Estate of Clyde W. Turner, Sr., W. Barclay Rushton v. Commissioner , 151 T.C. No. 10 ( 2018 )


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  •                                  151 T.C. No. 10
    UNITED STATES TAX COURT
    ESTATE OF CLYDE W. TURNER, SR., DECEASED, W. BARCLAY
    RUSHTON, EXECUTOR, Petitioner v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent*
    Docket No. 18911-08.                         Filed November 20, 2018.
    Decedent (D) transferred property to a family limited
    partnership (FLP) in exchange for general and limited partnership
    interests and then transferred portions of his limited partnership
    interest as gifts during his lifetime. In Estate of Turner v.
    Commissioner, T.C. Memo. 2011-209, we held that the inter vivos
    transfer of property to the FLP was subject to I.R.C. sec. 2036. In
    Estate of Turner v. Commissioner, 
    138 T.C. 306
     (2012), we held that
    D’s estate is not entitled to a marital deduction with respect to the
    value of certain property included in D’s gross estate under I.R.C.
    sec. 2036 because the property was the subject of lifetime gifts and
    did not pass to D’s surviving spouse.
    *
    This Opinion supplements our previously filed Opinion in Estate of Turner
    v. Commissioner, 
    138 T.C. 306
     (2012), supplementing T.C. Memo. 2011-209.
    -2-
    Under I.R.C. sec. 2036 the value of the property transferred to
    the FLP is included in D’s gross estate and results in Federal estate
    and State death tax liabilities. D’s estate’s liability for Federal estate
    and State death taxes arises solely because of the I.R.C. sec. 2036
    inclusion.
    R filed computations and amended computations for entry of
    decision pursuant to Rule 155, Tax Court Rules of Practice and
    Procedure. D’s estate objected. The parties disagree as to (1)
    whether D’s estate must reduce the I.R.C. sec. 2056 marital deduction
    by the amounts of the Federal estate and State death taxes owed that
    R claims must be paid from estate assets passing to the surviving
    spouse (marital deduction property) and (2) whether D’s estate may
    increase the marital deduction by postdeath income that was not
    included in the gross estate but was generated by marital deduction
    property.
    Held: D’s estate is not required to reduce the marital deduction
    by the amounts of the Federal estate and State death taxes it owes
    because (1) those taxes are attributable solely to the value of property
    included in the gross estate under I.R.C. sec. 2036, (2) the executor
    has a right under I.R.C. sec. 2207B to recover from the beneficiaries
    who received the property during D’s lifetime an amount equal to the
    Federal estate and State death taxes plus interest attributable to those
    transfers, and (3) the executor must exercise the right of recovery
    under I.R.C. sec. 2207B to prevent the marital deduction property
    from bearing D’s estate’s tax burden contrary to D’s intent.
    Held, further, D’s estate may not increase the marital deduction
    by the amount of postdeath income generated by the marital
    deduction property.
    Charles E. Hodges II and Rose K. Drupiewski, for petitioner.
    Caroline R. Krivacka and William Walter Kiessling, for respondent.
    -3-
    SUPPLEMENTAL OPINION
    MARVEL, Judge: This matter is before the Court on the objection by the
    Estate of Clyde W. Turner, Sr. (estate), to respondent’s proposed amended
    computation for entry of decision submitted in response to our holdings in Estate
    of Turner v. Commissioner (Estate of Turner I), T.C. Memo. 2011-209,
    supplemented by Estate of Turner v. Commissioner (Estate of Turner II), 
    138 T.C. 306
     (2012). The parties ask the Court to resolve the continuing controversy
    regarding the computation of the marital deduction under section 2056.1 The
    Court held a hearing, and counsel for both parties appeared and were heard.
    The parties’ arguments regarding the correct computation of the marital
    deduction require the Court to decide two questions: (1) whether the estate is
    required to reduce the marital deduction by the amounts of Federal estate and State
    death taxes it owes when those taxes are attributable to the values of gifts made
    during decedent’s lifetime but included in the gross estate by reason of section
    2036 (sometimes referred to as section 2036 assets) and (2) whether the estate is
    entitled to increase the marital deduction by postdeath income, generated by estate
    1
    Unless otherwise indicated, section references are to the Internal Revenue
    Code (Code) in effect for the date of decedent’s death, and Rule references are to
    the Tax Court Rules of Practice and Procedure.
    -4-
    assets, that was reported on Form 1041, U.S. Income Tax Return for Estates and
    Trusts, and paid to the surviving spouse.
    Background
    We adopt the findings of fact in Estate of Turner I and Estate of Turner II.
    For convenience and clarity, we repeat the necessary facts below.
    Clyde W. Turner, Sr. (Clyde Sr.), resided in Georgia when he died testate on
    February 4, 2004. Estate of Turner I, slip op. at 2. W. Barclay Rushton is the
    executor of the estate. Id. Mr. Rushton resided in Georgia when he petitioned this
    Court on behalf of the estate. Id.
    On April 15, 2002, Clyde Sr. and his wife, Jewell H. Turner,2 established
    Turner & Co., a family limited partnership (FLP) that qualified as a Georgia
    limited liability partnership. Id. at 8. Upon the formation of the FLP, Clyde Sr.
    and Jewell each contributed assets with a fair market value of $4,333,671 (total
    value of $8,667,342) to the FLP. Estate of Turner II, 138 T.C. at 311-312. In
    exchange, each received a 0.5% general partnership interest and a 49.5% limited
    partnership interest. Id. By January 1, 2003, Clyde Sr. had transferred, in the
    2
    Jewell H. Turner died on July 8, 2007, and a related case, Estate of Turner
    v. Commissioner, docket No. 29411-11, involving her estate is pending. For
    purposes of this Opinion, we refer to Jewell and/or her estate collectively as
    Jewell.
    -5-
    aggregate, limited partnership interests totaling 21.7446% to family members as
    gifts.
    In Estate of Turner I, slip op. at 52-53, we held, inter alia, that under section
    2036 the value of the property that Clyde Sr. had transferred to the FLP must be
    included in the value of his gross estate. In Estate of Turner II, 138 T.C. at 306-
    307, we held that the estate is not entitled to a marital deduction for the value of
    the property that was brought back into the gross estate by section 2036
    (sometimes referred to as the section 2036 inclusion).
    Before we filed our report in Estate of Turner II, we received and filed
    respondent’s computation for entry of decision (first computation). Respondent
    calculated that the estate owed an estate tax deficiency of $362,822.44. After we
    filed our report in Estate of Turner II, the estate filed a notice of objection to the
    first computation, presenting two alternative computations. Respondent filed a
    response to the estate’s notice of objection.
    On August 6, 2012, with leave of Court, respondent filed an amended
    computation for entry of decision (amended computation). As respondent
    explained in the motion for leave to file the amended computation, in the first
    computation he allowed a deduction for the interest on the estate tax but did not
    correspondingly reduce the marital deduction by that amount. According to
    -6-
    respondent, the amended computation corrects that mistake. Respondent’s
    amended computation shows an estate tax deficiency of $513,820.61.
    The estate filed a notice of objection to respondent’s amended computation,
    which presented two alternative computations: Option 1 shows an estate tax
    deficiency of $144,136, and option 2 shows an estate tax deficiency of $341,073.
    After concessions,3 the parties disagree as to (1) whether the estate must reduce
    the marital deduction by the amounts of the Federal estate and State death taxes
    (and related interest) it owes and (2) whether the estate may increase the marital
    deduction by the amount of postdeath income that was not included in the
    calculation of the gross estate but was instead reported on Form 1041 and
    distributed to the surviving spouse.
    3
    A comparison of the estate’s objections to the first and amended
    computations shows that the estate no longer disagrees that $523,143 of funeral
    and legal and accounting expenses reduces the marital deduction. Respondent
    concedes that interest on the State death tax is deductible. During the hearing the
    estate conceded that, as of the hearing date, expenses reportable on Schedule J,
    Funeral Expenses and Expenses Incurred in Administering Property Subject to
    Claims, and Schedule K, Debts of the Decedent, and Mortgages and Liens, of
    Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return,
    totaled $523,143 and that the estate is not entitled to deduct $7,485 of legal and
    accounting fees. The estate also concedes that the marital deduction should be
    reduced by $24,606, the amount of expenses claimed on Form 1041 that were
    charged to residue.
    -7-
    Respondent filed a response to the estate’s notice of objection to
    respondent’s amended computation. The estate, with leave of Court, filed a reply,
    and respondent filed his response to the estate’s reply to respondent’s amended
    computation. The parties’ evolving positions are described below.
    Discussion
    I.    Federal Estate and State Death Taxes
    The parties agree that the only taxable portion of the estate is the portion
    attributable to the section 2036 inclusion. The parties disagree as to whether the
    estate should reduce the marital deduction by the resulting Federal estate and State
    death tax liabilities (including interest). Respondent’s position is that the estate
    must reduce the marital deduction by the amounts of Federal estate and State death
    taxes the estate must pay because the only property available to fund the payments
    is property that would otherwise pass to Jewell and qualify for the marital
    deduction. Citing the estate’s section 2207B right of recovery, the estate
    disagrees.
    We start with the basics of subchapter A of subtitle B of the Code. Section
    2001(a) imposes a tax on the transfer of the taxable estate of every decedent who
    is a citizen or resident of the United States. Section 2031(a) provides that the
    value of the decedent’s gross estate includes the values of interests described in
    -8-
    sections 2033 through 2045. An estate may deduct from the value of the gross
    estate the value of certain property passing from the decedent to his or her
    surviving spouse (marital deduction). See sec. 2056(a). As relevant to this case,
    section 2056(b)(4) provides that in determining the value of any interest in
    property passing to the surviving spouse for which a marital deduction is allowed,
    we must take into account “the effect which the tax imposed by section 2001, or
    any estate, succession, legacy, or inheritance tax, has on the net value to the
    surviving spouse of such interest”. Section 2010 allows an estate a credit (unified
    credit) that reduces its estate tax liability.
    Section 2002 requires the executor of the estate to pay the estate tax.
    Regardless of the source of funds the executor uses to pay the estate tax, however,
    an issue remains regarding which beneficiary’s interest bears the financial burden
    of the tax. Often the decedent’s will provides guidance to the executor regarding
    how the executor should allocate the tax burden among the heirs, but the parties
    agree that Clyde Sr.’s will has no express provision regarding Federal estate and
    State death taxes or their apportionment, and we so find.4
    4
    These findings of fact supplement our findings of fact in Estate of Turner I
    and Estate of Turner II.
    -9-
    When a decedent fails to specify how an estate’s tax liabilities should be
    allocated, State law governs the manner in which those tax liabilities are allocated
    among estate assets. See Riggs v. Del Drago, 
    317 U.S. 95
    , 100-101 (1942). The
    parties agree that under Georgia law, the Federal estate and State death taxes and
    accompanying interest are paid from the residue.5 See Ga. Code Ann. sec. 53-4-
    63(a) (West 1996).
    In an effort to identify and define the residue, the parties focus on Items
    Eight and Nine of Clyde Sr.’s will. Item Eight expresses Clyde Sr.’s intent to
    leave assets to Jewell undiminished by any estate, inheritance, succession, death,
    or similar taxes and having a value “equal to the maximum marital deduction”.6
    5
    The term “residue” as it relates to a decedent’s estate generally means “the
    property comprising a decedent’s estate after payment of the estate’s debts, funeral
    expenses, costs of administration, and all specific and demonstrative bequests”.
    Bryan A. Garner, A Dictionary of Modern Legal Usage 762 (2d ed. 1995) (quoting
    Concise Dictionary of Law (2d ed. 1990)).
    6
    The relevant portion of Item Eight of Clyde Sr.’s will reads as follows:
    If Jewell survives me and if there is a federal estate tax in effect at the
    time of my death, I give, devise and bequeath to her cash, securities
    or other property of my estate (undiminished by any estate,
    inheritance, succession, death or similar taxes) having a value equal
    to the maximum marital deduction as finally determined in my federal
    estate tax proceedings, less the aggregate amount of marital
    deductions, if any, allowed for such tax purposes by reason of
    property or interests in property passing or which have passed to my
    (continued...)
    - 10 -
    Item Nine of Clyde Sr.’s will provides for the establishment of a trust for the
    benefit of the children and grandchildren of Clyde Sr. and Jewell if certain
    conditions are met.7 Because of the reference in Item Nine to “the rest, residue
    6
    (...continued)
    said wife otherwise than pursuant to the provisions of this Item;
    provided, however, the amount of this bequest shall be reduced by the
    amount, if any, needed to increase my taxable estate (for federal
    estate tax purposes) to the largest amount that, after allowing for the
    unified credit against the federal estate tax, and the state death tax
    credit against such tax (but only to the extent that the use of such state
    death tax credit does not increase the death tax payable to any state),
    will result in the smallest, if any, federal estate tax being imposed on
    my estate. * * *
    7
    Item Nine of Clyde Sr.’s will states:
    If Jewell survives me, I give, devise and bequeath all the rest, residue
    and remainder of my property of every kind and description
    (including lapsed legacies and devises), wherever situated and
    whether acquired before or after the execution of this Will, to the
    Trustee hereinafter named, to be held, administered and distributed as
    follows:
    (A) Commencing with the date of my death, my Trustee shall pay to
    or apply for the benefit of my wife and my issue such sums from the
    principal of and income from this Trust in such shares and
    proportions as in its sole discretion shall be necessary or advisable
    from time to time for the medical care, education, support and
    maintenance in reasonable comfort of my said wife and my issue,
    taking into consideration (to the extent my Trustee deems advisable)
    any other income or resources of my said wife and my issue known to
    my Trustee. * * *
    - 11 -
    and remainder” of property, the estate contends that Item Nine is the residuary
    clause of the will. The estate argues that the assets passing to the trust under Item
    Nine and not the assets passing to Jewell under Item Eight must bear the burden of
    the Federal estate and State death taxes and other expenses. Respondent argues
    that because of the section 2036 inclusion, the unified credit has been fully used
    and no trust under Item Nine comes into existence. Respondent urges us to
    conclude that the property passing to Jewell under Item Eight is the residue and is
    the only source available to pay the estate’s tax liabilities.
    The parties’ argument regarding which provision of the will constitutes the
    residuary clause, however, fails to focus on important facts in this case. Items
    Eight and Nine of Clyde Sr.’s will in effect require the executor to distribute to
    Jewell all property qualifying for the marital deduction unless a credit bypass trust
    was necessary to take advantage of the unified credit available to the estate.
    Pursuant to these provisions, the estate reported on the Form 706 that an
    18.8525% FLP interest was allocated to Jewell pursuant to Item Eight of Clyde
    Sr.’s will, and the remaining 8.9029% FLP interest was allocated to a credit
    bypass trust pursuant to Item Nine of the will. See Estate of Turner II, 138 T.C. at
    312.
    - 12 -
    Because we held in Estate of Turner I that the value of the section 2036
    assets must be included in the value of the gross estate, the allocations described
    above have changed. The section 2036 inclusion exhausted the unified credit
    under section 2010 and generated an estate tax liability. Because the unified credit
    has been fully used, it is no longer necessary to fund a credit bypass trust under
    Item Nine of Clyde Sr.’s will, and respondent’s first and amended calculations
    correctly reflect this. In fact, both parties’ computations recognize that (1) the
    trust under Item Nine has not been and will not be established or funded and (2)
    Jewell is entitled to a distribution of the value of any property interest included in
    the estate (except the section 2036 assets that Clyde Sr. transferred during his
    lifetime) adjusted as legally required.
    The problem we must solve here arises from the section 2036 inclusion.
    That inclusion created Federal estate and State death tax liabilities, but the only
    assets presently available to the executor from which he can pay the liabilities are
    assets that should pass to Jewell and which qualify for the marital deduction.
    Respondent argues that, because Clyde Sr. transferred the section 2036 assets
    during his lifetime and those assets are not available to the executor to fund the
    payment of the Federal estate and State death tax liabilities, the assets that would
    otherwise pass to Jewell and qualify for the marital deduction are the only source
    - 13 -
    of payment available to the estate and some part of those assets must be used to
    pay the liabilities, thereby reducing the marital deduction. In respondent’s view,
    Jewell is the only heir and the assets cannot pass to her undiminished by taxes as
    Item Eight of the will mandates. Accordingly, respondent contends, because the
    marital deduction is available only with respect to assets actually passing from the
    decedent to the surviving spouse, see sec. 2056(a); sec. 20.2056(a)-1(a), (b)(1)(ii),
    Estate Tax Regs., the marital deduction must be reduced to account for the assets
    used to pay Federal estate and State death taxes and related interest.
    The estate disagrees and points to section 2207B, which provides in part:
    SEC. 2207B(a). Estate Tax.--
    (1) In general.--If any part of the gross estate on which
    tax has been paid consists of the value of property included in
    the gross estate by reason of section 2036 (relating to transfers
    with retained life estate), the decedent’s estate shall be entitled
    to recover from the person receiving the property the amount
    which bears the same ratio to the total tax under this chapter
    which has been paid as--
    (A) the value of such property, bears to
    (B) the taxable estate.
    (2) Decedent may otherwise direct.--Paragraph (1) shall
    not apply with respect to any property to the extent that the
    decedent in his will (or a revocable trust) specifically indicates
    an intent to waive any right of recovery under this subchapter
    with respect to such property.
    - 14 -
    The estate contends that under section 2207B, the recipients of the section 2036
    assets during Clyde Sr.’s lifetime bear the burden of any taxes attributable to the
    section 2036 inclusion. We agree.
    Section 2207B is one of several Code sections that provide for a right of
    recovery for certain types of property or dispositions.8 Unless the will of a
    Georgia decedent expressly directs otherwise, Georgia law does not limit any
    rights to reimbursement for Federal estate taxes and other taxes that may be
    available to the executor under Federal law. See Ga. Code Ann. sec. 53-4-63(e).
    As discussed above, Clyde Sr.’s will does not address the payment of taxes
    or their apportionment, nor does it express any intent regarding the right of
    recovery under section 2207B or any other right of recovery provision. This is not
    surprising because Clyde Sr. did not know that the Court would apply section
    2036 to his lifetime transfers. Item Eight of Clyde Sr.’s will, however, clearly
    manifests his intention that the marital deduction not be reduced or diminished by
    8
    Other right of recovery provisions are: (1) sec. 2206, which allows a right
    of recovery for taxes generated by the inclusion of life insurance proceeds in the
    decedent’s gross estate; (2) sec. 2207, which provides for a right of recovery for
    taxes generated by property included in the gross estate by virtue of the decedent’s
    having possessed a power of appointment; and (3) sec. 2207A, which provides for
    a right of recovery for the tax attributable to qualified terminable interest property
    assets.
    - 15 -
    the estate’s tax liabilities.9 It is reasonable to assume that Clyde Sr. would want
    his executor to take all steps necessary to ensure that the property passing to his
    surviving spouse and qualifying for the marital deduction not be impaired.10
    9
    The parties do not address Estate of Wycoff v. Commissioner, 
    506 F.2d 1144
     (10th Cir. 1974), aff’g 
    59 T.C. 617
     (1973), but we find it appropriate to
    distinguish this case. In Estate of Wycoff v. Commissioner, 506 F.2d at 1146, the
    decedent’s will created two trusts, one in favor of his wife and the other for the
    benefit of his son. The decedent directed that Federal estate and State death taxes
    be paid out of the portion of his estate that was not in the marital trust; but at the
    same time, he granted the executor discretion to pay these taxes out of the marital
    trust if the executor considered it prudent to do so. The U.S. Court of Appeals for
    the Tenth Circuit reasoned that although the will expressed a preference for
    payment from the part of the estate not included in the marital trust, the will
    contained no positive direction that Federal estate and State death taxes be paid
    from the part of the estate not included in the marital share. Id. at 1150. The
    Court of Appeals stated: “[A]s we view it such an express provision would be
    necessary to justify a ruling for the executor” and held that “§ 2056(b)(4) renders
    the marital share available to the surviving spouse subject to the payment of death
    taxes.” Id. As a result, the Court of Appeals held that the value of the marital
    deduction had to be reduced by the amount of the applicable taxes.
    Estate of Wycoff is distinguishable because the executor of the estate could
    choose from which trust to pay the expenses. In this case, however, Clyde Sr.’s
    will is silent as to the payment of taxes, and we have found that Clyde Sr. wanted
    to maximize the marital deduction and that the executor must exercise the right of
    recovery under sec. 2207B.
    10
    Federal estate and State death taxes remain deductible expenses of the
    estate because the executor would be paying those taxes from assets included in
    the gross estate yet not actually owned by Clyde Sr. at death See sec. 20.2053-
    6(c)(1), Estate Tax Regs., which provides: “For the estates of decedents dying on
    or before December 31, 2004, no estate * * * tax payable by reason of the
    decedent’s death is deductible, except as provided in §§ 20.2053-9 and 20.2053-10
    with respect to certain state and foreign death taxes on transfers for charitable,
    (continued...)
    - 16 -
    Respondent argues that the right of recovery under section 2207B cannot
    preserve the maximum marital deduction because the right of recovery can be
    exercised only after taxes have been paid. However, the fact that the estate may
    exercise the right of recovery under section 2207B only after the taxes have been
    paid does not require that the marital deduction be reduced by the tax payment
    amounts.
    The process of administering an estate is multifaceted and can be quite
    complex and time consuming. It involves some or all of the following actions:
    the opening of a probate proceeding; the identification and valuation of a
    decedent’s assets and liabilities; the preparation of required tax returns and
    probate papers; the payment of relevant liabilities and bequests; the resolution of
    any disputes affecting the estate, such as estate tax disputes and beneficiary
    litigation; and the distribution of the residue in accordance with a decedent’s will
    or, if none, with applicable State intestacy laws. See generally 34 C.J.S. Executors
    & Administrators, sec. 212 (Westlaw 2018). In an estate that includes the value of
    section 2036 assets, an executor must find a way to pay the tax liabilities created
    by the section 2036 assets while dealing with the reality created by section 2036:
    10
    (...continued)
    etc., uses. However, see sections 2011 and 2014 and the corresponding
    regulations with respect to credits for death taxes.”
    - 17 -
    The actual section 2036 assets are not in the possession or control of the executor
    and cannot be used by the executor to pay the tax liabilities they create.
    Section 2207B gives an executor a mechanism to replenish estate assets that
    the executor uses to pay the Federal estate and State death tax liabilities
    attributable to the values of the phantom section 2036 assets included in the estate.
    Because the value of the section 2036 assets is already included in the calculation
    of the gross estate, any recovery under section 2207B should not increase the
    gross estate but will enable the executor to distribute to the surviving spouse the
    net value of the estate, undiminished by the tax liabilities attributable to the
    section 2036 inclusion.
    Respondent also argues that the effect of failing to reduce the marital
    deduction by the tax liabilities attributable to the section 2036 assets is to shelter
    from the estate tax the property brought into a decedent’s estate pursuant to
    section 2036. Respondent states that “this would effectively undo what has been
    accomplished by I.R.C. § 2036.” Respondent points out that if the executor
    pursues the recovery, the subsequent recovery of the estate tax amount makes the
    beneficiary who bore the burden whole.
    Respondent cites section 20.2056(b)-4(c)(1), Estate Tax Regs., in support of
    his argument. That section provides: “In the determination of the value of any
    - 18 -
    property interest which passed from the decedent to his surviving spouse, there
    must be taken into account the effect which the Federal estate tax, or any estate,
    succession, legacy, or inheritance tax, has upon the net value to the surviving
    spouse of the property interest.” However, it does not support respondent’s
    position because its application turns on whether the Federal estate tax has an
    effect upon the net value of the property interest passing to the surviving spouse.
    The regulation does not state that the Federal estate tax always has an effect
    on the net value of the surviving spouse’s interest. The examples in the regulation
    support a more limited and nuanced application of the regulation. Section
    20.2056(b)-4(c)(2), Estate Tax Regs., explains that if the decedent’s only bequest
    to the surviving spouse is $100,000 and the spouse is required to pay a State
    inheritance tax of $1,500, the value of the marital deduction is $98,500. Unlike in
    the case at hand, in this example it is the spouse, and not the executor of the estate,
    who is required to pay a State death tax.
    Section 20.2056(b)-4(c)(3), Estate Tax Regs., addresses a situation where a
    decedent devised real property to his surviving spouse and also bequeathed to her
    a nondeductible interest for life under a trust. In this example, the State of
    residence imposed an inheritance tax with respect to the two interests. Again, the
    example assumes that the surviving spouse bears the burden of paying the
    - 19 -
    inheritance tax liability and concludes that the tax payment reduces the marital
    deduction.
    Section 20.2056(b)-4(c)(4), Estate Tax Regs., further supports the
    conclusion that in evaluating the effect of the Federal estate tax upon the value of
    the interest passing to the surviving spouse, the regulation applies only when the
    surviving spouse’s share bears the tax burden. It provides:
    If the decedent bequeaths his residuary estate, or a portion of it, to his
    surviving spouse, and his will contains a direction that all death taxes
    shall be payable out of the residuary estate, the value of the bequest,
    for the purpose of the marital deduction, is based upon the amount of
    the residue as reduced pursuant to such direction. If the residuary
    estate, or a portion of it, is bequeathed to the surviving spouse, and by
    the local law the Federal estate tax is payable out of the residuary
    estate, the value of the bequest, for the purpose of the marital
    deduction, may not exceed its value as reduced by the Federal estate
    tax. * * *
    Unlike the examples discussed above, because of section 2207B the estate
    tax burden in this case is not imposed on the surviving spouse’s share of the estate
    and does not require a reduction in the marital deduction. Consequently, we
    conclude that respondent’s reliance on section 20.2056(b)-4(c), Estate Tax Regs.,
    is misplaced.
    Under section 2036 the gross estate includes the values of the section 2036
    assets that Clyde Sr. transferred during his lifetime. The fact that property that
    - 20 -
    might otherwise go to the surviving spouse would be used to pay the estate tax
    liabilities attributable to the section 2036 assets does not compel a conclusion that
    the marital deduction must be reduced. The estate is entitled to recover from the
    recipients of section 2036 assets during Clyde Sr.’s lifetime an amount equal to the
    liability attributable to the section 2036 inclusion that the estate pays. That
    recovery will enable the estate to distribute to the surviving spouse property value
    undiminished by the tax payments. Section 20.2056(b)-4(c), Estate Tax Regs.,
    does not require a different result when the Federal estate and State death taxes
    have no effect upon the net value distributable to the surviving spouse. See, e.g.,
    Estate of Gill v. Commissioner, T.C. Memo. 2012-7 (marital deduction not
    reduced where marital deduction property does not bear the economic burden of
    the tax). Accordingly, we hold that the estate need not reduce the marital
    deduction by the amount of Federal estate and State death taxes it must pay
    because the tax liabilities are attributable to the section 2036 assets, the estate has
    the right to recover the amount paid under section 2207B, and the estate must
    exercise that right to recover to give effect to Clyde Sr.’s intention that Jewell
    receive her share of the estate undiminished by the estate’s tax obligations.
    Respondent makes an additional argument that focuses on the interest owed
    on the Federal estate tax liability. Respondent contends that under section
    - 21 -
    20.2056(b)-4, Estate Tax Regs., the estate tax interest expense is a transmission
    expense,11 and therefore it reduces the residue and correspondingly reduces the
    marital deduction. However, under section 2207B(c), “[i]n the case of penalties
    and interest attributable to the additional taxes described in subsection (a), rules
    similar to the rules of subsections (a) and (b) [of section 2207B] shall apply.”
    Accordingly, the amount that the estate is entitled to recover from the section 2036
    asset recipients includes applicable interest.
    II.   Postdeath Income
    Relying on section 20.2056(b)-4(d)(1)(iii), Estate Tax Regs., the estate
    contends that the marital deduction should be increased by the amount of income
    generated by estate assets, i.e., postdeath income, allocated to the marital share.12
    Respondent disagrees. According to respondent, income from estate assets, which
    was reported on the Form 1041, was not included in the gross estate and therefore
    is not a deductible interest within the meaning of section 20.2056(a)-1(a) and (b),
    11
    Sec. 20.2056(b)-4(d)(1)(ii), Estate Tax Regs., defines estate transmission
    expenses as “expenses that would not have been incurred but for the decedent’s
    death and the consequent necessity of collecting the decedent’s assets, paying the
    decedent’s debts and death taxes, and distributing the decedent’s property to those
    who are entitled to receive it.”
    12
    The estate contends, and respondent does not appear to dispute, that the
    amount of postdeath income as of the hearing date was $159,391.
    - 22 -
    Estate Tax Regs. Section 20.2056(a)-1(a), Estate Tax Regs., provides: “A
    deduction is allowed under section 2056 from the gross estate of a decedent for the
    value of any property interest which passes from the decedent to the decedent’s
    surviving spouse if the interest is a deductible interest as defined in § 20.2056(a)-
    2.” See also sec. 20.2056(a)-1(b)(1)(iii), Estate Tax Regs. (property interest
    qualifying for the marital deduction must be a deductible interest). Section
    20.2056(a)-2(b), Estate Tax Regs., defines deductible interests as interests that do
    not fall within one of the categories of “nondeductible interests” described in
    section 20.2056(a)-2(b)(1) through (4), Estate Tax Regs. Section 20.2056(a)-
    2(b)(1), Estate Tax Regs., provides that “[a]ny property interest which passed from
    the decedent to his surviving spouse is a ‘nondeductible interest’ to the extent it is
    not included in the decedent’s gross estate.” In respondent’s view, because the
    postdeath income was not included in the gross estate here, it cannot increase the
    marital deduction.
    We start and end our analysis with the relevant estate tax provisions.
    Section 2001(a) imposes a tax on the transfer of the taxable estate of every
    decedent who is a citizen or resident of the United States. The value of the gross
    estate is determined by adding the value of all property owned by the decedent at
    the time of death. Sec. 2031(a). The taxable estate is then determined by
    - 23 -
    subtracting certain deductions from the value of the decedent’s gross estate. Sec.
    2051. Among the deductions allowed is the marital deduction under section 2056.
    Section 2056(a) provides that the value of the taxable estate shall be
    determined by deducting from the value of the gross estate an amount equal to the
    value of any interest in property that passes or has passed from the decedent to a
    surviving spouse. It contains an important caveat: The marital deduction is
    permitted “only to the extent that such interest is included in determining the value
    of the gross estate.” Sec. 2056(a).
    Any income that estate assets may generate after the date of the decedent’s
    death must be reported as ordinary income for Federal income tax purposes and
    income tax paid as appropriate. Secs. 1(e), 641, 6012. The income earned by an
    estate during the estate’s administration is not included in the gross estate and is
    not subject to Federal estate tax. See Estate of Horne v. Commissioner, 
    91 T.C. 100
    , 103 (1988).
    Section 20.2056(b)-4(d), Estate Tax Regs., is part of a broader set of
    regulations that explain how the marital deduction is calculated. The regulation
    provides rules for determining the effect of administration expenses upon the
    marital deduction. It defines three terms used in determining the effect of
    administration expenses--management expenses, transmission expenses, and
    - 24 -
    marital share. For purposes of section 20.2056(b)-4(d), Estate Tax Regs., marital
    share is defined as “the property or interest in property that passed from the
    decedent for which a deduction is allowable under section 2056(a).” Sec.
    20.2056(b)-4(d)(1)(iii), Estate Tax Regs. Marital share “includes the income
    produced by the property or interest in property during the period of
    administration if the income, under the terms of the governing instrument or
    applicable local law, is payable to the surviving spouse or is to be added to the
    principal of the property interest passing to, or for the benefit of, the surviving
    spouse.” Id.
    The estate contends that section 20.2056(b)-4(d)(1)(iii), Estate Tax Regs.,
    entitles the estate to increase the marital deduction by the amount of income
    earned after Clyde Sr.’s death during the administration of the estate because the
    regulation provides that the income is included in the marital share. Respondent
    disagrees for two reasons. First, the postdeath income interest is not a deductible
    interest under the regulation because it was not included in the gross estate.
    Second, the estate misreads section 20.2056(b)-4, Estate Tax Regs., because it
    fails to consider it in context.
    Respondent notes that paragraph (d) was added to section 20.2056(b)-4,
    Estate Tax Regs., in 1999 in response to the Supreme Court’s opinion in
    - 25 -
    Commissioner v. Estate of Hubert, 
    520 U.S. 93
     (1997). In Commissioner v. Estate
    of Hubert, 520 U.S. at 111, the Supreme Court, relying on a prior regulation, held
    that the estate was not required to reduce marital and charitable deductions by the
    amount of administration expenses paid from income generated by assets allocated
    to marital and charitable bequests. Under the regulation as applicable in Estate of
    Hubert, “[i]n determining the value of the interest in property passing to the
    spouse account must be taken of the effect of any material limitations upon her
    right to income from the property.” Sec. 20.2056(b)-4(a), Estate Tax Regs. (as in
    effect in 1996). The Department of the Treasury subsequently amended the
    regulation to delete the “material limitations” standard, see T.D. 8846, 1999-2
    C.B. 679, 682, and to introduce the principles for evaluating the effect of
    administration expenses upon the marital deduction that are currently found in
    section 20.2056(b)-4(d), Estate Tax Regs.
    Section 20.2056(b)-4(d)(2) through (4), Estate Tax Regs., classifies
    expenses into three categories: transmission expenses, management expenses
    attributable to the marital share, and management expenses not attributable to the
    marital share. It also provides three rules for taking into account the effect of
    those expenses. First, for purposes of determining the marital deduction, if
    transmission expenses are paid from the marital share, the value of the marital
    - 26 -
    share is reduced by the amount of the estate transmission expenses. See sec.
    20.2056(b)-4(d)(2), Estate Tax Regs. Second, the value of the marital share is not
    reduced by the amount of the estate management expenses attributable to and paid
    from the marital share.13 See id. subpara. (3). Third, for purposes of determining
    the marital deduction, the value of the marital share is reduced by the estate
    management expenses that are paid from the marital share but attributable to a
    property interest not included in the marital share. See id. subpara. (4).
    The estate points to the definition of “marital share” in section 20.2056(b)-
    4(d)(1)(iii), Estate Tax Regs., as the authority for increasing the marital deduction
    by the amount of postdeath income allocated and paid to the surviving spouse. At
    first blush, the estate would appear to be right. But while portions of section
    20.2056(b)-4(d), Estate Tax Regs., are confusing, we will accept respondent’s
    contention that marital share is defined solely for the purpose of calculating the
    effect of administration expenses on the marital deduction. It does not purport to
    increase the marital deduction otherwise allowable under section 2056, nor could
    it. Section 2056(a) limits the marital deduction to the value of the interest that is
    13
    Pursuant to sec. 2056(b)(9), however, the allowable marital deduction
    must be reduced by the amount of any such management expenses that are
    deducted under sec. 2053 on the decedent’s Federal estate tax return. Sec.
    20.2056(b)-4(d)(3), Estate Tax Regs.
    - 27 -
    included in the value of the gross estate. Income produced by the estate’s assets
    after the decedent’s death is not included in the calculation of the gross estate and
    therefore does not increase the marital deduction allowable under section 2056.
    See also sec. 20.2056(a)-1(a), Estate Tax Regs. Accordingly, although the
    postdeath income may increase the “marital share” under specified circumstances
    for purposes of calculating the impact of administration expenses on the marital
    deduction under section 20.2056(b)-4(d)(1)(iii), Estate Tax Regs., it does not, and
    cannot, increase the amount of the marital deduction otherwise allowable under
    section 2056 and related regulations. We hold that the estate may not increase the
    marital deduction by the amount of postdeath income generated by assets passing
    to Jewell.
    We have considered the remaining arguments of both parties for results
    contrary to those expressed herein and, to the extent not discussed above, find
    those arguments to be irrelevant, moot, or without merit.
    To reflect the foregoing,
    An appropriate order will
    be issued.
    

Document Info

Docket Number: 18911-08

Citation Numbers: 151 T.C. No. 10

Filed Date: 11/20/2018

Precedential Status: Precedential

Modified Date: 11/21/2018