Acting as executor for the estate of a friend or relative may be viewed as an act of love or kindness, and there may even be a little money in it. And in an aging population increasingly consisting of splintered families, doing this last favor for someone you didn't know all that well is likely to become increasingly common.
But before agreeing to take on the task, you should know that there can be real dangers involved.
A cautionary tale emerged a few weeks ago from the U.S. Tax Court, where a judge put an end to a 10-year nightmare for a St. Louis man who agreed to take care of a friend's estate and ended up being pursued by the Internal Revenue Service for thousands of dollars in taxes owed by the estate.
The Tax Court let the man off the hook, but it noted that there were "unique circumstances" involved, and it's clear that in other situations an executor might not be so lucky.
The case began in 1989 when one Jerry J. Calton died in St. Louis, leaving no will and no close relatives. His attorney knew that William D. Little was a friend of Calton's and suggested that he serve as personal representative. Little was not related to Calton and inherited nothing from him but agreed to take on the job.
Little was duly appointed by the probate court, and he hired another lawyer to handle legal matters of the estate, which had assets of about $350,000.
Since the estate was less than the amount--then $600,000--where estate taxes begin to be assessed, the lawyer advised Little that no taxes would be due. Little began paying the estate's debts and distributing money to the heirs.
As he was doing so, Little noticed that first a W-2 and then some 1099 forms were arriving in the mail, indicating that Calton, and subsequently the estate, had income. He asked the lawyer, who told him that because of the size of the estate no taxes would be due.
That advice turned out to be wrong. While the estate did not owe estate taxes, it did owe income taxes, and it was liable for income taxes that Calton himself owed for his earnings in the year he died.
In 1992 and 1993, the IRS, unaware that he was dead, began dunning Calton. The agency sent a proposed tax liability for 1989, then a notice of deficiency for that year, followed by similar notices for 1990. The lawyer, though, continued to advise Little that no taxes were due.
Finally, Little, as he prepared to close the estate, hired an accountant to review its administration. The accountant quickly realized that no income tax returns had been filed for Calton in 1989, or for the estate for 1990 or 1991. The accountant reconstructed the financial information and prepared returns showing a tax liability of nearly $50,000.
The estate had only $17,586.07 left, so Little sent that in along with a form making an offer in compromise, a device by which the IRS can settle a tax liability for less than it is owed because the taxpayer cannot pay the rest. The IRS rejected the offer and several months later returned the check uncashed.
The lawyer and the accountant had a number of meetings and conversations with IRS agents and thought they had negotiated a resolution. The lawyer then told Little there was no remaining tax liability and it was okay to pay out the balance of the estate. He did so and heard nothing further from the IRS for two years--at which point the agency demanded that he pay the entire tax liability.
Federal law makes it clear that a representative of a person or estate who pays other claims ahead of the government's is liable if the government doesn't get its money.
But the courts have granted some leeway, the Tax Court noted. The person has to have had notice of the government's claim--either directly or because the representative was in possession "of such facts as would put a reasonably prudent person on inquiry as to the existence of the unpaid claim of the United States."
The court agreed that the W2s, 1099s and IRS notices were enough to put Little "on inquiry" but that Little had in fact done his duty by checking with the lawyer.
The IRS had pointed to another case, in which the taxpayer was not let off and the court concluded that "the fact that he inquire[d] wrongly or haphazardly is not enough and is no defense."
But the court noted that Little was neither a college graduate nor had any experience with estates, while the taxpayer in the other case was "an attorney with experience in the administration of estates."
"The facts before us support a conclusion that [Little] fulfilled his duty of inquiry and was reasonable and acted in good faith in following the attorney's advice that no tax was due from the estate," the court concluded.
Whether another taxpayer would get such relief from the Tax Court is questionable. The court in the case cited by the IRS made it clear it does not intend to allow sloppiness as a defense, and professionals and well-educated taxpayers will have to meet a higher standard.
Thus, lawyers advise great caution in agreeing to act as an executor and even greater caution if you take on the job.
"The less familiarity you have with the deceased's circumstances, the more perilous it is," said Frederick J. Tansill, a McLean lawyer specializing in estates and estate planning.
And taxes are not the only potential problem, he added. Claims arising from everything from business deals to auto accidents can crop up against an estate. If the executor has distributed the assets, the claimants can come against that executor.
If the dead person had spent his or her last seven years in a nursing home, say, the chances of such claims are much less, but if you're dealing with someone in middle age, for example, there could be business claims or other issues, such as involvement in a hit-and-run accident just before the person's death.
Further, an executor who mishandles estate assets--by making risky investments or engaging in self-dealing, for example--could be liable to the heirs.
Thus, it's a good idea to consult a lawyer and possibly an accountant, especially if the estate is more than a modest amount. And since many estate issues turn on state law, it's a good idea to use a professional who practices in the jurisdiction where the estate will be probated.
There are some protections, though.
Executors ready to distribute assets can request an expedited audit of an estate tax return. That can be followed by a closing letter from the IRS that in effect says the return is okay. Or there is a proceeding where an executor can request a release from the IRS.
But there can still be income-tax booby traps, and "the prudent executor would want to examine the [dead person's] income tax history, review the returns, and maybe talk to the accountant for the estate," Tansill said. The IRS can come after you for up to three years, and for up to six if there has been a substantial understatement of tax, he added.
States have various procedures for protecting executors against other claims.
Virginia, for example, has a two-step court procedure that an executor would want to go through "to create a bulletproof shield," Tansill said. The executor can request a "debts and demands" hearing followed by a show-cause order, putting creditors on notice that they must file their claims or lose the right to pursue the executor.
Other states have other procedures, such as firm cutoff dates for the filing of claims.
And if it's any consolation, the executor's liability is limited to the value of the estate. "You can never be personally liable beyond the assets you are distributing," Tansill said.