Estate Containing Undeclared Funds

The discovery of a testator’s account containing undeclared funds (whether in Germany or in a foreign country, e.g. Switzerland, Luxembourg or Liechtenstein) is no reason for panic or anxiety. It is noted for the heirs peace of mind, that they are not liable for criminal offences committed by the testator. This means, that the heirs cannot be penalised for a tax fraud committed by the testator. The discovery of undeclared funds does however give rise to far-reaching obligations and the heirs should obtain advice from a tax-lawyer/ tax adviser / tax law specialist. The following outlines some of the principle obligations applying to heirs.

Once an heir becomes aware of undeclared funds being part of the estate, he is obligated to immediately report this to the Tax Authority under the provisions of the Tax Act (§ 153 AO). He must amend, supplement or complete tax returns submitted by the testator. “Immediately” in this context means “without culpable delay”.

This reporting duty not only applies to heirs, but also to the executors and the administrators of the estate. Any incompleteness or inaccuracy of a tax return which served the purpose of evading taxes must be reported. This means, that the heirs must correct all taxation periods which are not time-barred and for which no tax return or an incorrect/incomplete tax return was submitted by the testator despite his statutory obligations. The statute for limitations in taxation matters is generally not more than 10 years. If the testator has submitted his tax return very late or omitted to do so, this period may be extended up to 13 years.

If the heir, or the person under an obligation to report, complies with his duty to report and submit corrected tax returns, the Tax Authority will retrospectively assess and collect the taxes withheld on the basis of the new facts. In other words, the assessed back taxes are claimed against the estate. In the case of undeclared income from a business, the business-related taxes such as income tax, commercial tax and sales tax will also fall due for payment.

This means, that the amount of undeclared money inherited may diminish significantly, e.g if the estate contains 100,000 Euro in undeclared funds, the amount retained by the heirs may be much less than that.  If the heir does not comply with his duty to report undeclared funds, he faces two problems. On the one hand, the failure to report undeclared funds by omission constitutes tax fraud committed by the heir.

Further, the failure to comply with the duty to correct submitted tax returns in respect of income tax not paid by the testator, as set out in § 153 AO, also results in tax fraud being committed by the heir. On the other hand, it means that the heir will have to decide not to declare the income generated by those undeclared funds in his own tax return, just as the testator did.

He will thereby commit the offence of tax fraud himself. Conditional intent suffices for tax fraud being committed. This is the case, if an heir willingly accepts the non-declaration of undeclared funds, thereby causing prescribed taxes to be evaded.

The law prescribes a penalty range between 5 years (10 in some cases) imprisonment or a fine for the offence of tax fraud. In addition to being honest about one’s tax affairs, practical considerations should result in the heir deciding not to become involved in risky tax evasion manoeuvres concerning undeclared income, in particular in the case of a community of heirs.

In a community of heirs, one single member wishing to comply with his duties to declare taxes suffices to factually force all other members of the community of heirs to make frank disclosure.  Because the execution of estates is usually never free from conflict, such a constellation and the omission to report undeclared funds creates additional potential for threats and blackmail.

If the heir fully complies with his duties to declare and report, the undeclared funds will become legal under tax law. The heirs should obtain comprehensive advice in considering whether the funds should remain undeclared, or if a decision is made to return to legality. There are numerous risks to be considered in making this decision and it resembles a minefield.

It must be mentioned, that the Tax Authority also has other means of learning about the hidden assets, regardless of the decision made by the heir. All heirs entertaining the idea of withholding information about undeclared funds from the Tax Authorities should consider the reporting duties of estate administrators, fiduciaries and insurance companies to the Tax Authority, which they must comply with within one month of the bereavement.

Domestic banks are subject to these duties, but also branches of foreign banks in Germany and affiliated branches of domestic banks in a foreign country. In certain cases, even funeral undertakers are obligated to notify the Tax Authorities of a death (and thereby of a potentially tax-relevant inheritance). This applies to all cases, in which the customer (the testator) has prepaid the potential costs of a funeral to a trust account held by the funeral undertaker.

It must also be pointed out, that taxes withheld by the testator constitute liabilities on the “balance sheet” of his estate. These liabilities result in a reduction of the tax base used for calculating the inheritance tax, thus reducing the overall tax load on the inheritance. This only applies, if the tax debt has been reported to the Tax Authority in due time.

All heirs are well advised to obtain comprehensive advice in respect of the existing risks. A sensible decision on whether the tax fraud by the testator, which has no criminal consequences for the heir, will turn into tax fraud committed by the heir himself, can only be made on the basis of a detailed analysis of the options available and the associated risks.

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• Drafting of inheritance tax returns
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