Potts and Reilly, L.L.P.., Austin, TX

If an estate plan does not have a provision apportioning taxes, or the provision for the apportionment of taxes is ambiguous, then state law applies. While this is not the preferred choice among tax practitioners, there are clearly a number of times when a state's statute comes into effect. Estate of McCoy v. Comr., T.C. Memo 2009-61, is such a case.

In McCoy, the governing documents (a trust and a will) provided for specific bequests to individuals other than the decedent's wife to be paid from the residuary estate. Different definitions of “residuary” could be interpreted under the documents. The different definitions of “residuary” created ambiguity over the tax clause, which sourced the payment of taxes from the “residue of the trust.” No language specifically charged the payment of taxes to any particular share. The attorney who prepared the federal estate tax return reduced the specific bequests by their proportionate part of the estate taxes, under Utah's apportionment statute. Utah's apportionment statute apportions taxes to the source of the tax. As such, the property passing to the surviving spouse was not taxed. The IRS argued, however, that the marital share was the proper source of payment, and as such, additional estate taxes of approximately $412,000 were assessed on audit.

The Tax Court determined that unless the will clearly states that estate taxes shall be apportioned differently than under the state law, the state apportionment statute applies. The Tax Court sided with the Estate, determining that the will and revocable trust were unclear regarding the apportionment of tax. The IRS argued that the Tax Court should consider “extrinsic evidence” for the apportionment of taxes. The Tax Court, in a footnote, handled the evidentiary issues in an interesting way - noting that extrinsic evidence was not needed to interpret a will and revocable trust in which the decedent clearly did not address taxes at all, thus leaving the matter to the apportionment statute. The Tax Court explained that what little extrinsic evidence existed pointed toward: (a) the decedent being dyslexic, (b) the decedent signing a draft of his restated trust agreement without discussing it with his attorney, (c) the decedent never wanting to pay more taxes than absolutely necessary, and (d) the decedent never discussing the payment of taxes with his attorney or any one else. The Tax Court concluded that the decedent would have likely wanted taxes paid from the nonmarital share, which was the source of payment in the original trust agreement.

The Tax Court ruled that the Utah apportionment statute must be applied to apportion the Estate's taxes. Because Utah's apportionment statue provides that distributions creating the tax are the sources that pay the tax, a marital distribution will not pay tax. Therefore, the Tax Court in McCoy held that the marital share bore no part of the tax created by the specific bequests. This resulted in more property for the widow and less for the family members receiving specific bequests. Thus, McCoyhighlights the care required to prepare an appropriate tax clause.

For more information, in the Tax Management Portfolios, see Pennell and Danforth, 834 T.M., Transfer Tax Payment and Apportionment, and in Tax Practice Series, see ¶6180, Introduction -- The Estate and Gift Tax System.