News Briefings - Estate Planning

The following article was taken from the November 2009 issue of Estate Planner's Alert.

11/9/09 -- Final regs ease proposed regs but still toughen rules for deducting claims against an estate

IRS has issued final regs providing a new approach for determining the amount deductible for estate tax purposes under Code Sec. 2053 as a claim against the estate. Under the new approach, which also applies for other expenses deductible under Code Sec. 2053, post-death events are taken into account in determining the deductible amount, and deductions generally are limited to amounts actually paid by the estate in satisfaction of deductible claims and expenses. The final regs also reflect the deduction for state death taxes that went into effect for estates of decedents dying after 2004 after the credit for state death taxes was gradually phased out. The regs apply to estates of decedents dying after October 19, 2009. (TD 9468, 10/16/2009; Reg § 20.2051-1, Reg § 20.2053-1, Reg § 20.2053-3, Reg § 20.2053-4, Reg § 20.2053-5, Reg § 20.2053-6, Reg § 20.2053-9, Reg § 20.2053-10; Notice 2009-84, 2009-44 IRB)

RIA observation: As discussed at Estate Planners Alert, May 2007, the proposed regs provided a similar approach. However, the final regs ease the proposed regs' approach by providing a number of exceptions. The final regs also make other changes to the proposed regs. The exceptions and other key changes are discussed below.

Background. Code Sec. 2053(a) allows various deductions in arriving at the taxable estate including administration expenses (Code Sec. 2053(a)(2)) and claims against the estate. (Code Sec. 2053(a)(3))

The amount an estate may deduct for claims against the estate has been a highly litigious issue. There is little consistency among the many courts that have addressed the issue of the extent (if any) to which post-death events are to be considered in valuing claims.

Proposed approach retained with exceptions. The proposed regs generally provide that only claims actually paid by the estate may be deducted under Code Sec. 2053(a)(3). Many commentators disagreed with this approach and suggested that claims against a decedent's estate be valued on the basis of what was reasonably known on the date of the decedent's death. The final regs generally maintain the approach of the proposed regs but include several exceptions to it, including an exception for claims against the estate with respect to which there is an asset or claim includible in the gross estate that is substantially related to the claim against the estate and an exception for claims against the estate that, collectively, do not exceed $500,000 (not including those deductible as ascertainable amounts). Although both exceptions provide an opportunity to claim a deduction at the time of filing the estate tax return, in each case, the amount of the deduction is subject to adjustment to reflect post-death events, consistent with the general approach of the regs.

Settlements. The final regs remove the requirement of the proposed regs that a settlement be within the range of reasonable outcomes under applicable state law in order for a settlement amount to be deductible.

The final regs clarify that a deduction will not be denied for an otherwise deductible settlement amount if an estate can establish that the cost of defending the claim or contesting the expense, the delay associated with litigating the claim or expense, or another significant factor will impose a higher burden on the estate relative to the amount paid to settle the claim or the contested expense.

Rule for estimated amounts. The final regs clarify that the rule for estimated amounts applies not only to claims but to administration expenses as well.

The final regs eliminate the proposed regs' rule that if a deduction is allowed in advance of payment and the payment is thereafter waived or otherwise left unpaid, it is the duty of the executor to notify IRS and to pay the resulting tax, together with interest.

Protective claims. A commentator expressed concern that the protective claim procedures in the proposed regs would result in increased administrative costs and a delay in the administration of the estate because filing a protective claim effectively would keep the period of limitations open to the extent of the amount of the claim for refund. IRS says that because of the exceptions in the final regs, it expects that the number of protective refund claims filed to preserve a deduction under Code Sec. 2053 will be significantly smaller than was anticipated by commentators to the proposed regs. In addition, to address the commentator's concern regarding the effect of a protective claim for refund on the applicable period of limitations, IRS has issued Notice 2009-84 announcing its decision to limit the review of a return, in certain circumstances, when a timely filed claim for refund of estate taxes that is based on a deduction under Code Sec. 2053 ripens after the expiration of the limitations period on assessment.

Effect on charitable or marital deductions. The final regs include a rule confirming that, if a claim or expense is the subject of a protective claim for refund under Code Sec. 2053 and is payable out of a fund that meets the requirements for a charitable or marital deduction, the charitable or marital deduction will not be reduced by the amount of the claim or expense until the amount is actually paid.

Reimbursements. The proposed regs provide that a deduction is not allowed to the extent that the expense or claim is or could be compensated for by insurance, or is or could be otherwise reimbursed. The final regs provide that an executor may certify on the estate tax return that no reimbursement is available for a claim or expense if the executor neither knows nor reasonably should have known of the availability of any such reimbursement. In addition, the final regs provide that an executor need not reduce the amount of a claim or expense deductible under Code Sec. 2053 by the amount of a potential reimbursement if the executor provides a reasonable explanation on the estate tax return for his reasonable determination that the burden of necessary collection efforts would outweigh the anticipated benefits from those efforts.

Claims and counterclaims. The final regs provide that the current value of a claim against the estate with respect to which there is one or more substantially related claims or integrally related assets that are included in a decedent's gross estate may be deducted on the estate tax return, provided that the related claim or asset of the estate constitutes at least 10% of the decedent's gross estate, the value of each such claim against the estate is determined from a "qualified appraisal" performed by a "qualified appraiser," and the value of each such claim against the estate is subject to adjustment to reflect post-death events.

Claims by related parties. The final regs remove the proposed regs' rebuttable presumption that claims by a family member of the decedent, a related entity, or a beneficiary of the decedent's estate or a revocable trust are not legitimate and bona fide. Instead, they continue to include the generally applicable requirement that any claim or expense deductible under Code Sec. 2053 must be bona fide in nature. In addition, they include a nonexclusive list of factors indicative of the bona fide nature of a claim or expense involving a family member, related entity, or beneficiary of the estate of a decedent.

Recurring payments. The proposed regs provide that certain recurring, noncontingent obligations may be deducted as estimated amounts. The final regs clarify that an obligation subject to death or remarriage is treated as a noncontingent obligation.

Some commentators suggested that the proposed regs' disparate treatment afforded noncontingent obligations (deduction for present value of obligations) versus contingent obligations (dollar-for-dollar deduction as paid) is inequitable and produces an inconsistent result without meaningful justification. Because IRS found the arguments to be persuasive, the final regs eliminate the disparate treatment by removing the present value limitation applicable only to noncontingent recurring payments. However, IRS will consider this further and may issue future guidance.

The final regs clarify that the rules applicable to recurring payments do not apply to payments made in connection with a mortgage or other indebtedness described in Reg § 20.2053-7.

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