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Estate Denied Deduction for Pending Litigation Claim for Malpractice

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In Estate of Gertrude H. Saunders et al. v. Commissioner; 136 T.C. No. 18; No. 10957-09 (28 Apr 2011), the Tax Court rejected a claim by an estate that litigation could potentially cost the estate $30 million.   As demonstrated by various expert reports submitted on behalf of the estate, the value of the claim was too uncertain to be deducted based on estimates as of the date of death.

IRC Code Section 2053(a) allows various deductions in computing the taxable estate of a decedent, including claims against the estate.  IRS Reg. 20-2053-1(b)(3) permits a deduction for a claim that is “ascertainable with reasonable certainty, and will be paid.”  In the Estate of Smith (CA 5 12/15/1999), the Fifth Circuit allowed a deduction for the date-of-death appraised value of a claim outstanding at the decedent’s death even though the claim was later settled for a lesser amount.  Although the Tax Court agreed with the IRS that the deduction should be limited to the settled amount, the Fifth Circuit ruled in favor of the taxpayer that the deduction could not be based on a post-death settlement amount.

In Estate of Gertrude H. Saunders, the claim in question was on the contingent liability of the decedent’s pre-deceased husband.   The decedent’s husband was being sued for attorney malpractice at the time of his passing by a former client.  The former client’s estate sued for $90 million and to settle the pre-deceased husband’s estate, the Estate of Gertrude Saunders agreed with the IRS that Gertrude would be responsible for any judgment or settlement of the malpractice case.   Ms. Saunders passed away before the case went to trial and the estate claimed a $30 million deduction for the malpractice claim.

In 2007, a jury found in favor of the plaintiff, however, did not award any damages.  Upon settlement of the case, the Estate of Saunders paid $250,000 in attorney fees to the plaintiff’s estate attorney and waived its right to $289,000 of costs awarded in the state court judgment.

In its finding, the Tax Court stated it did not consider the post-death settlement of the malpractice case but rather focused on the various valuation reports provided by the estate.  One valuation report established the potential recovery against the estate to be $90 million and determined the likelihood of that recovery was a 25% to 50% chance.  Because of settlement possibility and other wide range of unknowns, the valuation was initially estimated at $30 million and then subsequently decreased to $25 million.  Another valuation expert provided an analysis and reduced the valuation for lack of assignability and estimated a net value of $19.3 million.  The IRS submitted a valuation report that determined that the claim was without merit, had “at most a 3% chance of recovery” and determined the value should be between $25,449 to $1,500,395.

The Tax Court determined that none of the experts for the estate could reasonably provide that the $30 million claimed on the estate tax return or any specific amount  would be paid as required by IRS regulations.   In his decision, Judge Cohen provided “Our review of the estate’s expert reports, standing alone, convinces us the value of the Stonehill claim against the Saunders estate is too uncertain to be ducted as of November 2004”.  The Tax Court concluded that the plaintiff’s claim against the estate was not deductible at the time of the decedent’s death and the amount actually paid during the administration of the estate was the amount that could be deducted.