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Estate executors: Avoid a personal tax trap

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in Small Business Tax

Serving as the executor of an estate is a weighty responsibility… perhaps even more so than you might think.

Big risk: If you’re not careful, you could be held liable for the estate’s federal tax debts. In other words, instead of paying the amount that’s due out of the estate’s assets, you might have to come up with the tax payments out of your own pocket!

Don’t think that’s possible? Consider this recent court case:

Two siblings were named co-executors of their father’s estate. They directed the estate to pay the amounts due for state and local taxes and certain other payments, but they didn’t arrange for the estate to pay the required federal estate tax.

Subsequently, the IRS initiated an action against the co-executors personally.

The co-executors argued that they should not be liable for the taxes because they were not aware that federal taxes should be paid before other debts. The siblings eventually worked out a settlement agreement with the IRS, and the agency accepted partial payment for the tax liabilities.

Bad news: The district court disagreed with the executors. It noted that the partial payment, which was made three years after the due date, did not modify the settlement agreement concerning the amount that was due. Thus, the co-executors are personally liable for the estate's federal tax liabilities, including interest and penalties, because they failed to pay the federal taxes before making distributions to the estate’s other creditors. (Irby III, et al., 2006-1 USTC 50,143, So. Dist. Ala., 12/21/05)

Bottom line: You can be on the hook if you’re the executor of an estate that fails to meet its tax obligations.

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