The Tax Court recently held that an estate’s settlement payment to one of its beneficiaries was not deductible since the payment lacked adequate consideration and was consistent with the decedent’s wishes expressed in her will.
When computing its taxable estate, an estate can deduct a claim against it that represents an enforceable personal obligation of the decedent existing on the date of the decedent’s death. In addition, a claim must be founded on a genuine promise or agreement involving full and adequate consideration and cannot be the result of the decedent’s testamentary intent.
In 1997 and 1998, Sylvia Bates executed a will and codicil that would, upon her death, create a trust to be funded by the assets that remained in her estate after all expenses were paid. The trust, to be administered by her granddaughter, Sheri Beersman, would distribute the majority of the trust assets equally to Bates’s three grandchildren and give $100,000 to Reggie Lopez, an unrelated individual with whom Bates had a close relationship. Beginning in 2004, Bates paid Lopez to help her with various tasks after she was diagnosed with Alzheimer’s disease. He was fully paid for his services. In 2005, Bates executed a second will that altered the first will and trust. It named Lopez as executor and trustee and provided that Scott Cable, another of the three grandchildren, would receive all of Bates’s personal property, and that Cable and Lopez would each receive half of the trust interest income.
Bates died on Feb. 18, 2005, and Lopez received $23,113 from a life insurance policy owned by Bates. Both wills were submitted for probate, and after nearly a year of legal wrangling, the heirs reached a settlement in which Lopez would receive $575,000 in full satisfaction of all claims related to the estate. In 2006, a court granted Beersman the authority to administer the estate. On the estate tax return, the estate deducted as administrative expenses $498,113, which consisted of the $575,000 settlement payment to Lopez plus the life insurance proceeds of $23,113, minus the $100,000 bequest to him. The IRS disallowed the deduction in its entirety, and in 2010 the estate petitioned the Tax Court for relief.
The IRS argued that the holding in Estate of Huntington, 100 T.C. 313 (1993), aff’d, 16 F.3d 462 (1st Cir. 1994), applied. The court in Estate of Huntington found settlement payments to beneficiaries were not deductible since they lacked adequate consideration and were consistent with the decedent’s testamentary intent. Bates’s estate argued that the payments in Estate of Huntington were made to family members, and the case at hand was different because Lopez was not a member of the decedent’s family. The court disagreed and held the reasoning in Estate of Huntington applies equally to cases involving nonfamily members. Even though Lopez was not a family member and other beneficiaries did not want him to receive any assets, he was named as a beneficiary in both trusts and had a legitimate interest in the estate, according to the court. Thus $475,000 of the settlement payment was not deductible.
The estate argued the life insurance proceeds of $23,113 were stolen from the estate since Lopez named himself as the beneficiary, and therefore the amount should be deducted as an administrative expense. The court disagreed, holding that the expenses did not satisfy the requirements of Regs. Sec. 20.2053-3(a), which defines administration expenses as those incurred “in the collection of assets, payment of debts, and distribution of property to persons entitled to it.”
Estate of Bates, T.C. Memo. 2012-314
By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota–Duluth.