Estate Tax Collection Case Shows Risks of Installment Plans

What Happened

A federal district court in Kansas granted summary judgment against two brothers who failed to pay federal estate taxes on their father's estate. The case, US v. Karst, illustrates the serious consequences trustees and beneficiaries face when they mismanage estate tax obligations.

The father had created a revocable trust during his lifetime and transferred all his property to it, including interests in closely held businesses. After his death, his two sons served as successor trustees and primary beneficiaries. They filed Form 706 reporting the estate tax liability and elected to pay the portion attributable to closely held business interests in annual installments under Section 6166 of the Internal Revenue Code.

The brothers made several initial installment payments but then stopped paying while distributing the trust assets to themselves as beneficiaries. This triggered acceleration of the entire unpaid tax liability. The IRS sued both brothers personally, seeking to hold them liable for the unpaid estate taxes both as trustees who held the property and as beneficiaries who received it.

What It Means

This case demonstrates critical risks facing New York families with substantial estates, particularly those holding closely held business interests. Under federal law, when an estate qualifies for installment payments under Section 6166, the closely held business must represent more than 35% of the adjusted gross estate. The installment election allows deferral of estate tax payments for up to five years, followed by ten equal annual payments.

However, New York families must understand that New York imposes its own estate tax with an exemption of $7,350,000, separate from the federal estate tax exemption of $15,000,000. This creates dual tax obligations that require careful coordination. The federal installment election does not extend to state estate taxes, meaning New York estate tax remains due within the standard timeframe.

The personal liability aspect proves particularly significant for New York trustees and beneficiaries. Federal law makes recipients of estate property personally liable for unpaid estate taxes up to the value of property received. This liability extends jointly and severally among all recipients, meaning each person can be held responsible for the full amount. In New York, where executors typically must post a surety bond, though wills can waive this requirement, trustees of revocable trusts face similar exposure without bond protection.

Context from SimplyTrust

Estate planning requires careful consideration of both federal and state tax obligations. For New York families with estates approaching or exceeding the state's $7,350,000 exemption threshold, proper planning becomes essential. The Karst case illustrates why trustees must maintain sufficient liquidity to meet tax obligations before distributing assets to beneficiaries.

When creating estate plans involving closely held businesses, families should consider funding mechanisms for tax payments. This might include life insurance policies, business redemption agreements, or maintaining liquid assets within the trust structure. The installment election, while providing cash flow relief, creates ongoing obligations that trustees must manage responsibly throughout the payment period.

Source: Estate Tax Collection: An Illustration of Payment Options, Decisions, and Consequences