The Legal Play Hap May

Most employers understand that the US government expects them to collect employment and excise taxes from their employees’ pay, and that this withholding is to be paid over to the IRS. It can be tempting to use this money towards other business expenses, but employers should resist the impulse. Not all employers realize the impact of unpaid employment trust and how that relates to personal liability. The fact of the matter is if the employment trust isn’t paid, managers can be held personally liable to the IRS.





How Unpaid Employment Trusts Can Affect Personal Liability

The impact of unpaid employment trusts can be enormous for individuals. Despite the expectation that a business filing bankruptcy will extinguish all debts, including to the IRS, this is not the case. And even if the business itself has gone bankrupt and cannot pay employment trust liability, the IRS will find someone to hold personally liable for that debt. Much of this standard was set by the case of Begier vs the IRS from 1990. While it is a bit of an older case, it still sets the precedent and is very much applicable today.



However, before we break the case down, it is important to establish a couple of talking points first:



* Trust fund taxes are essentially employment withholding taxes due to the Internal Revenue Service.

* Employers pay their employees but hold some money out of those payments to pay the government taxes such as FICA, Social Security, and Medicare. This is called an employment trust. (Contrary to popular believe, a trust is not just something established by a person in the event of their death or incapacitation.) At its root, the definition of trust means having someone hold onto something for the benefit of another.



Now, back to Begier vs the IRS. In this situation, American International Airlines fell behind in paying its employment trust fund taxes, which the Internal Revenue Service was aware of. It was not a small sum by any standard. The airline eventually filed for Chapter 11 bankruptcy. For the first 90 days of the bankruptcy, they acted as a debtor in possession and, during that time, decided to reconcile the trust fund money they owed to the IRS. After 90 days, the court appointed a trustee to come in and take over for existing management.



When the appointed trustee found out about the large sum of money the airline had paid to the Internal Revenue Service when there were many debts still owed to other airline creditors, the trustee sued the IRS to attempt to recover the money. The argument the trustee made was that the IRS was no more superior to other creditors and thus should not get priority over available funds.



The court in Begier held that the money held in trust was never the airline’s money to begin with. So when they went into bankruptcy, those employment trust funds were not part of the “debtor’s estate.” The trustee was not able to recover those funds



But the bigger question is why the airline managers decided to pay off employment trust taxes rather than pay off some of the other airline creditors, especially knowing that some of the other debts were just as large, if not larger, than the IRS debt. While the intentions of the managers cannot be known exactly, it is very likely that they understood that if that particular debt was not paid before the company had no money left, that debt would not be extinguished in the bankruptcy and the human individuals responsible for running the business would be held personally liable for those debts for years to come.



This is important, so we will repeat it again: business managers who are signatories on the company bank account and the people responsible for signing the checks to the IRS, known as “responsible parties” ,

This edition of the Legal Play includes special guest Judge Georgia L. Akers. In her legal career of 30+ years, Judge Akers has served as an attorney and as an associate probate judge. She spent more than a decade presiding as an associate judge over Harris County Probate Court No. 3 and, in that time, she learned and experienced many things from behind the bench. In addition to her work in probate court, Judge Akers also teaches estate administration at the University of Houston Law Center. There, she instructs students in the practical application of probate law in Texas, specifically concerning how estates are administered. Today, Judge Akers will share some of those valuable insights.





What Does an Associate Probate Judge Do?

An associate probate judge is empowered to perform any role that a probate judge would perform. The primary difference is that an associate judge doesn’t run for office - they are appointed by the judge to assist the court in any area necessary.



In the case of Judge Akers, she was in charge of hearing the will docket, guardianship docket and heirship docket. She would also preside over trials assigned to her by the probate judge.



“These were trials that needed a lot of patience and time,” according to Judge Akers.



Probate courts are intended only for probate cases. At Harris County Probate Court No. 3, the judges primarily hear wills, trusts, guardianships, and civil mental health documents.



“When someone dies, the will has to be probated, or there has to be some action taken in order to manage the estate. It is up to the probate court to hear those matters, rule on those matters, and name an appropriate person to serve.”



In the Texas Statutes Probate Code, any matters incident to probating an estate are also heard in probate court, which can expand the scope of the case.



“That gives us a lot of leeway to hear divorce cases in a situation with a guardianship, or a personal injury lawsuit, or a contract dispute if it’s involved in a decedent’s estate.”



According to Judge Akers, it’s a matter of convenience and efficiency, as it doesn’t make sense to split the details of the probate case among multiple courts.

What Makes Probate Court Cases Unique?

The documents used to develop a probate case - a will, for example - often have flaws that interfere with how the estate is managed. Judge Akers’ work as a probate judge often involves reviewing these documents and determining how they can be amended so they can pass through probate. In this way, probate judges and attorneys work closely with the decedent’s family (and other beneficiaries) to start the probate process.



There are other quirks specific to probate cases in Texas, such as:



* Probate cases require detailed, specialized knowledge - Judge Akers frequently receives communication from other attorneys concerning probate questions. If you don’t practice it, it can be difficult to intuit probate law, even for experienced attorneys. Fortunately, Texas has a robust estates code that provides solutions to just about any issue.“If there’s a problem with the will, there is some place in the estates code that will fix it, or at least get it into probate,” Akers observed.



It was also common for Judge Akers to support the attorney while questioning the witness, asking the witness questions that may have been missed. This would be unusual in other areas of law.



 

* Probate cases can involve unusual assets or will-related provisions - You never know what you’ll get from an estate case, and Judge Akers has presided over some that have involved unique assets. For example, her court oversaw the case of Dr. Michael DeBakey’s estate, a brilliant cardiovascular surgeon who had more than a dozen patents for surgical instruments to h...

1031 like-kind exchanges are a tax provision dictated by section 1031 of the Internal Revenue Code. They are used to defer taxes on capital gains resulting from a sale of real property, and therefore are an option for taxpayers who want to reinvest their funds into a different property.



Although 1031 exchanges are mostly straightforward, there are rules and deadlines to observe during the process. Failing to observe these rules may result in an expensive tax bill (and penalties). So, before engaging in a 1031 exchange, it is recommended that investors consult with a knowledgeable tax attorney first.





How a 1031 Like-Kind Exchange Works - a Small Business Example

1031 exchanges are generally reserved for investment purposes - a rule cemented by the 2017 Tax Cuts and Jobs Act (TCJA). Prior to the TCJA, tax paying entities could swap out some types of personal property (such as equipment), but 1031 exchanges are now confined to real estate property exchanges only.



For example, a small business owner - let’s say an auto dealership owner - decides that his current location is no longer suitable for his current needs, or perhaps the value of his current property has skyrocketed. Being a savvy investor, he starts looking for another location that might serve his auto dealership better and prepares to sell his current property. After a brief search, he finds an excellent location in a nearby suburb.



Economically, it’s better for everyone - the business owner, the real estate companies, the local community and the IRS - for this transaction to go ahead. It drives additional economic activity and produces additional tax revenue. However, by selling his current property, the auto dealership owner must pay capital gains taxes from the  proceeds of the sale.



To prevent taxes from blocking important economic activity, the IRS allows investors to switch out one like-kind property for another and defer capital gains taxes in the process. This is the tax-led philosophy behind allowing 1031 like-kind exchanges.



In this example, the auto dealership owner opts for a 1031 exchange to essentially move his business to a better location, using the funds generated from the initial property’s sale to acquire the new property. Any capital gains taxes generated from the sale are deferred, perhaps indefinitely.



This is a general overview of 1031 exchanges. In practice, there are several moving parts during the 1031 exchange process that taxpayers must manage to successfully see the process through.

The 1031 Like-Kind Exchange Process

If you and your tax attorney agree that a 1031 exchange makes sense for your current tax needs, here is what the process typically looks like:



* Determine which properties to exchange - First, you’ll need a pair of real properties to exchange. They must be “like-kind,” though the IRS’s definition in this area is broad. As long as both properties are investment properties, a 1031 is acceptable in most cases. Taxpayers can exchange an apartment complex for an industrial center, for example.

* Identify an intermediary (middleman) to facilitate the transaction - 1031 exchanges are automatically invalidated if the taxpayer accesses the proceeds from the sale at any point. Once the initial property is sold, the proceeds must be given to an intermediary that holds the funds in escrow. Those funds are used to facilitate the purchase of a new property. There are dedicated exchange facilitators who can serve in this role for investors.

* Make the exchange - From the date that the initial property is sold, you have 45 days to identify up to three potential exchange properties. These must be identified in writing and given to the intermediary. There’s a second deadline. From the date of sale,

For those who have never experienced an IRS audit, your only exposure to the process may be the brief portrayal in TV shows and movies where someone, or a team of people, wearing bland neutral suits shows up at your workplace and declares, “You’re being audited. Show us your books.” The reality of real-life audits is a bit different. If you’re being audited by the IRS, your first notification will likely come through the mail. The dreaded tax letter will be sent to the address on file with the agency, which means if you’ve moved without informing the government, it could be sent to a previous address. Whether it’s sent to the right address or not, the IRS will proceed with the audit, assessment, and collection process.



If you have received a tax letter from the IRS, a tax attorney can provide representation to the agency and guidance to their client on how to proceed.





You’ve Received Notice, but is it an Assessment or a Full-scale Audit?

 Increasingly, the IRS is sending out letters notifying taxpayers of an assessment rather than a full-scale audit. These assessments tend to be income adjustments that the IRS makes on their end due to information they’ve received from reporting agencies. In the letter, the IRS will explain the amount of taxes they believe is correct, with a possible explanation as to why, and then there will be an explanation of your rights to protest this change and the procedure to follow. When a taxpayer receives an assessment letter, they may respond and take steps to protest or appeal the decision. Otherwise, if the taxpayer does not respond, the IRS will move forward with collection. If the taxpayer has underpaid, notices that follow will inform the taxpayer how much is owed.



If the IRS has determined a full audit is necessary, the agency will notify the taxpayer that an audit is underway and that an assessment may be forthcoming. In the past, the IRS would often show up at the taxpayer’s place of residence or business to acquire documentation. Since the COVID pandemic, this part of the process is now largely done online and via telephone.

 Audit, Assessment, Collections: The Three-stage Notification Process

 It generally takes several months to complete an audit, and the taxpayer will be notified by mail throughout the process. Typically, the IRS will communicate with the taxpayer through the audit, assessment, and collection process, and typically looks like the following:



* Audit - The first piece of mail from the IRS will either be notification of an audit or of an assessment. If it’s an audit, the letter will notify the taxpayer that their tax situation is being reviewed. Requests for financial documentation will likely be forthcoming.

* Assessment - Once the audit is underway, or after it’s complete, the IRS will send a letter with an assessment in it. This assessment is the IRS’s official stance on the taxpayer’s position, specifying whether income or deductions are to be adjusted, and whether this will require the taxpayer to remit additional taxes. Following an assessment, the taxpayer will have a brief window where they may contest the IRS’s conclusions.

* Collections - If an assessment is made and moved forward, the taxpayer will receive a collections letter requesting payment.



A tax attorney can provide assistance at any point during this communication. For example, an attorney can help with acquiring or interpreting financial documentation. They can also push back against the IRS’s assessment, arguing on behalf of their taxpayer client and attempting to have the assessment thrown out.

 How Does the IRS Determine Who to Audit? 

The IRS audits one out of every 500-1,000 tax returns a year, and it uses a handful of strategies to determine who to audit, including:



* Random selection - A large part of the IRS’s selection cri...

When a business owner suddenly passes away, it raises the following questions about the company's future:



* Will the business continue to exist, and in what form?

* Who will oversee the business's affairs and decision making?

* How will clients and employees be retained?

* How can the business be guided through management and ownership uncertainty?



If a business owner dies with a will and succession plan, preserving the business may be as simple as pivoting to the next in line, whether that's a vice president, a partner, or a family member who has an interest in the organization.



This guide is for those instances when a business owner dies without a clear transition plan in place. If this is the case, you'll need to act fast to ensure the business can be preserved.





When a Business Owner Dies It Is Important to Act Quickly

Whether the business will be captained by someone else or liquidated, it's important for everyone involved to move quickly. Why? There are a few reasons, including:



* Client and customer retention - When a business owner dies, the resulting uncertainty may compel clients to terminate their relationship with the company and seek services through a competitor. By sorting through the company's affairs quickly, you will maintain confidence among existing clients.

* Employee retention - A business owner's death can create a great deal of uncertainty among employees. If the company's operations are sidetracked, it will also sidetrack payroll and benefits. The longer this goes on, the harder it will be to retain essential people. By implementing employee retention measures right away, you can prevent extended downtime due to labor shortfalls.

* Equipment and facility upkeep - Retaining customers and employees are the pressing matters, but some businesses also rely on equipment, which may deteriorate without constant upkeep. When a business owner dies, these assets will decline in value and condition if new ownership doesn't act promptly.



If the business and its assets are to be sold off, any heirs and partners will want to maximize the company's value. If the business is to be preserved and operated by a new person, retaining as much of its value as possible is also the priority. In both cases, you'll need to move quickly to keep the company intact.

First, Determine the Nature of the Business and Who Has an Interest in It

Whether the plan is to liquidate the business or continue operating it, the first thing to do is to determine what kind of entity the business is, and who has an interest in it.



Regarding the first point, business entities may be classified as a sole proprietorship, a partnership, or a corporation. If the business was a sole proprietorship, there may be no succession plan, or anyone empowered to step into the decedent's role.



If the business was a partnership or a corporation, you have some options. For instance, if the business was a general partnership, then another partner may be able to assume management duties and ensure there is no interruption in production or operation. If the entity was a corporation, shareholders may be able to quickly appoint a new head if the bylaws allow for it.



Once the entity's classification is clear, you'll need to speak to family members and employees to determine who has an interest in the business. It's important to establish early on who is interested in running the business and who wants to liquidate its assets. If there are disagreements, it's highly recommended that any heirs or beneficiaries bring in an attorney to mediate the process.

If No One Is In Charge of the Business,

When an individual passes away, it falls to those left behind to determine what happens with any property and assets that individual possessed during their lifetime. The process of finding all the property and assets can be extremely complex, depending on what the property is and where it is kept. It’s relatively simple to find things like a house and a car, as those are large, tangible items. But in many cases, a person’s wealth that may be passed to beneficiaries and heirs can be difficult to locate, especially if the assets are intangible items such as investment accounts and partnership interest. Often, the breadth and nature of an individual’s property and assets hasn't been communicated to any loved ones. This makes it far more difficult to locate some of the following assets:



* Bank accounts

* Brokerage accounts

* Property titles

* Insurance policies

* Interest holdings in partnerships or corporations



Records of these assets, and the ability to access them, are necessary to complete probate and ensure all heirs and beneficiaries receive their share.





Who is Authorized to Access a Decedent’s Assets?

Although family members may perform a basic database search following the estate owner’s death, they will find it difficult to get information about, let alone access to certain things like retirement or bank accounts. If the decedent planned ahead, they may have named a third-party to be able to ask questions or access the account in the event of an emergency or their death. But if no other party has been given the authority to access that information, most financial institutions will require letters testamentary or court orders to release information. Often it falls to the estate's executor to access those assets. Also termed an administrator, executors are empowered either by the decedent or by the courts to manage the decedent's affairs following death.



A probate case concerning the estate will need to be opened before an administrator - independent or dependent - can start accessing assets.



An independent administrator is named in the decedent's will and has broad powers in discovering and managing a decedent's assets. A dependent administrator is designated by the court if no one is specified in the will. Dependent administrators are limited in comparison to independent executors and must receive court authorization before they can access or make any decisions regarding the estate's assets.

 Leaving Assets Behind? Create and Leave a Will 

If you know you'll be leaving behind considerable wealth, invest a small amount of time into creating a will. Though it is fairly simple to create one, it is recommended to have an estate planning attorney help with this. (We are currently working with a client where the decedent used a software program to create her will, and there are lots of problems with it that have caused the client to hire our firm to resolve.) Once you have created your will, put it in a place where loved ones can easily find it. Make sure an executor has been named. Your will should also include a general summary of the estate's assets and where they can be found. This information will be valuable when it's time for your executor to gather property for probate.

Where Can an Executor Search for a Decedent’s Assets?

If no estate planning documents are available to provide an inventory and location of assets, the only option is to begin a thorough search that may include the following:



* Searching the decedent's home for documentation - The first step in every asset search is surveying the decedent's home for any helpful documentation.