Magazine article The CPA Journal

Where to Deduct Administration Expenses When Marital Deduction Is Claimed - Form 706 or Form 1041?

Magazine article The CPA Journal

Where to Deduct Administration Expenses When Marital Deduction Is Claimed - Form 706 or Form 1041?

Article excerpt

Deciding where to deduct administrative and interest expenses (Form 706 or Form 1041) depends on many factors. The decision of the U.S. Court of Appeals will now make the marital deduction a major factor.

In general, for an interest to qualify for the marital deduction under IRC Sec. 2056, the interest must be includible in the decedent's gross estate and pass to the surviving spouse.

THE NET VALUE RULE

Implicit in the passing requirement is the limitation of the deduction to the "net value" passing to the surviving spouse, as determined under IRC sec. 2056(b)(4). This usually relates to encumbrances such as mortgages on real property passing to a surviving spouse. The value of the residence, clearly must be reduced by any mortgage or other encumbrance. Also, in the absence of specific direction in the will of the decedent, most states embrace the concept of "equitable apportionment" of the burden of death taxes. If the interest passing to the spouse must bear a portion of the Federal estate tax or state death tax imposed on the decedent's estate, the net value of the marital deduction will be further reduced.

The U.S. Court of Appeals reversed an earlier decision by the U.S. Tax Court in the case of the Estate of Gordon P. Street v. Commissioner of Internal Revenue [U.S. Court of Appeals for the Sixth Circuit, No. 91-2230, September 8, 1992, affirming in part, reversing in part and remanding the decision of the U.S. Tax Court, 56 TCM 774, CCH Dec. 45,201(M)].

In this case, the Commissioner, in examining the estate tax return of a decedent, reduced the claimed marital deduction by the amount of administration expenses that had been deducted on the estate's fiduciary income tax returns. The IRS also sought to reduce the marital deduction by the amount of post death interest that had accrued on unpaid Federal and state death taxes.

The estate filed a petition on May 30, 1986, seeking a redetermination of the Commissioner's proposed adjustments. The parties had agreed by stipulation that the only issues that should be resolved by the Tax Court was whether the amount of the marital deduction must be decreased by the administrative expenses and by interest accruing on the Federal estate tax and state inheritance tax deficiencies.

THE TAX COURT RELIES ON RICHARDSON

The Tax Court held in favor of the estate. The Tax Court stated that if the administrative expenses and interest payable on the Federal and state taxes were chargeable to income, they would not reduce the marital deduction. Relying on Estate of Richardson v. Commissioner (CCH Dec. 44,388), 89 T.C. 1193 (1987), the Tax Court held that the interest payable on state inheritance and Federal estate tax was chargeable to income under Tennessee law and the terms of the will. The Tax Court likewise found that other administrative expenses were charged against income of the estate and would not reduce the marital deduction.

The Commissioner appealed, arguing that Reg. Sec. 20.2056(b)-4(a) requires that, when valuing the spouse's marital deduction, all administrative and interest expenses paid, or payable, out of income must be subtracted from the amount properly deductible. In response, the U.S. Court of Appeals said ".....The Commissioner argues that the Tax Court erred in failing to reduce the marital deduction available to petitioner by the amount of administrative and interest expenses incurred by the estate." The Tax Court held that because these expenses were chargeable to income and not to the principal of the estate, the amount which passes from decedent to the spouse would remain unchanged, and therefore there need not be any adjustment to the amount of the marital deduction.

COURT OF APPEALS CRIES "FOUL"

The U.S. Court of Appeals believed the Tax Court reached an improper result. Federal estate tax is imposed on "the transfer of the taxable estate" [26 U.S.C. Par. 2001 (a)]. The taxable estate is computed by subtracting, from the value of the gross estate, deductions enumerated in IRC Secs. …

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