Death and taxes – risk of personal liability for executors

Background

A legal personal representative (LPR) is the person responsible for attending to all tasks required to administer the estate of a deceased person. An LPR has a wide range of duties and must take care to comply with the terms of the will (if applicable) and the relevant legislation when carrying out those duties.

One aspect LPRs sometimes overlook or underestimate is their duty to finalise the tax affairs of the deceased and the estate. If an LPR does not carry out their duties properly in this regard, they run the risk of becoming personally liable for the payment of tax liabilities.

Appointment and duties of an LPR

An LPR is usually appointed by being named as executor under the deceased’s will. However, if the executor named in the will is unable or unwilling to act or if there is no will (i.e. if the deceased died intestate), an LPR is appointed as administrator under a grant of letters of administration issued by the Supreme Court.

Whether the appointment arises under a will or a grant of letters of administration, the LPR has a wide range of duties to carry out during the estate administration. While many of those duties may appear to be straightforward, the LPR must ensure they comply with the terms of the will (if applicable) and the relevant legislation to avoid the risk of personal liability if something goes wrong during the estate administration.

The finalisation of the tax affairs is often one of the last matters attended to in an estate administration, so it is important for an LPR to obtain legal and accounting advice at an early stage to avoid overlooking tax issues. A failure to do so could result in the LPR becoming personally liable for the tax liabilities of the deceased and/or the estate.

LPR’s tax responsibilities

An LPR’s responsibilities in respect of the deceased’s individual tax affairs include:

1. notifying the Australian Taxation Office (ATO) of the deceased’s death;
2. arranging for any outstanding tax returns of the deceased to be prepared and lodged with the ATO;
3. arranging for a final tax return (also known as a “date of death return”, which covers the period from 1 July to the date of death) for the deceased to be prepared and lodged with the ATO; and
4. attending to the payment of any tax liabilities.

An LPR’s responsibilities may be more extensive if the deceased’s financial affairs were more complex, e.g. if the deceased was involved with companies or trusts, operated a business or was the trustee or member of a self-managed superannuation fund (SMSF).

LPRs should also be aware the estate’s tax affairs are different from the deceased’s individual tax affairs – i.e. the estate is a separate taxpayer. The estate is treated as a trust for tax purposes and so the LPR’s responsibilities may include:

1. obtaining a tax file number for the estate (the deceased’s individual tax file number cannot be used);
2. arranging for tax returns to be prepared and lodged with the ATO; and
3. attending to the payment of any tax liabilities.

Risk of personal liability

As mentioned, the finalisation of the tax affairs is often one of the last matters an LPR attends to in the estate administration.

It can take quite some time for an LPR to gather information and documents required to finalise the deceased’s individual tax affairs, particularly if the deceased had a number of outstanding tax returns, did not use an accountant and/or did not leave clear records and paperwork.

The separate tax affairs of the estate also cannot be finalised until all estate assets have been collected and all estate liabilities have been paid or provided for. Depending on the nature of the estate assets and how they are dealt with during the estate administration, there is potential for substantial tax liabilities to arise.  For example:

1. capital gains tax (CGT) may be payable if real property held by the deceased is sold by the LPR in the estate;
2. capital gains tax may be payable if shares held by the deceased are sold by the LPR in the estate; and
3. income tax may be payable on superannuation death benefits paid to the LPR.

Tax liabilities arise under a notice of assessment issued by the ATO, but the ATO can also review and issue an amended notice of assessment up to four years from the date of the initial assessment. If an LPR wanted to avoid any risk of personal liability for tax liabilities, they might seek to delay distributing the estate assets until the review period had elapsed.

In the meantime, beneficiaries are often very eager to receive the cash, real property, shares and other assets sitting in the estate and so the prospect of waiting up to four years to receive their inheritance is unlikely to be palatable. Beneficiaries might instead ask (or pressure) the LPR to distribute assets to them before the estate administration is complete.  An LPR should act cautiously and conservatively in deciding whether it is appropriate and safe in the circumstances to do so.

If an LPR decides to make an interim distribution to the beneficiaries without taking proper advice, they could underestimate the tax position and not retain adequate funds to cover the tax liabilities. The LPR would then need to request the beneficiaries return funds to the estate to meet the tax liabilities, however, the beneficiaries may not be obliged to and so the LPR could be left with a shortfall.

In circumstances where an LPR distributes estate assets before the tax affairs have been finalised and/or with notice of a claim by the ATO, they may be personally liable to pay the tax liabilities of the deceased and/or the estate. It should be noted that any potential personal liability of an LPR for tax liabilities is capped at the value of the deceased’s assets the LPR collects into the estate – i.e. the LPR will not be liable for any amount over and above the value of the estate assets.

ATO Guideline

The ATO issued a Practical Compliance Guideline PCG2018/4 (Guideline) to enable LPRs of more straightforward estates to be able to finalise the estate administration without the fear of having to pay any potential liabilities personally if they distribute the estate assets within the ATO’s review period. It is important to note the Guideline does not apply to the separate tax affairs of the estate – it only applies in respect of the deceased’s individual tax affairs.

The Guideline only applies in certain circumstances, including where:

1. the LPR has obtained a grant of probate of the will or a grant of letters of administration from the Court;
2. in the 4 years prior to their death, the deceased:
   1. did not carry on a business;
   2. did not receive assessable distributions from a discretionary trust; and
   3. was not a member of an SMSF; and
3. the estate assets:
   1. comprise only cash, personal assets, real property in Australia, shares in public companies or other widely-held entities and superannuation death benefits;
   2. had a total market value of less than $5 million at the date of death;
   3. are not intended to pass to any foreign resident, tax-exempt entity or superannuation entity.

An LPR is considered by the ATO to have notice of any tax liabilities of the deceased at the date of their death – whether the liabilities arose in respect of tax returns lodged before or after the deceased’s death.

Under the Guideline, an LPR will be treated as having no notice of any further claim by the ATO if the LPR:

1. ensures all tax liabilities owing at the deceased’s date of death have been paid;
2. acts reasonably to lodge all outstanding tax returns for the deceased;
3. does not have notice of any irregularities with any tax returns lodged by or on behalf of the deceased; and
4. waits 6 months from the date of lodging the final tax return and does not receive notice from the ATO that it intends to review the deceased’s individual tax affairs.

However, in the event estate assets are discovered and collected by the LPR after the finalisation of the estate administration, the LPR’s duties under the Guideline continue and the LPR must determine whether those further assets impact the tax returns previously lodged for the deceased.

Other options for LPRs

An LPR acting in an estate that does not meet the Guideline’s criteria will have an ongoing risk of personal liability for the deceased’s individual tax liabilities. In such circumstances, an LPR may consider:

1. deferring a distribution of the estate assets until the ATO’s review period has elapsed (noting this unlikely to be well-received by the beneficiaries);
2. obtaining accounting and taxation advice as to the potential tax liabilities of the deceased and retaining a generous buffer in the estate when making an interim distribution to the beneficiaries; and
3. distributing estate assets to the beneficiaries on the basis the beneficiaries provide the LPR with an indemnity in respect of any tax liabilities of the deceased over and above the amount retained in the estate by the LPR.

Conclusion

An LPR’s duties in respect of the tax affairs of the deceased and the estate can be extensive and should not be treated as a mere formality.

It is imperative for an LPR to obtain appropriate accounting and taxation advice at an early stage of the estate administration or, at the very least, before deciding whether to make an interim distribution of the estate assets. This will assist the LPR to make informed decisions regarding the distribution of estate assets and reduce the LPR’s risk of personal liability for the payment of tax liabilities.