Chapter 34 - § 34.17 • BIXBY-WARMS ADJUSTMENT

• Jurisdiction: Colorado

§ 34.17 • BIXBY-WARMS ADJUSTMENT

As mentioned in § 34.2, if administration expenses are taken as income tax deductions on the federal return, the windfall to the person entitled to net income after income taxes, arising out of taking a corpus charge as an income tax deduction, may be reduced to make good the loss to the person on whom the increase in death taxes falls. This is illustrated by a well-reasoned California case⁷² in which certain stock was bequeathed specifically to the widow, so that she was entitled to the dividends on the stock collected by the executor pending distribution of the stock to her, after reducing the dividends by the federal and California income taxes paid by the executor thereon. By using administration expenses as income tax deductions, the income taxes were reduced by an amount greatly in excess of the increase in the combined death taxes. The widow was required to compensate corpus to the extent of the increase in death taxes but was allowed to keep the remainder of the windfall. The case follows the reasoning of an earlier New York lower court decision.⁷³ There are a number of other lower court decisions to the same effect.⁷⁴ Similar effects could result from taking medical expenses as income tax deductions, and likewise with casualty losses.⁷⁵

An analogous problem arises when an executor, exercising discretion, partially or wholly funds a testamentary trust with property, and the probate estate has income under § 662(a)(2) of the Internal Revenue Code of 1954, which is required to be included in the taxable income of the beneficiary (the trustee) but which, under trust accounting rules, must be accumulated in the trust (thus making the trust a complex one for that year). Under the Uniform Principal and Income Act (§ 34.14), the income tax on current income is an income charge. The income beneficiary of the testamentary trust is likely to contend that the income account of the trust should be credited and the principal account of the trust charged with the tax that was initially borne by the person who is ultimately entitled to the income of the trust. It has been said that corporate fiduciaries, in such cases, should make the adjustment contended for in the preceding sentence.⁷⁶ However, there is virtually no case law on the point and none in Colorado on the so-called Bixby-Warms adjustment. Further, the author is not aware of any cases where a court has been petitioned for instructions regarding the adjustment. This may...