Administrative Expenses Can Take A Bite Out of Delinquent Estate Taxes, Interest & Penalties
Client’s mother passed away in the early 1980s owning a number of properties in Los Angeles County, including a pair of valuable single family residences in Manhattan Beach. Client had originally attempted to administer the mother’s estate by himself and was even appointed as the Administrator of the mother’s estate by the Probate Court. Unfortunately, Client fell ill and never completed the administration of the mother’s estate. Following a full recovery, but more than twenty years later, Client, now elderly, and his family wished to develop and renovate the Manhattan Beach properties, which the family had been using as their residence and as an income producing rental since the mother’s death. Only at this time was it discovered by Client’s son-in-law that all of the properties were still the mother’s name, an obvious hurdle to obtaining financing for any possible development and/or to the sale of any of the properties. At the time of the mother’s death the properties were valued at $415,000. At the time at which Client met with CJT, the properties were valued at approximately $3,100,000.
Client came to CJT and was advised of numerous serious issues relating to the Estate. Not only had the administration of the probate Estate never been completed, but more significantly, both the state and federal inheritance/estate tax returns had never been filed (the mother had passed away while California still had its own separate inheritance tax, since repealed). The failure to file such returns not only created “secret” liens upon the property in favor of the government, but also resulted in penalties and an enormous amount of interest owing. After more than twenty years, the unpaid estate/inheritance tax, interest and penalties exceeded $575,000 and only continued to accrue. Facing a large tax bill such as this would unfortunately force the family to sell one of the two valuable and attractive Manhattan Beach properties, thereby eliminating elderly Client’s primary source of income.
Additionally, the failure to properly complete the administration of the Estate raised property tax reassessment issues as the mother’s death occurred prior to the passage of Proposition 58 (which now generally allows for the transfer of property tax bases between parents and children).
Client engaged CJT to represent Client to complete the probate administration; to prepare and file both the state and federal estate tax returns; and to address the property tax reassessment issues. CJT was able to have Client reinstated as Administrator of the Estate even though Client had previously failed to complete the administration. CJT was able to work with the probate referee, appointed by the Court, to obtain the most favorable valuations of the properties as of the mother’s date of death. CJT also worked closely with the probate referee in the preparation of the California Inheritance Tax Return, a function which must be performed by a probate referee, but which has not been necessary in California since 1982. Understandably, the probate referee was entirely unfamiliar with the process. CJT dealt directly with the lone remaining individual at the State Board of Equalization who was familiar with this particular type of return and obtained the most favorable outcome possible with respect to the California inheritance taxes, penalties and interest owed.
Most significantly, CJT was able prepare the federal estate tax return and obtain approval from the IRS, resulting in federal taxes, penalties and interest owed and paid of just $81,478, a savings of nearly $500,000. The amount owed and paid was approximately the same amount as the total original estate taxes that would have been owed in 1983, which, if paid at the time, would have necessitated the sale of one of the two Manhattan Beach properties (now each worth in excess of $1,200,000).
CJT thoroughly researched the relevant state and federal estate tax laws in effect for the time, while obtaining the more than twenty year old original state and federal tax forms needed to even properly complete and file the returns. The IRS itself took more than six months to find the proper federal forms, by which time CJT had located the forms elsewhere. CJT was able to successfully argue that a number of obscure and complex tax deductions were allowable in the calculation of the tax, interest and penalties for the Estate, most notably: the allowance of the deduction of all attorneys’ fees, Administrator’s fees and costs of administration (all incurred more than twenty years after death); the deduction of the costs relating to the sale of some of the properties (ordinarily not deductible, but in this case successfully argued as being necessary to pay the tax); and most notably, the allowance of the deduction for interest paid on overdue estate taxes. The interest deduction involved a complex calculation of how large a deduction would be needed to create an original tax due, and then penalties, resulting in an amount of interest due at the time of filing, which, if then paid, would yield the corresponding deduction. These calculations covered a period of more than twenty years of compounding interest, with rates changing at a minimum of quarterly. Due to the accruing interest over more than twenty years, each $1 dollar of allowed deductions, in effect, meant a savings of to the Estate of more than $6. The interest rate on unpaid tax during much of the 1980s exceeded 10%.
CJT referred Client to and worked directly with a reliable, experienced and reasonably priced CPA to deal with the income tax issues relating to the rental of properties and ongoing payments Client had made to himself as Administrator for managing the properties, technically owned by the Estate, which required the filing of fiduciary income tax returns for the Estate going back for more than twenty years. CJT also advised Client and CPA with respect to capital gain issues on the sale of certain properties.
CJT referred Client to and worked directly with a reliable and experienced realtor who was able to obtain maximum value for Client for the sale of a dilapidated rental property and a pair of vacant lots owned by the Estate. CJT was able to obtain Court confirmation of all sales of real property, such confirmation being required by the Court as a condition of the reinstatement of Client as Administrator.
Ultimately, Client was able to retain both Manhattan Beach properties, needing to sell only the aforementioned undesirable properties. The proceeds of such sales covered all of the unpaid taxes, interest, penalties, costs and attorneys’ fees, while still leaving Client additional funds. All told, due to the efforts of CJT, Client ended up in a more favorable position than had the administration been properly handled at the time of the mother’s death nearly 20 years earlier.