Estate of David Smith, Deceased v. Commissioner of Internal Revenue

510 F.2d 479

• Court: Court of Appeals for the Second Circuit
• Decided: February 4, 1975
• Docket: 133, Docket 74-1617
• Status: Published

Opinions

ROBERT P. ANDERSON, Circuit Judge:

David Smith, a sculptor, died on May 23, 1965 possessed of 425 pieces of sculpture, which he had created, along with cash and other liquid assets totalling $210,647.08. His will, dated January 21, 1965, was admitted to probate by the Surrogate’s Court of Warren County, New York, and Ira M. Lowe, Clement Greenberg, and Robert Motherwell were duly appointed and qualified as co-executors.

Had the large number of artistic works which he left at his death been generally known and had all of these works been immediately placed on the market they would have brought substantially less than could be received by feeding them slowly into the market over a period of time. Shortly after Smith’s death, therefore, the executors began an orderly process of gradual liquidation of the Estate’s holdings of sculpture through Marlborough-Gerson Galleries, which was entitled to a commission on each piece of sculpture sold in accordance with a 1963 contract that was subsequently renewed by the executors in 1968 and 1970. From May 23, 1965 through April 30, 1970, an aggregate of $1,187,144.67 in commissions was paid to Marlborough and allowed by the Surrogate’s Court. Further commissions of $396,400 were paid by the Estate to Marlborough from May 1, 1970 through August 21, 1973 and the Surrogate’s Court allowed these as well.

A federal estate tax return was filed on August 24, 1966 and a deficiency was agreed upon and paid on July 10, 1968. On August 7, 1969, the Commissioner of Internal Revenue (Commissioner) issued a notice of deficiency for $2,444,629.17 based upon a valuation of Smith’s estate of $5,256,918 and a disallowance of any payments of commissions in excess of $289,661.65.

Upon a petition by the executors for redetermination, the Tax Court reduced the value of the estate to $2,700,000, and no appeal has been taken from this appraisal. From the time of Smith’s death to August 21, 1973, the executors paid to the Galleries, with the approval of the Surrogate’s Court¹, the total sum of $1,583,544.67 in commissions for sales of Smith’s works, but the Tax Court allowed the Estate only $750,447.74 as deductions for sales commissions under § 2053(a)² of the Internal Revenue Code of 1954 (26 U.S.C. § 2053(a)) and Treas. Reg. § 20.2053-3.³ This allowance was the exact amount necessary to pay the decedent’s debts, the expenses of administration, and taxes as finally adjudicated.

Appellants first argue that, given the speculative and volatile market value of the sculptures, which were the Estate’s major assets, they were under a duty to liquidate sufficient of these assets as were necessary adequately to preserve their value, provide for debts, anticipated administration expenses and taxes of the Estate and diversify properly the Estate’s investments. In particular, they claim to have been put on notice by the Commissioner’s Notice of Deficiency dated August 7, 1969 that they had to be prepared to meet a contingent liability of $2,444,629.17 in additional federal estate taxes and $570,193.23 in additional New York estate taxes, and that sales to meet these obligations alone would have incurred more in commissions than the entire $1,602,644.67 which they in fact paid and now seek as a deduction. The disputed sale expenses, they contend, were therefore incurred as necessary steps in the course of their administration of the Estate and are deductible under Treas.Reg. § 20.2053— 3(d)(2).. The evidence indicates, however, that all of the expenses disputed by the Commissioner were incurred before the notice of deficiency was issued, all commissions incurred subsequent to the notice of deficiency having- been allowed. In fact, the $579,323.30 in cash needed to pay the expenses, debts, and taxes incurred by the Estate to April 30, 1970 had been realized by the Estate from the sale of sculpture by February 28, 1967. Under these circumstances the Tax Court’s determination that no more than $750,447.74 in sales commissions were necessary either to preserve the estate of pay debts, administrative expenses and taxes is not clearly erroneous. See Commissioner v. Duberstein, 363 U.S. 278, 80 S.Ct. 1190, 4 L.Ed.2d 1218 (1960).

Appellants further contend that the allowance by the New York Surrogate’s Court of all of the sales commissions as administrative expenses is determinative of their deductibility under § 2053(a) of the Internal Revenue Code of 1954 and Treas.Reg. § 20.2053 — 3(d)(2), and that if Treas.Reg. § 2053 — 3(d)(2) is read to deny a deduction for administration expenses properly allowed by state law, § 20.2053— 3(d)(2) is invalid. This argument is inapposite, however, to the facts of the instant case.

Both § 222 of the New York Surrogate’s Court Act and Treas.Reg. § 20.-2053-3, like most state laws concerning executors and administrators, require an administrative expense to be “necessary” in order to be allowable. See 31 Am. Jur.2d Executors and Administrators §§ 524, 527 (1967); In re Rosenberg’s Estate, 169 Misc. 92, 6 N.Y.S.2d 1009, 1012-1013 (Sur.Ct.1938). Normally, therefore, a Surrogate’s court decree approving expenditures by an executor as proper administrative expenses under New York law will be controlling and will not raise questions concerning possible. discrepancies between § 2053 of the Internal Revenue Code of 1954 and Treas.Reg. § 20.2053 — 3(d)(2). See Treas. Reg. § 20.2053 — 1(b)(2) (“The decision of a local court as to the amount and allow-ability under local law of a claim or administration expense will ordinarily be accepted if the. court passes upon the facts upon which deductibility depends.”); Dulles v. Johnson, 273 F.2d 362 (2 Cir. 1959), cert. den., 364 U.S. 834, 81 S.Ct. 54, 5 L.Ed.2d 60 (1960); Sussman v. United States, 236 F.Supp. 507 (E.D.N.Y.1962).

As noted in Pitner v. United States, 388 F.2d 651, 659 (5 Cir. 1967), however, the interest of the federal government in taxing the passage of property from a decedent’s estate to individual beneficiaries or to a trustee will not always completely or accurately be reflected in a state’s interests in supervising the fiduciary responsibilities of executors. In the present case, appellants’ claims for administration expenses were not contested in the Surrogate’s Court and there is some question as to whether some of these expenses were in fact incurred for the benefit of the estate in accordance with the general purpose of § 2053 rather than for the benefit of individual beneficiaries. See Commercial Nat. Bank of Charlotte v. United States, 196 F.2d 182, 183-184 (4 Cir. 1952); Cf. United States v. Stapf, 375 U.S. 118, 130-131, 84 S.Ct. 248, 11 L.Ed.2d 195 (1963), reh. den., 375 U.S. 981, 84 S.Ct. 477, 11 L.Ed.2d 428 (1964). In such circumstances, the federal courts cannot be precluded from reexamining a lower state court’s allowance of administration expenses⁴ to determine whether they were in fact necessary to carry out the administration of the estate or merely prudent or advisable in preserving the interests of the beneficiaries. Cf. Commissioner v. Estate of Bosch, 387 U.S. 456, 87 S.Ct. 1776, 18 L.Ed.2d 886 (1967); Commercial Nat. Bank of Charlotte v. United States, 196 F.2d 182, 185 (4 Cir. 1952); Treas.Reg. § 20.2053-1(b)(2). Viewed from this standpoint, the Tax Court’s determination that the additional sales of sculpture were not necessary to preserve the estate or to effect its distribution did not involve a refusal to follow New York law, but rather was the result of a de novo inquiry into the factual necessity for these expenditures.

It is, therefore, unnecessary to pass on whether Treas.Reg. § 20.2053 — 3(d)(2) is invalid if read to deny a deduction properly allowed by state law. As the determination of the Tax Court is not clearly erroneous, it is affirmed.

1 . Section 222 of the New York Surrogate’s Court Act, in effect at the time of decedent’s death, provided as follows:

Ҥ 222. Payment of expenses incurred by representative.

An executor, administrator, guardian or testamentary trustee may pay from the funds or estate in his hands, from time to time, as shall be necessary, his legal and proper expenses of administration necessarily incurred by him, including the reasonable expense of obtaining and continuing his bond and the reasonable counsel fees necessarily incurred in the administration of the estate. Such expenses and disbursements shall be set forth in his account when filed, and settled by the surrogate.”

§ 222 was succeeded as of September 1, 1967, more than two years after decedent’s death, by § ll-l.l(b)(23) of the New York Estates, Powers and Trusts Law (McKinney’s Consol. Laws, c. 17-b, 1967) (renumbered as of June 22, 1973 as ll-l.l(b)(22)), which provides that a fiduciary is authorized:

“(23) In addition to those expenses specifically provided for in this paragraph, to pay all other reasonable and proper expenses of administration from the property of the estate or trust, including the reasonable expense of obtaining and continuing his bond and any reasonable counsel fees he may necessarily incur.”

The revisers’ notes state that subparagraph (b)(23) is intended to incorporate the substance of § 222 of the Surrogate’s Court Act.'

2 . Section 2053 of the Internal Revenue Code of 1954 (26 U.S.C. § 2053(a)), provides as follows:

“(a) General rule — For purposes of the tax imposed by section 2001, the value of the taxable estate shall be determined by deducting from the value of the gross estate such amounts—

(1) for funeral expenses

(2) for administration expenses,

(3) for claims against the estate, and

(4) for unpaid mortgages on, or any indebtedness in respect of, property where the value of the decedent’s interest therein, undiminished by such mortgage or indebtedness, is included in the value of the gross estate,

as are allowable by the laws of the jurisdiction, whether within or without the United States, under which the estate is being administered.”

3 . Treas.Reg. § 20.2053-3 (1958), as amended by T.D. 6826, 30 F.R. 7708, June 15, 1965, provides in relevant part:

Ҥ 20.2053-3 Deduction for expenses of administering estate.

(a) In general. The amounts deductible from a decedent’s gross estate as ‘administration expenses’ of the first category (see paragraphs (a) and (c) of § 20.2053-1) are limited to such expenses as are actually and necessarily incurred in the administration of the decedent’s estate; that is, in the collection of assets, payment of debts, and distribution of property to the persons entitled to it. The expenses contemplated in the law are such only as attend the settlement of an estate and the transfer of the property of the estate to individual beneficiaries or to a trustee, whether the trustee is the executor or some other person. Expenditures not essential to the proper settlement of the estate, but incurred for the individual benefit of the heirs, legatees, or devisees, may not be taken as deductions

* * * * * *

(d) Miscellaneous administration expenses

(2) Expenses for selling property of the estate are deductible if the sale is necessary in order to pay the decedent’s debts, expenses of administration, or taxes, to preserve the estate, or to effect distribution

4 . Such administrative expenses must be the “type intended to be deductible” (United States v. Stapf, 375 U.S. 118, 130, 84 S.Ct. 248, 11 L.Ed.2d 195 (1964)), ultimately a question of federal law. See Pitner v. United States, 388 F.2d 651 (5 Cir. 1967). The holding in Pitner differs from the interpretation placed upon it by Judge Mulligan in his dissent. The court in that case assumed that the expense deduction was allowable by the laws of the jurisdiction under which the estate was being administered, and yet held that

“[i]n the determination of deductibility under section 2053(a)(2), it is not enough that the deduction be allowable under state law. It is necessary as well that the deduction be for an ‘administration expense’ within the meaning of that term as it is used in the statute, and that the amount sought to be deducted be reasonable under the circumstances. These are both questions of federal law and establish the outside limits for what may be considered allowable deductions under section 2053(a)(2).” 388 F.2d at 659.

Thus, the Fifth Circuit, as well as the Tax Court, have rejected the proposition that the only requirement for deductibility under Section 2053(a) is the allowability of the expense under state law.