Estate of Hester v. U.S., — F.Supp.2d —-, 2007 WL 703170 (W.D. Va. Mar 02, 2007)

The estate tax automatically makes the IRS the biggest creditor of most large estates.  Understanding this dynamic can translate into millions in savings for a client . . . or a colossal missed opportunity.

In the linked-to case the estate attempted to claim a $2.8 million estate tax refund based on the theory that the decedent had misappropriated millions in trust funds and thus the remainder beneficiaries of the subject trust would have claims against the estate that would result in corresponding estate tax deductions.  The estate’s theory collapsed in on itself because it didn’t claim the $2.8 million estate tax refund until after the statue of limitations period had run on possible claims against the decedent’s estate for misappropriating trust funds.  Here’s how the court articulated this point:

Allowing a deduction here, where a taxpayer is attempting to secure a refund for a theoretical liability that will never be paid and that is now barred by the statute of limitations, would essentially “exalt form over substance.” Estate of Hagmann, 60 T.C. at 468. Therefore, because the estate has neither an actual or expected claimant, or a cognizable claim, the misappropriated assets are not deductible under § 2053(a)(3).

Lesson Learned: Probate administration and estate tax reporting need to go hand-in-hand

In the linked-to case the estate failed to coordinate the probate proceeding with its anticipated estate tax positions.  The outcome would have likely been very different if – prior to expiration of the applicable statute of limitations – the estate had simply conceded a liability to the trust beneficiaries in the context of the probate proceedings – utilizing whatever mechanism is available under Virginia  law for doing so (in Florida, F.S. 733.703(2) authorizes a Personal Representative to file a proof of claim for all claims he or she has paid or intends to pay).

Failing to anticipate the estate-tax ramifications of actions taken – or not taken – in the probate proceeding likely cost this estate $2.8 million in avoidable estate taxes.