Federal Tax Debt: Important Things to Know Before Paying Creditors
Serving as the Personal Representative of an estate involves more than collecting assets and paying bills. One of the most important responsibilities is making sure that creditors are paid in the proper order. That becomes especially important when the deceased person may have owed federal taxes. Under federal law, a Personal Representative can potentially become personally responsible if estate assets are distributed to other creditors or beneficiaries before certain debts owed to the United States are paid.
The Federal Priority Statute
The key law is 31 U.S.C. § 3713, commonly known as the Federal Priority Statute. In general, when an estate does not have enough money to pay all of its debts, claims owed to the United States may be entitled to priority over many other debts. This can include unpaid federal income taxes and other obligations owed to the federal government. The statute is especially important because it does not merely affect the estate. It can potentially affect the Personal Representative individually.
How Can the Personal Representative Become Personally Liable?
Under 31 U.S.C. § 3713(b), a representative of an estate who pays other debts before paying a debt owed to the United States can become personally liable, up to the amount that was improperly paid out. For example, assume an estate has $75,000 in cash and owes:
$40,000 to the IRS;
$30,000 in credit card debt; and
$25,000 to beneficiaries under the Will.
If the Personal Representative distributes the estate funds to the credit card company and beneficiaries before properly addressing the federal tax debt, the government may attempt to recover the unpaid tax from the Personal Representative personally. That is why paying creditors too quickly can create serious problems.
Knowledge of the Tax Debt Matters
Personal liability generally becomes a concern when the Personal Representative knew, or had sufficient information to put the Personal Representative on notice, that the estate or the decedent owed money to the federal government. In other words, the Personal Representative can’t simply bury his or her head in the sand and not inquire about the possibility of outstanding tax debt. The Personal Representative should therefore be cautious if there are signs of possible unpaid taxes, such as:
- missing tax returns
- IRS correspondence
- tax liens
- prior payment plans
- large amounts of unreported income
- a business with unpaid payroll taxes
- prior tax disputes
- incomplete financial records
Ignoring warning signs and proceeding with distributions may create unnecessary personal risk.
Do Not Assume the Tax Return Tells the Entire Story
A Personal Representative should not automatically assume there is no federal tax issue simply because no tax bill is immediately apparent. The estate may need to determine whether: the decedent filed all required prior-year tax returns; a final individual income tax return must be filed; the estate itself must file income tax returns; employment or payroll taxes remain unpaid; an existing IRS balance is outstanding; or the IRS has asserted or may assert additional liability. Where the estate has substantial debt or questionable tax history, these issues should be investigated before significant distributions are made. These issues can be very complicated and it is highly recommended that you retain the assistance of an experienced accountant.
Nevada Priority Rules Still Matter
Nevada probate law establishes its own order for payment of estate expenses and creditor claims. However, Nevada’s probate priority rules must be considered together with applicable federal law. Federal claims can receive special treatment, and a Personal Representative should not assume that compliance with the ordinary Nevada creditor process automatically eliminates federal exposure. This is particularly important when the estate may be insolvent—that is, when there is not enough money to pay every creditor in full.
Be Careful About Paying Lower-Priority Creditors Too Soon
One of the most common mistakes a Personal Representative can make is paying bills as they arrive without first determining the estate’s complete financial condition. A credit card company, medical provider, or other creditor may send repeated notices requesting immediate payment. That does not necessarily mean the claim should be paid immediately.
Before making substantial payments, the Personal Representative should determine: what assets are available; what taxes may be owed; what administration expenses remain; what creditor claims have been filed; which claims have priority; and whether the estate has enough money to pay everyone. If there is any doubt, preserving estate funds until the priority issues are resolved is often safer than distributing them too early.
Beneficiaries Should Also Wait
The same concern applies to distributions to beneficiaries. A beneficiary may be anxious to receive an inheritance, but the Personal Representative should not make distributions until the estate’s obligations have been properly evaluated and court approval is obtained. Once estate funds are distributed, even pursuant to a court order, recovering them may be difficult. If federal taxes later surface, the Personal Representative may be placed in the uncomfortable position of trying to recover money from beneficiaries—or potentially facing personal liability.
The Bottom Line
A Personal Representative is not simply a check writer for the estate. The Personal Representative has a duty to administer the estate carefully and to make sure debts are addressed in the proper order. When federal taxes may be owed, extra caution is required. Under 31 U.S.C. § 3713, paying other creditors or beneficiaries before properly addressing debts owed to the United States can potentially expose the Personal Representative to personal liability. The safest approach is to understand the estate’s complete financial picture before seek court permission to distribute funds.
Drizin Law is providing this information for educational purposes only. It should not be construed as legal advice or a legal opinion as to any specific facts or circumstances. This information is based on general principles of Nevada law at the time it was created and you should be aware laws frequently change. Moreover, the laws affecting you may differ depending on the circumstances. You should consult with a qualified attorney in your own state or jurisdiction concerning your particular situation. Review of this information does not create an attorney-client relationship.
Lee A. Drizin, Esq. is the founder of Drizin Law and has practiced in Las Vegas for over three decades. His work focuses on probate, estate planning, trusts, and guardianship, with particular experience handling contested probate and administration matters. A UNLV graduate with a Master of Laws in Taxation from Boston University, Lee has built his career helping Nevada families navigate some of the most difficult times in their lives.
