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Sec. 1341(a) income tax benefit is includible in the gross estate.

In Smith, 108 TC No. 20 (1997), the Tax Court ruled, in a case of first impression, that a Sec. 1341 (a) income tax benefit was includible in a decedent's gross estate, even though the Sec. 1341 (a) benefit was contingent rather than certain on the date of death. A Sec. 1341 (a) benefit results from an income tax deduction or credit based on the repayment of an amount included in gross income in a prior year. The Tax Court also reaffirmed prior case law in ruling that post-death events are relevant in determining the amount of a liability deductible from the gross estate under Sec. 2053(a)(3) if the deductible liability is the amount (if any) actually paid.

Sec. 1341(a) provides income tax relief for taxpayers required to repay an amount previously included in income under a claim of right. The reduction in tax liability is the greater of the following two calculations. The taxpayer either deducts the amount repaid or claims a credit equal to the reduction in tax that would have occurred had the amount repaid been excluded from income in:the earlier year.

Sec. 2033,.includes in the gross estate "all property to the extent of the interest therein of the decedent at the time of his death." Sec.2053(a)(3) allows a deduction from the gross estate for claims against the estate. The amount allowed as a deduction must be determined as of the date of death if the claim is valid and fully enforceable on the date of the decedent's death (Ithaca Trust Co., 279 US 151 (1929)). Therefore, post-death events are not relevant for the valuation of such claims. Instead, approaches Such as annuity tables and expert testimony must be used to determine the date of death value. On the other hand, if the decedent's creditor has only a potential, unmatured, contingent or contested claim that requires further action before it becomes a fixed obligation of the estate, post-death events are relevant (Est. of Van Horne, 78 TC 728, aff'd, 720 F2d 1114 (9th Cir. 1983)). The deduction for these claims is any amount actually paid.

In Est. of Smith, Algerine Smith had leased land to Exxon, while retaining a royalty interest in oil and gas production. In 1978, the US. Department of Energy (DOE) sued Exxon for misclassifying certain crude oil, resulting in overcharges. In 1983, the district court ruled that Exxon owed the DOE $895 million, plus interest, which Exxon paid in 1986. In 1988, Exxon sued Smith and the other royalty interest owners for reimbursement of their shares of this payment; Smith vigorously contested Exxon's suit. In November 1990, Smith died. In February 1991, the district. court ruled that Smith was liable to Exxon, and in April 1991, Exxon claimed $2,482,719 from Smith's estate. In July 1991, the executor deducted $2,482,719 on the estate tax return as a claim against the estate. In February 1992, the parties settled for $681,840. The IRS determined that only $681,840 was deductible as a claim against the estate. The estate argued that the entire $2,482,719 claim was deductible because Exxon's claim was certain and enforceable on the date of Smith's death.

The amount of tax benefit could be determined, based on the amount of royalties repaid to Exxon. However, the estate contested the IRS's claim that this benefit was includible in the gross estate. The estate argued that, on the date of death, the, right to a Sec. 1341 (a) benefit did not exist, because the district court had not yet ruled on Exxon's claim. The payment to Exxon did not occur until after the settlement, 15 months after death.

The Tax Court ruled that Exxon's claim was neither valid nor enforceable on the date of Smith's death. Therefore, the estate's Sec. 2053(a)(3) deduction was limited to the amount actuary paid. The court pointed out that Smith and her estate had vigorously contested Exxon's claim. The estate could not then argue that the claim was valid and enforceable on the date of Smith's death.

On the Sec. 1341 (a) issue, the Tax Court ruled that the fact that the Sec. 1341 a) benefit was contingent on the date of Smith's death did not prevent its inclusion in the gross estate. The court reasoned that the Sec. 2053(a)(3) deduction and the Sec. 1341 (a) benefit are "inextricably linked." On the date of her death, Smith possessed the right to an income tax benefit based on whatever amount she ultimately had to pay Exxon. Because this payment decreased the gross estate under Sec. 2053(a)(3), it follows that the Sec. 1341(a) benefit increased the gross estate.

The Tax Court also pointed out that, if Smith had repaid Exxon prior to her death, her gross estate would be decreased by the repayment and increased by the Sec. 1341(a) benefit. The court indicated that there was no reason why the result should be different just because Smith died prior to the repayment. Finally, there is nothing in the estate tax law to prevent inclusion of the Sec. 1341 (a) benefit in the gross estate. In fact, the broad sweep of Sec. 2033 requires its inclusion.

Est. of Smith establishes the rule that a Sec. 1341(a) income tax benefit is includible in a decedent's gross estate. The benefit is based on the amount of the repayment, regardless of whether the repayment is certain or contingent on the date of death. However, the amount of the estate tax deduction under Sec. 2053(a)(3) does depend on whether the liability is certain or contingent on the date of death; it is possible that the Sec. 2053(a)(3) deduction would be larger than the repayment used to calculate the Sec. 1341 (a) benefit.
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Title Annotation:Internal Revenue Code section 1341(a)
Author:Sager, Clayton R.
Publication:The Tax Adviser
Date:Oct 1, 1997
Previous Article:Restoration of unified tax credit previously used.
Next Article:Interest expense for UBTI purposes.

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