities. As a result, the estate was insolvent.

McNicol, acting as PR, and later, after being appointed PR, transferred the shares of the corporations from the estate to herself.  She didn’t liquidate the assets or attempt to make any payments to the Government or to other debtors while the assets were in the estate. In October of 2003, the IRS contacted McNicol about the outstanding tax debts of the estate, formally submitting a probate claim. Negotiations ensued between the IRS and McNicol, but no resolution was reached. The IRS served McNicol with a formal notice of potential liability under the federal priority statute.[1]

Suit was filed by the Department of Justice in the United States District Court for the District of Massachusetts. The IRS sought over $340,000 from the estate and McNicol as PR, as well as a judgment of over $125,000 from McNicol personally[2]. The parties cross-moved for summary judgment. The court directed the parties to engage in settlement discussions which were unsuccessful. The cross-motions for summary judgment were then considered.

McNicol did not challenge the IRS assessments. Instead, she challenged that an equitable exception applied for family allowances and funeral and administrative expenses.[3] The District Court granted summary judgment in full to the government. It explained McNicol’s transfer triggered the federal priority statute and had expenses been paid out of the estate before being transferred, the result might have been different. McNicol appealed the case to the United States Court of Appeals, First Circuit. The Appeals Court affirmed the lower court’s decision.

Law, Analysis and Ruling

The federal priority statute provides that when there is an insolvent debtor, or the estate of a deceased debtor is insolvent, the federal government is first in line for payment of claims. While not strictly construed, this statute is liberally construed and basically grants the government an unqualified priority of payment for claims due. It also provides that if an executor or fiduciary transfers any of the debtors’ assets before first paying the federal government, they will be personally liable for those unpaid claims.

There are three elements[4] used to determine whether personal liability will exist:

  1. Were the assets of the estate transferred before the claims of the United States were paid?
  2. Was the debtor estate insolvent?
  3. Did the executor/personal representative have knowledge or should have reasonably investigated that the tax debt was owed?

The Appeals Court reviewed each the elements against McNicol’s actions. With regard to the transfer, they clarified that the transferred funds don’t have to be used to pay a debt as written in the statute but that it is enough that the assets of the estate were depleted[5]. Also, even though the insolvency and knowledge elements are not in the text of Section 3713(b), the courts read these elements into the requirements.[6] There was no question as to the insolvency of the estate. The proof that McNicol had knowledge came from McNicol’s own admissions to the Government.[7]

McNicol argued that she was not personally liable for the tax debt because equitable exceptions existed for the federal priority statute. The exceptions include payments for family allowances and administrative and funeral expenses.[8] The Appeals Court considered McNicol’s argument, but did not find it to be valid. First, the Government’s “undisputed” material facts stated that the fishing vessels were not sold to pay administrative expenses, but were kept to generate income to support the family’s lifestyle. The Appeals Court’s opinion also provided that the Government’s facts stated the following:

Ms. McNicol hoped that the IRS would not seek to collect the liabilities and that the statute of limitations period would expire.

Additionally, the Appeals Court held that McNicol lacked authenticated proof for any of the expenses she was claiming.

McNicol also attempted three other lesser arguments, such as she wasn’t actually appointed PR at the time of the first transfer, so therefore, the statute didn’t apply. The Appeals Court found no validity in any of these arguments. The Appeals Court affirmed the District Court’s grant of summary judgment to the Government. The federal priority statute was found to apply and the estate, McNicol as PR for the estate and McNicol, personally, were found liable for the tax debts.

Practice Notes

  1. In an insolvent estate, the personal representative should proceed with extreme caution before transferring assets to pay debts or expenses, especially in the case of outstanding tax liabilities, whether or not assessed.
  2. When arguing the equitable exception to the federal priority statute, be sure to know all the criteria and realize that it’s not without restrictions – expenses and allowances must be “reasonable” and there must be valid proof of the expenses.
  3. In litigation, be aware of the potential effects of relying on the submission of material facts by the opposing party. Present all relevant legal theories at the lower courts to preserve for argument at the appeals level.

[1] See 31 U.S.C. Section 3713(b).

[2] The footnotes to the case explain that this amount “was derived by adding the price for which the vessel owned by Sophia Gale, Inc. was eventually sold ($80,000) and one-half of the price for which the vessel owned by RR Fishing Corp. was eventually sold ($107,500), and subtracting the amount of the lien against the latter vessel ($61,562).

[3] See I.R.M. 34.4.1.7 (Aug. 11, 2004).

[4] See United States v. Renda, 709 F.3d 472, 480-81 (5th Cir. 2013).

[5] See United v. Coppola, 85 F.3d 1015, 1020 ((2d Cir. 1996).

[6] Id. at 3.

[7] The District Court’s opinion provided that deposition testimony showed McNicol knew about the tax debt.

[8] Id. at 2.

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