Charitable Deduction for Partial Disclaimer Allowed

The Eighth Circuit held that a partial disclaimer of an interest in an estate was valid and that the estate was entitled to a charitable deduction for the portion of the disclaimed amount that was given to a charitable foundation.

Background

In her will, Helen Christiansen named her only child, Christine Christiansen Hamilton (Hamilton), as her primary beneficiary and the executor of her estate. Hamilton disclaimed her interest in the estate “as finally determined for federal estate tax purposes” as to all amounts over $6.35 million. Christiansen’s will provided that 25% of any disclaimed amounts were to go to a charitable foundation. The IRS contested both the validity of the disclaimer and the amount reported as the estate’s overall value. The estate and the IRS eventually settled regarding the valuation of the estate, resulting in a larger value for the estate based largely on adjustments to marketability discounts the estate had claimed for limited partnership interests in a family ranching enterprise. This caused a corresponding increase in the value of the contribution to the charitable foundation. The IRS, however, denied the estate an increased charitable deduction, arguing that the act of challenging the estate’s return and the resulting adjustment to the estate’s value served as post-death, post-disclaimer contingencies that disqualified the disclaimer under Sec. 2518 and Regs. Sec. 20.2055-2(b)(1). The estate challenged the IRS’s determination in Tax Court, and the Tax Court held in favor of the estate. The IRS appealed the Tax Court’s decision to the Eighth Circuit.

IRS’s New Argument

In addition to its post-disclaimer contingency argument, the IRS contended that all fractional disclaimers that have a practical effect of disclaiming all amounts above a fixed dollar amount should be disallowed as against public policy because these disclaimers fail to preserve a financial incentive for the IRS to audit an estate’s return. According to the IRS, with such a disclaimer, any post-challenge adjustment to the value of an estate could consist entirely of an increased charitable donation, providing no possibility of increased tax receipts as an incentive for the IRS to audit the return and ensure an accurate valuation of the estate.

The Eighth Circuit’s Decision

The Eighth Circuit rejected both of the IRS’s arguments and affirmed the Tax Court. The court found that in its first argument, the IRS had failed “to distinguish between events that occur post-death that change the actual value of an asset or estate and events that occur post-death that are merely part of the legal or accounting process of determining value at the time of death.” According to the court, Regs. Sec. 20.2055-2(b)(1) deals with the existence of a transfer on the decedent’s date of death, not “the existence or finality of an accounting valuation at the date of death or disclaimer.” The court found that there was no support for the IRS’s contention that a challenge to the value of the estate was a post-death event that would disqualify a partial disclaimer per the regulations. Therefore, the IRS’s partially successful challenge of the estate’s return did not disqualify the disclaimer. The Eighth Circuit also rejected the IRS’s argument that it was against public policy to interpret the law in a way that decreased the IRS’s incentive to audit tax returns. The court stated, citing Sec. 7801(a)(1), that the IRS’s role is to enforce the tax laws and not to merely maximize the amount of taxes collected. In particular, with respect to charitable deductions, the court concluded that Congress’s clear policy in allowing these deductions is to encourage charitable donations and that allowing fixed dollar amount partial disclaimers furthers this policy. Finally, because of the numerous restrictions placed on fiduciaries by state law, the court found that it was unlikely that estate executors or administrators would purposely undervalue an estate because of the IRS’s decreased incentive to audit the estate.

Reflections

The argument that public policy dictates that courts should interpret the law so as to maximize the IRS’s incentive to audit taxpayers is disturbing, to say the least. One would hope that the position the government took in this case was merely a last-ditch effort to win an otherwise losing case and not representative of the IRS’s and Treasury’s general opinion on this issue.

Estate of Christiansen, No. 08-3844 (8th Cir. 11/13/09)