IRS Releases Proposed Regulations

to Achieve Nationwide Uniformity

 in Deducting Claims against the Estate

By: Philip Di Giorgio

 

The Internal Revenue Service recently released proposed regulations regarding which claims will be allowed as deductions and how those claims will be valued for estate tax purposes.  This article explores that issue.

           

            Section 2053(a) of the Internal Revenue Code provides as follows:

“For purposes of the tax imposed by section 2001, the value of the taxable estate shall be determined by deducting from the value of the gross estate such amounts—

(1) for funeral expenses,

(2) for administration expenses,

(3) for claims against the estate, and

(4) for unpaid mortgages on, or any indebtedness in respect of, property where the value of the decedent's interest therein, undiminished by such mortgage or indebtedness, is included in the value of the gross estate,

 

as are allowable by the laws of the jurisdiction, whether within or without the United States under which the estate is being administered.”   (Emphasis added.)

A.                 What Claims May be Taken as an Estate Tax Deduction?

In order to be taken as a deduction on the estate tax return, a claim must be an existing personal obligation of the decedent as of the date of death. Treas. Reg. 20.2053-4.  In order to be deductible a claim must be allowable under local law, Treas. Reg. 20.2053-1(a)(1)(iii), and the claim must have been contracted by the decedent, bona fide and, with the exception of charitable pledges and claims arising by law, must have been incurred for adequate and full consideration. Treas. Reg. 20.2043-1.

B.                 How Must Claims be Valued for the Purpose of Determining the Allowable Deduction from Estate Tax?

Claims that are certain and enforceable as of the date of death may be claimed as a deduction, as well as claims that are contingent or disputed as of the date of death.  The real controversy arises over how and as of when these claims must be valued.  The IRS has long taken the position that post death events must be taken into account in determining the value of claims taken as a deductions under IRC section 2053.  However, this has been the source of much litigation over the course of many years with differing results in differing jurisdictions.

For example in the Second and Eighth Circuits the courts have held that post death events must be taken into account in determining the deductible amount of claims.  See Estate of Shively, 5 AFTR 2d 1894, 276 F2d 372, and Estate of Sachs, 62 AFTR 2d 88-6000, 856 F2d 1158.

In the Ninth Circuit the courts have held that if a claim is certain and enforceable as of the date of death, then the value of the claim must be fixed as of the date of death.  However, if a claim is disputed or contingent, then post death events must be taken into account when determining the value of claims. Estate of Propstra, 50 AFTR 2d 82-6153, 680 F2d 1248, and Estate of Van Horne, 53 AFTR 2d 84-1549, 720 F2d 1114.  See also IRS Field Service Advice 200217022.

However, in the Fifth, Tenth and Eleventh Circuits, the courts have found that the value of a claim must be determined as of the date of death, regardless of post death events, which may not be considered. These circuits have followed the reasoning set forth by the U.S. Supreme Court in Ithaca Trust Co., 7 AFTR 8856, 279 US 151, where the Court held that post death events could not be considered in determining the value of a charitable remainder interest.  The Fifth, Tenth and Eleventh Circuits have extended this rule applied by the Supreme Court to charitable interests and applied it to claims in general.  See Estate of Smith v. Commissioner, 84 AFTR 2d 99-7393, 198 F3d 515; McMorris Estate v. Commissioner, 87 AFTR 2d 2001-1310, 243 F3d 1254; and O’Neal Estate v. US, 88 AFTR 2d 2001-5245, 258 F3d 1265.

Although the IRS disagrees with the method for valuing claims followed by the Fifth, Tenth and Eleventh circuits, it has followed the rulings for taxpayers residing in those circuits to date.

C.                 Proposed IRS Regulations

Surprisingly this longstanding disparity between the various circuits has not yet made its way to the Supreme Court for resolution.  Consequently, the treatment of this issue for any given taxpayer depends on where they live, which is not a very equitable standard for the application of federal tax law.  In an effort to resolve the issue, address the disparity and achieve uniformity in treatment, the IRS has proposed new regulations under Section 2053 of the Code.

The highlights of these proposed changes are enumerated below:

·        Post death events will be taken into account in determining the value of claims.

·        In general only amounts actually paid out in satisfaction of a claim will be allowed as a deduction.

·        The claim must be allowable under local law.

·        A deduction will be allowed for a claim that satisfies all of the applicable requirements even though the exact amount is not known provided that the amount is ascertainable with reasonable certainty and will be paid.  It would be the responsibility of the executor to advise the IRS of any change in the amount actually paid in satisfaction of the claim and to pay any additional estate tax resulting therefrom.

·        Court ordered resolutions of claims will be respected if the court passes upon the merits of the claim.

·        Settlements would be respected if reached in bona fide negotiations between adverse parties.

·        No deduction could be taken for a claim that is potential, unmatured or contested at the time the return is filed, but a protective claim for refund could be filed before the expiration of the period of limitations for claims for refund in order to preserve the estate’s right to claim a refund by reason of the deduction of the claim against the estate, to the extent that it is actually paid.

·        There will be a rebutable presumption that claims of family members, related entities and estate beneficiaries are not legitimate claims.

·        Claims that are unenforceable at the date of death or become unenforceable after the date of death will not be deductible.

·        Interest paid on claims that has accrued through the date of death, but is actually paid after death, will be allowed as a deduction.

The regulations as proposed would apply to the estate of any person dying on or after the date final regulations are published in the Federal Register.

A public hearing on the proposed regulations has been scheduled for August 6, 2007.

            If you have any questions about the matters discussed in this e-letter, please contact Lou Pierro or Arthur Dicker at (518) 459-2100.  Prior Tax Planning E-Letters may be accessed at www.pierrolaw.com.

 

**To the extent the preceding text contains an opinion on one or more Federal tax issues, such opinion was not written to be used and cannot be used for the purpose of avoiding penalties.  If you would like a written opinion on the Federal tax issues addressed in this email, upon which you can rely for the purpose of avoiding penalties, please contact our office.

 

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