U.S. Tax Court: Conn. Estate Cannot Claim $352K Charitable Deduction

Elder Law Answers case summary.The United States Tax Court upholds an IRS determination made after an audit that a Connecticut estate cannot claim a $352,000 charitable deduction from the gross value of the Estate. Estate of Block v. Commissioner of Internal Revenue (U.S.T.C. No. 10618-19, March 13, 2023).

Susan R. Block created a revocable trust in 1997. In 2015 she executed a will directing her residuary Estate to the trust, as amended. She passed away a month later, and the trust became irrevocable. The trust provided for a sub-trust to be funded upon Ms. Block’s death to benefit her sister and her sister’s husband. Upon their death, a charitable foundation was the remainder beneficiary.

The trust assets at the time of her death were worth $761,000. The trust became the subject of a 2017 IRS audit of its estate tax return (Form 706) timely filed in 2016. After the audit, the IRS informed the trustees in March 2019 that the trust owed an estate tax deficiency of $140,085.

The Form 706 for the Estate deducted from the gross Estate’s value the present value of the charitable remainder interest in the sub-trust. The IRS disagreed and disallowed the entirety of the Estate’s claimed charitable deduction of $352,085. As a result of this, there was a tax deficiency.

The trustees did not commence any judicial proceeding to reform any provisions of the Trust instrument. However, they did engage in a non-judicial reformation of the trust upon the commencement of the audit.

The problem was that 26 U.S. Code § 2055(e)(2)(A) (which governs deductions from the value of a gross Estate for charitable transfers) requires the income beneficiaries to get annual distributions of a fixed dollar amount or a fixed percentage of net asset value. The sub-trust did not comply with these requirements as it was written. Per the Internal Revenue Code, if a trust initially fails to meet these requirements, the Estate still may take a charitable deduction if there is a “qualified reformation” of the trust.

The trustees tried to reform the trust by making a non-judicial amendment to the trust instrument. However, the Tax Court concludes that because the trust did not qualify as a charitable remainder annuity trust at the time of Ms. Block’s death, the charitable remainder was not a reformable interest under the default rules, and the amendment made could not reform the trust.

The Tax Court also concludes that the exception to this – judicial reformation – did not apply here. This is because the trust amendment was executed more than 90 days following the due date for the estate tax return (July 21, 2016) and was not done through the judicial process. The trustees of the trusts asked the Tax Court to deem the Estate to have substantially complied with the exception with the amendment they did make, but the Tax Court declines to do so. It feels Congress had made clear that the rules for qualified reformations were to be construed strictly to prevent abuse of the charitable deduction.

The Estate also argued that Revenue Procedure 2003-57, 2003-2 C.B. 257, and Revenue Procedure 2003-59, 2003-2 C.B. 268 allow a trustee to amend the terms of a trust at any time and without court involvement to ensure it both qualifies as a CRAT and retroactively qualifies for an estate tax charitable deduction. The Tax Court again disagrees that these provisions applied in this case. It states that the non-judicial reformation contemplated by these procedures does not apply to corrections for “major, obvious defects” (such as the ones in the case at hand), and corrections to these issues require a judicial proceeding before the commencement of an IRS audit.

For the preceding reasons, the Tax Court concludes that the arguments made by the trustees were moot, irrelevant, or without merit and ruled in favor of the IRS.

Read the full text of this decision.