"Interpleader" and taxation on 1041

[WhiteOleander]

Our client is the executor of an estate. When the lady passed away, the will stated that her nephew (not our client) was the beneficiary. However, the nephew had pre-deceased the aunt and she did not change the will. The nephew had three children. One is of unknown whereabouts. All of this is tied up in the court. There was some real estate in the estate that has been sold and there will be capital gains.

Our client wants to get this finished and have it out of his hands. He was advised that he could put the funds into an escrow account of the court and an interpleader would be responsible until the court can find a way to settle eveything. (he has been told it might be years years). So.... the problem I am trying to research is the court has said to transfer the entire gross receipts from the sale because it is not subject to tax at this point. I disagree with this. I believe the IRS will say that the net after taxes is what can be tranferred. Someone is going to pay taxes on this money!!

Below is an email that gives some more detail. Indentifying info has been changed.
Has anyone dealt with this before?

************************************************** *
Mr Client called me last nite, and said the Judge told his lawyer he could do an "interpleader" and basically give the court the 400,000 to put in escrow until an administrator is appointed for the 3 kids. Their dad died without a will. The attorney said that the judge said Mr. Client would not have to pay income tax on the gain in 2013. It was sold by the estate and is reported in their ein number, about a 300,000 gain. We cannot k1 the kids to pass thru the gain, as there is no will and that will have to be adjudicated. I do not believe that information is correct, that the estate does not have to pay tax on the gain. The money may be held for years by the county court, and they will not pay tax on it, and if distributed, will pass without a long term capital gain, ie would not be taxable to the recepients.

Mr Client is coming in Tues for us to do a rough 1041 so he will know how much tax to set aside. His feeling is, that
if the estate has to pay on the gain, he is keeping the money until he gets papers from an administrator that dictates there is another estate that gets the money. Mr Client is the executor for his aunts estate. The aunt left this money to a nephew, who died. One kid cannot be found, is out in California.

The last question, if the 1041 has to pay on the capital gain, can he hold out the one hundred thousand income tax from the 400,000 that the will says they have coming? Thats all the cash left to liquidate.
************************************************** ***********
Thanks

[Burke]

I have a similar estate pending right now. 4 properties have been sold and all the proceeds have been paid into an attorney's escrow account until it is adjudicated as to who is getting what. This was ordered by the court due to lawsuits filed against the estate. All these sales were reported on the 1041; however, in my case there was no net gain after expenses (3 losses/1 gain) using FMV at date of death so the estate was not impacted. A $300K gain for inherited property seems extremely high. Was it appraised properly? Did they use tax assessment values? How soon was the property sold? The sales would be reported on the tax year of the sales so you would know exactly what the tax is. He would only transfer the net proceeds after all taxes have been paid. Are there other funds? Tell your client not to be in too big a hurry to get out of this responsibility. He does not want to incur personal liabilities for acting too fast. He should be getting paid an executor's fee. Did he have to post bond?

[John of PA]

Why not just file a 1041 and pay the tax at the Estate level to solve the tax issue and get all tax filings done. The tax may not be that much higher (than passing through on K-1's to whoever the court decides is the beneficiaries) becasue of the 20% maximum on capital gains.

[WhiteOleander]

Thanks Burke for your input.

John, that's what we want to do. But, it appears the judge wants ALL sale proceeds before paying the tax. I can't find any way to do that. I was thinking that perhaps there was an election the estate could make I wasn't aware of.

Maybe the judge needs some "schoolin' "

[Burke]

The sales proceeds have to be reported by the estate in the (tax) year of sale. If no distributions have been made to the bene's,the estate has to pay the tax! So the federal and state taxes need to be withheld from the proceeds before transfer, unless there are sufficient monies elsewhere to take care of this debt plus the remaining expenses of the estate. Perhaps if you produce the tax return with the amt of tax due and present it to the judge, it would help him understand this. I would still question the actual valuation on this property. How long has it been since the deceased's death?

[WhiteOleander]

Thanks Burke, Your thoughts are exactly how we plan to proceed. And, yes we are sure of the valuation. This has been going on since 2006. We have appraised values.

Appreciate your input.

[Burke]

After re-reading your OP on this, it appears there is nothing else left to do in the estate, so you should be able to do a final 1041, closing out the estate with an early date perhaps? Good luck on this and I hope your client/executor got compensated for it!

[mscash]

Michael S Cash, EA

Was the now deceased nephew left the house in the will or was he designated as the beneficiary of the estate? If the latter, then the estate should sell the house and pay fiduciary income tax on any profit and the two available children of the benificiary could get their share with the missing ones held back for some other kind of disposition.