On Jan 20, 2000, James Guyton, Sr sold his McAlpin, Florida poultry farm operation, known as Guyton Farms, for $190,000. The sale resulted in a taxable gain of approximately $160,000. James Sr. used a portion of the gain to pay off two mortgages, and then deposited nearly $100,000 in a joint farm-checking account that he maintained with his son, Blake. James Sr. died six months later, and his son, James Guyton, Jr. was named as executor of his estate. On the tax form 1040 filed in connection with the estate's tax liability for 2000, James Jr. listed the taxable gain of approximately $160,000 and the outstanding tax liability as approximately $132,000. He made tax payments in 2001, but by 2004, over $29,000 remained outstanding; with interest and penalties, James Jr. owed approximately $50,000. The Internal Revenue Service went after James Jr. in tax court asserting that he was personally liable as his father's executor.
James Jr. (who appeared pro se) argued that he shouldn't have to pay taxes on funds that went directly to Blake without passing through the probate estate. He claimed that Blake should be liable for the taxes as income with respect to a decedent (IRD) under Internal Revenue Code Section 691. In affirming the lower court's decision to grant the government's motion for summary judgment, the U.S. Court of Appeals for the Eleventh Circuit held that the farm-sale proceeds weren't IRD. The court's rationale was that, because James Sr. realized the gain from the sale of his farm prior to his death (and, actually received the sale proceeds prior to his death), his estate was liable for the tax rather than Blake. In other words, under IRC Section 691, IRD is income earned before death but not received until after death. Although James Sr. deposited the proceeds into the joint account with Blake, this didn't relieve the estate of its obligation to pay estate taxes U.S. v. Guyton, 2010 WL 1172428 (11th Cir. March 26, 2010).
So, what are the lessons here (aside from the fact that it's a bad idea to litigate against the government pro se)? Well, first is the obvious rule that a personal representative shouldn't distribute an estate until all of its taxes are paid, which is what we assume happened here. Second, testators don't pay enough attention as to who bears the burden of the taxes when they die. We've recently seen instances in which a son or daughter was to receive certain property under a parent's will or trust but the child convinced the parent to transfer that property into joint tenancy with them or deed it to them while the parent retained a life estate. "What's the harm the testator figures?" "I was going to leave it to him anyway. " The harm is in their documents, which often put the estate tax burden on the residue. In instances in which the property transferred during a testator's life was originally to pass as a part of the residue of an estate, that means the entire estate tax burden falls to the son or daughter's siblings.
We're not sure whether these children getting the lifetime transfer have figured this tax issue out or whether no one thought about it at all, but it's grist for the litigation mill regarding the testator's intent. Estate planners should consider whether the usual “burden on the residue” clause is best for every situation.