Estate may deduct interest on loan between two trusts.

• Author: Beavers, James A.

The Tax Court held that an estate could deduct as an administration expense interest incurred when a trust that was part of the estate borrowed funds to enable the estate to pay its federal estate tax.

Background

Walter Duncan's will divided his oil and gas business among his sons Vincent, Raymond, and Walter Jr., with each brother receiving his share of the business in trust. The trust created for Vincent's benefit (the Walter Trust) named Vincent, his spouse, and his descendants as beneficiaries during his lifetime. The trust granted Vincent the power to appoint the trust's remainder beneficiaries at his death. Vincent's son, Vincent Jr., and the Northern Trust Co. (NTC), which is a wholly owned subsidiary of the Northern Trust Corp., have served as the co-trustees of the Walter Trust since September 2005. Vincent also created a revocable trust, the Vincent J. Duncan 2001 Trust (the 2001 Trust), to hold other assets including his own oil and gas business and a ski resort. The amended trust instrument appointed Vincent Jr. and NTC as co-trustees and is governed by Illinois law.

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Vincent died in January 2006. His estate, which included the 2001 Trust, sold its marketable securities for approximately $2 million and received a $3.2 million distribution from one of Vincent's companies. NTC, however, estimated that the estate's federal estate tax liability would be approximately $11.1 million and determined that the 2001 Trust also needed to retain a cash reserve to satisfy the estate's other obligations (e.g., ongoing administration expenses and amounts Vincent owed to his former spouse under a divorce decree).

To raise the necessary funds, Vincent Jr. and NTC decided to borrow money. They determined the 2001 Trust needed a 15-year term on the loan because the volatility of oil and gas prices made income from the oil and gas businesses difficult to predict. They accordingly asked the Northern Trust Corp.'s banking department what the market rate was for a 15-year bullet loan. The banking department quoted a rate of 6.7%.

In October 2006, Vincent Jr. and NTC (as co-trustees of both the 2001 Trust and the Walter Trust) executed a secured promissory note (the note) reflecting a loan of almost $6.5 million from the Walter Trust to the 2001 Trust. The loan called for interest at a rate of 6.7%, compounded annually, with all interest and principal payable on October 1, 2021 (i.e., in 15 years). The note expressly prohibited the...