Estate liable for taxes on P.O.D. accounts

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The estate, rather than the beneficiary, is liable for estate taxes on nonprobate assets such as Payable on Death (P.O.D.) accounts, unless the decedent directs otherwise.

In a May 5 opinion by the Wisconsin Supreme Court, the court concluded that such an account transfers no property interest during the owner’s lifetime, and therefore, it cannot constitute an incomplete transfer that would make the beneficiary liable for the taxes under federal statutes.

James F. Sheppard died in 2007 without a will, with an estate valued at approximately $12 million. $3.8 million was held in two P.O.D. accounts, designating Jessica Schleis as the recipient.

Schleis was 17 at the time of death, and the money was transferred to her parents as guardians. They signed an agreement agreeing to pay any required estate taxes.

Instead, they withdrew the money and refused to pay the taxes. The estate brought suit, seeking reimbursement. Washington County Circuit Court Judge Patrick J. Faragher ruled in favor of the Schleises, and, in a unanimous opinion by Chief Justice Shirley S. Abrahamson, the Supreme Court affirmed.

26 U.S.C. 2002 sets forth the rule, with exceptions, that the estate is liable for all taxes, whether attributable to probate or nonprobate property. However, sec. 2207B provides an exception if the decedent transferred property but retained an interest in the property during his life.

Michael E. McMorrow, the attorney for the estate, argued that creation of a P.O.D. account transfers a conditionally-vested remainder interest in the property subject to the exception. McMorrow analogized the accounts to a traditional transfer with reservation of a life estate, a transfer which would shift the tax burden to the beneficiary.

But, the court limited the exception to traditional life estates, concluding that a P.O.D. account transfers no property interest during the life of the decedent. The court noted that the decedent need not notify the recipient of the creation of the account, and can close it at any time.

The court reasoned, “A property interest must be transferred during the owner’s lifetime in order for a life estate to be retained. The P.O.D. account does not constitute such a transfer.”

The court next held that the beneficiary is not liable to the estate under the doctrine of limited equitable apportionment.

The court acknowledged that many states require recipients of nonprobate assets to pay their pro rata share of estate taxes, but concluded that Wisconsin precedents reject that doctrine.

Explaining its rationale, the court wrote, “In the absence of a statute or a decedent’s written directions, in Wisconsin the burden of the federal and state estate taxes attributable to probate and nonprobate assets falls on the residue of the estate. The rationale for the ‘residuary rule’ has generally been that the decedent intended property transferred outside probate to be free of the usual burdens imposed on the probate estate.”

The estate argued that the result is unjust, because it imposes an undue burden on the heirs who take through the estate.

But the court disagreed. “There is no equitable basis to impose a constructive trust as a matter of law. James Sheppard could have directed a different result but he did not.”

In an interview, McMorrow noted that the rule only applies when there are no directions in the will. Here, the decedent died intestate, but a will could provide that P.O.D. beneficiaries must pay their pro rata share of estate taxes.

The holding could create an absurd situation in which the estate is unable to pay the taxes. If most of the decedent’s assets are nonprobate assets passing via P.O.D. accounts, theoretically, the taxes they generate could exceed the entire value of the probate assets. In such a case, however, McMorrow said that that federal law provides for joint and several liability on the part of the beneficiaries.

McMorrow said he may seek review in the U.S. Supreme Court.