Beneficiary and Fiduciary Liability for Income, Gift and Estate Taxes

If you are one of the beneficiaries of an estate or if you are the trustee of a trust, you need to understand the liability that comes with your role to prevent inheritance issues or personal liabilities.

Liabilities of a beneficiary

Taxes related to trust and estate law

If the beneficiary received assets from the estate or trust before the claim of the government has been paid, he or she will be liable for the unpaid claims of the government. However, the extent of the beneficiary’s liability will be based on the value of the asset transferred to them.

Taxes related to gifts or donations

In general, the donor is responsible for gift taxes. However, if the donor fails to pay the applicable tax on the gift, the recipient will be personally liable for the gift tax, up to the value of the gift.

Liabilities of a fiduciary

According to the tax code, the fiduciary has the responsibility to:

  • file the deceased final income and estate tax returns
  • represent the estate in all tax matters upon filing the required Noted Concerning Fiduciary Relationships
  • pay federal tax deficiencies first before settling other debts, in the event the estate or trust doesn’t have enough assets to pay all its obligations

Non-payment of the estate tax will give rise to an IRS lien, which is a legal claim by the government against the assets of the estate.

The IRS may require the fiduciary to pay the tax if as a result of the fiduciary’s actions, the assets in the estate or trust are no longer sufficient to settle its federal tax obligation. The IRS will follow normal deficiency procedures to assess and collect the tax once it ascertains that the fiduciary is personally liable for the tax deficiency.

Fiduciary liability prerequisites

The IRS determines whether or not the fiduciary is personally liable to pay federal tax based on the following conditions:

  • The IRS has a claim for taxes.
  • Despite knowledge of the claim, the fiduciary distributed the estate’s assets to a beneficiary or paid a debt, such as medical bills, state income tax, and unsecured debts (other debts may be covered by a PPI insurance) of the deceased.
  • The distribution of asset and payment of the debt happened when the estate or trust was insolvent or the distribution or payment gave rise to the insolvency.
  • The IRS has filed a timely assessment against the fiduciary personally.

How to reduce a fiduciary’s liability

As long as the estate or trust has enough assets to pay all tax liabilities, the fiduciary can make a partial distribution to the beneficiaries or pay the deceased’s creditors without being held personally liable for estate tax deficiencies.

The fiduciary needs to file IRS Form 4506 with the IRS. The fiduciary’s letters of administration and a Power of Attorney should also be included in the request. Additionally, the fiduciary may file IRS Form 4810, which is a request for prompt assessment, to expedite the process.

How to be discharged from personal liability

After filing the deceased’s federal income tax return(s) with the IRS, the fiduciary may write a request for release from personal liability for gift and income taxes. The fiduciary may also ask to be discharged from personal liability from federal estate tax via a written request.

The IRS has nine (9) months from the filing of any of the requests to inform the fiduciary if any tax (income and gift tax or estate tax) is due. Once the nine-month period expires or when the tax is paid, the fiduciary will be discharged from personal liability.

In order to avoid tax liabilities, beneficiaries and the fiduciary need to make sure that the government gets its claim on the assets before anything else. Proper estate planning can also help prevent such problems.