Tax Court in Brief | Estate of Kalikow v. Comm’r | Estate Tax Taxation and Deductions and QTIP Trust

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The Tax Court in Brief – March 6th – March 10th, 2023

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Tax Litigation:  The Week of March 6th, 2022, through March 10th, 2023

Estate of Kalikow v. Comm’r, T.C. Memo. 2023-21 | February 27, 2023 | Thornton, J. | Dkt. No. 14436-10.

Summary: Pearl B. Kalikow’s  (“Pearl”) husband died in 1990.  On January 4, 2006, Pearl passed away. The SK Trust (“Trust”) was created with the remainder of Pearl’s husband’s estate. On Pearl’s husband will it was instructed to the trustees of the Trust to pay the trust’s net income to Pearl during her lifetime. After Pearl passed away the Trust assets were paid over to trusts for the benefit of her children Edward Kalikow (“E. Kalikow”) and Lauren Platt (“Platt”).

Mr. Shalik and Mr. DeVita executors of Pearl’s husband’s estate, elected to treat the Trust as a QTIP trust under § 2056(b)(7). The Trust property was included in Pearl’s gross estate at its fair market value as of the date of her death. E. Kalikow and Platt created a Kalikow Family Partnership, L.P. (“KFLP”). The Trust transferred the property to KFLP in exchange of 98.5% partnership interest. The Trust property consisted of the 98.5% partnership interest, cash, and marketable securities. The trustees of the Trust were E. Kalikow, Mr. Shalik and Patt. After the payment of certain expenses, the remainder of Pearl’s estate was bequeathed to a charitable organization.

From a dispute between Mr. Shalik and E. Kalikow and Patt over the Trust distribution, it was agreed that the Trust would pay a settlement payment for undistributed income (2002-2005), including certain commissions, accounting fees, and legal fees. The IRS issued a Notice of Deficiency determining the value of the Trust limited partnership interest is lower than the amount reported on Form 706. The IRS reduced the Schedule F assets by the value of the estate’s pending claim against the Trust. E. Kalikow and Patt on the Cross-Motion for Partial Summary Judgment established that the value of the Trust assets included in the estate were properly reduced by the undistributed income amount under the Settlement pursuant to § 2044 and various items of the Settlement payment are deductible from the gross estate as administration expenses under § 2053.

Key Issues:

Whether, under 26 U.S.C. § 2044, the value the Trust assets included in the value of the gross estate is properly reduced by the agreed undistributed income amount?

Whether, under 26 U.S.C. § 2053, the estate is entitled to deduct any part of the agreed settlement payment as administration expenses?

Primary Holdings:

No, the amount was not properly reduced by the agreed undistributed income amount. Contrary to the arguments of E. Kalikow and Platt, the Tax Court determined that the Trust assets inclusion in Kalikow’s gross estate will not give rise to double taxation or estate tax on charitable bequest as established under 26 U.S.C. § 2044(a).

Yes, and no. The Tax Court determined the limitations on deductibility are not applicable to claims in favor of the estate that are includible in the decedent’s gross estate under 26 U.S.C.  § 2031. Therefore, the Tax Court concluded that the estate is not entitled to deduct any part of the agreed-upon settlement payment other than the amount paying out commission, conceded by the IRS under 26 U.S.C. § 2053.

Key Points of Law:

Estate Tax, Generally. A tax is imposed on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States. The estate tax is determined by the value of the taxable estate, among other items. See § 2001(b). The value of the taxable estate is the gross estate less deductions. See § 2051. “[T]he gross estate generally includes the value of property described in sections 2033 through 2044”. See Treas. Reg. § 20.2031-1(a).

Decedent’s Gross Estate. Under section 2033, a decedent’s gross estate includes the value of all property beneficially owned by the decedent at the time of death.  See Treas. Reg. § 20.2033-1(a).  Under 26 U.S.C. § 2044, generally, the amount included in the gross estate is “[t]he value of the entire interest in which the decedent had a qualifying income interest for life, determined as of the date of the decedent’s death.” See Treas. Reg. § 20.2044-1(d)(1). Generally, the value of property that is included in the gross estate is its fair market value at the time of the decedent’s death.  See § 2031(a); Treas. Reg. § 20.2031-1(b).  “[F]air market value is defined as the price that a willing buyer would pay a willing seller, both persons having reasonable knowledge of all the relevant facts and neither person being under a compulsion to buy or sell”. See United States v. Cartwright, 411 U.S. 546, 551 (1973); Treas. Reg. § 20.2031-1(b).

Deductions, Generally. Under 26 U.S.C. § 2053(a) a deduction for certain amounts including administration expenses and claims against the estate is allowed by the laws of the jurisdiction under which the estate is administered. Under 26 U.S.C. §2053(b) a deduction for expenses incurred in administering non-probate property is allowed if it is deductible under section 2053(a). These expenses must be “[a]ctually and necessarily, incurred in the administration of the decedent’s estate; that is, in the collection of assets, payment of debts, and distribution of property to the persons entitled to it.” See  Treas. Reg. § 20.2053-3(a). “[T]he only expenses in administering property not subject to claims which are allowed as deductions are those occasioned by the decedent’s death and incurred in settling the decedent’s interest in the property or vesting good title to the property in the beneficiaries.” See Treas. Reg. § 20.2053-8(b).

QTIP Trusts. The value of QTIP trust property (property in which the decedent had a qualified income interest for life and for which a marital deduction was allowed to the estate of a predeceased spouse under section 2056(b)(7)), generally is included in the gross estate. See 26 U.S.C. § 2044(a). “[T]he QTIP regime employs a fiction that treats QTIP as passing entirely from the first spouse to die to the surviving spouse.” See Estate of Morgens v. Commissioner, 133 T.C. 402, 412 (2009), aff’d, 678 F.3d 769 (9th Cir. 2012).  Generally, under the QTIP regime a transfer of QTIP is allowed to qualify for a marital deduction for the first spouse to die and escape to the inclusion in that spouse’s estate, notwithstanding a life interest passes to the surviving spouse. “[A]t the death of the second spouse, QTIP property is taxed as part of the surviving spouse’s estate.” See Estate of Mellinger v. Commissioner, 112 T.C. 26, 32 (1999); see also Estate of Morgens, 133 T.C. at 412.

Insights:  This case involves the disallowance of the reduction of the value of the Trust assets included in the value of the gross estate by the income under a settlement. The inclusion of such income did not trigger a double taxation on the gross estate or estate tax on charitable bequest under Section 2044. Moreover, the disallowance of settlement payments other than commissions as the other items were not made by the estate. It is recommended to make a tax analysis before reducing any amounts on the taxable estate or to take any deductions to avoid any tax contingency.