Sometimes an estate and the IRS cannot agree on adjustments to an estate tax return where a section 6166 election has been allowed. A final examination determination can not be made until after the case has gone through Tax Court. The Tax Court then enters a decision setting forth the amount of the deficiency and the amount of any deduction allowed for interest. This would ordinarily occur at a point relatively early in a 14-year section 6166 deferral. Any required "catch-up" payment would be billed to the estate by Cincinnati Campus as soon as the new numbers were received. Future annual billing notices would be adjusted accordingly.
Dates of Death Before January 1, 1998: For estates of decedents dying before January 1, 1998, all interest accrued on Federal estate tax was allowable as a deduction on the estate tax return under section 2053. This included interest accrued on tax deferred under section 6166. Annual payments of interest (and tax, if installments were due) based on the original return figures are required during the course of an IRS examination, the subsequent Appeals process, and the Tax Court litigation. Hence, after entry of the Tax Court decision, supplemental estate tax returns would have to be filed to claim each year's annual interest payment as a new deduction on the estate tax return.
Dates of Death After December 31, 1997 - No State Death Tax: Notwithstanding Section 2053(c)(1)(D), an estate tax deduction for interest on Federal estate tax will be allowable under the following circumstances:
- If a deficiency is assessed. The new computation ordinarily creates underpayments of interest (and any installments) that were due on each anniversary date preceding entry of the Tax Court decision. Interest is computed at regular underpayment interest rates on each such underpayment from its respective due date forward until payment, and this interest is allowable as a deduction on the estate tax return (while the underlying underpayment amounts themselves are not deductible). This will be true even if 100% of the tax is deferred under section 6166 both before and after entry of the Tax Court decision.
- If there is an underpayment of non-deferred tax.
- If any payments previously due under the section 6166 election were not paid timely. This will be true even if 100% of the tax is deferred under section 6166 both before and after entry of the Tax Court decision.
If all future payments due IRS are paid timely and in the correct amounts, and any catch-up payment is timely made, and no (additional) state death tax is payable, the Federal interest deduction will not change. In this event, if the Tax Court decision incorporates all interest due and payable on the catch-up payment date, the Tax Court decision would be the final decision and would not need to be modified at the end of the 14-year section 6166 deferral period.
Dates of Death After December 31, 1997 - State Death Tax Payable: Interest accrued and paid on state death tax is allowable as a deduction in full, even if there is a state section 6166 election that incorporates the relevant Internal Revenue Code sections in state law (e.g., New York, or California for dates of death from January 1, 1999 through December 31, 2004). If the state interest is an allowable administration expense under local law, it is deductible on the Federal estate tax return even if state law does not allow a deduction for state interest on the state death tax return. See Reg. 20.2053-1(a)(1). Furthermore, section 2058 limits the state death tax deduction on the Federal estate tax return to the amount of state death tax that has actually been paid.
If all state death tax was paid on the original return due date, an IRS deficiency would ordinarily result in an increase to the state death tax payable. If this is the case, then there would be a deduction for the interest accrued on any state tax deficiency. However, as the section 2011 state death tax credit (for deaths occurring before 2005) or the section 2058 state death tax deduction increases, the Federal estate tax (and interest thereon) decreases, so any adjustments to state death tax and interest thereon must be interrelated with the Federal tax and interest.
Modifying a Tax Court Decision: Before 1988, the only procedure for modifying a Tax Court decision that had been entered in an on-going section 6166 deferral case was to include a stipulation that the decision could be modified at the end of the 6166 deferral period to reflect the additional interest payments allowable as new deductions. Absent such a stipulation, estates could not recalculate the tax to reflect those additional interest payments, which occurred often enough to present a problem. (Note: IRS Appeals retained jurisdiction over a few cases for the full 14-year deferral period as a work-around solution, incorporating the final figures at the end.)
In response, section 7481(d) was enacted to remove the need for a stipulation to claim new Federal or state interest deductions in on-going section 6166 cases. Upon motion by the estate, "the Tax Court may reopen the case solely to modify the Court's decision to reflect such estate's entitlement to a deduction for such administration expenses under section 2053," effective for Tax Court decisions that had not become final on November 10, 1988. Tax Court Rule 262 reflects the same and prescribes the content of such motions.
Also see Tax Court Litigation IRM 22.214.171.124.6, which provides
In cases where an estate tax liability has been deferred under section 6166, a final decision should be entered. Pursuant to section 7481(d) and T.C. Rule 262, the petitioner may file a motion to modify the decision for allowance of interest expenses paid during the extended payment period once all the payments have been made. Only one Rule 262 motion may be filed at the end of the extended payment period in each case, but the estate may administratively file supplemental Forms 706, U.S. Estate Tax Return, to periodically recompute the estate tax liability and thus reduce the amount of the installment payments due over the extended payment period. See Rev. Proc. 81–27, 1981–2 C.B. 548. In cases decided by the Tax Court, a Rule 262 motion is necessary to obtain a refund or credit of taxes overpaid during the installment period. As soon as the decision is filed, the petitioner should be reminded to file a motion under Rule 157 to have the Tax Court retain the official case file pending a Rule 262 motion. The attorney should also retain the legal file. If a Rule 262 motion for allowance of interest costs is filed, it should be reviewed for reasonableness. The attorney should ordinarily have no objection to the motion. If there is an objection, reasons and support therefor should be filed with the court.
Practice Notes For the Period Between a Tax Court Decision and the End of the 6166 Deferral Period: The section 7481(d) motion is intended to be a one-time motion filed at the end of the 6166 deferral period. This means that after entry of the initial Tax Court decision, an estate can file supplemental returns pursuant to Rev. Proc. 81-27 showing a reduction in tax, and Cincinnati Campus can reduce the tax assessment below the amount shown in the Tax Court decision - but only if there is no credit or refund resulting from such reductions. Cincinnati (or a field examination group, if the supplemental return were to be selected for field examination) would send the estate (or designated agent) a computation report and a waiver, Form 890, showing the reduction in tax to be assessed. Upon receipt of the signed waiver, Cincinnati would adjust the assessments on the account accordingly. In this fashion, an estate can continue to pay deductible state interest on a state section 6166 deferral as the Federal deferral continues, and can realize the attendant decreases in assessments and billing notices along the way.
However, at the end of the deferral period - or when an estate decides to pay off the entire account at an earlier date - it is possible to make the final payment by way of an up-front interest deduction computation without first going through the section 7481(d) motion procedure. But this will require the cooperation of an IRS Estate Tax Attorney at Cincinnati Campus, who will run the up-front interest deduction computation out to an agreed-upon payment date. All deductible interest will be calculated as of that date and will be incorporated in the payoff amount. The computation and a Form 890 waiver reflecting these figures will be sent to the estate well before the payoff date. The estate (or designated agent) will submit the requested payment and signed waiver to the IRS so that it is received on the payoff date.
Upon timely receipt of the signed waiver and payment, the IRS at Cincinnati could then make the final adjustments to zero out the account balance without utilizing the section 7481(d) procedure, because these final adjustments to the account would not generate a credit or a refund. This has happened in the past. Whether it will happen in the future is not known, because the IRS is not obligated to provide this up-front deduction computation service. Whether this should even occur in light of the language in section 7481(d) is another consideration. See the note below for a method of coordinating both concepts.
Historical Practice Notes: To expedite this process in several cases for Cincinnati Campus, before the end of the deferral period we ran "up-front" interest deduction computations carried out to the end of the deferral period (to obtain the final amounts due), and secured timely final payment and a signed waiver, Form 890, from the estate. The estate submitted the up-front interest deduction computation package, the signed waiver, and its Rule 262 petition to local IRS Counsel (District Counsel, at the time), who, it turned out, had never seen this before. Two different approaches were followed by Counsel.
Counsel on the East Coast essentially rubber stamped the Cincinnati computation figures and used them in the Rule 262 proceedings in Tax Court.
Counsel on the West Coast independently ran their own computations, reached the same end result, and submitted them to the Tax Court in their Rule 262 proceedings. In each case the total time elapsed from start to finish was about 9 months.
The major complaint that Cincinnati Campus had with the section 7481(d) procedure, however, was that they had to keep track of the entire 7481(d) process before they could make the final account adjustments, which, as noted, took at least 9 months. If they had followed their initial inclination they would have immediately input the final adjustments, issued the final estate tax closing letter, and closed the file, as had been done with other similar cases.