Undisclosed Foreign Accounts
Serving as Executor can at times be more of a headache than an honor. On top of a pile of paperwork and dealing with a multitude of family issues, you can be sued!
Executors have a number of responsibilities, most importantly payment of the decedent’s outstanding tax liabilities, debts and bequests – in that order. In an effort to appease beneficiaries, many executors make distributions before confirming that the first priority payees are satisfied. This constitutes a breach of the executor’s fiduciary duty and subjects to executor to personal liability for taxes owed to the government.
Priority of payments
Executors are responsible for ensuring the proper administration of an estate, including paying all of the estate’s bills, and in the right order. Per 31 U.S.C. § 3713, taxes are the first priority payments, and only after they are paid, should credit cards, utilities, or any other bills or distributions be satisfied.
In the event that insufficient funds remain in the estate to pay the IRS, the executor will be personally liable for any unsatisfied tax liability if lower priority claims were paid first. This presents a significant problem where the decedent was delinquent on his or her taxes due to undisclosed foreign accounts and income.
Discovering undisclosed foreign accounts
Some accountants recommend that their executor clients file current year FBARs, but refrain from filing any prior year FBARs or amended tax returns, and not to advise beneficiaries to file Form 3520 – information that would reveal to the government of the existence of a foreign gift. The reasoning is that executors are responsible only for the current year’s taxes and foreign account reporting, and should not engage in speculation as to whether the decedent’s noncompliance was willful (intentional) or not.
This course of action can backfire drastically. Taxes and penalties owed by a taxpayer for failure to report foreign income and assets during their lifetime, become debts of their estate after they pass away. If those debts are not satisfied because the executor first pays lower-priority debts and makes distributions to beneficiaries, the executor will become personally responsible for the tax liability. In addition, although these accountants are correct in stating that an executor should not speculate as to the willfulness of a decedent in failing to report their foreign income and/or accounts, that knowledge is not needed to remedy delinquent returns. Nor is the executor doing the beneficiaries a favor by failing to inform them that they have the duty to report gifts from foreign accounts.
Ultimately, the duty is on the executor to ensure that the government is paid first. If you are left with insufficient funds to pay a later-discovered tax bill, good luck getting distributions back from the beneficiaries! This is why it is so crucial for executors to consult with a tax attorney and accountant from the start.
In Part II, we will review an executor’s obligations, as well as applicable criminal and civil penalties.