Equitable apportionment of estate tax deficiency.

AuthorO'Driscoll, David

Died in 1990, survived by his wife and six minor children. During his life, L's mother created various family trusts; L exercised a power of appointment over these and other trusts to create various new trusts (N). However, the value of the N trusts was not included in L's gross estate on the Federal estate tax return. On audit, the IRS found that the N trusts should have been included in L's gross estate; the increase in the taxable estate led to an estate tax deficiency, which left the residual probate estate insufficient to pay the estate's outstanding expenses.

Tax Court

In Tax Court, the parties stipulated that the N trusts would be included in L's gross estate, but left it to the Tax Court to decide whether the resulting estate taxes were payable from N (the trusts that generated the tax) or a revocable trust (R) created by L three days before he executed his will. R provided that on L's death, the R assets would be allocated between a marital trust (M) and a nonmarital residuary trust.

The Tax Court found that the R trust instrument provided for payment of estate taxes and legal costs if the residuary probate estate was insufficient, and that the estate taxes and legal costs should be paid out of R assets that otherwise would go to M. The estate appealed to the Seventh Circuit.

Analysis

Under Sec. 2056(b)(4), an estate is only required to pay estate tax on transfers not qualifying for the marital deduction, such as transfers to beneficiaries other than the surviving spouse. Typically, the resulting estate tax is paid from property that otherwise would pass to the surviving spouse, thereby reducing the marital deduction by that amount of Federal estate tax. State law controls, however, how the estate tax burden is allocated among the estate assets; see Riggs, 317 US 95, 101 (1942). Here, the decedent was domiciled in Illinois when he died, so that state's law governs how his estate tax is to be allocated; see Caroline C. Doetsch, 312 F2d 323,328 (7th Cir. 1963).

State law: Illinois has no statute specifying which assets of a taxable estate bear the burden of any estate tax, but the state's default rule is equitable apportionment; thus, the estate tax burden is allocated pro rata to the portions of the taxable estate that generated the tax. "[L]ogic, reason, and simple justice dictate that, unless there is a contrary intention expressed by the decedent, as in a will in testate estates, the doctrine of equitable contribution should be...

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