An estate may, in certain circumstances, elect to pay estate tax in a series of payments over a number of years. This election is available to estates in which assets are used in an active trade or business comprise more than thirty-five percent (35%) of the estate. Payment of estate tax can be extended over a ten-year term with the first payment delayed for five (5) years. This election enables small businesses to continue after the death of the owner.
What can go wrong?
In (Estate of) Johnson v. U.S., the estate deferred payment of estate tax over ten years. A hotel comprised $11.5m of value in an estate of $16m. The estate paid installments for the proportion of estate tax attributable to the hotel in the years 1996 to 2006 and represents. Estate tax on non-business assets such as a residence, stocks and bonds, is not deferred
In 2002, the hotel went bankrupt after the estate paid $5.0m of the deferred tax, leaving about $1.8m outstanding. The estate defaulted on the payment plan and the government filed suit on the grounds of transferee liability §6324(a).
In Johnson, a revocable living trust held four partnerships, one for each child. The trustees distributed the partnerships, not the estate. Transferee liability is based upon receiving property, on or after date of death, that was included in the gross estate. The beneficiaries claimed they weren’t transferees because they did not receive the property from the decedent’s estate. The trustees admitted they were transferees but claimed the action was time barred. The trustees also claimed that they were not liable for the tax because the estate had enough money at the time of death.
The court held the deferral agreement tolled the statute of limitations and the government could pursue the trustees and the beneficiaries as transferees.
One of the many issues in the deferral of estate tax liability is the obligations of the fiduciaries and beneficiaries to one another. In Estate v. Turco, the court-appointed administrator sought to recover proceeds of life insurance payable to trusts and use those proceeds to pay tax that was deferred. In Turco, the decline in real estate values was also the cause of the inability to pay.
The Johnson and Turco cases demonstrate what can go wrong.
Clearly, business conditions can impact the ability to pay and upset expectations of the parties. What if the business is left to one beneficiary and other assets (stocks, insurance, IRAs) are left to other beneficiaries? There is a bit of dilemma in planning the estate plan. Do you leave the business to the beneficiary with the aptitude for it but subject the other beneficiaries to the economic risks? Look at Turco and Johnson, the crash in the real estate market prevented repayment of deferred estate tax. On the other hand, is there enough in the way of liquid assets to pay the estate tax. Where does that leave the other beneficiaries, in terms of an inheritance, if the liquid assets pay the taxes.
The hard work is not making the election. Instead, it lies behind the scenes in dealing with the potential issues.