In Estate of Adell, T.C. Memo 2014-89, Franklin Adell died on Aug. 13, 2006, a resident of Michigan.  Earlier that year, Franklin paid a legal judgment that had been entered against his son in the amount of $6,667,018 on his son’s behalf.  When the estate filed a Form 706, on Nov. 13, 2007, it reported the amount of the judgment as a loan receivable and an asset of the gross estate.  On the Form 706, the estate reported $15,288,517 of total estate tax due.  Included in the estate were three closely held businesses; accordingly, the estate was able to make an election under Internal Revenue Code Section 6166 to defer payment of a portion of the estate tax for five years and pay the estate tax in installments.  The estate paid $8,094,558 of estate tax at the time it filed the Form 706; payment of the remaining $7,193,960 was deferred.  On Dec. 17, 2007, the Internal Revenue Service assessed $15,288,517 of estate tax against the estate on the basis of the estate tax return. 

On Nov. 17, 2008, the estate filed an amended Form 706, which reclassified the $6,667,018 judgment as a taxable gift.  At the same time, the estate filed a Form 709 to report the gift, which showed $2,889,108 of gift tax due.  On Aug. 10, 2010, the estate filed a second amended Form 706, which reported a different value for one of the closely held business interests.  Consistent with the first amended estate tax return, the second amended return classified the payment of the judgment as a taxable gift. 

On Oct. 11, 2010, the IRS assessed $2,889,108 of gift tax on the basis of the gift tax return filed in 2008.  The IRS also assessed a $650,049 penalty for late filing of the gift tax return, a $606,713 penalty for late payment of the gift tax and $742,847 of interest.  Because the estate changed the manner in which it reported the judgment after the estate tax had been assessed, the judgment was included in both the estate tax assessment and the gift tax assessment. 

 

Notices of Deficiency

On Nov. 9, 2010, the IRS issued two notices of deficiency, one for the estate tax liability and the other for the gift tax liability.  The estate tax notice of deficiency indicated that the estate owed $39,673,096 of estate tax.  In determining the amount of estate tax owed, the IRS included the $6,667,018 judgment as an asset of the gross estate.  The gift tax notice of deficiency indicated that the estate owed $2,889,108 of gift tax as reported on the Form 709, plus an additional $71,563 of unreported gift tax.  

The estate filed a timely petition in response to the estate tax notice of deficiency, alleging that the judgment shouldn’t have been included as an asset of the taxable estate and that one of the closely held business interests was overvalued.  In response to the gift tax notice of deficiency, the estate filed a protest letter, which was assigned to an Appeals officer for consideration.  The protest letter requested that the IRS: (1) stay all collection actions, (2) consolidate consideration of the gift tax liability with consideration of the estate tax liability, and (3) abate the penalties on the grounds that the judgment had already been reported as an asset on the Nov. 13, 2007 estate tax return and that the gift tax liability could be satisfied by applying a portion of the $8,094,558 estate tax payment against the gift tax liability. 

On Aug. 13, 2012, , the Appeals officer sent a letter to the estate disallowing the claim for abatement of gift tax, penalties and interest.  The letter stated that there was no overpayment of estate tax available to apply against the gift tax liability because the estate remained liable for the deferred portion of the estate tax, and the case involving the estate tax issues was still pending in the Tax Court.  On Sept. 19, 2012, the IRS sent the estate the notice of determination sustaining the proposed levy.  The estate filed a petition with the Tax Court.

 

Payments Don’t Apply to Gift Tax Liability

The estate first argued that the IRS should have credited the payment it made with its Nov. 13, 2007 estate tax return against its gift tax liability because the estate had designated the payment to be applied in such manner.  The IRS allows a taxpayer to designate the application of a voluntary tax payment when the taxpayer submits the payment if the IRS has assessed one or more tax liabilities against the taxpayer and if the taxpayer provides specific, contemporaneous written directions for the application of payment.  If the taxpayer doesn’t designate the application of payment in this manner, the IRS will apply the payment in a manner that best serves its interest. 

The Tax Court stated that, at the time the estate remitted its payment, the IRS had assessed only the estate tax against the estate; the gift tax return wasn’t filed until more than a year later, and the IRS didn’t assess the gift tax liability until 2010.  Therefore, the estate couldn’t have designated that the payment made on Nov. 13, 2007 be applied against the gift tax liability. 

 

No Overpayment of Estate Tax

The estate’s second argument was that it made an overpayment of estate tax.  Under IRC Section 6402(a), the IRS may credit a taxpayer’s overpayment against any tax liability of the taxpayer.  IRC Section 6403 provides that for a tax payable in installments, any overpayment of an installment must first be applied to any unpaid installments; if the amount of the overpayment exceeds the full amount of tax due, then it may be credited or refunded under IRC Section 6402.  The estate paid $8,094,558 of tax when it filed the Nov. 13, 2007 return, which represented the nondeferrable portion of the total estate tax due.  On its first amended estate tax return, the estate reported $5,205,499 of nondeferrable estate tax due because the judgment was recharacterized as a gift and no longer treated as a loan receivable.  The estate therefore argued that it overpaid the nondeferrable portion of the estate tax by $2,889,108. 

The Tax Court cited case law for the authority that Section 6403 applies where the taxpayer makes an election under Section 6166 and overpays the nondeferrable portion of the estate tax and that under Section 6403, the IRS must apply any overpayment of the nondeferrable portion to the deferred portion before any credit or refund can be issued to the taxpayer.  Although the estate had overpaid the nondeferrable portion of the estate tax, it didn’t pay more than the full amount of estate tax due.  Therefore, there was no overpayment of estate tax available to credit against the estate’s gift tax liability.