If your friend or loved one has passed away and you were named the Executor of their estate, it’s now time to begin the process of settling accounts and making final asset distributions. In the event that an estate has insufficient assets to pay outstanding debts of the decedent, the Pennsylvania Probate, Estates and Fiduciaries Code (PEF Code) sets out the order in which such debts must be paid. So, when you are dealing with payments to creditors, family members, state agencies and especially government entities like the IRS, who gets paid first? Read on to learn more about the PA probate process.
Naturally many people would prioritize U.S. government agencies over others in terms of debt payment. What if you are the Executor of an estate which has insufficient funds to settle all accounts? According to PA Probate Statute § 3392, payments must be made in the following order:
While federal tax liens are not specifically enumerated in the above hierarchy, § 3392 is specifically “subject to any preference given by law to claims of the United States.” However, federal statutes governing the federal government’s priority over claims and judgements may seem conflicting at first impression.
In general, the “Supremacy Clause” of the U.S. Constitution dictates that federal laws take precedence over state laws and constitutions. This federal priority is further codified in 31 U.S.C.A. § 3713 (a)(1)(B) which states that “a claim of the United States Government shall be paid first when…the estate of a deceased debtor, in the custody of the executor or administrator, is not enough to pay all debts of the debtor.”
However, the Federal Tax Lien Act of 1966, 26 U.S.C. § 6323, enumerates several exceptions for when a federal tax lien is invalid against other specific judgment liens or creditors.
United States v. Estate of Romani is the key case in which the Supreme Court harmonized the seemingly conflicting federal priority statute with the Federal Tax Lien Act. In Romani, the federal government opposed the administrator’s transfer of real property to the decedent’s creditor by arguing that the federal priority statute governed, and in turn placed higher priority to, the decedent’s tax liens. The creditor had “perfected” their lien by recording it against the real property prior to the government’s issuance of the Notice of Lien.
The Court held that by the explicit terms of § 6323, the government’s tax liens were invalid against an earlier recorded judgment lien. Analyzing the history of the priority statute as well as the policy objectives of the Tax Lien Act, the Court further stated that “nothing in the federal priority statute’s text or its long history justifies the conclusion that it authorizes the equivalent of a secret lien as a substitute for the expressly authorized tax lien that the Tax Lien Act declares “shall not be valid” in a case of this kind.” 523 U.S. 517, 518 (1998).
Further, the court stated that the Tax Lien Act is the latter, more specific statute which reflects “Congress’ judgment as to when the government’s claims for taxes should yield to many sorts of interests” in order ameliorate the harsh consequence of the priority rule on other secured creditors. As such, judgment liens recorded prior to the government’s filing of a Notice of Lien, are governed by §6323 of the Tax Lien Act and will have a higher priority claim over federal tax liens.
Many state courts have issued rulings interpreting the Tax Lien Act’s application to other classes of claims. These rulings have also been adopted by the IRS Internal Revenue Manual which provides a comprehensive guide to the federal lien priority statutes. As set forth in the manual, the excepted classes of claims which can be paid before a tax lien include reasonable administrative and funeral expenses, as well as family exemptions and/or allowances.
Reasonable administrative and funeral expenses are permitted to be paid prior to federal liens as they are “incurred for the general welfare of creditors.” IRM 126.96.36.199. These expenses include court costs and filing fees, reasonable fiduciary and attorney fees, and expenses incurred to collect and preserve the estate assets.
Similar to Pennsylvania’s PEF code, many states provide for a payment of a “family exemption” to the surviving spouse or other family members who resided in the same household as the decedent for a period of one year prior to their death. Such payments have been held to not be “debts” subject to federal priority and are in turn deducted from the gross estate prior to any payment of judgment liens.
In light of these exceptions, Executors navigating the PA probate process must take great care and seek proper legal advice of counsel with regard to payment of a decedent’s debts. Especially when involving an insolvent estate, an Executor can uphold their fiduciary duty in preserving and administering estate assets under the guidance of an experienced estate attorney.
Kathy Bacenet serves on the firm’s Estates team, helping individuals and business owners navigate simple and complex estate planning and administration matters.