On July 20, 2021, the Tax Court issued a Memorandum Opinion in the case of Estate of Lee v. Commissioner (T.C. Memo. 2021-92). The primary issue presented in Estate of Lee was whether the IRS abused its discretion in rejecting the petitioner’s offer-in-compromise by erring to properly compute the estate’s reasonable collection potential by including amounts distributed by the executor.
Challenging the IRS Lien before Appeals
IRC § 6320(b) permits a taxpayer to challenge an IRS lien before the Appeals Office, and IRC § 6320(c) (incorporating IRC § 6330(d)) provides for Tax Court review of an Appeals Office determination. Abuse of discretion exists when a determination is “arbitrary, capricious, or without sound basis in fact or law.” Schwartz v. Commissioner, 348 F. App’x 806, 808 (3d Cir. 2009) (quoting Murphy v. Commissioner, 125 T.C. 301, 320), aff’g T.C. Memo. 2008-117. In this regard Appeals is “owed considerable deference” when considering the adequacy of a taxpayer’s proposed OIC. Id. Thus, if Appeals followed all statutory and administrative guidelines and provided a reasoned, balanced decision, the Tax Court will not reweigh the equities. Thompson v. Commissioner, 140 T.C. 173, 179 (2013).
Reasonable Collection Potential (RCP)
IRC § 7122(a) authorizes the IRS to compromise an outstanding tax liability, and the regulations set forth three grounds for such a compromise: (1) doubt as to liability; (2) doubt as to collectibility; or (3) promotion of effective tax administration. Treas. Reg. § 301.7122-1(b). The estate proposed to compromise its estate tax liability based on doubt as to collectibility. The IRS may compromise a tax liability based on doubt as to collectibility where the taxpayer’s assets and income render full collection unlikely. Treas. Reg. § 301.7122-1(b)(2).
Conversely the IRS may reject an OIC where the taxpayer’s RCP is greater than the amount he proposes to pay. See Johnson v. Commissioner, 136 T.C. 475, 486 (2011), aff’d, 502 F. App’x 1 (D.C. Cir. 2013); Murphy, 125 T.C. at 309. Appeals is generally directed to reject offers substantially below the taxpayer’s RCP where the offer is premised, as it was here, on doubt as to collectibility. See Rev. Proc. 2003-71, § 4.02(2). The issue before the Tax Court was whether Appeals abused its discretion by including the amounts distributed by the executor in the RCP formula.
The executor of an estate must pay the estate tax. IRC § 2002. The executor may be held personally liable under 31 U.S.C. § 3713, often referred to as the Federal Priority Statute (FPS), if the executor pays a debt of the estate before satisfying and paying a claim owed to the United States. 31 U.S.C. § 3713(b); Treas. Reg. § 20.2002-1 (defining a “debt” as including a beneficiary’s distributive share of an estate). The term “claim” for purposes of the FPS means “any amount of funds or property that has been determined by an appropriate official of the Federal Government to be owed to the United States by a person, organization, or entity other than another Federal agency”, 31 U.S.C. § 3701(b)(1), and includes an estate’s Federal tax liability, Bank of West v. Commissioner, 93 T.C. 462, 467 (1989); see also United States v. Moore, 423 U.S. 77, 84-85 (1975) (holding that phrases used in the FPS should be liberally interpreted). An executor is personally liable for the unpaid claims of the United States to the extent the executor makes a distribution of assets from the estate when either the estate was insolvent at the time of the distribution, or the distribution rendered the estate insolvent and the executor had knowledge or notice of the Government’s claim. 31 U.S.C. § 3713(b); Leigh v. Commissioner, 72 T.C. 1105, 1109 (1979); Treas. Reg. § 20.2002-1.
An executor must have had actual or constructive knowledge of the Government’s claim when the estate had sufficient assets to pay it or notice of such facts as would put a reasonably prudent person on inquiry as to the existence of the Government’s unpaid claim. Leigh v. Commissioner, 72 T.C. at 1109-1110; New v. Commissioner, 48 T.C. 671, 676-678 (1967); Irving Trust Co. v. Commissioner, 36 B.T.A. 146, 148 (1937). A notice of deficiency with respect to estate tax liabilities given to an executor before the executor’s distribution of estate assets is sufficient to satisfy this notice requirement. See Viles v. Commissioner, 233 F.2d 376, 380 (6th Cir. 1956), aff’g T.C. Memo. 1955-142; Irving Trust Co. v. Commissioner, 36 B.T.A. at 148; see also Estate of Frost v. Commissioner, T.C. Memo. 1993-94, *15.
The IRS’s notice of deficiency, issued to the executor before he made the February 2007 distribution, was sufficient to create a claim under the FPS. See Viles, 233 F.2d at 379-380; Irving Trust Co., 36 B.T.A. at 148; Estate of Frost, T.C. Memo. 1993-94 at *15. Furthermore, the record establishes that Mr. Frese had actual knowledge of the unpaid claim at the time of the February 2007 distribution. As such, the executor made the February 2007 distribution at his own peril, and any advice he may have received in this regard cannot absolve him from liability. See King v. United States, 379 U.S. 329, 339-340 (1964). As such, the executor could be held personally liable for the estate’s unpaid estate tax.
Collecting the Estate Tax
IRC § 6901(a) provides that a fiduciary’s liability for payment of an estate tax under the FPS is to be “assessed, paid, and collected in the same manner and subject to the same provisions and limitations as in the case of the taxes with respect to which the liabilities were incurred.” See also IRC § 7701(a)(6) (defining “fiduciary” as including an executor acting in a fiduciary capacity). Furthermore, the period of limitations for assessment against a fiduciary under the FPS is “not later than 1 year after the liability arises or not later than the expiration of the period for collection of the tax in respect of which such liability arises, whichever is the later.” IRC § 6901(c)(3); Treas. Reg. § 301.6901-1(c)(4). IRC § 6502(a)(1) in turn provides a 10-year period of limitations for the collection of estate taxes. The IRS assessed the outstanding estate tax deficiency against the estate in July 2010, thereby starting at least a 10-year window for respondent to also pursue collection against the executor through IRC § 6901 with respect to his FPS liability.
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