WisBar News: Recipient of pay-on-death account funds not liable for estate taxes, supreme court holds:

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    Recipient of pay-on-death account funds not liable for estate taxes, supreme court holds

    Joe Forward
    Legal Writer

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    May 7, 2010 – Under federal and state tax law, the recipient of a pay-on-death (P.O.D.) account is not required to reimburse the decedent’s estate for taxes paid, the Wisconsin Supreme Court recently held.

    In Estate of Sheppard v. Schleis, 2009AP1021 (May 4, 2010), the supreme court – in an opinion by Chief Justice Shirley S. Abrahamson − applied federal and state tax law to affirm the Circuit Court for Washington County, which granted summary judgment to the recipient of P.O.D. accounts totaling approximately $3.8 million.

    Facts of the case

    Prior to his death on July 2, 2007, James F. Sheppard established two P.O.D. accounts naming his minor goddaughter, Jessica Schleis (Jessica), as the recipient. At death, the P.O.D. accounts were valued at $3.8 million. Sheppard died without a will.

    Jessica’s parents signed an “Estate Tax Withholding” agreement that kept 50 percent of the P.O.D. account balance on deposit for the purpose of paying “required estate taxes.”

    However, the Schleises withdrew the full balance on advice from Jessica’s guardian ad litem, who advised the Schleis family that Jessica was not responsible for federal or state estate taxes. Sheppard’s estate (the estate) disagreed. Suit followed.

    The circuit court granted summary judgment to the Schleis family. The supreme court granted a petition to bypass the appeals court. The issues and the court’s analysis follow.

    Issue: Does the Internal Revenue Code provide a decedent’s estate with a right to recover a portion of federal estate taxes from the recipient of a P.O.D. account?

    The court explained that 26 U.S.C. Section 2002 requires a decedent’s estate to pay federal estate taxes whether attributable to probate or non-probate property.

    In other words, it does not matter that a portion of the federal estate tax due is generated by property that passed through a nonprobate transfer, unless an exception applies.

    The estate invoked an exception (section 2207B) that gives a proportionate right of recovery for taxes paid on property that was included in the decedent’s gross estate by reason of section 2036 – lifetime transfers where decedent retains an interest in the property transferred.

    Under Wisconsin law governing P.O.D. accounts, the court concluded, the creation of a P.O.D. account does not amount to a lifetime transfer. That is, the recipient’s property interest in the P.O.D. account transfers upon the death of the decedent, not during decedent’s lifetime. In addition, creation of a P.O.D. account does not transfer a remainder interest upon creation, because “the recipient has only the potential expectancy of receiving the proceeds if the depositor makes no changes” to the account before death.

    Thus, creation of the P.O.D. account did not fall within the meaning of a “transfer” under section 2036, and the section 2077B exception does not apply, the court held.

    Issue: Must a recipient of a P.O.D. account reimburse an estate for a portion of the Wisconsin estate taxes attributable to the P.O.D. account when decedent dies intestate?

    Following FirstarTrust Co. v. First National Bank of Kenosha, 197 Wis. 2d 484, 541 N.W.2d 467 (1995), the court concluded that “the residue of the estate pays the Wisconsin estate taxes attributable to nonprobate property in the absence of clear directions from the testator providing otherwise.” But Sheppard left no will and no clear directions.

    Issue: Does a common-law rule of limited equitable apportionment exist, requiring a recipient of a P.O.D. account to reimburse an estate for federal and state estate taxes?

    In the absence of effectively specified language from the decedent, state statutes usually determine how to apportion federal and state estate taxes among beneficiaries of non-probate assets, the court said. Wisconsin does not have an apportionment statute.

    The estate asked the circuit court to adopt an apportionment rule, which it refused to do, stating “that is the province of the Supreme Court.”

    After examining three Wisconsin cases that discuss an equitable apportionment rule, the Supreme Court declined to recognize one in this case, stating: “The precedent is clear: 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 this “residuary rule,” the court stated, is that a decedent usually intends nonprobate transfers “to be free from the burdens imposed on the probate estate.”

    Does an agreement signed by parents of a minor recipient of a P.O.D. account impose reimbursement liability on the parents or the minor to reimburse the estate?

    Finally, the Court determined that an “Estate Tax Withholding Agreement” signed by the recipient’s parents, which kept 50% of the account balance to remain on deposit “for the purpose of paying required estate taxes” did not obligate the Schleis family to pay estate taxes because they were not required to pay them, the court held.

    The court concluded: “This two-sentence document cannot be interpreted to create an independent obligation on the part of the Schleises to pay a share of estate taxes that neither they nor their daughter owed.”

    By Joe Forward, Legal Writer, State Bar of Wisconsin