On February 19, 2005, the United States Tax Court decided the case of Eileen S. Belmont v. Commissioner. Eileen Belmont’s Will gave the residue of her estate to the Columbus Jewish Foundation. The executor elected to deduct that on the Estate’s income tax return, claiming that $219,580 would go to the Foundation. But litigation ensued on an unrelated matter and about $35,000 of that donation amount was eaten up in litigation costs. The IRS claimed the Estate lost the entire deduction, and the Tax Court agreed. There are two morals to the story: (1) when you make your Will, you need to pay your attorney for the time it takes to make sure all of your beneficiary designations match what you put into your Will; and (2) when you are the executor, you need to get your attorney to help you figuring out the timing of when income taxable events occur.
Eileen S. Belmont v. Commissioner
The legal result in this case occurred because an estate can take an income tax deduction for a charitable gift required by the Will, which has yet to be paid, but the deduction is dependent on accurately forecasting what amount will actually be paid to the charity.
Eileen S. Belmont lived in Ohio at the time she died. Diane Sater was the executrix. The only potential heirs were a brother who lived in California and a half-sister in Ohio. Probate began on April 5, 2007. Her Will gave two “Swedish tiles” to a friend and the rest to her mother. But her mother predeceased her. The Will provided, in that event, $50,000 would go to brother David, and the rest would go to the Foundation, a 501(c)(3) charitable organization.
Ms. Belmont owned two pieces of real estate. One was her home in Ohio and the other was a condominium in California. Prior to purchasing the condominium in California, Ms. Belmont owned a house in Santa Monica. David lived there until August 2000 when the house was sold and he moved back to Ohio to help take care of their mother. After the mother died, Ms. Belmont purchased the condominium and permitted David to move into it. He had lived there nine months when Ms. Belmont died. David proposed to the attorney for the estate that he exchange his $50,000 bequest for a life tenancy interest in the condominium. But the executrix sent him a letter saying he could not do that because the Foundation did not want to hold real estate as an investment and, as a result, asked him to leave the condominium. She offered him a $10,000 stipend from the Foundation (this was not explained in the Court’s opinion but was presumably a one-time payment). He refused and instead filed a creditor’s claim alleging that there was an agreement that had existed between him, Ms. Belmont and their mother giving him a life tenancy interest in the condominium. Because David was a client of a local mental health organization in California where a prominent attorney was on the board, he obtained the services of that attorney free of charge. He filed a Lis Pendens. His claim was rejected by the executrix, so he filed a petition based on a resulting trust theory. After trial in October 2011, David won and the Estate appealed. The appellate court upheld the decision. All of that cost the Estate about $35,000.
In the meantime, the estate had collected $243,463 from the State Teachers Retirement Pension Fund of Ohio which was income in respect of a decedent (“IRD”), meaning it was taxable, ordinary income. $24,346 was withheld for federal tax and the remainder went into the Estate’s bank account. The taxes on the IRD would have been a lot more that that, so the estate needed a deduction, and as much of it as possible. And the estate could not wait to see what the outcome of the dispute with David was going to be to see what the estate could actually pay (obviously, if the estate had already paid the foundation, this dispute with the IRS would not have occurred). On the 2008 federal income tax return for the Estate, the Estate, already aware of the potential claim by David, told the CPA that the Foundation was going to get $219,580, a big enough deduction to offset the IRD, taking the tax withheld. So the CPA put that on the income tax return as a charitable income tax deduction. Because David had a potential claim outstanding, the executor knew that some expenses were going to be incurred dealing with that claim, but the executor never told the CPA about any of that.
After the trial and after all of the expenses were paid, the estate had only about $185,000 left to pay the Foundation the $219,580. And thus the Estate was about $35,000 short.
The Court decision does not say exactly how the IRS found out, but it did and, when it did, it cited Section 642(c)(2) which provides that any part of the gross income of an estate which, pursuant to the terms of the Will, is permanently set aside during the taxable year for a purpose specified in Section 170(c) is allowed as a deduction to the estate. The IRS claimed the estate had not “permanently set aside” the $219,580. In its defense, the estate referred to Reg.Sec. 1.642(c)-2(d) which says that risks that a fund would be depleted which are “so remote as to be negligible” do not prevent the estate from taking the deduction. And so the fight with the IRS was over whether the estate’s litigation expenses were foreseeable or so remote as to be negligible.
Timing becomes very important. In late 2007, the Estate retained the law firm to open an ancillary estate administration in California. David had discussed with the estate’s Ohio attorney prior to that date the idea of exchanging the $50,000 bequest for the life tenancy interest. Proceedings began in California on February 14, 2008, before the estate income tax return was filed, and on the same date, the executrix mailed to David that letter denying his request and telling him to move out. On April 2, David filed the creditor’s claim. 15 days later, he filed the Lis Pendens. The estate’s taxable period ended on March 31, 2008. By the time the CPA was preparing the return and certainly before it was filed in July of 2008, the executrix was very aware that David was making a claim and there was no doubt at that time that some amount was going to have to be spent defending against the claim. The only issue was how much and whether it would be enough to eat into the $219,580.
The Tax Court detailed all of the expenses the estate had to pay and cited the Graev v. Commissioner case decided by the Tax Court in 2013, which defined the phrase “so remote as to be negligible” as “a chance which persons generally would disregard as so highly improbable that it might be ignored with reasonable safety and undertaking a serious business transaction.” In the much earlier case of Briggs v. Commissioner, the Tax Court said that it meant “a chance which every dictate of reason would justify an intelligent person in disregarding as so highly improbable and remote as to be lacking in reason and substance.” The estate countered by citing Commissioner v. Upjohn’s Estate, a decision by the 6th Circuit in 1941 to support its position saying that expenses to David’s claim were “remote possibilities” that might “deplete funds” which “should not be considered when determining whether funds are permanently set aside for purposes of IRC section 642.” But the Tax Court didn’t buy the argument.
Based on those cases and the facts before it, the Tax Court found that when the estate filed its tax return on July 17, 2008, there were sufficient facts “to put the estate on notice that the possibility of an extended and expensive legal fight – and consequently the dissipation of funds set aside for the foundation – was more than “so remote as to be negligible.””
Because of the way the statute and regulations are written, the Tax Court upheld the IRS’s assessment of $75,662 in taxes. In other words, the entire charitable income tax deduction was disallowed. Said another way, the estate did not get a deduction for $185,000. It got a deduction for $0.