Administrative expense deduction for interest on inheritance.

A district court allowed an estate tax administrative expense deduction for interest that accrued on a bequest--as required under state law--while the executrix waited for the IRS to issue a closing letter.

Facts

M was appointed independent executrix of A's estate under A's will. The will included a $10 million pecuniary bequest to H, Inc., dependent on H's status as a charitable organization at A's death. M waited to receive a closing letter from the IRS before funding this bequest. Under Texas Probate Code Section 378B(f), interest began to accrue on the bequest to H at a 6% annual rate, beginning one year after letters testamentary were issued to M. M sought an estate tax refund based on a deduction for payment of the interest. The IRS rejected the refund claim, arguing that M was not entitled to deduct the interest expense on A's estate tax return.

Analysis

An expense is deductible as an administration expense under Sec. 2053(a) and Regs. Sec. 20.2053-3(a) if it is: (1) incurred in the administration of a decedent's estate, (2) actually and necessarily incurred and (3) allowable by the laws of the jurisdiction under which the estate is being administered.

The first criterion permits estate tax deductions for expenses incurred in estate administration. Expenses facilitating a property distribution to the persons entitled to it are deductible administration expenses (Regs. Sec. 20.2053-3(a)). Here, the issue is simple: A's will mandated that H possess tax-exempt status as a charitable organization before the bequest to it was funded. In discharging her duties as the estate's personal representative, M was specifically required to ascertain H's status. Any expenses, including statutory interest expenses, incurred by H in making this determination--if actual, necessary and allowable under Texas law--were thus incurred in the administration of the decedent's estate.

The second criterion permits estate tax deductions actually and necessarily incurred. Administration expenses, however, will not be allowed for a longer period than the executor is reasonably required to retain the property. M submits that she properly withheld funding the bequest to H until an estate closing letter was received and an audit completed. Once she confirmed--two years and nine months after the decedent's death--that H was an organization described in Sec. 2055, she promptly paid the bequest. The IRS argued that M imprudently and unnecessarily chose to wait almost 2 1/2 years to make the payment.

The court concludes that the expense was necessary. Given the size of the bequest, coupled with the explicit requirement in A's will that H be a charitable organization, M prudently determined that evidence received from the organizations was not sufficiently reliable to permit her to fund the bequest. In addition, M prudently with held funding the bequest until the estate received an IRS closing letter and resolved any estate tax audit. Receipt of a closing letter prior to distributing estate assets is, in the general practice of estate administration, not an imprudent exercise of an executor's fiduciary duties.

The third criterion permits deductions for administration and certain other expenses allowable by the laws of the jurisdiction under which the estate is being administered (Sec. 2053(a)). Because M's statutory interest expense is mandated by the State of Texas, it is clearly 'allowable by the laws of the jurisdiction' under Sec. 2053(a). Thus, the interest expense properly incurred by M is a deductible administration expense.

EST. OF SALLY JACKSON, ND TX, 1/30/04