Gifts, Bequests, Deductible Expenses, And Estate Tax

Gifts, Bequests, Deductible Expenses, And Estate Tax

Estate of Spizzirri v. Comm’r, T.C. Memo 2023-25 | February 28, 2023 | Urda, J. | Dkt. No. 19124-19


Short Summary. Decedent was a wealthy lawyer and investor. During the last few years of his life, decedent paid significant sums to one of his daughters, one of his stepdaughters, and multiple women with whom he was either socially or romantically connected.

At the time of his death, decedent was married to his fourth wife. Decedent and wife had entered into a prenuptial agreement, which was subsequently amended over the course of several years. As amended, the prenuptial agreement provided that wife would receive at decedent’s death the right to reside at one of decedent’s properties for five years free of charge and that decedent’s will would include a bequest of $1,000,000 to each of wife’s daughters. This provision of the prenuptial agreement acted as a “waiver and release . . . of all rights in and to each other’s estate under any rule or law . . . entitling a surviving spouse to all or any part of the estate or property of a deceased spouse or to any interest therein.”

Decedent passed away in 2015. Decedent’s will did not include the payments reflected in the prenuptial agreement. Wife and her daughters brought claims against decedent’s estate. Eventually, the estate entered into a binding settlement with wife and paid each of wife’s daughters $1,000,000. The estate reported these payments to the Internal Revenue Service on Forms 1099-MISC.

The estate’s Form 706, United States Estate (and Generation Skipping Transfer) Tax Return, was due on February 10, 2016. On February 19, 2016, the estate requested a six-month extension to file the return, which was granted, extending the deadline to August 12, 2016. In July 2016 the estate’s tax return preparer requested a second extension of the filing deadline because of the ongoing probate litigation with wife. The IRS informed the estate that a second extension could not be granted as a matter of law.

On November 29, 2016, shortly after the conclusion of the probate litigation, the estate filed its federal estate tax return. The estate reported zero dollars in adjusted taxable gifts. It deducted as claims against the estate both the $3 million in payments to wife’s daughters and the appraised value of wife’s right to reside in one of decedent’s properties for five years. The estate further claimed administration expense deductions, including deck repairs for one of decedent’s properties.

The IRS issued a notice of deficiency determining a deficiency in estate tax of $2,251,189 as well as an addition to tax under section 6651(a)(1) of $450,238 for failure to timely file. The notice increased decedent’s lifetime adjusted taxable gifts from zero to $193,441. The notice disallowed the deductions claimed for the payments to wife’s children and wife’s right to reside in one of decedent’s properties. It likewise disallowed the administration expense deductions for the deck repairs for one of decedent’s properties.

Key Issues

Were decedent’s payments to various family members or friends during the last few years of his life taxable gifts?
Were the payments to wife’s daughters and the value of wife’s five-year right to reside in one of decedent’s properties deductible as claims against the estate?
Were the estate’s expenses for deck repairs on one decedent’s properties deductible as expenses to repair and maintain decedent’s properties?
Was the estate liable for penalties for failure to timely file its estate tax return?
Primary Holdings

The estate failed to meet its burden of proving that decedent’s payments to various family members and friends were not gifts subject to the gift tax. The estate’s failure to call the recipients themselves (other than decedent’s daughter) potentially gave rise to an adverse inference that, had they been called, their testimony would not have supported the estate’s contentions. Moreover, decedent paid the amounts at issue by checks with no indication that they were meant as compensation. Decedent did not issue or file any Forms 1099 or W-2 related to these payments, nor did he report these payments on his personal income tax returns. Witnesses at trial also did not address decedent’s payments to six of the nine recipients at issue. While trial testimony reflected that the other three recipients helped decedent in various ways during the last few years of his life, the testimony did not resolve whether the payments were anything other than gifts.

The estate’s deduction for payments of $1 million to each of wife’s three children and the value of wife’s five-year right to reside in one of decedent’s properties were disallowed, because the claims were either not bona fide or not for consideration. The payments were not contracted bona fide but rather “essentially donative in character” and testamentary gifts. The estate did not provide any evidence that the recipients included the payments as income, which might indicate that the payments were not gifts. Moreover, the payments were not contracted for with adequate and full consideration in money or money’s worth, as the amended prenuptial agreement clearly states that the consideration for the claims is wife’s waiver of her marital rights, which runs directly contrary to the prohibition in section 2043(b), which states that “a relinquishment or promised relinquishment of dower or curtesy, or of a statutory estate created in lieu of dower or curtesy, or of other marital rights in the decedent’s property or estate, shall not be considered to any extent a consideration ‘in money or money’s worth.’”

The estate did not meet its burden of showing that the expenditures for replacing the decks at one of decedent’s properties were necessary for the preservation and care of the property (and therefore deductible), rather than improvements to make the house more attractive for potential buyers (and therefore nondeductible). Although the executor credibly testified as to his view that the decks “needed extensive repair in order to pass any inspection,” his view was not reflected in the estate’s appraisal report (which did not address structural integrity). The estate did not provide any corroboration that the replacement of the decks was necessary for a sale or to maintain the fair market value claimed on its return.

The estate did not establish reasonable cause for failure to timely file an estate tax return, and the penalty assessment was upheld. There was nothing to indicate that probate litigation deprived the estate of sufficient information to file a proper return. The estate also failed to establish reasonable cause based on reliance upon a tax return preparer, because their tax return preparer credibly testified that he advised the state to file the estate tax return before the extended deadline.
Key Points of Law

Generally, a taxpayer bears the burden of proving by a preponderance of the evidence that the determinations of the Commissioner in a notice of deficiency are incorrect. See Tax Court Rule 142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933).

Section 7491(a) shifts the burden to the Commissioner, however, with respect to a factual issue relevant to a taxpayer’s liability where the taxpayer, inter alia, provides credible evidence.
“Credible evidence is the quality of evidence which, after critical analysis, the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted (without regard to the judicial presumption of IRS correctness).” Higbee v. Comm’r, 116 T.C. 438, 442 (2001) (quoting H.R. Rep. No. 105-599, at 240–41 (1998) (Conf. Rep.), as reprinted in 1998-3 C.B. 747, 994–95).

“[W]e are not compelled to believe evidence that seems improbable or to accept as true uncorroborated, although uncontradicted, evidence by interested witnesses.” See, e.g., Estate of Erickson v. Comm’r, T.C. Memo. 2007-107, 2007 WL 1364407, at *6.

The gift tax imposes an excise tax on the transfer of property by gift during the donor’s lifetime. See R.C. § 2501(a)(1). The gift tax is imposed whether the gift is made directly or indirectly, whether it is real or personal property, and whether it is tangible or intangible. I.R.C. § 2511(a); see Dickman v. Comm’r, 465 U.S. 330, 334 (1984) (“The language of [sections 2501(a)(1) and 2511(a)] is clear and admits of but one reasonable interpretation: transfers of property by gift, by whatever means effected, are subject to the federal gift tax . . . [T]he gift tax was designed to encompass all transfers of property . . . .”).

“Donative intent on the part of the transferor is not an essential element in the application of the gift tax to the transfer.” Reg. § 25.2511-1(g)(1). “The application of the tax is based on the objective facts of the transfer and the circumstances under which it is made, rather than on the subjective motives of the donor.” Id.
The tax is imposed on “taxable gifts,” which is defined as the total amount of gifts made during the calendar year less specified deductions. R.C. § 2503(a).
Section 2503(b) provides an annual exclusion from gift tax. The annual exclusion was $13,000 during 2011 and 2012 and $14,000 for 2013 through 2015. See What’s New – Estate and Gift Tax, IRS, (last updated Dec. 20, 2022).

The estate tax imposes a tax “on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States.” R.C. § 2001(a).
A decedent’s gross estate includes “the value at the time of his death of all property . . . wherever situated.” § 2031(a).

For purposes of determining the taxable estate, the value of the gross estate is reduced by permissible deductions, including claims against the estate that are allowable by applicable state law and administration expenses. §§ 2051, 2053(a)(2) and (3).

The deduction for claims against the estate is subject to section 2053(c)(1)(A), which provides that “the deduction allowed . . . in the case of claims against the estate . . . shall, when founded on a promise or agreement, be limited to the extent that they were contracted bona fide and for an adequate and full consideration in money or money’s worth.” The “purpose of this section . . . was to prevent deductions, under the guise of claims, of what were in reality gifts or testamentary distributions.” Carney v. Benz, 90 F.2d 747, 749 (1st Cir. 1937); see also Estate of Pollard v. Comm’r, 52 T.C. 741, 744 (1969).

An estate must establish that “the promise resulting in the claim on the estate ‘was contracted for in good faith for value which augmented the decedent’s estate.’” See Estate of Kosow v. Comm’r, 45 F.3d 1524, 1531 (11th Cir. 1995) (quoting Leopold v. U.S., 510 F.2d 617, 624 (9th Cir. 1975)), vacating and remandingC. Memo. 1992-539; see also Estate of Tiffany v. Comm’r, 47 T.C. 491, 497 (1967).

“The ‘bona fide’ and ‘consideration’ elements in section 2053(c)(1)(A) are related but separate requirements, and if either is missing the deduction fails under this section.” Estate of Cole v. Comm’r, T.C. Memo. 1989-623, 1989 WL 138921, rev’d on other grounds sub nom. Devore v. Comm’r, 963 F.2d 280 (9th Cir. 1992).
The bona fide requirement generally prohibits a deduction “to the extent it is founded on a transfer that is essentially donative in character (a mere cloak for a gift or bequest).” Reg. § 20.2053- 1(b)(2)(i).

“[T]ransactions among family members are subject to particular scrutiny, even when they apparently are supported by monetary consideration, because that is the context in which a testator is most likely to be making a bequest rather than repaying a real contractual obligation.” Estate of Huntington v. Comm’r, 16 F.3d 462, 466 (1st Cir. 1994), aff’g 100 T.C. 313 (1993); see also Estate of Tiffany, 47 T.C. at 499.

Treasury Regulation § 20.2053-1(b)(2)(ii) sets forth factors to evaluate determine a claim involving family members is bona fide. Among other “[f]actors indicative (but not necessarily determinative) of the bona fide nature of a claim,” the Treasury Regulation considers whether (1) “[t]he transaction underlying the claim or expense occurs in the ordinary course of business, is negotiated at arm’s length, and is free from donative intent,” (2) “[t]he nature of the claim or expense is not related to an expectation or claim of inheritance,” (3) “[p]erformance by the claimant is pursuant to the terms of an agreement between the decedent and the family member, . . . and the performance and the agreement can be substantiated,” and (4) all amounts paid in satisfaction of the claim “are reported by each party for Federal income . . . tax purposes . . . in a manner that is consistent with the reported nature of the claim.”

In addition to being contracted bona fide, section 2053(c)(1)(A) requires that claims against the estate be contracted for “an adequate and full consideration in money or money’s worth” to be deductible. Satisfaction of this requirement “may not be predicated solely on the fact that the contract is enforceable under State law,” Estate of Glover v. Comm’r, T.C. Memo. 2002-186, 2002 WL 1774231, at *14, but instead necessitates “a higher standard of consideration,” Estate of Carli v. Comm’r, 84 T.C. 649, 658 (1985).

“In good tax code fashion, there is a further provision, section 2043(b)(1), which tells us that some things do not constitute ‘consideration in money or money’s worth.’” Estate of Herrmann v. Comm’r, 85 F.3d 1032, 1035 (2d Cir. 1996), aff’gC. Memo. 1995-90, 1995 WL 84623.

Specifically, “a relinquishment or promised relinquishment of dower or curtesy, or of a statutory estate created in lieu of dower or curtesy, or of other marital rights in the decedent’s property or estate, shall not be considered to any extent a consideration ‘in money or money’s worth’.” I.R.C. § 2043(b)(1). The purpose of this provision “was to eliminate a particular form of estate tax avoidance which involved the contractual conversion of a wife’s dower (or other property rights she may have as surviving spouse) into a deductible claim against the gross estate.” Estate of Glen v. Comm’r, 45 T.C. 323, 333 (1966).

In sum, a spouse’s inheritance rights in the decedent’s property do not constitute consideration under section 2053(c)(1)(A). Estate of Rubin v. Comm’r, 57 T.C. 817, 823–24 (1972), aff’d without published opinion, 478 F.2d 1399 (3d Cir. 1973).

Spousal rights of support and maintenance lie outside the strictures of section 2043(b) and accordingly are treated differently for purposes of section 2053(c)(1)(A).

As the U.S. Court of Appeals for the Eleventh Circuit has observed, “the IRS does not dispute that the waiver of support rights may constitute full and adequate consideration under § 2053; nor could it.” Estate of Kosow v. Comm’r, 45 F.3d at 1531; see also Estate of Carli, 84 T.C. at 657, 661; Estate of Fenton v. Comm’r, 70 T.C. 263, 275 (1978). “Therefore, the claim for payment after the death of the decedent, to the extent that it is based on such release [of spousal support rights], is deductible . . . as a claim based upon an adequate and full consideration in money or money’s worth to the extent of the value of the . . . support rights.” Estate of Fenton, 70 T.C. at 275.

Section 2053(a)(2) allows a deduction from the gross estate for administration expenses as permitted by the laws of the state where the estate is administered.

Treasury Regulation § 20.2053-3(a) explains that the deduction is “limited to such expenses as are actually and necessarily, incurred in the administration of the decedent’s estate; that is, in the collection of assets, payment of debts, and distribution of property to the persons entitled to it.”

“The expenses contemplated . . . are such only as attend the settlement of an estate and the transfer of the property of the estate to individual beneficiaries or to a trustee . . . .”
“Expenses necessarily incurred in preserving and distributing the estate, including the cost of storing or maintaining property of the estate if it is impossible to effect immediate distribution to the beneficiaries, are deductible . . . .” Treas. Reg. § 20.2053-3(d)(1); see also Marcus v. DeWitt, 704 F.2d 1227, 1230 (11th Cir. 1983).

“Expenses for preserving and caring for the property may not,” however, “include outlays for additions or improvements; nor will such expenses be allowed for a longer period than the executor is reasonably required to retain the property.” Treas. Reg. § 20.2053-3(d)(1).

Expenses incurred to enhance the salability of a decedent’s residence are generally not deductible under section 2053.See Estate of Grant v. Comm’r, T.C. Memo. 1999-396, 1999 WL 1111778, at *10–11, aff’d, 294 F.3d 352 (2d Cir. 2002).

Section 6651(a)(1) imposes an addition to tax for a taxpayer’s failure to file a required return on or before the specified filing date, including extensions.
A taxpayer bears the burden of proof with respect to its liability for an addition to tax. See Estate of Jackson, T.C. Memo. 2021-48, at *248; Estate of Ramirez, T.C. Memo. 2018-196, at *32.
An addition to tax is inapplicable if the taxpayer’s failure to file the return was due to reasonable cause and not to willful neglect. I.R.C. § 6651(a)(1); see also United States v. Boyle, 469 U.S. 241, 243 (1985); Williams v. Comm’r, T.C. Memo. 2022-7, at *4.

The Estate bears the burden of proof with regard to the “reasonable cause” exception to section 6651(a). See Boyle, 469 U.S. at 245; Higbee, 116 T.C. at 447.
“Reasonable cause” exists if the taxpayer exercised ordinary business care and prudence but was nevertheless unable to file the return on time. See McMahan v. Comm’r, 114 F.3d 366, 368–69 (2d Cir. 1997), aff’gC. Memo. 1995-547; Treas. Reg. § 301.6651-1(c)(1).

Reliance on a tax professional can constitute reasonable cause if that professional advises the taxpayer on a substantive tax issue, such as whether a liability exists or a return must be filed.Boyle, 469 U.S. at 250–51.

To claim reasonable reliance on professional advice, the taxpayer must prove that “(1) [t]he adviser was a competent professional who had sufficient expertise to justify reliance, (2) the taxpayer provided necessary and accurate information to the adviser, and (3) the taxpayer actually relied in good faith on the adviser’s judgment.” Neonatology Assocs., P.A. v. Comm’r, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).

Insights: Among the insights that can be gleaned from this case, perhaps the most fundamental are 1) a taxpayer should always maintain documentation supporting their claims (in this case, that certain payments were not taxable gifts or that certain repairs were necessary preserving the estate’s property); 2) legal agreements (such as prenuptial agreements) can have an affect on characterization of payments for tax purposes; and 3) if a taxpayer files a tax return late, they are likely going to get hit with penalties unless they can show reasonable cause.

Have a question? Contact Jason Freeman And Team, Freeman Law, Texas.

Mr. Freeman is the founding and managing member of Freeman Law, PLLC. He is a dual-credentialed attorney-CPA, author, law professor, and trial attorney. Mr. Freeman has been recognized multiple times by D Magazine, a D Magazine Partner service, as one of the Best Lawyers in Dallas, and as a Super Lawyer by Super Lawyers, a Thomson Reuters service.
He was honored by the American Bar Association, receiving its “On the Rise – Top 40 Young Lawyers” in America award, and recognized as a Top 100 Up-And-Coming Attorney in Texas. He was also named the “Leading Tax Controversy Litigation Attorney of the Year” for the State of Texas” by AI.

Subscribe to TaxConnections Blog

Enter your email address to subscribe to this blog and receive notifications of new posts by email.