Estate Couldn't Recover Costs Of Winning Charitable Deduction From Will Settlement

Estate of Antonio J. Palumbo, (DC PA 03/09/2011) 107 AFTR 2d ¶2011-750

A district court has declined to award an estate attorney fees and other costs of winning a dispute with IRS over the deductibility of a settlement. Specifically, the court previously held that the estate was entitled to an estate tax charitable deduction as a result of a settlement between the decedent's son and a charity. The court denied the costs because it found that IRS's position was substantially justified.

Underlying decision. 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. However, 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 claimed that it was entitled to the residuary estate because the missing residuary clause was due to scrivener's error. The parties reached a settlement under which 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.

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, which held in favor of the estate. Based on the evidence presented, the court 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, it found that the estate was entitled to a $11,721,141 charitable deduction.

Background. Under Code Sec. 7430, taxpayers who prevail against the U.S. in court (or at the administrative level) may be awarded reasonable litigation and administrative costs (including the costs of recovering the award). Recovery of such costs is subject to limitations—the taxpayer must have exhausted administrative remedies, must not have unreasonably protracted the proceedings, and must meet financial eligibility requirements. In addition, a taxpayer will not be treated as a prevailing party where IRS proves its position in the proceeding was substantially justified. Code Sec. 7430 requires a party seeking attorney's fees and costs from the government to meet the requirements set forth in 28 USC 2412(d)(2)(B), which bars an estate with a net worth of over $2 million from recovering costs.

Parties' arguments. The estate sought an award of attorneys' fees and costs as the prevailing party under Code Sec. 7430. IRS argued that an award of attorneys fees and other costs was improper for these reasons:

... The estate had a net worth of over $2 million.

... IRS's position was substantially justified throughout the litigation.

... The estate failed to submit evidence justifying the fees sought.

The estate acknowledged that its net worth exceeded $2 million but said that this did not bar recovery because the Charitable Trust was the real party in interest. It advanced arguments as to why IRS's position wasn't substantially justified and said it submitted ample evidence detailing its costs.

Court finds substantial justification issue controlling. The court said it did not need not to reach the question of net worth, and more specifically, who is the real party in interest in terms of determining net worth, because it found that IRS was substantially justified in its position. Similarly, that finding made it unnecessary for the court to ascertain the reasonableness of the fees and costs sought to be awarded.

The court observed that, under Code Sec. 7430(c)(4)(B)(ii), the government's position is presumed not to be substantially justified if IRS did not follow its applicable published guidance in the administrative proceeding. Also, the court noted that Code Sec. 7430(c)(4)(B)(ii) directs a court, in determining whether the government's position was substantially justified, to take into account whether the government lost in courts of appeal for other circuits on substantially similar issues.

The estate seized on these two provisions to claim that IRS's position was not substantially justified. It pointed to rulings and cases that it claimed IRS did not follow, including Rev Rul 89-31, 89-1 CB 277. However, the court examined the cited rulings and cases and found that they were factually distinguishable. The key difference in most instances was that the estate in the current case was not a designated residuary beneficiary under the '99 will. Accordingly, the court found that IRS's position was substantially justified and thus declined to award costs.

References: For recovery of litigation costs, see FTC 2d/FIN ¶U-1240; United States Tax Reporter ¶74,304; TG ¶71405.