Estate of Saunders v. Comm'r

• Decision Date: 12 March 2014
• Docket Number: No. 12–70323.,12–70323.
• Citation: 745 F.3d 953
• Parties: ESTATE OF Gertrude H. SAUNDERS, Deceased; Richard Riegels, Co–Executor; William Saunders, Co–Executor, Petitioners–Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

745 F.3d 953

ESTATE OF Gertrude H. SAUNDERS, Deceased; Richard Riegels, Co–Executor; William Saunders, Co–Executor, Petitioners–Appellants,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellee.

No. 12–70323.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted Feb. 13, 2014.

Filed March 12, 2014.

Thomas R. Daniel, Esq. (argued), Gelber, Gelber & Ingersoll, Honolulu, HI, for Petitioners–Appellants.

Kathryn Keneally, Jonathan S. Cohen, and Jennifer M. Rubin (argued), Tax Division, Department of Justice, Washington, D.C., for Respondent–Appellee.

Appeal from a Decision of the United States Tax Court. Tax Ct. No. 10957–09.

Before: CONSUELO M. CALLAHAN and MILAN D. SMITH, JR., Circuit Judges, and ALVIN K. HELLERSTEIN, Senior District Judge.^*

OPINION

M. SMITH, Circuit Judge:

In this appeal from the tax court, we consider whether the Estate of Gertrude Saunders (the Estate) properly claimed a $30 million deduction on its estate tax return for a lawsuit pending at the time of Gertrude Saunders' death (the Stonehill Claim, or the Claim), even though the suit ultimately settled for a smaller sum. The Commissioner of Internal Revenue (the Commissioner) disallowed the $30 million deduction. Because the estimated value of the Stonehill Claim at the time of Gertrude Saunders' death was not ascertainable with reasonable certainty, the tax court properly upheld the Commissioner's disallowance of the $30 million deduction, but allowed a deduction in the amount for which the Claim settled. We therefore affirm the decision of the tax court.

FACTUAL AND PROCEDURAL BACKGROUND

William Saunders, Sr., an attorney residing in Hawaii, died on November 2, 2003. His wife, Gertrude Saunders, died slightly more than one year later, on November 27, 2004.

I. The Stonehill Claim

Prior to his death, William Saunders represented Harry S. Stonehill. On September 24, 2004—after the deaths of both Stonehill and William Saunders—Stonehill's estate filed suit in Hawaii state court against the estate of William Saunders. Stonehill's estate asserted that William Saunders committed legal malpractice, breach of confidence, breach of the duty of loyalty, and fraudulent concealment in connection with his representation of Stonehill. Specifically, Stonehill's estate alleged that William Saunders provided damaging information about Stonehill to the Internal Revenue Service, thereby breaching the fiduciary duty he owed to Stonehill, and allegedly exposing Stonehill to considerable tax liability. Stonehill's estate sought to recover damages of at least $90 million.¹

A jury trial on the Stonehill Claim began on May 28, 2007—several years after Gertrude Saunders' death—and the jury delivered its verdict about six weeks later. While the jury determined that William Saunders had breached his duties to Stonehill, it also concluded that William Saunders' misconduct did not cause any damages to Stonehill or his estate. The Stonehill estate appealed. Thereafter, while the appeal was pending, the parties to the Stonehill Claim settled their dispute. Under the terms of the settlement, William Saunders' estate agreed to pay $250,000 in exchange for a complete release from liability.

II. The Challenged Deduction

At the time of Gertrude Saunders' death on November 27, 2004, the Stonehill Claim remained pending and contested. On February 23, 2006, her Estate filed its Form 706 estate tax return. In connection with that return, the Estate deducted $30 million for the estimated date-of-death value of the Stonehill Claim. The Estate based the amount of its deduction for the Stonehill Claim on an August 30, 2005 appraisal letter prepared by attorney John Francis Perkin. ²

On February 10, 2009, the Commissioner issued a Notice of Deficiency to the Estate. In that Notice, the Commissioner asserted that the Estate had improperly deducted $30 million for the Stonehill Claim, and that its return therefore reflected an estate tax deficiency of $14.4 million.³

III. Prior Proceedings

On May 8, 2009, the Estate petitioned in tax court for redetermination of the deficiency claimed by the Commissioner. To support their respective positions, the parties proffered expert reports to the court, each of which endeavored to assign a date-of-death value to the Stonehill Claim. The Estate submitted two letters from Perkin, and reports from Philip M. Schwab and James J. Bickerton. The Commissioner countered with reports from James E. King and James E. McCann.

A. Expert Valuations

The experts' opinions varied widely. As noted above, Perkin opined in his 2005 letter that, given the “the wide range of unknowns as of November 2003,” the Stonehill Claim was worth $30 million at the date of William Saunders' death. He acknowledged, however, that an adverse judgment on the Stonehill Claim could result in liability ranging “between one dollar ($1) and ninety million dollars ($90,000,000).” In his 2009 letter, Perkin revised his valuation downward to $25 million. Relying on information from Perkin, Schwab calculated what he termed the “aggregate weighted monetary value of all outcomes” as of the date of Gertrude Saunders' death. Using this approach, he valued the Stonehill Claim at $19.3 million. Finally, Bickerton determined that the Claim was worth at least $22.5 million when it was filed.

The Commissioner's experts calculated much lower estimates. According to King, the Claim was worth, at most, $3.06 million on the date of Gertrude Saunders' death. Relying on information from King, McCann assigned the Stonehill Claim a value of $3.2 million, $6.3 million, or $7.5 million as of that date, depending on the damages award assumed.

B. The Tax Court's Decision

The tax court handed down its opinion on April 28, 2011, concluding that the Commissioner properly disallowed the Estate's $30 million deduction for the Stonehill Claim. Instead, the tax court determined that the Estate could deduct the amount actually paid in connection with the Claim. On December 30, 2011, the tax court entered a decision finding an estate tax deficiency of $12,400,223. The Estate timely appealed.

JURISDICTION AND STANDARD OF REVIEW

We have jurisdiction under 26 U.S.C. § 7482. We review the tax court's legal conclusions, including its interpretation of the Internal Revenue Code and Treasury Regulations, de novo. Metro Leasing & Dev. Corp. v. Comm'r, 376 F.3d 1015, 1021 (9th Cir.2004) (citing Boeing Co. v. United States, 258 F.3d 958, 962 (9th Cir.2001)).

DISCUSSION

I. Legal Framework

“The federal estate tax is a tax on the privilege of transferring property upon one's death.” Marshall Naify Revocable Trust v. United States, 672 F.3d 620, 623 (9th Cir.2012) (quoting Propstra v. United States, 680 F.2d 1248, 1250 (9th Cir.1982)) (internal punctuation omitted). To determine the value of the taxable estate, the gross estate is reduced by any deductions allowable under the Internal Revenue Code. 26 U.S.C. § 2053(a). “Claims against the estate are one type of deduction allowable under the Internal Revenue Code.” Naify, 672 F.3d at 623 (citing 26 U.S.C. § 2053(a)(3)).

A. Treasury Regulations

Treasury Regulations applicable at the time of Gertrude Saunders' death clarify the deductibility of claims against an estate.⁴ Under these Regulations, claims against an estate are “personal obligations of the decedent existing at the time of his death, whether or not then matured, and interest thereon which had accrued at the time of death.” Treas. Reg. § 20.2053–4. Further, “[o]nly claims that are ‘enforceable against the decedent's estate may be deducted.’ ” Naify, 672 F.3d at 623 (quoting Treas. Reg. § 20.2053–4).

Of course, the exact value of a claim pending against an estate at the time of the decedent's death is not always known. Recognizing this, the Regulations permit an estate to deduct the estimated value of such a claim in some circumstances. SeeTreas. Reg. § 20.2053–1(b)(3). “The Treasury Regulations mandate that, in order to deduct the estimated amount of a claim against the estate, the estate must show that it is, inter alia, ‘ascertainable with reasonable certainty.’ ” Naify, 672 F.3d at 624 (quoting Treas. Reg. § 20.2053–1(b)(3)). Further, the Regulations provide that the estimated amount of a claim is deductible only if the amount “will be paid.” Treas. Reg. § 20.2053–1(b)(3). Thus, the Treasury Regulations preclude an estate from deducting “a claim based on a vague or uncertain estimate.” Naify, 672 F.3d at 624 (citing Treas. Reg. § 20.2053–1(b)(3)). Rather, if a claim's estimated value at the date of death is not ascertainable with reasonable certainty, but becomes certain post-mortem, “an estate may petition the tax court or file a claim for a refund.” Naify, 672 F.3d at 624 (citing Treas. Reg. § 20.2053–1(b)(3)).

B. Case Law

We have applied the Regulations at issue in this case several times. In so doing, we have classified claims as either “certain and enforceable,” on the one hand, or “disputed or contingent,” on the other. See Naify, 672 F.3d at 626–28. This distinction governs whether courts may consider post-death events—such as the settlement here—when determining the permissible deduction for claims against an estate. In Propstra, we held that “when claims are for sums certain and are legally enforceable as of the date of death, post-death events are not relevant in computing the permissible deduction.” Propstra, 680 F.2d at 1254. We also held, however, that “post-death events are relevant when computing the deduction to be taken for disputed or contingent claims.” Id. at 1253 (emphasis added). Thus, under our case law, courts may “consider post-death events when valuing a disputed or contingent claim against an estate.” Naify, 672 F.3d at 626.

Our distinction between certain and enforceable claims and disputed or contingent claims flows naturally from the text of the governing Treasury Regulations. When, as in Propstra, a certain and enforceable claim is pending against an estate at the date of...