Don’t Rock the Section 2053 Boat – You’ll Tip the 706 Over

Recent Cases Dealing with Administrative Expenses

Turner v. U.S., 306 F.Supp.2d 668 (January 30, 2004), Deductions for Interest Paid on Delayed Pecuniary Bequest

The will of Sally Jackson will left $10 million to a charity, the Juliette Fowler Homes, Inc., provided that the charity was an organization described in IRC §2055(a).  The decedent’s independent administratrix delayed satisfying the bequest until she received a closing letter from the IRS. Pursuant to § 378B(f) of the Texas Probate Code, statutory interest began to accrue at six percent on the bequest one year after letters testamentary were issued. The IRS conducted an audit of the estate, and issued a closing letter accepting the return as flied. The administratrix satisfied the bequest promptly after receiving the closing letter, and also sent the beneficiary over $1 million in interest. The administratrix filed a claim for refund based on an estate tax deduction under IRC § 2053(a) for the interest. The IRS denied the refund, arguing that the interest was not deductible for estate tax purposes.

The U.S. District Court granted the estate summary judgment, allowing an estate tax deduction for the interest. The court noted that the regulations allow a deduction for any administrative expense only if the expense is: (1) incurred in the administration of the decedent’s estate, (2) actually and necessarily incurred, and (3) allowable by the laws of the jurisdiction under which the estate is being administered, Treas. Reg. § 20.2053-3(a).

The IRS first claimed that statutory interest payments were not actually expenses incurred in the administration of the estate, but rather a legal mechanism by which the estate income was allocated among its beneficiaries. The court disagreed, and accepted the estate argument that interest paid on a delayed bequest is no different from interest paid to another creditor. The IRS next argued that the interest was not “necessarily” incurred, because the administratrix “unreasonably” waited two and one-half years to satisfy the bequest. The court disagreed and held that the expense was necessary, because the will required that the administratrix ascertain the tax-exempt status of the charity before satisfying the bequest. Fowler Homes was a subordinate organization that claimed tax-exempt status through its affiliation with a charitable organization, the Christian Church (Disciples of Christ). The administratrix did receive from Fowler Homes three documents in support of its relationship with the Christian Church, but none of these documents were sufficient to prove conclusively the necessary relationship between Fowler Homes and the Christian Church. The administratrix, therefore, prudently withheld funding the bequest until the estate received an IRS closing letter and resolved any estate tax audit.

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