Estate’s claimed deductions recharacterized as gifts or bequests

Various deductions taken on an estate tax return were disallowed by the IRS as well as gifts made by the decedent in prior years added back to the estate. The IRS’s determination was sustained by the Tax Court.

Facts: Richard D. Spizzirri was a lawyer and investor with a gross estate of over $81 million. At the time of his death in 2015, he was married to his fourth wife, Holly Lueders, although they were estranged. They had signed a prenuptial agreement that was modified five times during their marriage. In one of the modifications, the prenuptial agreement stated that Spizzirri would have in effect a will in which he bequeathed payments of $1 million to each of Lueders’s three children from a previous marriage. The prenuptial agreement also had provisions providing for Lueders’s entitlement to certain property rights and payments from Spizzirri’s estate and the right to live five years rent-free in his home in East Hampton, N.Y., in lieu of any other rights that she might be entitled to as the surviving spouse.

Although the prenuptial agreement and its following modifications stated that Spizzirri would keep in effect a will that reflected the provisions in the agreement, Spizzirri did not do so. Spizzirri’s original will was created in 1979, prior to his marriage to Lueders. He made four codicils to the will beginning in 2014 to deal with the inheritance rights of his children born outside his marriage and relating to a condominium he owned with one of his girlfriends.

During his marriage to Lueders, Spizzirri had numerous female companions. He fathered two children with different women and purchased a condominium with another woman. During the last five years of his life, Spizzirri made numerous cash payments to these and other women. He also made cash gifts to his family. The total taxable gifts to be added back to the estate as determined by the IRS were $193,441.

After Spizzirri’s death on May 12, 2015, Lueders and her children separately filed claims against the estate, which were ultimately settled. The estate agreed to pay $1 million to each of Lueders’s children per the terms of the third modification agreement to the prenuptial agreement. The estate reported these payments to the children on a Form 1099-MISC, Miscellaneous Income.

The estate filed an extension for its estate tax return on Feb. 19, 2016, which was after the due date for the return. The extension included a payment of $11.8 million. In July 2016, the estate asked for a second extension of time to file due to the ongoing litigation with Lueders. The IRS denied this request.

On Nov. 29, 2016, shortly after the settlement of the litigation with Lueders, the estate filed the late estate tax return. On the return, the estate deducted the payments to Lueders’s children as “claims against the estate” rather than reporting them as bequests. The estate also took a deduction for the appraised value of Lueders’s right to reside in Spizzirri’s East Hampton home, as well as an estimated value of five years’ property maintenance expenses on it. In addition, the estate took deductions for repairs to Spizzirri’s Aspen, Colo., property as “administration expenses.” No taxable gifts were reported on the estate tax return.

The IRS sent a notice of deficiency that denied the above-referenced deductions, assessed a late-filing penalty, and adjusted Spizzirri’s lifetime adjusted taxable gifts from zero to $193,441.

Issues: The estate, in response to the IRS’s denial of deductions, argued that Lueders had provided consideration via her waivers of spousal support and equitable distribution in exchange for the deducted amounts of $3 million paid to her children and the value of her right to reside rent-free in the East Hampton property for five years. Regarding payments made to family members and friends, where the estate reported no taxable gifts, the estate argued that these payments were made for care and companionship services during the last few years of the decedent’s life and therefore were not gifts.

On the denial by the IRS of deductions for property repairs to the Aspen property as administration expenses, the estate asserted that these deductions were for emergency repairs due to unsafe conditions and were needed to pass any inspection for sale. On refuting the assessment of latefiling penalties, the estate argued that the net amount due on the payment due date was zero as a result of the overpayment remitted prior to that date. Therefore, there should not be any filing penalties.

Holding: The Tax Court ruled in favor of the IRS on all counts. The estate did not put forth enough evidence to prove that Spizzirri’s payments to his family and friends from 2011 through 2015 were for “care and companionship services,” and the Tax Court ruled that they were in fact gifts. The court agreed with the IRS’s contentions that these payments were made with donative intent. Evidence of this included the fact that Spizzirri never issued a Form W-2, Wage and Tax Statement, or a Form 1099-MISC, Miscellaneous Income, for any of these payments, nor did he report them as expenses on his tax return.

Regarding the deductions for claims against the estate for the value of Lueders’s use of the East Hampton property, the court relied on Sec. 2053(c)(1)(A), which states that claims against an estate must be contracted for “adequate and full consideration in money or money’s worth” to be deductible. The court further cited Sec. 2043(b)(1), which disallows a relinquishment of a “dower or curtesy” or “of other marital rights in the decedent’s property or estate” as “consideration ‘in money or money’s worth.’ ”

The court also ruled that the testamentary transfers of $1 million to each of Lueders’s three children were bequests and “essentially donative in character.” These transfers were not contracted for adequate and full consideration and therefore could not be taken as claims against the estate. Further, per Regs. Sec. 20.2053-1(b)(2) (ii), claims against the estate may not be related to an expectation or claim of inheritance. The court also relied on the prenuptial agreement’s language to reinforce its conclusion that the transfers to Lueders and her children were an expectation of inheritance. The fact that the estate did not show that Lueders or her children counted these transfers as taxable income further reinforced the court’s conclusion.

Regarding the administration expenses for the Aspen property, the estate could not provide any corroboration that the repairs to the property were necessary for the care and preservation of the property, and, therefore, the disallowance was upheld.

Finally, the Tax Court reduced but upheld the late-filing penalty. The estate had declared that the probate litigation hindered the estate’s ability to timely file an accurate return. However, the Tax Court noted that the estate was required to file the return timely based on the “best information available” and then amend the return, if necessary, citing Estate of Wilbanks, T.C. Memo. 1991-45. The penalty amount was reduced to correct a calculation error.

■ Estate of Spizzirri, T.C. Memo. 2023-25

— David R. Silversmith, CPA, CFP, CFE, MBA, is a senior tax manager in Hauppauge, N.Y.; Mani Gupta, CPA, is a senior tax manager in Cranford, N.J.; and Christine G. Pronek, CPA, MST, is a partner in Cranford, N.J., all with PKF O’Connor Davies Advisory LLC. To comment on this column, contact Paul Bonner, the JofA’s tax editor.