• QTIP trust estate tax value not reduced by obligation to survivor’s estate—In Estate of Kalikow v. Commissioner (T.C. Memo. 2023-21 (Feb. 27, 2023)), the Tax Court held that the full value of qualified terminable interest property (QTIP) assets were included in the value of the decedent’s gross estate under Internal Revenue Code Section 2044, without reduction by the agreed-on undistributed income amount.
Pearl Kalikow was the beneficiary of a QTIP marital trust established under her husband Sidney’s estate plan. The QTIP trust owned a majority interest in a limited liability company that owned 10 apartment buildings in New York City that generated significant income. During Pearl’s life, she was entitled to all of the income from the QTIP trust. After her death, the remainder of the trust property was to be held in two separate trusts for their children.
After her death, several of Pearl’s grandchildren requested the trustees to account for the trust, asserting that Pearl hadn’t properly received all the trust income. Ultimately, the trustees and the family settled, and the court-approved agreement required the trustees to pay $9.5 million to Pearl’s estate. Of this amount, $6.2 million represented the income that hadn’t been properly paid to Pearl’s estate, and the other $3 million were legal fees and trustee commissions.
Under Pearl’s will, she left her estate to charity. So ultimately, the amounts payable to her estate from the settlement, after expenses, would be paid to charity.
The estate filed two Forms 706. The executors filed one Form 706 that reported all estate assets other than the QTIP trust, and the trustees of the QTIP trust (who had been appointed limited administrators by the Surrogate’s Court) filed a separate Form 706 that reported the value of the QTIP trust. The Internal Revenue Service reviewed the estate tax returns and issued a notice of deficiency due to a significant re-valuation of the family limited partnership that owned the real estate. In addition to the re-valuation, the IRS didn’t reduce the value of the QTIP trust by the settlement payment.
The trustees argued that if the QTIP trust wasn’t reduced by the value of the payment to Pearl’s estate, the IRS was essentially imposing an estate tax on a bequest to charity. The Tax Court disagreed, noting that under the settlement agreement, the QTIP trust wasn’t solely liable for the settlement payment. In fact, it was jointly and severally liable along with several other trusts, and it wasn’t expected that the QTIP trust would be the source of settlement payment.
The estate then claimed that the settlement payment made by the QTIP trust should be deductible under IRC Section 2053(b), which allows a deduction for administrative expenses and claims against the estate. The court again disagreed, stating that Section 2053 is only applicable to claims or expenses paid by the estate. The obligations of the trust to the estate under the agreed-on settlement payment doesn’t give rise to any deduction by the estate.
• Lawyer’s estate owes gift taxes and can’t deduct payments made pursuant to prenuptial agreement—In Estate of Spizzirri v. Comm’r, No. 19124-19 (Feb. 28, 2023), the Tax Court held that Richard Spizzirri’s estate owes gift taxes and can’t claim deductions for bequests to his wife and her children outside of the prenuptial agreement (prenup). Richard was a lawyer who lived extravagantly, had multiple children from and outside several marriages and died married to his fourth wife, Holly.
During the last few years of his life, Richard paid large sums to his daughter, stepdaughter and several women with whom he was either socially or romantically connected. The estate reported no taxable gifts, claiming that these payments were for care and companionship services during the last years of Richard’s life. The Tax Court disagreed, noting the murky relationship with the women. None of the women reported the payments as income; there were no indications that these payments were compensation.
Richard and Holly had signed a prenup, which they had amended many times. In its last version, he was to pay each of her children $1 million and provide her the right to reside in his Easthampton, N.Y. home for five years after his death. He never updated his estate plan to provide for these payments; Holly and her children filed claims against the estate and were ultimately paid. On Richard’s estate tax return, the estate claimed a deduction for the payments to the three children, as well as the value of Holly’s right to reside in Easthampton, as claims against the estate.
Under IRC Section 2053, claims against the estate must be contracted bona fide and for adequate and full consideration. In addition, there are special rules relating to spousal payments. Relinquishing a right to a statutory inheritance right (dower or curtesy) isn’t consideration, but relinquishment of a spousal support right is consideration. The estate argued that Holly had waived her spousal support in exchange for the payments, and therefore, she had provided consideration. The Tax Court disagreed and held that the prenup very specifically noted that the $3 million payment and right to reside in Easthampton was specifically granted in exchange for Holly’s inheritance rights. As a result, it wasn’t deductible. (It also didn’t qualify for the marital deduction because her right to use the home was only for five years, not for life.)
Finally, the estate claimed deductions for administration expenses for “emergency repairs” and “continued maintenance” for Richard’s Aspen house. But while the executor claimed that the property needed extensive repairs to pass any inspection, the court disallowed the deductions, stating that although the executor’s testimony was credible, it wasn’t supported by the appraisal report, and the repairs didn’t appear necessary to preserve the property. Instead, they looked to be improvements targeted to ready the property for sale; as a result, they weren’t deductible.
• Tax Court allows “tax affecting” valuation for shares in the Biltmore Company—In Cecil v. Comm’r (T.C. Memo. 2023-24 (Feb. 28, 2023)), the Tax Court considered whether the earnings of an S corporation (S corp) should be “tax affected” by imposing an assumed corporate tax rate to pretax earnings. Taxpayers William and Mary Cecil owned the Biltmore House in the Blue Ridge Mounts of North Carolina—the largest privately owned house in the United States. The extensive property was used for agricultural, farming and timber, as well as recreational purposes (it’s a tourist destination for its gardens, restaurants, fly fishing, biking, river rafting, etc. and held a significant art collection). The Cecils owned the property through TBC, a Delaware S corp. In 2010, William and Mary each made gifts of their stock in TBC, and they each filed Forms 709, which reported their respective gifts of TBC stock valued at over $10 million. The IRS issued a notice of deficiency, asserting undervaluation of the TBC stock.
The court evaluated the various approaches of the Cecils’ appraisers and IRS experts who applied variations of the market/income/asset methods. Acknowledging that all of the experts on both sides agreed that tax affecting was appropriate to value stock in the Biltmore Company, the Tax Court confirmed that a rate of 17% was appropriate for tax discounting, in addition to discounts for lack of control and lack of marketability. The court noted, however, that it wasn’t always appropriate to apply tax discounts when valuing S corps.
• U.S. Supreme Court holds that Bank Secrecy Act imposes only single penalty, regardless of the number of accounts—In Bittner v. United States, No. 21-1195, the U.S. Supreme Court handed down a 5-4 opinion holding that the Bank Secrecy Act imposes a single $10,000 penalty for the non-willful failure to file a timely, accurate annual report of foreign bank and financial accounts (FBAR), regardless of the number of foreign accounts that aren’t reported on that report. While FBAR penalties for non-willful violations will be measured on a per-report basis, penalties for willful violations will continue to incur penalties per account.