Thursday, March 24, 2011

Settlement Paid Under Botched Will Yields Charitable Deduction For Estate

Estate of Antonio J. Palumbo, (DC PA 03/09/2011) 107 AFTR 2d ¶560

A district court has held that a large sum (almost $12 million) paid to a charity under a settlement agreement between the decedent's son and the charity qualified for an estate tax charitable deduction. The court rejected IRS's assertion that no deduction was allowable because the amount was not paid by operation of a residuary clause in the decedent's will. The court allowed the deduction because the will's draftsman acknowledged botching the will and there was no collusion among the parties to achieve a deduction.

Facts. Antonio J. Palumbo died on Dec. 16, 2002. In’74, he had created the A.J. and Sigismunda Palumbo Charitable Trust (the Charitable Trust).

Mr. Palumbo executed various wills and trust instruments with testamentary provisions during his lifetime. At the time of his death, his will executed on July 6,’99, together with its three codicils was in effect. The first paragraph stated that taxes were to be paid out of the residuary estate. The third paragraph of the will identified and defined the Charitable Trust, naming it as a remainder beneficiary in several places throughout the will and the three codicils.

The estate and IRS agreed that there was no express residuary provision in the will due to a scrivener's error on the part of Mr. Palumbo's attorney. Earlier iterations of the will had a residuary provision.

As a result of the lack of a residuary provision, Mr. Palumbo's son claimed that as the sole intestate heir, he alone was entitled to the residuary estate. However, the Charitable Trust contacted Mr. Palumbo's son and claimed that it was entitled to the residuary estate because the missing residuary clause in the’99 will was due to scrivener's error. Counsel for Mr. Palumbo's son and the Charitable Trust entered into negotiations and eventually reached a settlement agreement with respect to the distribution of the residuary estate. The settlement was agreed to by Mr. Palumbo's son, the Charitable Trust, Mr. Palumbo's daughter-in-law, Mr. Palumbo's wife at the time of his death, and the Attorney General for the Commonwealth of Pennsylvania.

Under the terms of the agreement, the Charitable Trust received a portion of the residuary estate amounting to $11,721,141 and Mr. Palumbo's son received $5,600,000 and real property. The settlement agreement was approved by a July 10, 2003 Order of the Orphans' Court Division of the Court of Common Pleas of Elk County, Pennsylvania, upon the filing of a joint petition for approval of the settlement.

After entering into the agreement, the estate filed a claim for a federal estate tax charitable deduction in the amount of $11,721,141. IRS disallowed the charitable deduction, finding that the transfer had been made by Mr. Palumbo's son via a settlement agreement, and not by Mr. Palumbo through his’99 will.

The estate then sued in district court. The estate asserted that it was entitled to a return of the taxes paid on the $11,721,141 (plus interest), because this amount should be allowed as a charitable deduction under Code Sec. 2055.

Background. A deduction from the gross estate is allowed for the value of property included in the decedent's gross estate and transferred by the decedent during his lifetime or by will to qualifying organizations for public, religious, charitable, scientific, literary, educational, and certain other purposes. The amount of the deduction is the value of the property or interest transferred but may not exceed the value of the transferred property required to be included in the gross estate. (Code Sec. 2055)

District court sides with estate. IRS urged the Court to narrowly construe Code Sec. 2055 to disallow the deduction. However, the court declined to do so because of the facts of the case and legislative history, which showed that Code Sec. 2055 was designed to encourage charitable gifts.

IRS also argued that the court had to find in its favor because the Charitable Trust had no enforceable right to any portion of the residuary estate under Pennsylvania law. The court observed that Mr. Palumbo repeatedly manifested his intent to leave the residuary of his estate to the Charitable Trust as evidenced by earlier iterations of his will and other documents provided to the court by the parties. In addition, the court noted that the attorney who drafted the will admitted in a malpractice suit that he failed to include a provision concerning the residuary estate.

IRS countered that, under Pennsylvania law, the district court could not consider matters external to the’99 will. The court agreed that it is generally the rule of law in Pennsylvania to look only to the “four corners” of a document in order to ascertain the testator's intent. However, the court stressed that in Pennsylvania, there is a long-standing, case law-supported history which indicates that two general principles apply when interpreting a will: (1) when a person prepares a will, it is presumed that the person intended to dispose of the entirety of the estate and not die intestate as to any portion of it, and if possible to do so, a will must be construed to avoid an intestacy; and (2) the duty of the court is to ascertain, if possible, the intent of the testator.

Summarizing the situation, the court noted that there was no dispute that the’99 will was the last written iteration of Mr. Palumbo's intent. However, the parties agreed that prior testamentary documentation provided for a residuary estate, and that in all prior documentation, the residuary estate was left to the Charitable Trust. It was also uncontested that Mr. Palumbo's attorney admitted that he made a scrivener's error when preparing the’99 will, in that he failed to include a provision for the residuary estate. The parties also agreed that after the dispute arose, arm's length negotiations resulted in the settlement.

The court concluded that the negotiations were held at arms-length, that all of the legatees signed the settlement agreement (which was approved by the Orphan's Court), and there was no evidence of any collusion among the parties to the agreement nor any collusion on the part of their respective attorneys.

The court also found that the prior instruments showed Mr. Palumbo's intent to devise and bequeath his residuary estate to the Charitable Trust and that there was no evidence that he intended to disinherit the Charitable Trust. The court thus determined that the failure of the’99 will to provide for a residuary estate was not by design of the testator but due to human error on the part of his attorney. As such, the Court found that the estate was entitled to a charitable deduction under Code Sec. 2055 in the sum of $11,721,141.

References: For estate tax deduction for charitable transfers, see Federal Tax Coordinator 2d ¶R-5700; United States Tax Reporter Estate & Gift ¶20,554; TaxDesk ¶777,000; TG ¶41301.

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