You Can Lead the Irs to the Law, but You Can't Make it Think-why Section 2053 Proposed Regulations Are Dead Wrong

• Publication year: 2007
• Author: Michael C. Gerson, Esq.

YOU CAN LEAD THE IRS TO THE LAW, BUT YOU CAN'T MAKE IT THINK-WHY SECTION 2053 PROPOSED REGULATIONS ARE DEAD WRONG

Michael C. Gerson, Esq.^*

As noted in the author's earlier article, "A Claim is a Claim is a Claim: Post-death Events and Section 2053 Deductions,"¹ on April 23, 2007, the IRS issued proposed regulations² providing that the amount of an estate tax deduction for a claim against the estate equals the amount paid. This article analyzes the IRS proposals and explains why they are fatally flawed.

I. BRIEF BACKGROUND

Internal Revenue Code section 2053(a)(3) allows an estate tax deduction for "claims against the estate . . . as are allowable by the laws of the jurisdiction."³ In determining whether or not post-death events are relevant to this deduction, "the cases in this field dealing with post-death evidence are not readily reconciled with one another, and at times it is like picking one's way through a minefield in seeking to find a completely consistent course of decision."⁴ One line of cases, starting in 1929, determined that the amount deductible for a claim is only the amount actually paid.⁵ Another line of cases, starting in 1935,⁶ stated that the amount deductible is based on the value of the claim at date of death.⁷

The courts' inconsistency has been reflected in the IRS position on this issue as well. Generally, the IRS position has been that "the law requires this Court to deny the deduction based upon a rule of 'no payment, no deduction,'"⁸ and that "post-death events are controlling in determining the amount that may be deducted as a claim against the estate whether or not the claim is contested or contingent."⁹ However, when the post-death events result in an increase in the amount paid for a claim against the estate, the IRS has argued successfully that post-death events do not affect the deduction for a claim against the estate.¹⁰ In essence, the IRS position has been that whatever generates the most revenue in a particular situation is correct.

II. OVERVIEW OF PROPOSED REGULATIONS

On April 23, 2007, the IRS issued proposed regulations requiring actual payment prior to any deduction for a claim against the estate.¹¹ These proposals amend existing regulations under Section 20.2053-4, last amended in 1958, "to clarify that events occurring after a decedent's death are to be considered when determining the amount deductible under all provisions of Section 2053 and that deductions under Section 2053 are limited to amounts actually paid by the estate in satisfaction of deductible expenses and claims."¹² In essence, the proposed regulations adopt the "no payment, no deduction" theory.¹³

Under these proposed regulations, if the claim is "potential, unmatured, or contested at the time the return is filed,"¹⁴ the executor is not allowed to claim any deduction or even make a protective election.¹⁵ Only when paid are the amounts deducted.¹⁶ If the claim remains pending prior to the statute of limitations expiring, then prior to the expiration of the statute of limitation the executor may "file a protective claim for refund to preserve its rights to claim a deduction under Section 2053(a),"¹⁷ explaining "the reasons and contingencies delaying actual payment," with the IRS acting on the claim only after the executor notifies the IRS that "the contingency has been resolved."¹⁸ In addition, if subsequent to the filing of the estate tax return, the estate receives a tax refund or other adjustment to a paid claim, the estate must notify the IRS and pay additional taxes, or file a refund claim for overpaid taxes.¹⁹ The IRS also believes that claims by family members "may create the potential for collusion in asserting invalid or exaggerated claims."²⁰ Thus the proposed regulations establish "a rebuttable presumption that claims by a family member of the decedent, a related entity, or a beneficiary of the decedent's estate or revocable trust are not legitimate and bona fide and therefore are not deductible."²¹

As support for amending the nearly 50-year-old regulations, the IRS notes a split in authority between those cases adhering to the Supreme Court's position that valuation is made at date of death²² and those following the Eighth Circuit's position that a deduction is allowed only for amounts actually paid.²³ The way the IRS presents this issue is misleading: only the Eighth Circuit,²⁴ and possibly the Court of Claims,²⁵ has adopted the rule that amounts deducted for claims against the estate equal only the amounts paid.²⁶ The majority of the other circuits-Fifth, Seventh, Ninth, Tenth and Eleventh—applies the date of death principle.²⁷ Also, the IRS presents no cogent reason why the Eighth Circuit should be preferred to the Supreme Court. Instead, the IRS rejects the Supreme Court's and the majority's position because, in the IRS view, such valuation

has required an inefficient use of resources for the taxpayers, the IRS, and the courts. Determining a date of death value requires the taxpayer and the IRS to retry the substantive issues underlying the claims. . . . Furthermore, this approach has proven to be expensive . . . In addition, this approach generally results in a deduction that is different from the amount actually paid on disputed claims. Finally, the date-of-death valuation approach often forces the taxpayer involved in actively defending against a claim to take contradictory positions on the estate tax return and in the substantive court pleadings, and may actually increase the taxpayer's potential liability. . . . After carefully considering the

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numerous judicial decisions and the analysis and conclusion in each, the legislative history of Section 2053 and its predecessors, . . . and in order to further the goal of effective and fair administration of the tax laws, the proposed regulations adopt rules based on the premise that an estate may deduct under Section 2053(a)(3) only amounts actually paid.²⁸

The IRS notably avoids discussing that it essentially litigated this exact position and lost in the First,²⁹ Second,³⁰ Fifth,³¹ Seventh,³² Eighth,³³ Ninth,³⁴ Tenth,³⁵ and Eleventh³⁶ Circuits, the Court of Claims,³⁷ the Tax Court,³⁸ and various district courts.³⁹ The IRS also neglects to mention that these regulations attempt to overturn three recent adverse appellate court rulings⁴⁰ in order to advance the IRS "failed litigating position."⁴¹ In addition, in issuing these proposals, the IRS does not discuss the statutory language and ignores both the basic character of the estate tax and other estate-tax statutes. For these reasons, these sour-grapes regulations are not valid.

III. ANALYSIS OF PROPOSED REGULATIONS

A. Standard for Reviewing IRS Regulations

Analyzing the validity of these proposed regulations is a two step process. The first step is to analyze Section 2053 itself.⁴² "If the plain meaning of the statute only supports one interpretation, the statute is not ambiguous."⁴³ If this statute is unambiguous, the IRS has no discretion to issue regulations contrary to that unambiguous statute; instead, the plain meaning of the unambiguous statute must be implemented.⁴⁴

The plainness or ambiguity of statutory language is determined by reference to the language itself, the specific context in which that language is used, and the broader context of the statute as a whole.⁴⁵

All acts of the legislature should be so construed, if practicable, that one section will not defeat or destroy another, but explain and support it.⁴⁶

That is, "a reviewing court should not confine itself to examining a particular statutory provision in isolation. Rather, the meaning—or ambiguity—of certain words or phrases may only become evident when placed in context."⁴⁷ Also, if a court has declared the statute clear and unambiguous⁴⁸ or declared what congressional intent is,⁴⁹ the IRS has no discretion to issue regulations contrary to that court ruling or court declaration of congressional intent.⁵⁰

The second step occurs only if Section 2053 is ambiguous or silent on the treatment of claims against the estate. Then, the question becomes whether the IRS position is based on a permissible construction of the statute.⁵¹ A permissible construction is one that is "reasonable"⁵² as "Congress has delegated to the Commissioner the power to promulgate all needful rules and regulations for the enforcement of the Internal Revenue Code, 26 U.S.C. §7805(a), [and courts] must defer to his regulatory interpretations of the Code so long as they are reasonable."⁵³ The regulations will be rejected if unreasonable or "arbitrary, capricious, or manifestly contrary to the statute."⁵⁴ The regulation may not amend⁵⁵ the statute or add "something which is not there."⁵⁶ Also, the Commissioner "has no more power to add to the Act what he thinks Congress may have overlooked than [it] has to supply what Congress has deliberately omitted."⁵⁷ That is, the IRS's "authority to issue regulations is not the power to make law—for no such power can be delegated by Congress—but the power to adopt regulations to carry into effect the will of Congress as expressed by the statute."⁵⁸ "In determining whether a particular regulation carries out the congressional mandate in a proper manner, we look to see whether the regulation harmonizes with the plain language of the statute, its origin, and its purpose."⁵⁹

B. The Proposed Regulations Are Contrary to Section 2053

As noted above, the first step in determining the validity of the proposed regulations is to read Section 2053 and determine if its meaning is plain and the statute is unambiguous, and if so what it says. If a court has already made that determination, then that is the clear meaning of the statute.⁶⁰ The IRS may only issue regulations consistent with that unambiguous, clear meaning.⁶¹ In determining the clarity of the statute, the plain language and context are considered.⁶² For the reasons stated below, the author believes that the proposed regulations are contrary to the clear meaning of Section...