August 9, 2011
By: Frank S. Baldino
Estate Planning Journal August 2011
Estate of Gertrude Saunders, 136 TC No 18 , Tax Ct Rep (CCH) 58610, Tax Ct Rep Dec (RIA) 136.18, 2011 WL 1598642 .
In Estate of Gertrude Saunders,1 the Tax Court held that under the prior version of the Section 2053 regulations, an estate tax deduction for claims against the estate is limited to amounts actually paid.
Facts
William Saunders was an attorney who at one time represented Harry Stonehill. Stonehill died in 2002, Saunders died in 2003, and his wife died in 2004. The estate of Stonehill sued Mr. Saunders, alleging that Mr. Saunders had committed legal malpractice, breached his duty of confidentiality, and breached his duty of loyalty to Stonehill by informing the IRS that Stonehill had a Swiss bank account. The suit alleged that as a result of the disclosure by Mr. Saunders, the IRS investigated Stonehill for tax fraud and collected back taxes that Stonehill owed. The suit against Saunders sought over $90 million in compensatory damages plus punitive damages.
After a trial, in July 2007, the jury found that Mr. Saunders had breached his fiduciary duty of confidentiality and his duty of undivided loyalty to Stonehill, but the jury also found that neither breach was a legal cause of injury or damage to Stonehill or to his estate. The court ordered the Stonehill estate to pay the estate of Mr. Saunders the costs of $289,000. The Stonehill estate appealed the judgment, but the parties ultimately settled with the estate of Mr. Saunders paying $250,000 in attorney's fees to the Stonehill estate.
The estate tax return for the estate of Mr. Saunders was filed in February 2005, and the estate claimed a deduction of $30 million with respect to the Stonehill estate malpractice claim. The estate tax return of Mr. Saunders was examined, and a closing document was issued stating that the value of the malpractice claim would be resolved in the estate of Mrs. Saunders.
The estate tax return for Mrs. Saunders was filed in February 2006. A deduction of $30 million was claimed on the return regarding the Stonehill estate malpractice claim. A letter prepared by the lead defense attorney in the malpractice action was filed with the estate tax return and concluded that the Stonehill claim against the estate was valued at $30 million. The estate tax return of Mrs. Saunders was examined and a notice of deficiency was issued reducing the deduction for the malpractice claim from $30 million to $1 million.
Each side in the case submitted the opinions of multiple experts. The lead defense attorney prepared a second letter reducing his estimate of the value of the claim from $30 million to $25 million. An independent appraiser hired by the estate of Mrs. Saunders estimated the value of the claim to be approximately $19 million. Another defense attorney submitted a letter estimating the value of the claim at $22.5 million. One of the government's experts valued the claim as having almost no value because the chance of recovery was very low. Another government expert valued the claim at $3.2 million.
Analysis
Reg. 20.2053-1(b)(3) , as in effect for the respective dates of death of Mr. Saunders in 2003 and Mrs. Saunders in 2004 provided:
An item may be entered on the return for deduction though its exact amount is not then known, provided it is ascertainable with reasonable certainty, and will be paid. No deduction may be taken upon the basis of a vague or uncertain estimate. If the amount of a liability was not ascertainable at the time of final audit of the return by the district director and, as a consequence, it was not allowed as a deduction in the audit, and subsequently the amount of the liability is ascertained, relief may be sought by a petition to the Tax Court or a claim for refund as provided by sections 6213(a) and 6511, respectively. [Emphasis added.]
The court recognized that the tax law distinguishes between the rules applicable to claims in favor of an estate that are included in a decedent's gross estate and the rules applicable to claims against an estate that are allowable under certain circumstances as a deduction. In valuing the gross estate, including claims in favor of the estate, post-death events are not considered in valuing assets. In valuing claims in favor of an estate, it is permissible to assume various outcomes, assign probabilities to those outcomes, and quantify the results.
With respect to claims against an estate, however, the position of the IRS was that the regulations under Section 2053 required a stricter standard. In order for a claim against an estate to be deductible, the value of the claim must be “ascertainable with reasonable certainty.” The court recognized that with respect to claims against an estate, courts differ in the extent to which events subsequent to the date of death may be considered. This case would be appealable to the Ninth Circuit, so the court followed the law of that circuit—which has held that post-death events are taken into account in determining the value of a disputed or contingent claim.
The court noted that the various reports presented by the estate's experts valued the claim at $30 million, $25 million, $19.3 million, and $22.5 million and that this fact was a prima facie indication of the lack of reasonable certainty regarding the value of the claim. The court noted that none of the estate's experts opined, nor could they reasonably opine, that the $30 million claimed on the estate tax return would in fact be paid. The court also noted that the stark differences between the reports of the estate's experts and those of the IRS's experts merely reinforced the uncertainties inherent in the process. The court concluded that the Stonehill claim was not deductible as of the date of death. However, the court stated that the amount actually paid during the administration of the estate could be deducted.
Comments
The holding of this case is not surprising since it was appealable to the Ninth Circuit, and that circuit court did not permit a claim against the estate to be deducted based on an estimate of the value of the claim. This case and the position of the Ninth Circuit are consistent with the current Reg. 20.2053-1(d)(4) , which provides that a deduction for a contingent or uncertain claim is deductible only as payments are actually made by the estate. In these situations, the estate should file a protective claim for refund before the limitations period for refunds expires. This rule does not apply to claims based on estimated amounts if the IRS is satisfied that the amount of the claim is “ascertainable with reasonable certainty” and “will be paid.”
1 136 TC No 18 , Tax Ct Rep (CCH) 58610, Tax Ct Rep Dec (RIA) 136.18, 2011 WL 1598642 .
Frank S. Baldino is an estate planning attorney at Lerch, Early & Brewer in Bethesda, Maryland. He has extensive experience in the areas of estate planning, charitable giving, estate planning for non-U.S. citizens, tax planning with respect to retirement plans and stock options, asset protection planning, business succession planning and estate and trust administration. For more information about estate tax deductions, contact Frank at (301) 657-0715 or fsbaldino@lerchearly.com.
