Estate of McVey v. Dep't of Revenue

Decision Date17 December 2015
Docket Number2014–SC–000013–DG
Citation480 S.W.3d 233
Parties Estate of Mildred L. Mcvey, Appellant v. Department of Revenue, Finance and Administration Cabinet, Commonwealth of Kentucky, Appellee
CourtSupreme Court of Kentucky

COUNSEL FOR APPELLANT: Lawrence R. Webster, Webster Law Offices, PO Drawer 712, Pikeville, Kentucky 41502.

COUNSEL FOR APPELLEE: Bethany G. Atkins, Office of Legal Services for Revenue, PO Box 423, Frankfort, Kentucky 40602–0423.

OPINION OF THE COURT BY JUSTICE NOBLE

This case raises three legal questions. First, does a reviewing court owe any deference to the Kentucky Board of Tax Appeals as to questions of law? Second, may inheritance taxes paid as a "cost of administration" under a will's tax-exoneration provision be deducted from the value of distributive shares under KRS 140.090 and thereby reduce the overall tax liability? And, third, is the payment of tax by an estate on behalf of a beneficiary under a tax-exoneration clause itself a taxable "bequest of tax"?

As to the first question, because the Board of Tax Appeals does not administer the statutes at issue in this case, and because the statutes are not ambiguous, no deference is owed. Because this case raises only questions of law, de novo review is appropriate.

As to the second and third questions, inheritance taxes paid by the estate on behalf of a beneficiary of the estate are not "costs of administration" but are rather separate bequests which are subject to inheritance taxes. Those taxes paid by the estate do not reduce the total tax liability.

When a will has a tax-exoneration clause requiring inheritance taxes owed by the beneficiaries of the will to be paid from the residuary estate, and calls such payment of taxes a "cost of administration" (which is the case here), those taxes paid on behalf of the beneficiaries by the estate are nonetheless a bequest. The legislature has set forth in KRS 140.090 a list of what may be deducted from the gross value of an estate, and inheritance taxes paid by the estate on behalf of the beneficiaries are not on that list, nor do they fit under the deduction for "costs." As such, there can be no deduction from the estate's gross value when the estate pays those taxes for the beneficiaries.

Regardless of the language in the will saying these taxes are to be paid as a "cost of administration," such costs are defined by law and not the will of the testator. It is a simple maxim that only the legislature may say what property may be deducted, because the purpose of inheritance taxes—or any tax—is to provide revenue for the government. If a beneficiary receives property, or the benefit of the property, he simply owes taxes on that property to the government.

These legal principles seem simple, but the complex nature and variety of bequests in Mrs. McVey's will and the disposition of other property outside the will cloud their application, as will be set forth below. This case requires the application of higher-order math or dogged calculations. Careful attention must also be paid to the order in which bequests under the will (and otherwise) are to be made. In light of this, it is apparent that neither the Estate's original inheritance-tax return nor the Department of Revenue's audit revisions were correct, as will be set forth below.

The Court of Appeals reached the correct legal conclusions in this case, for the most part, in affirming the Department's assessment of tax. Like the Department, it properly limited the Estate's attempted deductions and concluded that tax is owed on a bequest of tax. But, again like the Department of Revenue, the court did not properly apply the law to the facts of this case. Specifically, the court, and the Department, ignored that the will requires payment of inheritance taxes for all taxable parts of the estate before calculation of a residue to be distributed to residuary beneficiaries, which substantially affects how the tax in this case should be calculated. But the Department's attempted correction of the inheritance-tax return resulted in an under-calculation of the tax, meaning that at least the full amount of the tax assessed is properly owed. However, the Department has not appealed or claimed the Estate owed more tax than was assessed. The judgment of the Court of Appeals is therefore affirmed.

The above conclusions are substantiated by the background and analysis that follows.

I. Background

Mildred L. McVey died on January 23, 2007. At the time of her death, she had a substantial estate valued at $1,973,939.

The bulk of her property consisted of a transfer-on-death (or TOD) securities account with Smith Barney Investments with a total value of $1,733,417. Such accounts pass outside of probate, with ownership passing directly to the named beneficiaries on the death of the owner. KRS 292.6507. The transfer "is effective by reason of the contract regarding the registration between the owner and the registering entity and KRS 292.6501 to 292.6512 and is not testamentary." KRS 292.6509. However, the property in this account remains subject to inheritance taxes as if part of the estate, unless the beneficiary is exempt by statute. This account appears to have been transferred to Mrs. McVey's step-daughter, Jimmy Lois Tureene, and nephew, Stanley K. Laughlin, Jr., with each taking 50%.

The remainder of her property, valued at $240,522, was subject to a will, which was probated in Pike District Court as the Estate of Mildred McVey.1 Mrs. McVey's nephew, Laughlin, was appointed administrator of the estate. The properly deductible costs of administering the will totaled $25,687.03,2 leaving $214,834.97 in property to be distributed. Mrs. McVey made various specific bequests of money and property, real and personal, to individuals and churches. These bequests had a total value of $71,922, leaving a total of $142,912.97 as the residuary estate.3

Of the residuary estate, half was slated to be left to three individuals in varying percentages.4 Mrs. McVey's step-daughter, Jimmy Lois Tureene, was given 64.71%; her nephew, Stanley Laughlin, was given 29.41%; and Billy Rice, who apparently was not kin to Mrs. McVey, was given 5.88%. The other half of the residuary estate was not addressed in the will and thus was set to pass through intestacy to her heirs at law. Her only heir at law was Laughlin.

The residuary estate, however, was not free and clear to pass to these beneficiaries and heir. Mrs. McVey intended her estate to pass "tax free" to the beneficiaries, with their inheritance taxes paid instead out of the residuary estate. Thus, she included the following "tax-free clause" or "tax-exoneration clause" (or in reality a bequest of tax) in her will:

Any death or inheritance taxes payable at my death on my estate whether on property passing under this will or otherwise shall be paid out of my residuary estate as a cost of administration and shall not be charged in any way to any beneficiary or recipient of my estate.

The Estate prepared a Kentucky inheritance and estate tax return. The return reflects the transfers on death to Tureene and Laughlin, which were taxable events to the extent not exempted by nature of their relationship to Mrs. McVey. (Under the statute, Tureene's transfer was exempt because she was a step-child; Laughlin's was not because he was a nephew.) The return also reflects the specific bequests in the will, though the specific cash amounts listed are less than their face value in the will, apparently because the Estate believed, based on its view that the tax-exoneration clause should be given effect before the specific bequests, that there would be insufficient cash after payment of costs and taxes to cover the full bequests.

The return does not show a residuary estate to pass after payment of taxes because, according to the Estate's calculations, the entire residue will be consumed by costs and taxes. (This is stated in the future tense, because the estate has not yet been finally settled.) In addition to the allowed costs noted above, the Estate included the costs of taxes as a debt of the decedent, which reduced the property available in calculating the distributive shares of beneficiaries.

The return includes a tax-computation page with a multi-column table showing all the gifts from the estate and the tax owed on them. One column describes the beneficiaries and the gifts they received. The second shows the beneficiaries' relationship to the decedent. Another column, labeled "Distributive Share," shows the value of each gift. The final column shows the amount of tax owed, if any, on each gift. Several of the beneficiaries were exempt from tax, such as the step-daughter Tureene, see KRS 140.080(1)(c)(4), and the churches, see KRS 140.060, which is reflected in the tax column.

But the remaining beneficiaries—a trio of great-nieces, a recipient of a specific cash bequest (North Middletown Cemetery), and Laughlin—were not exempt. Their total inheritance-tax liability was calculated as $134,369.48. This number included the taxes to be paid on behalf of the great-nieces and the cemetery. It also included a calculation of two instances of "bequest of tax": the tax on the tax to be paid on behalf of the great-nieces, and a second level of tax on the first bequest of tax.5 The bulk of the total tax, $132,387.80 of it, reflected the tax on the portion of the TOD account and other property that passed to Laughlin. The return does not show a bequest of tax for Laughlin.

The Department of Revenue conducted an audit of the return, finding several claimed errors.

First, the Department corrected an error in how the tax was calculated on the great-nieces' gifts, and added a calculation for bequest of tax for the cemetery. At the hearing before the Kentucky Board of Tax Appeals, and before this Court, the Department claimed that its adjustments here were only to correct a simple math error, but that is only half correct as examination of the corrected return shows more than a simple math...

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