Ninth Circuit: Estate Overstated Amount of Charitable Deduction

(Parker Tax Publishing April 2019)

The Ninth Circuit affirmed a Tax Court decision sustaining a deficiency against an estate for overstating the amount of a charitable deduction. The Ninth Circuit rejected the estate's argument that the charitable deduction of certain estate assets should be valued at the time of the decedent's death and agreed with the Tax Court that later-occurring events, including the executor's revaluation and delivery of assets worth far less than the claimed charitable deduction, were properly taken into account in determining the value of the charitable deduction. Dieringer v. Comm'r, 2019 PTC 84 (9th Cir. 2019).

Background

Victoria Dieringer died in unexpectedly in 2009. Victoria and her late husband, Robert Dieringer, had twelve children together, including Eugene Dieringer, Patrick Dieringer, and Timothy Dieringer. The Dieringer family owns Dieringer Properties, Inc. (DPI), a closely held corporation that manages real estate in Oregon and Texas. After Robert passed away and before Victoria's death, Eugene was the president of DPI, Patrick was the executive vice president and secretary, Victoria was the vice president, and Timothy was the office manager. Before Victoria's death, the only shareholders of DPI were Victoria, Eugene, and Patrick.

Victoria's will provided that all of her estate would pass to the Victoria Evelyn Dieringer Trust (the trust). The trust provided for Victoria's children to receive some personal effects but no other proceeds from her estate. The trust also provided for $600,000 in donations to various charitable organizations. Any assets remaining in the estate would then pass to the Bob and Evelyn Dieringer Family Foundation (the foundation), a Code Sec. 501(c)(3) organization, as a charitable contribution. Eugene was appointed as the sole trustee of both the trust and the foundation.

Before Victoria died, the DPI board had discussed purchasing Victoria's DPI shares as part of ongoing succession planning. The board resolved in November 2008 to periodically purchase Victoria's shares. Victoria was agreeable to the plan and reiterated her interest in having DPI purchase her shares at a February 2009 board meeting. However, when Victoria died, there were no specific redemption agreements in place.

Eugene was appointed the executor of Victoria's estate. The estate requested an independent appraisal of Victoria's DPI shares for estate administration purposes. The appraisal determined that the value of Victoria's shares on the date of her death was $14.1 million.

In November 2009, DPI was converted from a C corporation to an S corporation. The board decided that it should also redeem Victoria's shares that were to pass to the Foundation. DPI agreed to redeem all of Victoria's shares from the Trust for $6 million based on a 2002 appraisal, since the date of death appraisal had not yet been completed. The agreement provided that the price would be adjusted retroactively to reflect the date of death value. DPI executed two promissory notes payable to the Trust in exchange for the shares. Eugene, Patrick, and Timothy entered into separate subscription agreements to purchase additional DPI shares in order to provide funding for DPI to make payments on the notes.

DPI ordered another appraisal of the value of Victoria's DPI shares as of the date of her death for the purpose of the redemption (redemption appraisal). Eugene instructed the appraiser to value the shares as if they were a minority interest in DPI, so the appraiser applied a 15 percent discount for lack of control and a 35 percent discount for lack of marketability. As a result, the shares were valued significantly less in the redemption appraisal than in the date of death appraisal. DPI determined that it could not afford to redeem all of Victoria's shares, so the redemption agreement was amended and DPI consequently redeemed all the shares for a total purchase price of $5.2 million.

In January 2011, the Trust distributed the notes and the remaining DPI shares to the foundation. For 2011, the foundation reported the following contributions of (1) DPI shares valued at $1.8 million, (2) a long-term note receivable valued at $2.9 million, and (3) a short-term note receivable valued at $2.25 million. The estate's tax return reported no estate tax liability. The estate claimed a charitable contribution deduction of $18.8 million based on the date of death value of Victoria's DPI shares.

The IRS issued a notice of deficiency to the estate in 2013 indicating a deficiency of $4.1 million and imposing a Code Sec. 6662 penalty of $824,000 for negligence in using the date of death appraisal as the value of the charitable contribution of Victoria's shares. The estate challenged the notice in the Tax Court, and the Tax Court upheld the IRS's reduction of the estate's charitable contribution and the deficiency assessment. The estate appealed to the Ninth Circuit.

Analysis

Under Code Sec. 2031(a), the valuation of the gross estate for estate tax purposes is typically done as of the date of death, and post-death events are generally not considered in determining the estate's gross value. When an estate transfers assets to charities by will, Code Sec. 2055(a) allows a deduction of the value of the assets from the value of the gross estate.

Deductions are valued separately from the value of the gross estate, and separate valuations allow for the consideration of post-death events. In Ahmanson Foundation v. U.S., 674 F.2d 761 (9th Cir. 1981), a case involving an estate's donation of nonvoting shares to a charitable foundation, the Ninth Circuit explained that an estate tax deduction is allowed only for what is "actually received" by the charity. The court held that when valuing the deduction for the nonvoting shares, a discount should be applied for the fact that the shares had been stripped of their voting power, notwithstanding that a discount was not applied to the value of the nonvoting shares in the gross estate.

In Ithaca Trust Co. v. U.S., 279 U.S. 151 (1929), where the remainder of an estate was donated to charity after a post-death contingency, the Supreme Court held that the deduction should be valued as of the date of death. In Wells Fargo Bank & Union Tr. Co. v. Comm'r, 145 F.2d 132 (9th Cir. 1944), the Ninth Circuit held that the value of a charitable deduction had to be determined from data available at the time of death.

The estate argued that the charitable deduction had to be valued as of the date of Victoria's death, in keeping with the date of death valuation of the estate; the estate contended that Ahmanson is limited to situations where the testamentary plan diminishes the value of the charitable property. The estate further contended that if post-death events could be considered, the Tax Court should have determined that the decline in value of DPI stock was due at least partially to market forces.

The Ninth Circuit affirmed the Tax Court and upheld the IRS's reduction of the estate's charitable deduction. The court found that neither Ithaca Trust nor Wells Fargo set in stone the date of death as the date of the valuation of assets for purposes of a charitable deduction. The court also noted that some deductions not only permit consideration of post-death events but require them. For example, Code Sec. 2053(a) allows a deduction for funeral expenses that cannot accrue until after death, Code Sec. 2055(c) limits a charitable deduction to the value remaining in an estate after the payment of taxes, and Code Sec. 2055(d) limits a charitable deduction to the value of transferred property included in a gross estate, but by negative implication permits such a deduction to be lower than the value of donated assets at the moment of death.

The court also noted that the Third Circuit in In Re Sage's Estate, 122 F.2d 480 (3d Cir. 1941), recognized that valuations of the gross estate and a charitable deduction are separate and may differ. The Ninth Circuit quoted from Ahmanson that "the proper administration of the charitable deduction cannot ignore such differences in the value actually received by the charity" and reasoned that this rule prohibits crafting an estate plan or will so as to game the system and guarantee a charitable deduction that is larger than the amount actually given to charity.

The Ninth Circuit found that Victoria structured her estate so as not to donate her DPI shares directly to charity, or even directly to the foundation, but to the trust. Victoria enabled Eugene, the court said, to commit almost unchecked abuse by setting him up to be executor of the estate, trustee of trust, and trustee of the foundation, in addition to his roles as president, director, and majority shareholder of DPI. The Ninth Circuit agreed with the Tax Court that Eugene improperly directed the appraiser to determine the redemption value of the DPI shares by applying a minority interest valuation, when he knew a majority interest applied and the estate had claimed a charitable deduction based on a majority interest valuation. The Ninth Circuit found that Eugene manipulated the charitable deduction so that the foundation received only a fraction of the charitable deduction claimed by the estate.

The Ninth Circuit rejected the estate's argument that Ahmanson was limited to abuses in the four corners of the testamentary plan. The court pointed out that Victoria's will laid the groundwork for Eugene's manipulation by concentrating power in his hands even after she knew of and assented to the share redemption plan. The Ninth Circuit also found that the Tax Court did not err in finding no evidence that the decline in value of the DPI shares was due to a decline in the economy.

The Ninth Circuit also upheld the imposition of the Code Sec. 6662(a) penalty. The court found that the estate was negligent in not only failing to inform the appraiser that the redemption was for a majority interest but in instructing the appraiser to value the redeemed stock as a minority interest.

For a discussion of estate tax charitable deductions, see Parker Tax ¶227,701.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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