The Facts

D, the decedent, passed away in April 1988, leaving a gross estate that included a motel and restaurant business (M). The value of M, including real property. and the net value of M's assets used in its operation, was approximately 54% of the value of D's gross estate. The representatives of D's estate filed with the estate tax return an election under IRC Sec. 6166 to pay the federal estate tax attributable to the business in 10 equal annual installments.

Representatives of D's estate listed the business for sale during July 1988, and it was eventually sold in January 1990. The personal representatives of D's estate operated M as an ongoing concern from D's death until the sale.

The personal representatives of D's estate wanted to deduct operating expenses incurred in the operation of M from the period of D's death to the date of sale of M as expenses of administration under Sec. 2053(a)(2).

Estate Tax Law

Sec. 20.2053-3(a) of the Estate Tax Regulations provides generally that amounts deductible from a gross estate as "administration expenses" are limited to expenses that are actually and necessarily incurred in the administration of the decedent's estate; i.e., collection of assets, payment of debts, and distribution of property to the persons entitled to it. The expenses contemplated in the law are those only that attend settlement of an estate and the transfer of the property of the estate to individual beneficiaries or to a trustee. Expenses that are incurred for the individual benefit of heirs, legatees or devices, are not deductible. Administrative expenses include executive commissions, attorney's fees, and miscellaneous expenses.

Reg. Sec. 20.2053-3(d) states that miscellaneous administration expenses include such expenses as court costs, surrogates' fees, appraisers' fees, clerk hire, etc. Expenses necessarily incurred in preserving and distributing the estate are deductible, including the cost of storing or maintaining property. of the estate, if it is impossible to effect immediate distribution to the beneficiaries. Expenses for preserving and caring for the property may not include outlays for additions or improvements. Statutory commissions and expenses paid by an estate that are allocable to services performed by the estate representatives after the decedent's death and that are incurred for the purpose of distribution of trust assets under a decedent's will and settling the estate are deductible as administration expenses under Sec. 2053(a)(2).

Prior Case Law

In Estate of Papson v. Commissioner, 73 T.C. 290 (1979), the decedent owned a shopping center comprising over 35% of the gross estate. The estate hired a real estate broker to find a new tenant after a major tenant of the shopping center was adjudicated bankrupt and vacated the premises. In holding that the broker's commission qualified as deductible administration expense under Sec. 2053(a)(2), the Tax Court emphasized that, due to the exceptional circumstances in the case, "... where not only did the assets involved represent a very large portion of the estate but also the tenant occupied such a significant portion of the premises, and its occupant was so abruptly and unexpectedly terminated,..." the broker's commission incurred to lease the premises was necessary in order to preserve the estate. The court attached importance to the fact that the circumstances presented were "exceptional" and that the payment of the commission represented a single transaction. The court further stated that if the commission was on a short-term lease involving a minor portion of the property, its views on deductibility as an administration expense might well be different.

Analysis

The TAM provides that these operating expenses (virtually every expense incurred in the business) are not ordinary and necessary "administration expenses" within the meaning of Sec. 2053(a)(2). The expenses were incurred in the normal course of operating a profit-making venture and constitute the actual costs involved in generating income through the active operation of a business. The nature and extent of these expenditures indicate that the activities involved went beyond simply maintaining or "restoring" the value of the business to its date of death value, or settling the affairs of the estate. Thus, the expenditures are significantly different from the brokerage commission approved by the court in Estate of Papson, which represented an expense incurred in a single, extraordinary transaction. Rather, the expenses involve the normal day-today operating expenses that would be incurred in any event.

One argument for deductibility as an administrative expense was if the business ceased, its value would have decreased. However, the IRS does not believe this necessitates characterization as an administration expense since the primary objective of the expenditures was to conduct the business on a day-to-day basis and generate post-death profit. The purpose of paying these expenses was not to "preserve" or maintain the business. Any "preservation" or "maintenance" consequences were a secondary consequence of operating the business.

This position is supported by the fact that, under state law, as well as general common law, these expenses are chargeable only against the business assets and not the general estate assets. Thus, although these expenses may be legitimately incurred by the executor, state law treats the operation of a business (and the expenses incurred) as an activity distinctly separate and apart from the normal administration of the estate.

The TAM provides, as stated in Estate of Papson, that mere election under Sec. 61666 is not sufficient to qualify normal operating expenses as deductible administration expenses. The purpose of the election is to allow the estate to continue to operate the business as a going concern so that the federal estate tax liability can be paid without having to liquidate the going concern. To allow the estate to treat the normal business expenses incurred during the election period as an administration expense would produce a result that would, in effect, allow the estate to reduce the taxable estate by an amount that is nearly equal to the entire value of the business owned and operated by the decedent. The IRS is doubtful that such an interpretation of Sec. 2053 that results in so significantly distorting the value of the taxable estate, was intended by Congress. The reader should be aware that Sec. 6110(j)(3) provides that a written determination may not be used or cited as precedent.