Friday, July 15, 2011

Will Construction Affecting Debt Payments Reduces Marital Deduction

PLR 201126030

In a Technical Advice Memorandum (TAM), IRS has construed a decedent's use of “it is my desire” in his will to provide a specific request to his children. This construction affected how the decedent's debts would be repaid and caused a greater reduction in the marital deduction than would have been the case if the language had been construed as precatory (i.e., as merely a wish or advisory suggestion).

Observation: Had the language been construed as precatory, the subject property would have passed under the residuary clause and would have been applied in payment of the debts. Under IRS's construction, the debt was paid by reducing specific bequests including specific bequests to the surviving spouse. This, in turn, reduced the marital deduction. Even under the estate's view, there would have been some reduction in the marital deduction because the residue would not have been sufficient to wipe out all of the debts. But the reduction in the marital deduction would have been less.

Background. The value of a decedent's taxable estate is determined by deducting from the value of the gross estate an amount equal to the value of any interest in property that passes or has passed from the decedent to the surviving spouse. (Code Sec. 2056)

Facts. Decedent died with a will, survived by Spouse and Children. Article III of the Will provides:

To the extent that I own any equity interest at my death in any of the following closely held investments, i.e. [Assets], it is my desire that such equity interests be retained and that each of them be distributed so that all such equity interests are ultimately owned in equal shares by [Children]. If any of them are deceased, it is my desire that the decedent's share of such equity interests be owned equally by such decedent's children.

Article IV and Article V of Decedent's Will contain specific bequests to Spouse.

Article X creates a Family Trust for the benefit of Decedent's Children. Article X uses the language “I give all of the rest, residue and remainder of my property....” Spouse does not have an interest in Family Trust.

The TAM was requested in order to determine whether the language “it is my desire” included in Article III of Decedent's Will is mandatory or precatory. If the language is mandatory, Article III is a specific bequest of Assets to Decedent's Children. If the language is precatory, Assets will pass under Article X as part of the residue of Decedent's Estate.

Estate includes substantial debt obligations owed by Decedent at death, and State's rules of abatement in Statute are applicable. Under these rules, if the language in Article III constitutes a specific bequest, the amount that passes to Spouse will be reduced together with the amount of Estate's marital deduction under Code Sec. 2056. On the other hand, if the language is precatory, Assets will pass under the Article X residuary provision. Under Statute, the debt obligations will eliminate the residue and the remaining debt will be counted against the specific bequests. Under these circumstances, Estate's marital deduction will be greater.

Language is mandatory. Applying the relevant state law, the TAM says the language is mandatory. It stressed that Article III is an instruction to the Executor. In other articles where Decedent intended Executor to have discretion, the language clearly reflected that.

State law provides that when the same words appear in different parts of an instrument, it is presumed that the settlor intended the words to have the same meaning. In both Article III and Article VIII, Decedent refers to his “desires.” Unlike Article VIII, which clearly provides there is no obligation to comply with those desires, Article III contains no such language. Such a clear contrast in language indicates that Decedent intended the use of the phrase “it is my desire” in Article III to be mandatory.

The TAM says that the conclusion that Article III is a specific bequest gives effect to every part of Decedent's Will and is supported by a reading of the four corners of the document. Article III is the first specific bequest and is followed by specific bequests in Articles IV through IX. As in the other specific bequests, Article III uses words of command and provides survivorship rights to Decedent's grandchildren should any child of Decedent predecease Decedent. Article X logically follows with the creation of a trust of the rest, residue and remainder of Decedent's property. There is no mention of Assets elsewhere in Decedent's Will. Given the specificity with respect to other assets enumerated in Decedent's Will, it is unlikely that Decedent failed to specifically address such important assets.

The Estate argued that Article III is simply an expression of Decedent's “hopes” regarding Assets. It said that Decedent recognized that Assets might have to be sold, or at least pledged, in order to pay taxes, debts and expenses of administration; so, in order to provide Executor with instructions and flexibility, Decedent chose to express his “hopes” in Article III in the form of precatory language. As such, Estate argued, Article III is merely a preamble or preface and reflects Decedent's intent that Assets be a part of the residuary estate under Article X of the Will.

The TAM disagreed, emphasizing that it is well settled under State law that, if the specific language used by a settlor is clear, it is unnecessary to construe the instrument as a whole because the language speaks for itself. Courts must not redraft instruments to vary or add provisions under the guise of construction of the language to reach a presumed intent. Article III is a separate article consistent with the format found in Articles IV through IX in which Decedent also makes specific bequests. Article III is an instruction to Executor that clearly identifies Decedent's children as beneficiaries and that provides survivorship rights for Decedent's grandchildren. There is simply no language within the four corners of Decedent's Will to indicate that Article III is a preamble or to support the argument that Assets described in Article III are to be disposed of under Article X.

Accordingly, the marital deduction was reduced to a greater extent than would have been the case had the estate's construction prevailed.

References: For the estate tax marital deduction, see Federal Tax Coordinator 2d ¶R-6000; United States Tax Reporter Estate & Gift ¶20,564; TaxDesk ¶778,000; TaxDesk ¶778,000; TG ¶41401.

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