HIBERNIA BANK The decedent’s estate included a mansion which proved difficult to

sell. The heirs did not want it and everyone agreed it should be sold.

To finance the upkeep of the mansion cost the estate $60,000 a year. The P.R., Hibernia Bank, borrowed the funds necessary for that purpose from itself and earned just under $200,000 in interest income.

IRS contested the deduction of the interest paid as an administration expense. The state probate court had allowed the expense.

In another application of the principal of Estate of Bosch the court disallows the deduction on the estate tax return since it was not necessary for the administration of the estate. The mansion could have been distributed soon after decedent died.

HIBERNIA BANK II What economic- tax reason do you suppose was

behind the PR’s decision not to distribute the house until it was sold and the proceeds of sale distributed?

This decision cost the estate about $100,000 plus interest. Do you think the bank is really liable to the estate for that amount?

What income tax deductions could the heirs take if the house had been distributed in 1965, the year Mrs. Clark died?

Would the result in this case differ if the sale of the house was necessary to pay the estate’s debts?

What gets me is that the answer

is here just staring us in the

face.

What gets me is that the answer

is here just staring us in the

face.

EXPENSES OF ADMINISTRATION

Personal Representative’s fees, lawyers fees, accountants and appraisers are common expenses of administration.

Usually you will estimate the amount of attorney fees on the estate tax return, since only at the end of probate or tax controversies or other litigation is the actual amount knowable.

In estate tax litigation, attorney fees must be proved and a part of the final judgment or they will be lost as a deduction through res adjuicata.

Interest on the estate tax is a deduction, even though it is an unknown amount until the amount of the tax is finally determined and paid. It amounts to a difficult calculation; IRS will calculate it for you.

EXPENSES CONTINUED Selling expenses, such as broker’s fees, are only

deductible if the estate needs cash to pay debts, preserve assets, or to facilitate distribution.

The estate becomes an income tax paying entity at the moment time of death; a fiscal year is available and is usually elected.

The expenses of administration are deducted on either the estate’s income or estate tax return, but not both. You can pick and choose where you would like to have them deducted

Business expenses accrued at the time of death can be deducted on both the estate’s income tax return and as debts on the estate tax return.

DEDUCTIONS IN RESPECT OF A DECEDENT

Remember IRD? Income in respect of a decedent. There is a corresponding deduction that can be taken both for income and estate tax purposes.

Example. Farmer rents farmland for $10,000 a year, payable half in March and half in November; he dies in August. His estate deducts the $5000 rent paid in November on its income tax return and the debt is also deductible as a debt of the estate on the estate tax return.

LEOPOLD V UNITED STATES

Leopold had children by his first wife, and a child with Constance, his second. They divorced soon after the marriage.

In the divorce he agreed to bequeath at least $250,000 to their child Beatrice. When he died the estate took a deduction for $264,000 the final amount owed pursuant to a formula. IRS denied the deduction, claiming that an heir can never be a creditor of an estate and that the payment was not founded on an adequate consideration.

LEAPOLD V. U.S. CONCLUDED

Because the wife (Constance) took less in alimony so that her child would get more the bequest to child was deductible. Is there any tax consequence to Constance this fact situation? Remember, this contention was made but failed for lack of proof in Spruance, p. 126.

What are the estate tax consequences of a Marvin v. Marvin type of arrangement, that is, an agreement between two unmarried parties that they will share their property in some fixed percentage?

Suppose a daughter sues her father’s estate on a business deal; Is the settlement deductible as a debt of the estate? I have had several cases arise involving this issue.

Questions, p. 445-6

1. The loan taken out to fund a gift is deductible. The loan is a debt; it matters not what the decedent does with the funds.

Any judgment is a deductible debt of the decedent.

The $100,000 paid to the niece is deductible for services rendered; the niece should be income taxable upon receipt of the funds.

HUNTINGTON’S ESTATE The husband’s first will gave his kids $25,000 each plus

a remainder in all his property; however his second will gave all his property to his second wife. The Husband died.

The kids sued his second wife asserting that she had promised to leave it all to them and they settled for $425,000 shortly before the wife’s death. The wife’s estate deducted that payment and the IRS resisted.

The payment was supported by good contractual consideration, but that is not enough for it to be deductible by the estate.

Here, dad may have just changed his mind and decided to disinherit the rascals.

McMorris” EstateEvelyn died in 1991. She inherited stock from

her husband who died in 1990 and soon thereafter sold the stock at a gain, resulting in a federal and state income tax of $4.6 million. Her P.R. deducted that amount on her estate tax return as a debt of the decedent.

IRS audited her husband’s estate tax return and increased the value of the stock which increased the basis of the stock Evelyn inherited, resulting in her sustaining a loss on its sale and the IRS refunded the $4.6 million income tax paid.

MORE MCMORRISIRS disallowed the deduction for income

taxes on Evelyn’s estate tax return, claiming that events that occur after death may be taken into account in determining the amount of a deduction. The estate alleges that only those facts known at the time of death may be considered.

While the rule may be different in other situations the court holds that the amount of a claim against the estate is only determined by facts existing at the date of death. Whether a claim is valid can be determined by post-death events.

DEBTS CONTINUED Note Woody’s estate, p.451. Dad promise to pay his son’s debt

to his daughter was a deductible debt of his estate. In effect he made a gift to the son when the daughter agreed to the arrangement so there is little tax impact anyway.

Future alimony payments are a debt of the decedent, and the amount deductible is its present value. What if the former spouse remarries soon after the decedent’s death, thus terminating alimony? See notes, p. 463 and Estate of Lester, p. 459.

Note Smith’s Estate p. 460; a debt thought to be $2.5 million on the date of death was ultimately settled for $680,000; the full $2.5 million was allowed as a deduction as that was the best guess of the amount of the debt at the time of death. The court there said that whether a claim was enforceable could be determined by facts occurring after death, but not a matter valuing a claim.

MISCELLANEOUS THOUGHTS.

On page 462 your author describes cases that go both ways on debts that are barred by “non-claim statutes.” In North Dakota we refer to these provisions as the Notice to Creditors. If the estate publishes the notice as required by law, claims must be presented within three months or are barred. §30.1-19-03, NDCC.

The McMorris decision seems to be the emerging majority rule, so the value of the debt at death debt is likely deductible but the spread between that amount and the ultimate payment is arguably income taxable as forgiveness of debt income.

Observe that the McMorris decision can work to the benefit of the IRS should the amount of the debt increase after the estate tax return is filed and the statute of limitations has elapsed.

DEBTS CONCLUDED The amount of decedent’s income tax accrued up to

time of death is a deductible debt. Another debt to be aware of is accrued real estate

taxes. Canada has no estate tax, but imposes an income tax

on the appreciation in value of assets over their basis at the time of death which is deductible as a debt of the decedent who has Canadian property.

The state estate tax used to be a partial credit on the federal estate tax; now it is merely a deduction.

Casualty losses may be deducted either on the income or estate return, but not both. Estate casualty losses are rare. I’ve never seen one.

FIRST NATIONAL BANK OF OMAHA V U.S.

Decedent’s will left $100,000 to a cemetery association; such organizations are not political subdivisions, but rather non profit organizations without shareholders.

Such contributions are deductible under the income tax statute (§170, IRC) but there is no mention of them in the estate tax charitable deduction statute (§2055, IRC).

FIRST NATIONAL CONTINUED

Since the bequest favored the decedent’s family and the cemetery did not have a pauper’s field the association was not a qualifying charity.

Such a contribution might qualify in the general category of charitable organizations if they had pauper’s graves and certainly if a city or county owned the cemetery.

Bar associations surprisingly may qualify for the deduction. The decedent’s will can delegate to the PR the choice of the

charity to be benefited. Private foundations ( that is, not publicly supported)

nevertheless qualify; a good example would be the Ford Foundation which was set up to keep Ford Motor under the Ford Family control.