The proper treatment of administrative expenses: the debate rages on.

Ever since the enactment of the unlimited marital deduction, the proper treatment of administrative expenses has been a fertile area of debate between taxpayers and the IRS. This article analyzes three recent cases, Martin,(1) Est. of Richardson(2) and Est. of Street,(3) that highlight the intensity of this debate. In situations in which a will provides for an unlimited estate tax marital or charitable deduction, executors have routinely deducted administrative expenses on the estate's income tax returns rather than on the estate tax return. During an IRS examination, a determination is made as to the return on which such administrative expenses have been deducted; if they have been deducted on the estate's income tax return, the IRS typically reduces the residual marital or charitable deduction by a corresponding amount. If the marginal estate tax rate is already 55%, the effective tax rate on the taxable portion of the estate due to reduction of the marital or charitable deduction could be as high as 122%.(4) If reduction of the marital or charitable deduction causes the taxable estate to exceed the unified credit equivalent, interest will be assessed on the deficiency.(5)

Understanding the Interplay of

Fiduciary and Tax Accounting

There is general misunderstanding by both fiduciaries and the IRS about the correct fiduciary accounting treatment for administrative expenses. This misunderstanding stems from a failure to distinguish between the treatment of such expenses for fiduciary accounting purposes, as opposed to their tax consequences. Treatment of an item for fiduciary accounting purposes is relevant (but not determinative) of its effect on the estate tax return.(6)

The primary obligation of an executor or fiduciary responsible for an estate is collecting and consolidating the decedent's assets, satisfying any valid debts of the decedent (including estate taxes) and making distributions as provided for under the will after payment of all claims. Unfortunately, this process often spans several years.

On the death of the first spouse, most wills provide for a credit trust, to the extent there is any remaining unified credit, with the rest of the estate passing to a residual trust qualifying for the marital deduction. During this period of administration, an estate typically incurs significant administrative expenses, including executor's fees, investment banking fees or other investment counseling expenses, estate tax and estate income tax return preparation fees, and legal and accounting fees. Other administrative expenses include appraisers' fees and costs of storing and maintaining property.

An executor must determine the assets and liabilities in the probate estate. Based on this information, the following issues must be resolved: (1) the total value of the assets passing under the marital trust and (2) how much income should be distributed to the surviving spouse. This process is further complicated by the fact that, while the estate's assets and liabilities are fixed as of the date of death, administrative expenses are incurred by the estate for several years thereafter.

In determining the proper treatment of administrative expenses, an executor must first look to the will to determine whether the decedent provided any guidance as to how to allocate these costs. A typical will normally provides an executor with the maximum degree of discretion allowed under state law in allocating items between income and corpus. In many jurisdictions, state law provides complete latitude in exercising discretion in allocating items between income and corpus. The only limiting standard seems to be one of reasonableness and fairness; this is often only found by reference to common law, not statute. In some states (e.g., Florida), certain administrative expenses must be allocated either to corpus or income.(7) Oklahoma provides that, absent instructions to the contrary, administrative expenses are allocated to income.(8)

From a fiduciary accounting perspective, there are three types of administrative expenses. The first type is items that, in all fairness, should be charged only to corpus. For example, the cost of preparing the estate tax return: it is a cost that was known to be needed as of the date of death, was anticipated by the decedent, is nonrecurring in nature, and its primary function is the preservation of estate assets. This category of administrative expense includes expenses that are inherent to winding up an estate and determining the terms of the will. Certainly, a portion of the executor's fee and attorney's fee falls into this category. Clearly, the costs of probating the estate should be borne by corpus.

The second category of administrative expenses are those that should be charged solely against estate income. For example, investment fees incurred in managing the estate's assets to maximize income or fees incurred to prepare the estate's income tax returns benefit only the income beneficiary. These costs relate solely to the postdeath management of the estate to maximize income rather than to resolve which assets are a part of the estate or to whom they will ultimately be distributed. Using a fairness standard, it would be inequitable to allocate these expenses against corpus.

The last category, by far the largest, is administrative expenses that can be allocated against either estate corpus or income (i.e., from an equitable perspective, there is no compelling argument to charge estate income or corpus). Typically, these expenses have either a direct or indirect benefit to both estate income and corpus. In allocating this last category of administrative expense, a fiduciary looks for direction from the will and determines whether the item is chargeable against the estate's income or corpus. Other than state law (which is typically silent), there is no standard against which the executor's allocation can be challenged. Traditionally, most administrative expenses were charged against the estate's corpus. However, the modern legislative trend is to grant the executor discretion in allocating these expenses against corpus or income.(9)

Determination of the Taxable Estate

Once administrative expenses have been allocated against either corpus or income for fiduciary accounting purposes, the executor can determine the estate and income tax consequences of such items.(10) Secs. 2056 (the marital deduction) and 642(g)(which precludes the double deduction of administrative expenses under Sec. 2053 or 2054 on both the estate tax and estate income tax returns) are at the core of the debate concerning treatment of administrative expenses. In general, Sec. 2056 provides a marital deduction determined by deducting from the gross estate the value of any interest in property that passes or is passed from the decedent to a surviving spouse, but only to the extent that such interest is included in determining the value of the gross estate. Sec. 2056(b)(4)(B) provides that, in determining the marital deduction, the value of any interest in property passing to the surviving spouse must be reduced by any encumbrance or tax imposed on it.

Under Regs. Sec. 20.2056(b)-4(a), in valuing an interest passing to the surviving spouse, account must be taken of the effect of any material limitations on the spouse's right to income from the property. The regulation illustrates this principle with an example ("Regulation Example") of a bequest of property in trust for the benefit of the decedent's spouse, the income from which (from the date of the decedent's death until distribution of the property to the trustee) is to be used to pay administration expenses.(11)

These regulations have remained virtually unchanged since their 1974 enactment. In fact, provisions in Sec. 2056(b)(4) are found in Section 812(e) of the Revenue Act of 1948. Congress originally provided that in considering the value of the marital deduction, "where such interest on property is encumbered in any manner, or where the surviving spouse incurs any obligation imposed by the decedent with respect to passing of such interest, such encumbrances or obligation shall be taken into account in the same manner as if the amount of a gift to such spouse of such interest were being determined." Consistent with this legislative philosophy, Congress expressly considered and rejected the notion that an estate could increase the marital deduction by using the estate's income to pay claims against the estate.(12)

In 1974, administrative expenses were routinely allocated against corpus. Thus, using the estate's net income to pay for these expenses would increase the value of the corpus passing to the surviving spouse. However, recent trends in testamentary schemes allow administrative expenses to be allocated either against corpus or income. As used in Regs. Sec. 20.2056(b)-4, "income" clearly refers to fiduciary income, not taxable income.

Example 1: An estate consists of $1,000,000 in assets that produce no income, all of which are to be distributed to the surviving spouse. The executor spends $50,000 to obtain the services of a portfolio manager; as a result, the estate produces $125,000 of dividend income. The $50,000 of investment expense qualifies as an administrative expense; thus, the executor should be permitted to allocate it against the estate's gross income without reducing the marital deduction. Economically, the estate has realized $75,000 [$125,000 - $50,000) of income. Since fiduciary income is defined under state law and not by IRS regulations, it is possible for administrative expenses to be properly allocated against income as part of the calculation for determining fiduciary income.

Judicial Interpretations

Since the ability to allocate administrative expenses between corpus or income is a recent legislative development, judicial discussion of the tax implications of this allocation is not extensive.

One of the earliest cases involving this issue is Est. of Roney.(13) There, the will provided for a marital deduction equal to the value of the residual trust. Under Florida law, the testator's will could allocate administrative expenses against either corpus or income. However, if the will was silent as to how the administrative expenses were to be borne, Florida law dictated that they were first charged to any property not disposed of by will, and then out of property passing to the residual beneficiary.

The executor irrevocably deducted administrative expenses on the estate's income tax returns; therefore, under Sec. 642(g), the estate was precluded from deducting the administrative expenses again on the estate tax return. Because the will neither indicated where the administrative expenses were to be deducted nor provided the executor with discretion to allocate them, the Tax Court held, and the Eighth Circuit agreed, that, under Florida law, the residual trust was decreased and the marital deduction was correspondingly decreased, thereby increasing the taxable estate. The court ignored as "besides the point" the estate's argument that the administrative expenses had in fact been charged against the estate's income. Any such allocation was void as impermissible under Florida law given the terms of the will. This illustrates the point that, absent directions in the will to the contrary, state law currently controls the allocation of administrative expenses.

In Martin, the Seventh Circuit correctly reduced the marital deduction by administrative expenses and taxes payable by the estate. Mrs. Martin died in 1981, before the Code was amended to remove the 50% cap on the marital deduction. The probate estate totaled only $3,254. At death, Mrs. Martin's assets, including insurance proceeds, totaled $14,400. However, her taxable estate included $852,060 of taxable gifts made within three years of death and a trust, valued at $781,764, in which she was the life tenant and her husband was the remainderman. Thus, the gross taxable estate totaled $1,648,250, of which the surviving spouse was to receive the remainder interest in the trust, plus everything else the decedent owned at death, up to half of the gross estate.

Because most of the prior taxable gifts had been to charities, the executor calculated $43,815 in Federal estate tax and $2,024 of state estate tax. The IRS reduced the marital deduction by roughly $69,000, the difference between the assets available to the estate and the $72,000 of expenses and taxes owed it, resulting in an additional $23,000 of Federal estate tax. The estate argued that the decedent's will clearly mandated the maximum marital deduction, thereby precluding a reduction of the marital bequest for administrative expenses.

The Seventh Circuit noted that the author of a will may specify which bequests pay the taxes and costs of administration. However, none of the lifetime bequests here could be charged with the taxes and administrative expenses, because they were beyond the decedent's control at the time of her death. The court correctly determined that administrative expenses had to have been paid out of the trust in which the decedent had a life estate. Therefore, the amount actually received by the surviving spouse had to have been reduced. Martin stands for the proposition that, despite testamentary direction to the contrary, if the only available source for payment of administrative expenses is the marital bequest, the marital deduction must be correspondingly reduced.

Probably the most important case in this area is Richardson, in which the will provided for the maximum marital deduction with a carve-out for a unified credit trust. The will authorized the executors to allocate administrative expenses against income or principal and to deduct such expenses on the estate tax or estate income tax return so as to minimize the estate's combined estate and income tax.(14) At the time, Tennessee law provided for a maximum marital deduction of one-half of the taxable estate.

The estate incurred significant interest expense due to the late payment of both Federal and Tennessee estate taxes. The sole issue before the Tax Court was whether the interest payable on the estate tax deficiencies was chargeable against the estate principal or the income produced therefrom. The executor had allocated these expenses against the estate's income and deducted them on the estate's income tax return. The IRS argued that the interest was allocable against the estate's principal, thereby reducing the marital deduction. Both parties agreed that Tennessee law was silent concerning the category to which the interest should be charged.

The determinative fact for the court was the testator's primary intention to provide for the maximum marital deduction. In order not to frustrate the decedent's intent, interest expense had to be allocated against the estate's income, not corpus. The court failed to find any controlling authorities that would require it to rule against the taxpayer. Finally, the court noted that in Est. of Bailly,(15) interest incurred as a result of a Sec. 6166 election to defer the payment of estate taxes was deductible against the estate tax, necessitating repeated amendment of the estate tax return. The court refused to extend this uncertainty to the determination of an estate tax marital deduction. The court held that the executor could allocate the interest expense against the estate's income in determining the size of the residuary spousal bequest without reducing the marital bequest.

* Street

Another decision concerning the allocation of administrative expenses is Street. Like Richardson, Street dealt with a Tennessee estate that provided for a residual marital deduction. The sole issue before the Sixth Circuit was whether administrative expenses and interest payable on Federal and state estate taxes allocated against the estate's income reduced the residual bequest to the surviving spouse. The will provided that all estate and death taxes were payable out of the residuary estate, but the executor had discretion to allocate all expenditures between corpus and income.

The executor allocated administrative expenses and all interest accruing on Federal estate tax and state inheritance tax deficiencies against the estate's income. The IRS argued that these expenses reduced the marital deduction. The Tax Court stated that if administrative expense and interest were chargeable to income, they would not reduce the marital deduction. Relying on Richardson, the Tax Court held for the estate, finding that these items were properly chargeable to income under Tennessee law and the terms of the will.

On appeal, the government argued that Regs. Sec. 20.2056(b)-4(a) requires the marital deduction to be reduced to the extent administrative and interest expenses are paid out of estate income. The Sixth Circuit noted that the regulation fixes the date of death for determining the size of the marital deduction and that the deduction is limited to the net value of any deductible interest passing to the surviving spouse. Furthermore, as previously discussed, Regs. Sec. 20.2056(b)-4(a) requires that, in determining the value of any interest in property passing to the spouse, account must be taken of the effect of any material limitations on the surviving spouse's right to income from the property. The court then cited the Regulation Example.

The Sixth Circuit bifurcated its analysis between the roughly $900,000 of administrative expenses and $6 million of interest expense at issue. The court ruled that Regs. Sec. 20.2056(b)-4(a) and the Regulation Example specifically addressed administrative expenses and ruled in favor of the IRS with regard to that item. The court concluded that the regulations make no distinction between administrative expenses chargeable to principal or income under state law. Instead, the marital deduction has to be reduced to the extent administrative expenses are paid out of the estate's income as a matter of Federal law, and not as determined by the vagaries of local law.

Finally, the court cited the legislative history of See. 2056 and its bar against increasing the size of the marital deduction by purchase. The legislative history indicates that income earned on the residue prior to distribution increases the residue. However, expenses paid during this period decrease the residue. Therefore, any decrease should be reflected in the marital deduction, which must be reduced to correspond to the assets available at the decedent's death.(16)

The Sixth Circuit ruled for the taxpayer with regard to the interest expense. It distinguished interest expense on taxes from administrative expense by noting that the latter accrues at death, while the former accrues after death. This distinction is difficult to follow in light of Est. of Bahr,(17) which permits interest accruing on estate taxes to be deducted on the estate tax return. Implicitly, Bahr indicates that while interest may accrue after death, it is a liability of the estate and hence must have been a liability, though an indeterminate one, as of the date of death.

Tax Court's Current Stance

The Tax Court continues to reject the position held by the Fifth and Sixth Circuits. In Hubert,(18) the will created a residual bequest that qualified in part for the marital deduction and in part for the charitable deduction. Under a settlement agreement entered into to resolve a will contest, the surviving spouse was an income beneficiary of the residual trust, which had as remainder beneficiaries both a charity and the surviving spouse. Thus, the income and remainder interest holders were adverse parties. The executor was authorized to allocate administrative expenses against either corpus or income. The Tax Court upheld the taxpayer's contention that, to the extent administrative expenses were allocated against the estate's income, the residual marital and charitable bequests should not be reduced. Therefore, the corresponding marital and charitable deductions should not be reduced.

In Hubert, the Tax Court addressed many of the arguments raised by the Sixth Circuit in Street. First, it interpreted Regs. Sec. 20.2056(b)-4(a) as not mandating a setoff against the marital deduction for administration expenses allocable to income. Rather, that regulation only mandates that material limitations on the right to income cause a reduction of the marital deduction. The use of income to pay administrative expenses is not, by definition, a material limitation on the right to receive income. Support for this interpretation was found under Sec. 2523(e), which requires that for a donor to obtain a marital deduction for a gift in trust to his spouse over which the spouse has a general power of appointment, the spouse must be entitled to all trust income. Under Regs. Sec. 25.2523(e)-1(f)(3), a spouse is deemed to have received all of the income from a trust, even if trustees' commissions and other charges are paid out of income, provided the spouse is not deprived of substantial beneficial enjoyment.

Next, the Tax Court rejected the IRS's argument that the legislative history's prohibition on using estate income to satisfy claims against it also applied to administrative expenses:

The Senate report describes the result only if income is used to pay claims against the estate, it does not discuss administration expenses at any point. There is a clear distinction between claims against the estate and administration expenses which are allocable to income, and this distinction mandates different treatment of the two. Claims against the estate are by definition, in existence at the date of death; therefore, by their very nature, claims against the estate relate to corpus and must be charged thereto. By contrast, administration expenses come into existence only after the death of the decedent and may relate to both income and corpus. As a result, administration expenses logically can be charged to either income or corpus. Here they were charged to income in accordance with the will and Georgia law. Accordingly, he legislative history cited by respondent does not control the treatment of administration expenses in the case before us.(19) (Emphasis added.)

The court accurately noted that the decedent's executors had been granted significant flexibility in accounting for the estate's administrative expenses, both for estate and income tax purposes, and for probate accounting purposes. Moreover, Congress has sanctioned such flexibility by permitting deduction of such expenses on either the estate tax or estate income tax returns.(20)

Lastly, the Tax Court rejected the distinction made by the Sixth Circuit in Street between interest on estate and inheritance taxes and administrative expenses. First, it concluded that the Regulation Example is an example of how the rule might be applied, not an exhaustive listing of the rule's application. Thus, if it applies to administrative expenses, it should also apply to interest on estate taxes. Moreover, administrative expenses and interest on taxes cannot be distinguished according to the time at which they accrue, as both accrue after death. The Tax Court noted that, by their nature, administrative expenses vary greatly from estate to estate and, as a result, are too uncertain to be deemed to accrue as of death. Thus, they should be treated just as the Tax Court treated interest on estate taxes in Richardson.

The opinion in Hubert is not without two forceful dissenting opinions. The thrust of their analysis is that, while income earned on estate property is not included in the gross estate, projected future income is an important element in determining the value of assets contained in the gross estate. The dissents assert that the use of such future income to pay administration expenses is, by definition, an improper reduction of the estate's income augmenting the estate's corpus.

The dissents' analysis is overly simplistic. It is predicated on the assumption that all administrative expenses relate solely to corpus. As discussed earlier and noted in the majority opinion, administrative expenses relate to both income and corpus. The dissents also fail to recognize that the income beneficiary is only entitled to the "net" (not "gross") income of the estate. Given the discretion already granted executors by most states to determine an estate's net income by allocating administrative expenses between corpus and income for fiduciary accounting purposes, there is no compelling statutory or policy reason for disregarding the exercise of their discretion under the estate tax.

The Tax Court also refused to follow the Sixth Circuit's line of reasoning in Allen.(21) There, the will provided for a residual marital trust. The Oklahoma statute provided that, absent other direction in the will, most administrative expenses were chargeable against estate income. The income attributable to the marital deduction portion of the estate exceeded the estate's administrative expenses. Following its rationale in Hubert, the Tax Court held that the allocation of administrative expense against the estate's income did not reduce the marital deduction to the extent the estate had sufficient income to absorb the allocation. Despite contrary holdings by other jurisdictions, this continues to be the Tax Court's position.(22)

Economic Analysis

Economically, a very compelling argument can be made that certain administrative expenses should be chargeable against income (and not corpus) without affecting the size of the marital deduction.

Example 2: X's estate has $4,000,000 of assets and no liabilities. Under X's will, all of the estate's assets are to be distributed to Y, the surviving spouse and executor. The estate incurs the following administrative expenses: $50,000 to prepare the estate tax return, $10,000 to prepare the estate's initial income tax return and $25,000 in investment advisory fees. The estate earned 8% on its assets ($320,000) during its initial year. The estate elects to allocate the $50,000 estate tax return preparation fee against corpus and all other administrative expenses against income; thus, the marital deduction is $3,950,000 ($4,000,000 - $50,000). If estate tax return preparation fees are also deducted on the estate tax return, the estate owes no estate tax.(23) The estate would also have $285,000 of distributable and taxable income ($320,000 of income on estate assets - [$25,000 of investment fees + $10,000 income tax return fees]).

Example 3: A's estate has $10,000,000 in assets and $6,000,000 of debt. It earned $800,000 on its assets and incurred $480,000 in interest expense. Administrative expenses are the same as in Example 2. A's estate, like X's estate, should not owe any estate tax and should have a $3,950,000 marital deduction ($10,000,000 - [$6,000,000 + $50,000]). A's estate would also have $285,000 of taxable and distributable income ($800,000 - [$480,000 + $25,000 + $10,000]). It makes sense from an economic perspective that Examples 2 and 3 produce similar results for tax purposes.

However, the IRS takes the position that the two examples are not identical. In Example 2, the IRS would argue that all of the administrative expenses reduce the marital deduction. Therefore, the marital deduction would only be $3,915,000 ($4,000,000 - $85,000). If the estate deducted all administrative expenses on the estate tax return, there would be no estate tax, but taxable income would be $320,000, rather than $285,000. Because the estate has $285,000 of fiduciary income, there would be income tax liability. In Example 3, the IRS would argue that the marital deduction would be $3,435,000 ($10,000,000 - [$6,000,000 + $565,0001). Moreover, if administrative expenses were deducted on the estate tax return to reduce the taxable estate to zero, A's estate would have $800,000 of taxable income.

Despite the two economically equivalent examples, the IRS's position regarding administrative expenses produces significantly different tax results. An executor's decision to pay a liability currently, or defer payment of such liability and incur interest expense, as illustrated in Example 3, depends on estate liquidity and on whether the executor believes the estate will earn more income (net of interest expense) by deferring payment of that liability. Thus, the decision becomes an investment decision and should affect the estate's income, but not the marital deduction.

Unfortunately, the Sixth Circuit's approach in Street is far too simplistic. As discussed earlier, many expenditures incurred by executors relate largely, if not exclusively, to the production of income. In fact, certain expenses traditionally considered solely allocable to corpus also pertain in part to income production. For example, the fee structure for some executors is a percentage of assets held by the estate plus a percentage of revenue earned by the estate. Why is the executor's fee based on a percentage of revenue earned by the estate? The executor is charging the estate for his services in managing the estate's assets to produce income for the benefit of the income beneficiaries.

There are countless examples of expenditures that benefit both estate corpus and income. In reality, interest expense will have a corpus element as well as an income element. Most commentators laud the Street decision's treatment of interest expense as allocable to income. The logic of this decision is that interest is incurred to prevent assets from being sold; these assets, in turn, are available to generate income for the estate. However, if these assets are, e.g., publicly traded securities, they may have a current dividend of 2% and annual appreciation of 8%-10%. Yet in most instances, capital appreciation is allocable to corpus and not income. Thus, unless. the estate consists entirely of bonds or money market funds, interest expense will benefit both estate corpus and income.

Congress recognized the dual nature of administrative expenses and authorized estates to deduct administrative expenses on either the estate tax or estate income tax return, but not both. Congress intentionally gave estates this election, granting executors discretion to minimize their tax liability by applying these expenses against the estate's income or corpus. Commentators argue that giving executors the discretion to allocate administrative expenses against corpus or income, no matter where they are deducted for tax purposes, is tantamount to giving them discretion to add to residual bequests.(24) However, estate administration expenses, by their nature, require some sort of allocation, because administrative expenses are not solely allocable to corpus or income. Executors have fiduciary obligations that cannot be breached in making these allocations. Often, as in Allen, the income beneficiary and remainder interest holders have disparate interests. Because executors are required to estimate the total administrative expense to be incurred by the estate when the estate tax return is filed, it seems incongruous to say executors cannot allocate those same expenses between corpus and income.

Planning Suggestions

If an estate is not in the Fifth or Sixth Circuit, there is authority to aggressively allocate administrative expenses against income and deduct them on either the estate tax or estate income tax return. If expenses are allocated against income, the marital deduction should not be reduced. This position is limited to situations in which, after allocation of the expenses, a reasonable level of income is still available for distribution. There are a number of economic arguments underlying this position; the Tax Court can be expected to support those arguments. It may even be possible to use administrative expenses - that have been allocated against income to reduce the size of a taxable estate.

Example 4: An estate has $4,000,000 in assets; $3,000,000 is to be distributed to the surviving spouse and $1,000,000 to the decedent's children. If the estate incurs $400,000 of administrative expense that is allocated against income, it could deduct those expenses on the estate tax return, thereby reducing the taxable estate to $600,000. If the decedent's full unified credit remained unused, the estate would owe no estate tax. Of course, the $400,000 of administrative expenses could not then be deducted on the estate's income tax return. The executor would need to determine whether the estate tax or income tax liability had the higher effective tax rate to determine on which return to advantageously deduct administrative expenses.

In most situations in which there is a residual marital deduction, it is advisable to allocate as much of the administrative expense as possible to income rather than to corpus.

Conclusion

More detailed regulations concerning the proper allocation of administrative expenses are desperately needed to delineate those expenses allocable solely against estate corpus for purposes of determining the marital deduction irrespective of state law provisions (e.g., probate expenses). Similarly, certain administrative expenses should be allocable solely against income (e.g., investment fees).

Finally, regulations are needed to permit all other administrative expenses to be allocated against income or corpus. Executors should be limited in making this allocation only when expenses exceed an estate's income. In that case, any excess expense would have to be allocated against corpus, which would have the effect of reducing a residual marital deduction. Regulations should recognize that the marital deduction is not reduced by administrative expenses properly allocated to an estate's income.

Until regulations are issued, executors outside the Fifth or Sixth Circuit can allocate all administrative expenses against an estate's income for fiduciary accounting purposes and deduct them on either the estate's income or estate tax return without impairing the estate tax marital or charitable deduction.

(1) Lee Martin, 923 F2d 504 (7th Cir. 1991)(67 AFTR2d 91-1174, 91-1 USTC [paragraph] 60,055). (2) Est. of Walter E. Richardson, Jr., 89 TC 1193 (1987). (3) Est. of Gordon P. Street, 974 F2d 723 (6th Cir. 1992)(70 AFTR2d 92-6220, 92-2 USTC [paragraph] 60,112), rev'g in part and aff'g in part TC Memo 1988-553. (4) For an estate subject to a 55% marginal estate tax rate, the creation of an individual $1 of taxable estate will result in an additional $1.22 of estate tax, due to the estate having to pay estate tax on the tax itself. Thus, $2.22 in assets is required to have $1 pass to a nonmarital or noncharitable beneficiary of an estate facing a 55% marginal tax rate ($2.22 x ($1.00 - $0.55) = $1.00). (5) For most estates, there is a multiplier effect on the estate tax liability whenever the marital or charitable deduction is reduced. This is because the incremental estate tax itself may be funded out of the marital or charitable bequest, in turn reducing those deductions even further. (6) Sec. 642(g) grants the executor the option of deducting administrative expenses either of Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return, or Form 1041, U.S. Fiduciary Income Tax Return. (7) Fla. Stat. Ann. Section 734.04 (West 1941). (8) Okla. Stat. Ann. tit. 60, sec 175.36A (West 1971). (9) For example, Ga. Code, Title 53, Section 53-15-3 (29)(C) Michie Law Publishers, 1982) authorizes a testator to grant complete discretion to an executor to apportion and allocate receipts and expenses between principal and income; the executor determines "which taxes (and other governmental charges) shall be charged against principal or income or apportioned between principal and income and in what proportions." (10) Greatly oversimplified, the taxable estate is calculated by subtracting from the gross estate claims against the estate and certain deductions (primarily, the marital deduction, charitable deduction and deductions for funeral and administrative expenses). See Secs. 2051 and 2053-2056. (11) See Regs. Sec. 20.2056(b)-4(b) and -4(c). (12) The legislative history further provides that the interest passing to the surviving spouse from the decedent is only such interest as the decedent can give. If the decedent by his will leaves the residue of his state to the surviving spouse and she pays (or if the estate income is used to pay) claims against the estate so as to increase the residue, such increase in the residue is acquired by purchase and not by bequest. Accordingly, the value of any such additional part of the residue passing to the surviving spouse cannot be included in the marital deduction. See S. Rep. No. 80-1013, 80th Cong. 2d Sess., Part II (1948), at 6. (13) Est. of Newton B.T. Roney, 33 TC 801 (1960), aff'd per curiam, 294 F2d 774 (5th Cir. 1961)(8 AFTR2d 6072, 61-2 USTC [paragraph] 12, 040). (14) Richardson, note 2, at 1195. Item IX of Mr. Richardson's will provided: "In addition to all other powers, and notwithstanding any other provision of this my will, my Executors shall have full discretion to apply the deductions allowable for claims, expenses, indebtedness, taxes, and losses, as contemplated by Sections 642, 2053, and 2054 of the Code, as the same now exist or may hereafter be amended, to either income tax or estate tax in such manner as to minimize the total state and federal income and death taxes payable by my estate or as a result of my death. Such allocation may be made regardless of whether its effect is to favor one beneficiary or class of beneficiaries over another or whether such charges shall be charged to income or principal for distribution purposes." Id. (15) Est. of Pierre L. Bailly, 81 TC 246 (1983). (16) The Sixth Circuit's decision in Street has since been followed by the Federal Circuit in James W. Burke, 944 F2d 1576 (Fed. Cir. 1993)(72 AFTR2d 93-6705, 93-2 USTC [paragraph] 60,146), and by the Court of Federal Claims in Gisele C. Fisher, 28 Fed. Cl. 88 (1993)(71 AFTR2d 93-2184, 93-1 USTC [paragraph] 60,132). Both of these cases amplify the Sixth Circuit's reasoning in Richardson. A detailed discussion of these cases would add little to the understanding of the administrative expense issue, however, they represent a widening number of jurisdictions that reject the Tax Court's position in Richardson. (17) Est. of Charles A. Bahr, Sr., 68 TC 74 (1977). (18) Est. of Otis C. Hubert, 101 TC 314 (1993). (19) Id., at 326. (20) S. Rep. No. 80-1013, note 12. (21) Est. of Frances Blow Allen, 101 TC 351 (1993). (22) The Tax Court recently reaffirmed its stance in Street in Est. of Henry L. Tessmer, TC Memo 1994-401, n. 10. (23) I.e., $4,000,000 (total assets) - $50,000 (administrative expenses allocated against corpus) = $3,950,000. Thus, because of the $3,950,000 marital deduction, there is no taxable, estate. If the $50,000 of administrative expense was not deducted on the estate tax return, there would have been a taxable estate of $50,000, and, assuming the unified credit had been fully used during the testator's life, estate tax would be due that would further increase the taxable estate and reduce the marital deduction. (24) See, e.g., Covey, "Recent Developments Concerning Estate, Gift and Income Taxation - 1993," U. of Miami Law Center, 28th Annual Philip E. Heckerling Institute on Estate Planning.