A recent Tax Court ruling reaffirms estate inclusion rules governing qualified terminable interest property (QTIP) trusts and the requirements for valuation of QTIP assets and determination of expenses. It also presents yet another lesson in how estate plans and family challenges can pose difficulties for all.
In Estate of Kalikow v. Commissioner, T.C. Memo. 2023-21, the court considered the issue of deducting administrative fees from an estate to reduce estate tax due and discussed Internal Revenue Code Section 2053. In addition, the implications of the initial litigation from a planning perspective are important to consider in the context of the broader realities of estate planning. The family had significant issues that served as a catalyst for litigation.
QTIP Trust Created
Here’s what happened. Sidney Kalikow died, and some years later his wife, Pearl, died. Sidney’s will created a QTIP for Pearl that included a requirement to pay the surviving wife all income. QTIP status was elected on his estate tax return under IRC Section 2056(b)(7). Most of the assets in the trusts were interests in a family limited partnership (FLP) that owned rental real estate. Pearl was entitled to income distributions from the trust for life, and on her death, the assets remaining in the QTIP were to be divided and paid to trusts for each of the two children. It was asserted that the wife was underpaid income to the extent of almost $17 million. Litigation followed, and a settlement was reached in which the QTIP agreed to pay the wife’s estate about $6.5 million of undistributed income and about $2.7 million in fees. The two remaining issues were: (1) whether the value of the trust assets included in the gross estate pursuant IRC Section 2044 should be reduced by the agreed-on undistributed income amount, and (2) whether the estate is entitled to deduct any part of the agreed-on settlement payment as administration expenses pursuant to Section 2053.
Deduction for Administration Expenses
The court determined that the QTIP's settlement payment didn’t support a deduction for administrative expenses by the estate under Section 2053. In calculating the value of Pearl’s gross estate, the value of the QTIP couldn’t be reduced by the settlement. The fair market value of the QTIP assets had to be included in Pearl’s gross estate at the time of her death under Section 2044. The court held that there was no basis for the trust’s liability to affect the date-of-death value of the FLP interests.
There was also a valuation dispute concerning the value of the FLP interests. The estate reported the 98.5% of FLP interests value at about $42 million, and the IRS argued it was worth about $105 million. They settled on about $54 million.
The QTIP established on Sidney’s death left assets, following the death of his surviving wife, in further trust to the two children, a son and a daughter. This appears to have been a nuclear family. However, the wife’s will bequeathed the residue of her estate to charity, not to her children. This difference in beneficiaries becomes significant in the context of the litigation. The co-trustees of the trust were a son, Pearl and an independent individual (an accountant) and after Pearl’s death, the daughter was added as an additional co-trustee. However, the children weren’t executors of their mother’s estate. Were the children estranged from their mother based on the dispositive scheme she had in her will?
More than three years after Pearl’s death, one of her grandchildren petitioned the court to compel the QTIP trustees to render an account of the trust. The son and the independent co-trustee each filed competing accounts of the QTIP trust. This might suggest that the litigation was quite contentious even apart from possible issues as between Pearl and her children.
Consider that Pearl’s estate plan created a reason for the children and estate to fight. The family, estate and trust endured 10 years of litigation as well as very substantial legal fees and assuredly caused incredible stress for everyone involved. The tax issues the family lost might pale in comparison to the legal costs incurred and the personal damage to the family.
Fiduciary and Related Considerations
The accountant was both a co-trustee on the QTIP trust and executor of the wife’s estate, and his accounting firm received substantial fees for services. The accountant in his role as executor argued for positions to increase the size of the estate. That position would have increased the bequests to charity under Pearl’s will but reduced what the children received under the QTIP following her death. Were these overlaps in fiduciaries and professionals beneficial to the family? Might having introduced other advisors into the mix, or a professional or corporate fiduciary, mitigated some of the antagonism? Might it have been possible to have taken steps to address, and perhaps mollify, some of the inherent conflict between Pearl’s dispositive scheme and the very different plan under the QTIP? Might provisions incorporated into the FLP governing objective distribution standards have had a positive impact?
Was It Worth It?
The QTIP value was settled at about $55 million. The unpaid income from the QTIP was settled at about $6.5 million. Legal fees to the estate were about $1.4 million. Assume the QTIP had comparable fees. So nearly $3 million in legal fees were paid for one side to realize about $6.5 million. About $3.5 million net on a $55 million estate is about 5%. And that doesn’t factor in the possible harm to family relationships. What of any negative implications of the negative publicity from the litigation to business goodwill?