Look It Up In The Dictionary
IRS says no, but Judge Foley is prepared to give an estate a deduction for a loss suffered by the LLC, 99% of whose membership interests were held by the decedent.
Tax Court has grappled with this Protean creation of statute before. See my blogpost “Is An LLC A Person?” 9/11/15, where The Judge With a Heart, STJ Armen, fought that one out to a no-decision.
But now Judge Foley is writing for a unanimous Court in a full-dress T. C., Estate of James Heller, Deceased, Barbara H. Freitag, Harry H. Falk, and Steven P. Heller, Co-Executors, 147 T. C. 11, filed 9/26/16.
And if this post is a trifle late, I occasionally have to practice law.
Facts are stipped. The late James placed much wealth in a family LLC (his gross estate was $26 million, un bello spendere). But $16 million thereof was invested by co-ex’r Falk, who ran the LLC, in a well-known securities firm.
Falk and the co-ex’rs took out $11 million to pay estate taxes and divvied up the rest to the late James’ children, each of whom had an 0.5% membership interest.
The well-known securities firm, which had paid such generous returns to the LLC, was run by Wall Street wizard, and more recently long-term guest of us taxpayers, Bernie Madoff.
The LLC’s holdings in the Madoff account went rapidly to zero. The estate claimed a $5 million loss, being whatever was left after they pulled the $11 million.
Of course, we don’t know what, if anything, Irving (“Captain”) Picard, Esq., and his next-generation co-voyagers, might have clawed back on behalf of others similarly swindled. Falk fired off a protective refund claim, just in case. See 147 T. C. 11, at p. 4, footnote 4.
As aforesaid, IRS said no. There was theft all right, but it was theft from the LLC. The LLC was not the estate.
But no one’s legal argument is safe in Tax Court when there’s a dictionary lying around at 400 Second Street, NW. See my blogpost “Revenez, Enfants de la Patrie,” 9/21/15.
The theft loss section, Section 2054, speaks of losses during estate administration “arising from theft.”
Going to the dictionary in this case of first impression, since the statute and regs don’t deal with this, here’s Judge Foley.
“The estate tax is imposed on the value of property transferred to beneficiaries. See secs. 2001, 2031(a), 2051. In that context, a loss refers to a reduction of the value of property held by an estate. See Black’s Law Dictionary 1087 (10th ed. 2014) (defining a loss as ‘the disappearance or diminution of value’). While [LLC] lost its sole asset as a result of the Ponzi scheme, the estate, during its settlement, also incurred a loss because the value of its interest in [LLC] decreased from $5,175,990 to zero.” 147 T. C. 11, at p. 5.
And if one dictionary isn’t enough, here’s another.
“Respondent concedes that Madoff Securities defrauded [LLC] but contends that the estate is not entitled to a section 2054 deduction because [LLC] incurred the loss. In support of this contention, respondent emphasizes that pursuant to New York law, [LLC], not the estate, was the theft victim. Section 2054, however, allows for a broader nexus (i.e., between the theft and the incurred loss) than does respondent’s narrow interpretation. ‘Arise’ is generally defined as ‘to originate from a source’. See Merriam-Webster’s Collegiate Dictionary 62 (10th ed. 2001). Pursuant to the phrase ‘arising from’ in section 2054, the estate is entitled to a deduction if there is a sufficient nexus between the theft and the estate’s loss. See White v. Commissioner, 48 T.C. 430, 435 (1967) (finding a similarity between losses caused by direct and proximate damage of a section 165(c)(3) ‘other casualty’ and those arising from the specifically enumerated section 165(c)(3) causes). It is sufficient indeed. The nexus between the theft and the value of the estate’s [LLC] interest is direct and indisputable. The loss suffered by the estate relates directly to its [LLC] interest, the worthlessness of which arose from the theft.” 147 T. C. 11, at p. 6. (Emphasis by the Court). (Footnote omitted).
The aim of the estate tax is to tax whatever the legatees and distributes get. Here, what they got was $5 million less than what the late James had.
I got bounced from a tax review blog recently for suggesting an IRS appeal. So, with nothing to lose, I’ll suggest another.