Life After Death? The Role of PostmortemEvents in Valuing Deductions for ClaimsAgainst Estates

I. IntroductionSection 2053(a) of the Internal Revenue Code (IRC) provides for the deduction of certain expenses, indebtedness, and taxes from an estate's gross value for the purpose of determining the net taxable value of an estate.1 Specifically, that section provides, "For purposes of the tax imposed by section 2001, the value of the taxable estate shall be determined by deducting from the value of gross estate such amounts . . . for claims against the estate."2 The practical impact of this provision is that an estate, in computing net taxable value, may deduct from its gross value the amount of any legally enforceable claims of third parties, thereby reducing the estate's tax liability.Section 2053(a) does not, however, specifically address the issue of whether an estate should value such claims as of the date of death irrespective of subsequent events, or whether postmortem events can affect this valuation. Several complex problems arise due to the vagueness of the statute.3 Because the code is silent as to the issue of the timing of such valuations, executors lack a definite rule governing the computation of the value of such deductions and face the prospect that the Internal Revenue Service (IRS) will issue a notice of deficiency should postmortem events alter the value of claims that existed as of the date of death.The following illustration demonstrates the potential problems that arise as a result of the code's failure to address this issue.4 In 2002, Jane Doe makes a gift of stock in the family business to her son, John Doe. Jane determines that the value of the stock is $2,000,000 at the time of the gift, and she pays gift taxes in the amount of $435,000.5 Three years later, in 2005, Jane dies and her estate is worth $3,000,000. Shortly after her death, the IRS initiates an investigation into the valuation of the gift she made to her son. The IRS determines that the stock she gifted was in fact worth $3,000,000 and, as a result, that her tax liability on the 2002 gift was actually $930,000.6 Assume for the purposes of this illustration that the IRS cannot issue a notice of deficiency against Jane's estate because the statute of limitations has run. Instead, the IRS asserts liability against John Doe for the $495,000 shortfall7 pursuant to [sec] 6324 of the tax code, which shifts liability for unpaid gift taxes to the donee when the liability becomes unenforceable as against the donor by reason of lapse of time.8 In response, John Doe promptly files an action in probate court asserting a claim against Jane's estate for the $495,000 deficiency. Jane's estate consequently deducts $495,000 from the gross value of the estate pursuant to John's claim, resulting in an estate tax liability of $1,037,500.9One year later, John and the IRS reach a settlement valuing the gifted stock at $2,500,000. This valuation would have resulted in a gift tax liability of $680,000.10 Thus the value of John's claim after the settlement decreases to $245,000.11 Herein lies the problem. If Jane's estate may rely on the date-of-death valuation of the claim, the $495,000 deduction remains intact, and the estate's tax liability of $1,037,500 does not change. However, if postmortem events, like John's settlement with the IRS, can affect the value of deductions for claims, then Jane's estate must amend the value of the deduction from $495,000 to $245,000, and as a result the estate's tax liability will increase to $1,163,300.12 This represents a $125,800 increase in tax liability for Jane's estate.13The previous illustration underscores the need for legislative or judicial guidance in determining the timing of valuation of deductions for claims against estates. When a postmortem event reduces the value of a claim for which an estate initially took a deduction, the executor will argue that the date-of-death valuation should govern. Conversely, when a postmortem event increases the value of such a claim, the executor will seek to increase the amount of the estate's deduction for this claim. …