Ninth Circuit Upheld Tax Court's Determination that Litigation was not "Ascertainable with Reasonable Certainty" at the Time of Decedent's Death and so "Hazard of Litigation" Valuation Discount Did Not Apply
Estate of Foster v. Commissioner (2014-1 U.S.T.C. 60,675 (C.A. 9, March 26, 2014)
At the time of her death, the decedent was the defendant in several lawsuits in her capacity as trustee of three marital trusts established under her husband's estate. The executors of the decedent's estate had the marital trusts appraised, and the appraisal included a 29% discount attributable to the hazards of litigation presented by the lawsuits against decedent in her capacity as trustee. The Service denied the "hazards of litigation" discount. Subsequent to the decedent's death, the suits were settled.
The Tax Court upheld the Service's denial of the "hazards of litigation" discount because the litigation was not "ascertainable with reasonable certainty" at the time of the decedent's death. In preparation for the trial at the Tax Court level, the executors obtained a second appraisal, which determined only a 12.9% to 17.2% discount (the difference between the two appraisals was approximately $8.1 million). The Tax Court used this discrepancy as proof there was a lack of reasonable certainty with respect to the litigation.
This is an interesting case in light of Estate of Saunders v. Commissioner (U.S. 9th Circuit, No. 12-70323 (March 12, 2014)), where the Ninth Circuit considered valuation discounts for litigation pending at the time of decedent's death. The Court noted that unlike the taxpayers' experts in Saunders, the experts in Foster could not reasonably opine that the amounts they suggested would ever actually be paid by the Estate. In fact, one of the lawsuits against the decedent had been decided in her favor before her death (the experts had noted in their appraisal that an appeal was pending with respect to that particular litigation).
It is important to note that in both Saunders and Foster, the Court applied the Section 2053 regulations prior to the 2009 changes. Prior to 2009, in order to deduct the estimated amount of a claim against the estate, the estate had to show that the amount of the claim was ascertainable with reasonable certainty and the estimated amount is deductible only if the amount will be paid. Under new Treas. Reg. § 20.2053-4(d)(1), generally no estate tax deduction can be taken for claims against the estate while the claim is merely potential or unmatured. If a claim later matures, it can be deducted in connection with a timely refund claim. In order to preserve the estate's right to claim a refund for claims that mature and become deductible after the expiration of the period for filing a refund claim, the estate should file a protective claim for refund.