May 1, 2007 12:00 PM, Rorie M. Sherman Editor in Chief

By: Rorie M. Sherman Editor in Chief

From David A. Handler, partner in the Chicago office of Kirkland & Ellis, LLP, we have this report:

• Hester: Assets improperly held by decedent are includible in an estate — In Estate of Hester v. United States, No. 5:06-cv-00041 (D.Ct. Va. March 2, 2007), Wendell Hester was the beneficiary and trustee of a trust created by his late wife Dorothy. In 1998, in breach of his fiduciary duties, Wendell transferred all of the trust assets to himself, commingling the funds with his own assets.

  After Wendell's death several months later, his estate published a notice for creditors and claimants against the estate to file their claims, but no such claims were made. The estate included the value of all of Wendell's assets, including those misappropriated from the trust, in the value of his estate on the estate tax return.

  Later, the estate sought a federal estate tax refund on two grounds: First, the estate claimed that the misappropriated trust assets were improperly included in the gross estate. In the alternative, the estate argued that it was entitled to a deduction — for a claim against the estate or indebtedness — under Internal Revenue Code Section 2053(a)(3) or (a)(4) equal to the trust's asset value.

  On March 2, the U.S. District Court for the Western District of Virginia held that the misappropriated trust assets were properly included in the estate's value because Wendell exercised dominion and control over the assets as if they were his own without any obligation to repay the assets. Because of his “interest” in the assets, they were includible in his estate. The court stated, “Taxation is not so much concerned with the refinements of title as it is with the actual command over the property taxed,” citing Burnet v. Wells, 289 U.S. 670, 678 (1933).

  The court also held that the estate was not entitled to a deduction under IRC Section 2053(a)(3), because the trust's beneficiaries never asserted a claim against Wendell or his estate. Further, even if a claim was made, the estate would not be entitled to a deduction because a claimant would be barred by the applicable state statute of limitations on breach of fiduciary duty.

  Lastly, the estate was not entitled to a deduction for “indebtedness” under IRC Section 2053(a)(4), because, the court said: “[A] debt is defined for federal tax purposes as an unconditional and legally enforceable obligation for the payment of money … The estate was theoretically or hypothetically liable, but it was not ‘indebted’ because neither Wendell nor the estate had an unconditional and legally enforceable obligation for the payment of money.”

• Henson: No deduction for payment to spouse under a settlement agreement — Jim Henson, who died in 1990, will always be best known for his work as creator of the Muppets, a group of popular puppets, many of which, like Big Bird, appeared on the hit children's television show Sesame Street. But, in an interesting postscript to his life, his five children paid $21 million in taxes on his estate, which was valued at $72 million. In 2000, they sold his business for $680 million and asked for a refund on their estate taxes for some of the nearly $11 million they paid their mother, Jane Henson, to settle her possible claim to the sale of the business. Recently, a court denied this deduction. But don't cry for these Muppet kids. In 2003, they bought the business back for $78 million and sold it again (minus the Sesame Street characters) to the Disney Company for an undisclosed sum.

  The decision on their tax claim came on Jan. 12, 2007, in Estate of Henson v. United States, No. 05 Civ. 8212 (D.Ct. N.Y.) Their mom and dad had entered into a separation agreement under which Jane was to receive a portion of the proceeds Jim received from a sale or merger of his company if it was sold during her lifetime. Jim died, and while he'd bequeathed all of his stock in his company to the children, some shares were held in escrow to protect mom from a default on the estate's outstanding obligations to her.

  When in 2000 the children wanted to sell the company, they believed that they did not have unencumbered title to the shares in escrow, so they agreed to pay their mother $10,660,339. In exchange, Jane agreed to terminate the escrow agreement and release the shares held in escrow. According to the estate, the payment was “in full and complete satisfaction and settlement” of Jane's share, as provided under the separation agreement, in the event of a sale or merger. After making this payment, the estate filed a refund claim in 2002 for a little more than $4 million, plus interest. The Internal Revenue Service disallowed this claim and the estate filed for a refund action.

  To support its claim for a refund, the estate made three arguments. First, that the estate is entitled to a deduction under IRC Section 2053 because the children's payment to Jane was in satisfaction of Jane's valid and enforceable claim against the estate. The court rejected this argument, finding that the separation agreement required a payment to Jane only if “the Husband received value” from a sale or merger, and the definition of “Husband” included Jim, his estate or any trusts created by Jim during his lifetime, but not the value his children received from a subsequent sale of stock they inherited. Therefore, when the estate transferred the shares to the children, the payment requirement could no longer be satisfied. In other words, Jane could not claim a portion of the proceeds, and the estate could not claim a deduction under IRC Section 2053. Had the estate sold the shares, then Jane would have been entitled to a share of the proceeds and would have had a valid claim.

  Second, the estate argued that the IRS overvalued the estate because the stock was burdened with the separation agreement's obligation to Jane and therefore, the gross estate value should have been reduced by an amount equal to the children's payment. The court rejected this argument because Jane did not have a valid claim against the estate.

  Lastly, the estate argued that the children's payment to Jane entitles the estate to a marital deduction under IRC Section 2056(a), because those funds constituted property that passed from the decedent to his surviving spouse. The court held that because Jim left his stock to his children, and the children subsequently made a payment to Jane, no property interest in the stock “passed from the decedent to his surviving spouse” as required under Section 2056(a).

• Goldstein: Estate's payment was a deposit entitled to refund — In Estate of Goldstein v. United States, No. 05-1273T, (Fed. Cl. March 16, 2007) the estate of Phillip Goldstein was unable to file final federal and state estate tax returns on their due date (June 22, 1999) because of ongoing litigation and difficulty in valuing a mortgage. It never requested an extension to file. On May 5, 2000, the estate's tax counsel hand-delivered a check to the IRS with the notation “Estate Tax/Philip Goldstein.” The accompanying cover letter stated, “In accordance with our telephone conversation on April 13, 2000, I attach my Attorney [Interest on Lawyer Account] check no. 1229, payable to the United States Treasury, in the amount of $165,000. This payment is to be applied to the estate tax on the above named decedent [Philip Goldstein]. The Form 706 has as yet not been filed.”

  The estate's tax counsel sent a letter advising the estate that he had paid $165,000 out of escrow for federal estate tax.

  On Nov. 12, 2004, the estate filed a late federal tax return. After deductions, the taxable estate was $636,126 and the federal tax was $206,167. After the unified credit of $202,050 and a state estate tax credit of $4,117 were deducted, however, the estate had no federal estate tax liability. On April 29, 2005, the IRS issued an estate tax closing document, confirming that no federal estate tax liability was owed.

  The estate requested a refund of the $165,000 payment, which was denied by the IRS because the return was postmarked more than three years after the return due date plus any extensions. The estate filed a complaint in the U.S. Court of Federal Claims alleging that the remittance of $165,000 to the IRS was “a deposit in the nature of a cash bond that must be returned to the taxpayer upon demand” under Revenue Procedure 84-58.

  The court determined that the remittance was a deposit, entitling the estate to a refund pursuant to IRC Section 6511. The remittance was determined to be a deposit, because Revenue Procedure 84-58, 1984-2 C.B. 501, provides that deposits, but not payments, may be identified as designated deposits, or undesignated remittances. Because the remittance was not designated and a tax liability was not proposed, the IRS, in accordance with Rev. Proc. 84-58, should have treated the remittance as a deposit.

• Roski: Section 6166 does not require bond or special lien in every case — In Estate of Roski v. Commissioner, 128 T.C. No. 10 (April 12, 2007), the estate elected to pay its estate tax in installments under IRC Section 6166(a)(1). The IRS informed the estate that it would have to secure a bond equal to twice the amount of tax-deferred or provide a special lien under IRC Section 6324A to qualify for the election. The IRS' requirement was based on a recent IRS decision to make a bond or a special lien a prerequisite for all Section 6166 elections. The estate sent the IRS a detailed letter enumerating why it was not practical to secure a bond or a special lien. It requested that the IRS find that it unnecessary because of the minimal financial risk based on the estate's financial circumstances. The IRS sent the estate a notice denying the 6166 election, because the estate failed to provide a bond or a special lien.

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