Death does not necessarily mark the end of your estate. In fact, for some families, it may mean the beginning of your financial legacy. On the other hand, for other families, it may mean the beginning of some serious taxes. The prospect of future tax battles with the IRS was the subject of the recent case of U.S. v. Mary Carol S. Johnson. Forbes explored this case in an article titled “When Estates Don't Pay Tax, IRS Chases Beneficiaries.” The case recounts the story of Anna Smith, her fortunes in the Stateline Hotel, and the IRS audit that ultimately led to a battle over a lost fortune. Smith’s fortune was bound up in stock in the hotel, and it was worth enough at her passing to trigger an estate tax that the family elected to pay in installments over several years (which can be done). According to her estate plan, the family distributed the stock amongst themselves under with an agreement to set aside a portion to pay the estate taxes owed. Apparently that agreement was reached in the “good days” of the hotel. In fact, those days were so good that the IRS audit on the estate tax return, years later, came up with higher numbers and a greater tax. Of course, when the IRS finally got around to making that decision, the hotel was not doing so well. However, the family agreed to pay the higher tax as a matter of duty and paid on those rates for several years. Boom. The hotel value collapsed, the stock became worthless, and the estate had nothing left to pay for the taxes on the past wealth. The IRS, not being one to forgive and forget, didn’t forget and carried on the fight to the beneficiaries and personal representatives of the estate. In the end, the IRS held two members of the family acting as personal representatives to be personally liable, even though they did the right thing by the original numbers. The original article is an interesting read and a sobering reminder, albeit far from unique. The IRS can audit any taxpayer, even if it’s an estate, and sometimes it has good reasons to do so. As a sidebar, the case demonstrates the importance of an accurate valuation. Regardless, this U.S. v. Mary Carol S. Johnson serves as a lesson for those currently planning their estates. With the current lifetime gifting exemption pegged at $5.12 million, this may be a window of opportunity to pass significant wealth before the year’s end. Bottom line: If the estate doesn’t fully pay off any amounts due, the IRS turns to the estate beneficiaries, sometimes even for amounts forgotten until years later.
Reference: Forbes (June 28, 2012) “When Estates Don't Pay Tax, IRS Chases Beneficiaries”