Monday, June 15, 2015
Lawsuit settlement payments not deductible for income tax purposes after claiming same as a deduction for estate tax purposes.
Lawsuit settlement payments not deductible for income tax purposes after claiming same as a deduction for estate tax purposes. In a recent decision by the Eleventh Circuit Court of Appeals, Batchelor-Robjohns v. United States, No. 14-10742, 2015 WL 3514674 (11th Cir. June 5, 2015), the Court denied an income tax deduction for an estate that already took an estate tax deduction for lawsuit settlement payments. The Estate had filed suit concerning $41 million in payments it made to settle various lawsuits against the Estate. The Estate deducted the payments from its gross estate for estate tax purposes as claims against the estate pursuant to I.R.C. §2053(a)(3). The estate and Internal Revenue Service agreed that this deduction was proper, and the estate tax liability was not at issue before the district court. However, after taking the estate tax deduction, the Estate also claimed an $8.3 million credit on its income tax return for the settlement payments. The district court rejected the Estate's claim, finding that I.R.C. §642(g) barred the Estate from claiming both an estate tax deduction under § 2053 and an income tax deduction for the same payment. The Eleventh Circuit agreed. The government maintained that the Estate cannot use the $41 million repayment to reduce both its estate and income tax obligations, and instead may only deduct the payments from either one tax or the other. The Eleventh Circuit agreed. The Estate argued on appeal, as it did in the district court, that sections 162 and 212 provide the basis for permitting the “double deduction” of the settlement payments at issue because the payments arise out of the Decedent’s business activities in selling his corporate assets, and thus are ordinary and necessary business expenses. The Eleventh Circuit disagreed. The Eleventh Circuit’s analysis focused on the I.R.C. provisions relating to overlapping estate and income tax deductions. I.R.C. §642(g), entitled “Disallowance of double deductions,” generally prevents an estate from claiming both an estate tax deduction under I.R.C. §2053 and an income tax deduction for the same payment. The statute provides: Amounts allowable under §2053 or §2054 as a deduction in computing the taxable estate of a decedent shall not be allowed as a deduction ... in computing the taxable income of the estate or of any other person, unless there is filed ... a statement that the amounts have not been allowed as deductions under §2053 or §2054 and a waiver of the right to have such amounts allowed at any time as deductions under §2053 or §2054. I.R.C. §642(g) contains an exception, however, for “income in respect of decedents.” A double deduction is permitted for “taxes, interest, business expenses, and other items accrued at the date of a decedent's death” that fall within § 2053(a)(3) as claims against the estate, as long as they are also allowable under §691(b). See 26 C.F.R. § 1.642(g)–2. Section 691(b), in turn, provides that a decedent's estate may claim both deductions if the expense falls within one of six statutes: sections 162, 163, 164, 212, 611, or 27. When there are claims that could potentially be available as a deduction for federal estate tax, federal income tax, or both, competent counsel should be consulted to determine how best to take available deductions to minimize estate and/or income tax liability.