When a decedent’s estate includes interests in a closely held business, and it is large enough to incur federal estate taxes, the executor has the option of deferring the tax and paying it off in installments. In theory, this avoids having to sell the business to pay the tax. Selling a closely held business for fair value in a short space of time is a practical impossibility. But in practice the deferral of the tax doesn’t always solve the problem either.
When Anna Smith died in 1991, her estate’s main asset was a trust that she had created. The trust held 9,994 shares of stock in State Line Hotel, Inc., a Las Vegas hotel and casino, valued at $11,508,400. The total value of Smith’s estate was some $15 million, triggering an estate tax liability of $6.6 million. The liquid assets of the estate were used to pay $4 million of the tax, and the balance was deferred for five years and then was to be paid over ten years.
Under Nevada law the trust could not continue as the owner of the hotel beyond 1993 without going through additional regulatory hoops. Therefore, the trust was dissolved, and the shares were divided among Anna’s four children.
In 1995 the IRS decided that the estate had low-balled the value of the shares in the hotel, and it assessed additional estate taxes of $2.4 million. The estate contested the deficiency, and eventually it settled for an increase in the estate tax due of $240,381.
In 1997, about a week before the first installment of the deferred tax was due, an IRS agent contacted the executors of the estate to suggest “an alternative to your continued personal liability for the unpaid estate tax.” The alternative was to execute a special lien for the estate tax, using the shares in the hotel as security. The four beneficiaries agreed to the arrangement. Shares worth some $6 million (based upon the 1995 settlement) secured the tax debt of some $1.8 million.
However, after the IRS agent submitted the agreement to her manager, she was advised that the IRS would not accept closely held stock as collateral because of potential problems with securities laws. The executors responded, through their lawyers, that any securities laws issues were the IRS’ problem, not theirs.
To cut to the chase, the hotel went bankrupt in 2002, rendering the shares owned by the children worthless—in fact, they took deductions of over $1 million for their losses. That also rendered worthless the collateral that the IRS held for the tax debt.
Next, the IRS filed suit against Anna’s four children to collect the balance of the estate tax due, under trustee, transferee, and beneficiary liability theories. By the time that the lawsuit commenced, two of the children had died. Their estates could have been substituted as parties to the action, but the IRS never made the necessary motions, so the suit against them was dismissed. Ultimately, the beneficiaries prevailed on most of the issues before the Court.
Next the beneficiaries asked the IRS to pay half of their attorney’s fees, specifically fees related to the discharge of fiduciary duties, to the liability of the trustees, and to the attempt to foreclose the tax lien. The District Court concluded that the government’s position on these issues was not substantially justified, and it awarded the estate fees totaling $316,206.
Of course we hope that you and your beneficiaries never experience bankruptcy. However, this situation does highlight the value of having a trust. We at The Trust Company of Kansas want to help ensure that disputes over estate taxes are avoided in any circumstance, and that your wishes for your estate are carried out upon your death.
THE TRUST COMPANY OF KANSAS ABIDES BY A SIMPLE PHILOSOPHY: MINIMIZE BURDEN, BESTOW FREEDOM.
As our longtime partners will tell you, we help our clients accomplish their goals, not our own. And we stay focused on the financial aspects of their lives so that they can stay focused on their priorities.
Our goal is to build a legacy by helping you protect yours. And we ensure that you meet your goals by closely monitoring your assets, so that you may continue enjoying a lifestyle to which you’ve become accustomed.
The officers at The Trust Company of Kansas are always willing to discuss your goals for your estate and help you to create a plan that is well-aligned with your wishes. If you have a specific question about wealth management or trusts, please contact us at (800) 530-5254 or visit tckansas.com/contactus, and one of our Certified Trust and Financial Advisors will be happy to assist you.