In Riegels v. Commissioner (In re Estate of Saunders),1 the U.S. Court of Appeals for the Ninth Circuit addressed whether it was proper for the Tax Court to disallow a $30 million deduction claimed by the estate of Gertrude Saunders (the estate) for a lawsuit that was pending at the time of Gertrude’s death. In reaching its decision, the Tax Court had considered the post-death settlement of this lawsuit for an amount that was less than 10 percent of the amount claimed by the estate as a deduction, and the Ninth Circuit analyzed whether this was permissible under the applicable sections of the Internal Revenue Code and Treasury Regulations.
Lawsuit Against Late Husband’s Estate
Gertrude died on Nov. 27, 2004; she had survived her husband, William Saunders, Sr. (William), by one year and 25 days. During his life, William practiced law and represented Henry Stonehill (Henry), who died in 2002. Prior to his death, Henry was embroiled in over 10 years of tax litigation. On Sept. 24, 2004, Henry’s estate filed complaints against William’s estate, requesting at least $90 million in damages for legal malpractice, breach of confidence, breach of duty of loyalty and fraudulent concealment (the claim), based on William’s alleged disclosure to the Internal Revenue Service of a Swiss bank account maintained by Henry, which, in turn, allegedly exposed Henry to “considerable tax liability.”2
The claim was tried before a jury on May 28, 2007, roughly two-and-a-half years after Gertrude’s death. The jury determined that although William breached his duties of loyalty and confidentiality, William’s actions didn’t financially harm Henry or his estate. Henry’s estate filed an appeal, but a settlement was ultimately agreed to whereby William’s estate was released from all liability in exchange for a payment to Henry’s estate of $250,000 in attorney’s fees.3
Gertrude’s Estate Claims $30 Million Deduction
The claim was filed just 64 days before Gertrude died, and it remained pending and contested at Gertrude’s death. On Feb. 23, 2006, the estate filed its estate tax return, claiming a deduction of $30 million as the estimated value of the claim at the time of Gertrude’s death. This deduction was based on an appraisal letter prepared by an attorney.4
On Feb. 10, 2009, the IRS issued a notice of deficiency (or 90-day letter) to the estate, asserting $14.4 million in taxes due, based on the purportedly improper $30 million value ascribed to the deduction claimed by the estate. The estate timely petitioned the Tax Court for redetermination,5 and thereby “booked” its “ticket to Tax Court.”
Two years later, with the case finally before it, the Tax Court held that the IRS properly disallowed the estate’s claimed $30 million deduction, and instead determined that the estate could only deduct the $250,000 it actually paid to settle the claim after the estate tax return was due. As such, the Tax Court reduced the IRS’ asserted deficiency from $14.4 million and found a total estate tax deficiency of roughly $12.4 million, which the estate appealed.6
Deductibility under Code IRC Section 2053
Under Section 2053(a)(3), an estate may deduct the value of any claims against it that are permitted under the laws of the jurisdiction where the estate is administered. Furthermore, the regulations that applied at Gertrude’s death essentially defined “claims against an estate” as “personal obligations of the decedent existing at the time of his death, whether or not then matured, and interest thereon which had accrued at the time of death.”7 An estate may deduct the estimated value of a yet-unpaid claim against it if it can show that: (1) the value of the claim is “ascertainable with reasonable certainty”; and (2) the claimed amount “will be paid.” If a claim isn’t ascertainable with reasonable certainty at the decedent’s death, then the estate may petition the Tax Court for relief or file for a refund once the claim’s value becomes certain.8
The Ninth Circuit had applied Section 2053(a)(3), and the corresponding regulations, in several prior decisions that distinguished “certain and enforceable” claims from “disputed or contingent” claims. The distinction from that body of precedent was critical because it controlled whether post-death events could be considered; in particular, post-death events could be considered if the claim was “disputed or contingent” but not if the claim was “certain and enforceable.”9 The Ninth Circuit noted that the distinction flowed logically from the regulations, because any claim that is “certain and enforceable” at the decedent’s death necessarily has a value that is “ascertainable with reasonable certainty.” Likewise, the value of any claim against an estate that is “disputed or contingent” at the decedent’s death is generally not “ascertainable with reasonable certainty.”10
The Ninth Circuit then determined that the claim was “disputed” at Gertrude’s death because it was: (1) then still pending; (2) litigated extensively; and (3) scheduled for jury trial. Similarly, William’s estate consistently denied that William had done anything wrong.11 The estate relied on the Ninth Circuit’s decision in Estate of Shapiro v. United States12 to support its argument that the claim was “certain and enforceable” at Gertrude’s death. According to the estate, Shapiro dictated that post-death events should never be considered when determining the value of a claim against an estate. However, the Saunders court disagreed, claiming that: (1) the estate’s interpretation of Shapiro was based on a short paragraph that was, essentially, read out of context; (2) the Shapiro court hadn’t intended to deviate from established Ninth Circuit precedent; and, most importantly, (3) Shapiro lacked the authority to overturn precedent because it was decided by a three-judge panel, rather than the entire Ninth Circuit.13 Therefore, consistent with Naify, the Ninth Circuit rejected any interpretation of Shapiro as a substantial departure from Ninth Circuit precedent on the deductibility of disputed claims against an estate.
Furthermore, the Ninth Circuit affirmed the Tax Court’s holding that, at Gertrude’s death, the estimated value of the claim wasn’t “ascertainable with reasonable certainty.” The Ninth Circuit noted the vast range of possible values for the claim, as proffered by the estate’s experts, and highlighted one expert’s opinion that the estimated value of the claim could be anywhere from one dollar to $90 million.14 Such an extreme range of potential values would’ve presumably sounded the claim’s death knell under the applicable regulations, which disallow claimed deductions if based on “a vague or uncertain estimate.”15 It’s of little surprise, then, that the Ninth Circuit held that the claim wasn’t “ascertainable with reasonable certainty” and thereby denied the $30 million deduction claimed by the estate.
The Ninth Circuit also affirmed the Tax Court’s holding that the estate could deduct the amount paid to settle the claim. In particular, the Ninth Circuit had previously held that when “a claim’s value is not ascertainable with reasonable certainty, but later becomes certain, an estate may petition the tax court or file a claim for refund.”16 Since the claim remained in dispute at Gertrude’s death, established Ninth Circuit precedent allowed one to consider post-death events when determining the correct deduction amount. Since the claim’s value was clearly certain when it settled for $250,000 (roughly two years after Gertrude’s death), the Ninth Circuit affirmed the Tax Court’s holding that the estate could deduct that amount.
Regulations Applicable to Decedents Dying on or after Oct. 20, 2009
Saunders is one example of the long-disputed consideration of post-death events when valuing claims for purposes of the estate tax deduction, under Section 2053(a)(3), for claims against the estate.17 In 2007, the Treasury Department issued proposed regulations to help reduce confusion and clarify whether post-death events should be considered in such situations.
The final regulations, which were issued on Oct. 20, 2009, provide that an estate may deduct yet-unpaid claims against it if “the amount to be paid is ascertainable with reasonable certainty and will be paid.”18 Those regulations further state that a contested or contingent claim “cannot be ascertained with reasonable certainty” and, therefore, can’t be deducted by the estate. Moreover, the regulations allow deductions if the “Commissioner is reasonably satisfied that the amount to be paid is ascertainable with reasonable certainty and will be paid,” and, most importantly, in reaching this decision, “the Commissioner will take into account events occurring after the date of a decedent’s death.”19 As such, Saunders is effectively consistent with the final regulations, but these regulations also arguably contradict Supreme Court precedent and circuit-level decisions that either marked a line in the sand at the decedent’s date of death or took a more nuanced approach.20
Although Saunders is based on the pre-2009 regulations, it remains consistent with the current regulations, which apply to estates of decedents who died on or after Oct. 20, 2009. As discussed above, the Ninth Circuit held that the claim was “contested,” which meant that it couldn’t be ascertained with reasonable certainty, and, therefore, disallowed the $30 million deduction claimed by the estate while permitting it to deduct the $250,000 settlement amount that the parties agreed to several years after Gertrude’s death. If Gertrude had survived another five years, the same outcome would’ve resulted under the revised regulations; in fact, Treas. Regs. Section 20.2053-1(d)(4)(ii) would’ve required the Commissioner to consider the post-death settlement amount.
1. Riegels v. Commissioner (In re Estate of Saunders), 2014 U.S. App. LEXIS 4647 (9th Cir. Mar. 12, 2014).
2. Ibid. at 3-4; Estate of Saunders v. Comm’r, 136 T.C. 406, 409 (2011).
3. Riegels v. Comm'r, supra note 1 at 4.
4. Estate of Saunders v. Comm’r, supra note 2 at 409-411 (2011). Although the claim was brought against William’s estate, the parties agreed that, due to the agreement closing William’s estate, the deductibility issue would be resolved with respect to Gertrude’s estate, and the claim would be valued as of Gertrude’s date of death. Ibid. at 418.
5. Riegels v. Comm'r, supra note 1 at 5.
6. Ibid. at 6-7. The vast portion of this $12.4 million deficiency was related to a deduction claimed by the estate of approximately $1.9 million for attorneys’ fees and other costs that it paid in defending the claim. The Commissioner subsequently acknowledged that the estate was entitled to a deduction for these amounts, and so this $1.9 million deduction wasn’t at issue in the case. Ibid. at 5.
7. Treasury Regulations Section 20.2053-4 (prior to 2009 amendment (T.D. 9468, 2009-2 C.B. 570) that applied to “estates of decedents who died on or after October 20, 2009”).
8. Treas. Regs. Section 20.2053-1(b)(3) (prior to 2009 amendment (T.D. 9468, 2009-2 C.B. 570) that applied to “estates of decedents who died on or after October 20, 2009”).
9. Riegels v. Comm'r, supra note 1 at 9, citing Marshall Naify Revocable Trust v. United States, 672 F.3d 620, 626-628 (9th Cir. 2012).
10. Ibid. at 9-10, citing Marshall Naify Revocable Trust v. United States, 672 F.3d 620, 624 (9th Cir. 2012) and Propstra v. United States, 680 F.2d 1248, 1253 (9th Cir. 1982).
11. Riegels v. Comm'r, supra note 1 at 14.
12. Estate of Shapiro v. U.S., 634 F.3d 1055 (9th Cir. 2011).
13. Riegels v. Comm'r, supra note 1 at 16, citing Marshall Naify Revocable Trust v. United States, 672 F.3d 620, 628 (9th Cir. 2012).
14. Riegels v. Comm'r, supra note 1 at 18.
15. Treas. Regs. Section 20.2053-1(b)(3) (prior to 2009 amendment (T.D. 9468, 2009-2 C.B. 570) that applied to “estates of decedents who died on or after October 20, 2009”) (emphasis added). This provision is now found in Treas. Regs. Section 20.2053-1(b)(4).
16. Riegels v. Comm'r, supra note 1 at 21-22, citing Marshall Naify Revocable Trust v. United States, 672 F.3d 620, 624 (9th Cir. 2012) and Treas. Regs. Section 20.2053-1(b)(3).
17. Indeed, for many years, even the circuit courts were split on this issue. See Deborah L. Hildebran-Bachofen & John R. Cella, “Section 2053 Final Regulations on Claims Against the Estate: You Have to “Pay to Play”, The Will & The Way (May 2010) (illustrating divergence in circuit-level interpretation of Supreme Court’s date-of-death valuation rule as originally established in Ithaca Trust Co. v. United States, 279 U.S. 151 (1929), www.manningfulton.com/newsstand/10-section-2053-final-regulations-claims-against-estate-you-.
18. Treas. Regs. Section 20.2053-1(d)(4)(i).
19. Treas. Regs. Section 20.2053-1(d)(4)(ii).
20. See Ithaca Trust Co. v. U.S., 279 U.S. 151 (1929) (establishing date-of-death valuation rule and concluding that “the value of the thing to be taxed must be estimated as of the time when the act is done”), O’Neal v. United States, 253 F.3d 1265 (11th Cir. 2001) (holding post-death events wouldn’t be considered when valuing estate’s deduction for transferee gift tax liability claims against it under IRC Section 2053) and Sachs v. Comm’r, 856 F.2d 1158 (8th Cir. 1988) (holding date-of-death valuation principle wasn’t absolute).