June 1, 2012
By: Frank S. Baldino
Estate Planning Journal June 2012
Gill, TCM 2012-7
In Gill,1 the Tax Court allowed a portion of the legal fees incurred in estate litigation to be deducible as an administrative expense on the federal estate tax return.
In 1994, Raymond Gill and his wife, Joan Gill, executed estate planning documents that included a will and a revocable trust. The terms of Mr. Gill's revocable trust provided that on his death, if Mrs. Gill survived him, all trust assets up to the estate tax exclusion amount would be distributed to a newly created credit shelter trust, with the residue to be distributed to a martial trust for the benefit of Mrs. Gill for her life and the remainder to their two children. If Mrs. Gill did not survive Mr. Gill, then Mr. Gill's revocable trust provided that the assets of the revocable trust would be distributed equally to the two Gill children. Mrs. Gill's revocable trust was similar to Mr. Gill's revocable trust.
Both Mr. and Mrs. Gill's revocable trusts provided that the trustee of the revocable trust would also serve as the trustee of the credit shelter and marital trusts. Mr. and Mrs. Gill were named co-trustees of both revocable trusts. Upon the death of either Mr. or Mrs. Gill, the surviving spouse would become the sole trustee of both revocable trusts and the trustee of the other's credit shelter and marital trusts, with their two children becoming co-trustees upon the death or inability to serve of the surviving spouse.
Mrs. Gill died in January 1995, and Mr. Gill became the sole trustee of Mrs. Gill's revocable trust and the trustee of Mrs. Gill's credit shelter and marital trusts. Four months after Mrs. Gill's death, Mr. Gill married a co-worker. Prior to their marriage, Mr. Gill and his wife-to-be, Valerie, entered into a prenuptial agreement pursuant to which Mr. Gill and Valerie Gill each waived their applicable marital rights to the property of the other, including any rights to the other's estate at death. At the time of his marriage to Valerie Gill, Mr. Gill had lung cancer and was undergoing debilitating chemotherapy. Valerie Gill cared for Mr. Gill from the time of their marriage until his death.
In August 1995, Mr. Gill amended the terms of his revocable trust. Under the amendment, upon Mr. Gill's death, Valerie Gill and SunTrust Bank were to become co-trustees. The Gill children would not become co-trustees until the refusal or inability of Valerie Gill to serve as a trustee. The amendment further directed that all income of Mr. Gill's marital trust be paid to Valerie Gill for life, with trustee discretion also to pay trust principal to Valerie Gill. The Gill children retained their remainder interest in Mr. Gill's marital trust. Also in August 1995, Mr. Gill executed a last will and testament that named Valerie Gill and SunTrust Bank as co-personal representatives of his estate, devised Mr. Gill's tangible personal property to Valerie Gill, and transferred the residue of Mr. Gill's estate to his revocable trust. This will superseded the prior will that had named Mr. Gill's children as the co-personal representatives of his estate.
Upon Mr. Gill's death in September 1996, according to the amended terms of the revocable trust, Valerie Gill and SunTrust Bank became the co-trustees of his revocable trust, and according to the new will became co-personal representatives of his estate. In January 1997, the Gill children filed a claim in the Florida probate court against the estate alleging breach of fiduciary duties by Mr. Gill while acting as trustee of Mrs. Gill's revocable trust, her credit shelter trust, and her marital trust. The Gill children requested complete accountings for each of the three trusts. Litigation between the Gill children and Valerie Gill and SunTrust Bank in their roles as co-personal representatives of the estate resulted. It was alleged that Mr. Gill had made improper withdrawals of trust principal from Mrs. Gill's credit shelter and marital trusts. A settlement was reached in which the co-personal representatives agreed to make a payment from the estate to the Gill children.
In January 1997, the Gill children filed a complaint against Valerie Gill in her individual and fiduciary capacities and against SunTrust Bank in its fiduciary capacity. This litigation was brought by the Gill children in both their individual and fiduciary capacities, since they were successor co-trustees of Mr. Gill's revocable trust under both the original and amended terms of his revocable trust and as nominated co-personal representatives of his estate under his prior will. In the complaint, the Gill children sought to set aside Mr. Gill's will and the amendments to his revocable trust, alleging that Valerie Gill exerted undue influence on Mr. Gill and forced him to amend his estate plan for her benefit.
Litigation ensued over the next three years, and the parties entered court-ordered mediation which lead to the execution of a settlement agreement in September 2000. The settlement agreement provided that Valerie Gill would make a payment to the Gill children, and that she would resign as trustee of Mr. Gill's revocable trust with SunTrust Bank to become the sole trustee.
Valerie Gill failed to uphold her obligations under the settlement agreement. In September 2002, Valerie Gill and SunTrust Bank, in their fiduciary capacities, filed a declaratory judgment action seeking to set aside the settlement agreement. The suit was found by the Florida court to be frivolous and was dismissed with prejudice. Valerie Gill and SunTrust Bank appealed but the decision was affirmed. After losing the appeal, Valerie Gill filed a second declaratory judgment action in Florida court, this time in her individual capacity. The Florida court entered summary judgment in favor of the Gill children.
Beginning in 2002 the Gill children also filed various actions in either their individual or individual and fiduciary capacities, in response to Valerie Gill's failure to carry out the settlement agreement. The Gill children did not seek assets in excess of what they would have received under the settlement agreement.
In 2006, the parties entered another round of mediation and entered into a new settlement agreement in June 2007. The 2007 settlement agreement declared the 2000 settlement agreement void. The settlement agreement provided that Valerie Gill would make a payment to the Gill children. The settlement agreement also provided for Mr. Gill's estate to reimburse certain legal fees incurred by the Gill children and Valerie Gill. The reimbursement to be received by the Gill children was less than the actual legal fees expended by them during the course of litigation. The Florida court, in approving the settlement, stated that the legal fees were essential to the proper administration and settlement of the estate and revocable trust, and necessary to determine the beneficiaries, to carry out the intent of Mr. Gill, and to effect the proper distribution of his estate and his revocable trust.
The IRS issued a notice of deficiency to the estate, and the estate filed a petition in Tax Court. The estate sought to deduct the reimbursement of the legal fees paid to the Gill children and Valerie Gill as additional administration expenses over what was initially reported on the estate tax return. The IRS contested the deductibility of a portion of the reimbursement payments.
In order for legal fees to be deductible for estate tax purposes, three requirements must be satisfied. The legal fees must be:
- Allowable under the laws of the jurisdiction under which the estate is being administered.
- Reasonable in amount.
- Essential to the proper settlement of the estate. 2
Examining the first requirement, the Tax Court noted that the Florida court expressly found that the legal fees were allowable expenses to be paid by the estate because such legal fees were essential to the proper administration and settlement of the estate and revocable trust, and necessary to determine the beneficiaries, to carry out the intent of Mr. Gill, and to effect the proper distribution of his estate and his revocable trust. Based on the findings of the Florida court, the Tax Court found that the legal fees were allowable under Florida law.
Next the Tax Court examined whether the legal fees reimbursed by the estate were reasonable in amount. This court found that the legal fees reimbursed were reasonable in amount. In reaching its conclusion, the Tax Court gave weight to the fact that the Florida court allowed reimbursement of the legal fees by the estate and that the Gill children were reimbursed less than their actual legal fees.
Finally, the court considered whether a deduction for the reimbursed legal fees was proper under Section 2053. Reg. 20.2053-3(c)(3) provides:
Attorneys' fees incurred by beneficiaries incident to litigation as to their respective interests are not deductible if the litigation is not essential to the proper settlement of the estate within the meaning of paragraph (a) of this section. An attorney's fee not meeting this test is not deductible as an administration expense under section 2053 and this section, even if it is approved by a probate court as an expense payable or reimbursable by the estate.
Reg 20.2053-3(a) provides in part:
The amounts deductible from a decedent's gross estate as “administration expenses” *** are limited to such expenses as are actually and necessarily incurred in the administration of the decedent's estate; that is, in the collection of assets, payment of debts, and distribution of property to the persons entitled to it. The expenses contemplated in the law are such only as attend the settlement of an estate and the transfer of the property of the estate to individual beneficiaries or to a trustee, whether the trustee is the executor or some other person. Expenditures not essential to the proper settlement of the estate, but incurred for the individual benefit of the heirs, legatees, or devisees, may not be taken as deductions.
The IRS argued that the legal fees at issue were not deductible because they were not paid for services essential to the proper settlement of the estate. Instead, the IRS claimed the legal fees were incurred for the personal benefit of the Gill children and Valerie Gill. The Tax Court stated that the decision by the Florida court approving reimbursement of the legal fees by the estate is not determinative of whether such legal fees are deductible under Section 2053. The estate argued that the legal fees were deductible because they were incurred in litigation essential to the proper settlement of the estate. Furthermore, the estate contended that even if the litigation involved only who would take which assets, the litigation was still necessary to determine the true testamentary intent of Mr. Gill. The estate also argued that both the Gill children and Valerie Gill owed certain fiduciary duties to Mr. Gill and his estate. The estate claimed that these fiduciary duties obligated the Gill children and Valerie Gill to defend what they each believed to be the testamentary intent of Mr. Gill.
The court separately addressed the legal fees associated with the 1997 to 2000 litigation and mediation and the 2002 to 2007 litigation and mediation in determining whether the reimbursed legal fees were incurred in activities essential to the proper settlement of Mr. Gill's estate. The initial litigation and mediation from 1997 to 2000 was between the Gill children and the estate, with the Gill children suing in both their individual and fiduciary capacities as successor co-trustees of Mr. Gill's revocable trust and nominated co-personal representatives of his estate under the prior will. The litigation addressed the undue influence issue surrounding Mr. Gill's will. Because the Gill children acted in their fiduciary capacities and the litigation resolved the undue influence issue, the court held that the litigation and mediation from 1997 to 2000 involved more than a dispute between beneficiaries of a decedent in which the estate merely occupied the position of a stakeholder. The court therefore held that the estate's reimbursement of the Gill children's legal fees was deductible as an expenditure essential to the proper settlement of the estate. The court stated that the fact that the Gill children personally gained as a result of their actions was not a reason to disallow the expense as a deduction.
The court next turned to the legal fees incurred in the 2002 to 2007 litigation and mediation. The court held that the Gill children's reimbursed legal fees were deductible expense to the estate because the Gill children's involvement in the litigation and mediation from 2002 to 2007 was necessary to enforce the result of the 1997 to 2000 litigation and mediation. The court stated that Valerie Gill's actions forced the Gill children to defend and seek to enforce the 2000 settlement agreement, which was the result of the 1997 to 2000 litigation and mediation. The court noted that the Gill children did not seek estate assets in excess of what they would have received under the 2000 settlement agreement and that the Gill children did not initiate frivolous lawsuits and did not seek to prolong the litigation unnecessarily.
On the other hand, the court held that the reimbursement of Valerie Gill's individual legal fees associated with court approval of the 2007 settlement agreement were not deductible expenses to the estate because unlike the Gill children, Valerie Gill was not seeking to enforce the 2000 settlement agreement. The court found that all of her individual actions were only attempts to obtain assets that had been assigned to the Gill children in the 2000 settlement agreement. The court found that Valerie Gill's individual legal fees associated with court approval of the 2007 settlement agreement were incurred for her individual benefit rather than for the benefit of the estate.
The estate argued that even if Valerie Gill's individual actions taken from 2002 to 2007 relate only to how much she would personally receive from the estate, those actions were still essential to the proper settlement of the estate because they helped to determine the proper testamentary intent of Mr. Gill. The court rejected this argument as inconsistent with Reg. 20.2053-3 and the standard that in order for the legal fees to be deductible, a case must involve more than a dispute between beneficiaries of a decedent in which the estate merely occupies the position of a stakeholder.
This case is an important reminder that not all legal fees incurred in estate litigation are deductible for federal estate tax purposes regardless of whether the parties receive from the estate reimbursement of some or all of the legal fees they incurred. This fact must be taken into account when negotiating and structuring settlements as well as in the preparation of the federal estate tax return.
1 TC Memo 2012-7, RIA TC Memo ¶2012-007, 103 CCH TCM 1026 .
2 See Section 2053(a) and Reg. 20.2053-3(c)(1).