Can settling your probate case provide you with a tax break?

With estate tax rates that could reach 55 percent in 2013 along with a falling exemption, it is not surprising that taxpayers will look for every way possible to reduce their tax burden, and one potential way of accomplishing this is with deductions. Typically, after an estate is valued, it is entitled to certain deductions from its value. For example, if an estate was valued at $ 20 million and the estate was entitled to 3 million dollars of deductions, the taxable estate would only be $ 17 million. The most common deductions are the charitable deduction and the administrative expense deduction. Generally, when a sum of money is paid by an estate, it is considered deductible if it is supported by adequate consideration and not attributable to the testator’s testamentary intent, i.e., the testator must not have intended to give anything away and some type of service must be provided for the estate). I.R.C. 2053(c)(1)(A). Thus, distributions to beneficiaries are usually not deductible. In Estate of Bates v. Comm’r, the Tax Court disallowed a deduction by the estate because the deduction related to a settlement from a claim brought by a beneficiary. Decedent had a longstanding and extremely close relationship with the claimant, expressly provided that he would receive estate assets, and memorialized her testamentary intent. In addition, the court resolved the amount of estate assets that the claimant was entitled to receive, and the settlement payment was paid in full satisfaction of any claim relating to the estate.

On the estate’s tax return, the estate reported that recipient of the settlement payment, Mr. Lopez, was a beneficiary and that the settlement payment was paid to settle title to beneficiaries. During decedent’s lifetime, Mr. Lopez was paid for the services he rendered, and no part of the settlement payment related to a claim for unpaid services. In short, Mr. Lopez’s claim represented a beneficiary’s claim to a distributive share of the estate. Though the settlement turned out to be in excess of the beneficiaries original interest in the estate, the court did not allow any of the settlement to be deducted. Furthermore, the court disallowed expenses paid by one of the beneficiaries relating to a private investigator to be characterized as a deduction. The beneficiary had hired the private investigator to monitor the probate litigation.

The overall take away from Estate of Bates v. Comm’r is that the underlying legal theory of a claim can have substantial tax consequences. If a claim is brought as a creditor claim, it should be deductible while a will contest should not be deductible. Also, professional fees are deductible if they are done for the benefit of the estate as opposed to just for one beneficiary. If a claim is brought under the creditor theory, the deduction would benefit not only the estate, which would reap the benefits of the deduction, but the prosecuting party. The prosecuting party is more likely to get a favorable settlement if a settlement makes economic sense for the other side, i.e., if it operates as a deduction which lowers the tax burden of the estate and leaves the state with more post-tax assets.

If you or someone you know needs assistance dealing with the complexities of probate administration, the experienced legal team at Chepenik Trushin LLP is here to help.