Value of QTIP Trust in Estate Wasn't Reduced by Payment for Undistributed Income

(Parker Tax Publishing March 2023)

The Tax Court held that, in determining the value of a decedent's gross estate, the value of a qualified terminable interest property (QTIP) trust of which the decedent was the beneficiary was not reduced by a settlement payment representing undistributed income from the QTIP trust because under Code Sec. 2044, the fair market value of the QTIP trust was included in the decedent's gross estate at the time of her death. The court also held that the QTIP trust's obligation to make the settlement payment did not give rise to a deduction for administration expenses by the estate under Code Sec. 2053, finding instead that the estate's claim against the trust was itself property to be included in the gross estate. Estate of Kalikow v. Comm'r, T.C. Memo. 2023-21.

Background

Pearl Kalikow, who died in 2006, was preceded in death by her husband, Sidney Kalikow. Sidney's will made Pearl the beneficiary of a qualified terminable interest property (QTIP) trust, known as the SK Trust, which entitled her to income distributions for life. The principal property held in the SK Trust at the time of Pearl's death consisted of (1) a 98.5 percent interest in the Kalikow Family Partnership, L.P. (KFLP), which held interests in apartment buildings in New York City, and (2) $835,000 cash and marketable securities. Upon Pearl's death the SK Trust assets were to be paid over to two trusts (known as the Article Fourth Trust and the Article Fifth Trust) for the benefit of the Kalikows' two children, Edward Kalikow and Lauren Platt (collectively, the limited administrators). The executors of Pearl's estate were Eugene Shalik and James DeVita.

After Pearl's death, litigation ensued in a New York Surrogate's court over whether all the income from the SK Trust property had been properly distributed to her during her lifetime. Shalik alleged that Pearl's proper receipt of trust income had been diminished by the amount of $16,946,827. The litigation was eventually settled with an agreement that the SK Trust would pay the estate $9.2 million. Of that amount, $6,572,310 was designated for undistributed income claims, and the balance was designated for various commissions and fees.

The Surrogate's court awarded Edward Kalikow and Lauren Platt permanent limited letters of administration specifically for the purposes of filing, supplementing and defending any audit and/or any judicial tax proceeding relating to the portion of Pearl's estate tax return concerning the SK Trust. The decree ordered the limited administrators and the executors to exchange copies of executed Forms 706, United States Estate (and Generation-Skipping Transfer) Tax Return.

In 2007, the executors filed on the estate's behalf a Form 706 that was made "in respect of all assets of the estate other than decedent's interest in the [SK] Trust." On Schedule F, Other Miscellaneous Property Not Reportable Under Any Other Schedule, the executors' Form 706 reported total other miscellaneous property of $31, 869,441, including "undistributed income due" from the SK Trust of $4,632,489, along with a claim of the estate against the trustees of the SK Trust for loss of profits, excess taxes paid, interest and other damages in an amount to be determined.

The limited administrators prepared on the estate's behalf a separate Form 706 which incorporated the estate's assets and deductions as included on the executors' Form 706 and also included the SK Trust assets. More particularly, the Schedule F attached to the limited administrators' Form 706 incorporated the $31,869,441 of assets (including the $4,632,489 claim for undistributed income from the SK Trust) as reported on the executors' Form 706 and also reported $43,300,000 of SK Trust assets, made up of a 98.5 percent limited partnership interest in KFLP, with a reported value of $42,465,000, and cash and marketable securities valued at $835,000. In a statement attached to the Form 706, however, the limited administrators noted that they disputed any claim by the executors for amounts due from the SK Trust and its administrators "as those claims have no merit."

In a notice of deficiency, the IRS determined, among other things, that the value of the SK Trust's 98.5 percent limited partnership interest in KFLP was $105,664,857 instead of $42,465,000 as reported on the limited administrators' Form 706. The IRS also reduced the estate's Schedule F assets by the $4,632,489 value of the estate's pending claim against the SK Trust, as originally reported on the executors' Schedule F and as incorporated in the estate's assets reported on the limited administrators' Schedule F.

Shalik and the limited administrators separately petitioned the Tax Court on the estate's behalf. Shalik's petition argued that the IRS erred by decreasing the gross estate by the $4,632,489 value of the estate's claim against the SK Trust as reported on Schedule F of the executors' Form 706 and asked the court to include this asset in the gross estate with a value of $16,946,827, rather than the smaller amount originally reported on the executors' Schedule F. The limited administrators also asserted that the IRS erred by decreasing the gross estate by the $4,632,489 value of the estate's claim against the SK Trust. They also argued that the value of the SK Trust should be reduced by the amount of any claim allowed for undistributed income due the estate from the SK Trust. Only the resulting net value, they contended, should be included in the gross estate. The limited administrators and the IRS stipulated that the value of the SK trust's 98.5 percent limited partnership interest in KFLP at the date of Pearl's death was $54,492,712.

After stipulations, the parties agreed that the only outstanding matters to be decided related to the agreed-upon settlement payment's effect, if any, on the value of the SK Trust assets included in Pearl's gross estate. The IRS moved for partial summary judgment that the agreed-upon settlement payment did not reduce the value of the gross estate. In a cross-motion for summary judgment the limited administrators contended that (1) the value of the SK Trust assets included in the estate under Code Sec. 2044 was properly reduced by the agreed-upon undistributed income amount, and (2) the various components of the agreed-upon settlement payment were deductible from the gross estate as administration expenses under Code Sec. 2053.

Code Sec. 2044(a) generally includes in the gross estate the value of QTIP trust property, i.e., property in which the decedent had a qualified income interest for life and for which a marital deduction was allowed to the estate of a predeceased spouse under Code Sec. 2056(b)(7). The QTIP regime generally allows a transfer of QTIP to qualify for a marital deduction for the first spouse to die and thereby to escape inclusion in that spouse's estate, even though only a life interest passes to the surviving spouse. Under Code Sec. 2044 and Reg. Sec. 20.2044-1(d)(1) the amount included in the gross estate is generally "the value of the entire interest in which the decedent had a qualifying income interest for life, determined as of the date of the decedent's death." Consequently, where the decedent is the beneficiary of a QTIP trust, the decedent's gross estate must generally include the fair market value of the trust assets as of the date of the decedent's death.

Analysis

The Tax Court held that the value of the SK Trust assets included in Pearl's estate was not reduced by the amount of the settlement payment representing undistributed income under Code Sec. 2044. The court noted that the executors of Sidney's estate elected to treat the SK Trust as a QTIP trust under Code Sec. 2056(b)(7). Consequently, under Code Sec. 2044(a) the SK Trust property was included in Pearl's gross estate at its fair market value as of the date of her death. As of that date, the SK Trust held a 98.5 percent partnership interest in KFLP and $835,000 in cash and marketable securities. The court noted the parties' stipulation that the value of the SK Trust's 98.5 percent limited partnership interest in KFLP was $54,492,712. Accordingly, the court held that under Code Sec. 2044(a) Pearl's gross estate included SK Trust assets of $55,327,712 ($54,492,712 plus $835,000).

The court reasoned that, having stipulated to the relevant value of the SK Trust's KFLP partnership interest, the limited administrators could not successfully argue for some lesser value of this asset on account of the undistributed income payment liability. The court also noted that the settlement agreement imposed the liability for the settlement payment jointly and severally upon the SK Trust, the Article Fourth Trust and the Article Fifth Trust. The liability for the settlement payment, the court found, did not run to KFLP. Consequently, the court said there was no basis to conclude that this liability would affect the date-of-death fair market value of the SK Trust's KFLP partnership interest, i.e., the liability would not affect the price of this partnership interest as determined between a hypothetical willing buyer and seller as of the date of Pearl's death. Moreover, the court found that the settlement agreement indicated that the settlement payment was not expected to be made from the SK Trust's KFLP partnership interests. Furthermore, the court said that the SK Trust would have an offsetting claim against third parties for the undistributed income payment liability.

The court also held that the obligation of the SK Trust to make the agreed-upon settlement payment to the estate did not give rise to any deduction under Code Sec. 2053 by the estate. Rather, the court found that the estate's claim against the SK Trust was itself property to be included in the gross estate. The court explained that even if it assumed that the estate actually incurred the fees and commissions specified as components of the agreed-upon settlement payment, Reg. Sec. 20.2053-4(d)(3) provides that reimbursement of these expenses under the settlement agreement would preclude any deduction by the estate.

For a discussion of qualified terminable trusts, see Parker Tax ¶227,130. For a discussion of deductions against a gross estate for administration expenses, see Parker Tax ¶227,520.

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.

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com

We hope you find our professional tax research articles comprehensive and informative. Parker Tax Pro Library gives you unlimited online access all of our past Biweekly Tax Bulletins, 22 volumes of expert analysis, 250 Client Letters, Bob Jennings Practice Aids, time saving election statements and our comprehensive, fully updated primary source library.

Try Our Easy, Powerful Search Engine

A Professional Tax Research Solution that gives you instant access to 22 volumes of expert analysis and 185,000 authoritative source documents. But having access won’t help if you can’t quickly and easily find the materials that answer your questions. That’s where Parker’s search engine – and it’s uncanny knack for finding the right documents – comes into play

Things that take half a dozen steps in other products take two steps in ours. Search results come up instantly and browsing them is a cinch. So is linking from Parker’s analysis to practice aids and cited primary source documents. Parker’s powerful, user-friendly search engine ensures that you quickly find what you need every time you visit Our Tax Research Library.

Dear Tax Professional,

My name is James Levey, and a few years back I founded a company named Kleinrock Publishing. I started Kleinrock out of frustration with the prohibitively high prices and difficult search engines of BNA, CCH, and RIA tax research products ... kind of reminiscent of the situation practitioners face today.

Now that Kleinrock has disappeared into CCH, prices are soaring again and ease-of-use has fallen by the wayside. The needs of smaller firms and sole practitioners are simply not being met.

To address the problem, I’ve partnered with a group of highly talented tax writers to create Parker Tax Publishing ... a company dedicated to the idea that comprehensive, authoritative tax information service can be both easy-to-use and highly affordable.

Our product, the Parker Tax Pro Library, is breathtaking in its scope. Check out the contents listing to the left to get a sense of all the valuable material you'll have access to when you subscribe.

Or better yet, take a minute to sign yourself up for a free trial, so you can experience first-hand just how easy it is to get results with the Pro Library!

Sincerely,

James Levey

Parker Tax Pro Library - An Affordable Professional Tax Research Solution. www.parkertaxpublishing.com