• Don't Rock the Section 2053 Boat - You'll Tip the 706 Over
  • September 21, 2011 | Authors: Robin L. Klomparens; Douglas L. Youmans
  • Law Firm: Wagner Kirkman Blaine Klomparens & Youmans LLP - Mather Office
  • Mark Hughes died in May 2000 with an estate of more than $300 million. The federal estate tax return showed estate taxes of more then $200 million. The Hughes estate had substantial tax liability but, due to the nature of the trust’s investments, did not have sufficient liquid assets to pay this liability. Most of the trust’s assets were in limited liability companies from which the trust had no power to compel cash distributions, and the trust’s interests were subject to stringent restrictions on transfer. Thus, through a settlement with the IRS, the trustees agreed to borrow $49 million from a third party using a zero coupon loan transaction to pay the federal and state tax liabilities. The loan would carry a rate of 8.75 percent, with all unpaid principal interest due on December 31, 2027. Aside from a $10 million payment due September 9, 2005, no interim interest payments would be required for the loan. The trust would incur a total of approximately $309 million in deductible interest expense by the due date of the loan because prepayment of the loan was prohibited. Because IRC § 2053 permits a current estate tax deduction for all interest payable throughout the term of the 25-­-year loan, with no present-­-value discount of this sum, the trustees calculated this financing arrangement would reduce the trust’s liability for estate tax by more than $166.5 million. Absent any loan transaction, the trust owed $212,460,485 in estate taxes, due immediately. However, by using IRC § 2053 to deduct the full amount of interest paid on a $49 million loan, the trust court successfully reduce its estate taxes to approximately $49 million, for a savings of $166.5 million in estate taxes paid to the IRS. The trial court approved the trustees entering into a loan to pay its estate taxes over the objections of the guardian of the estate’s principal beneficiary. The appeals court affirmed the lower court’s decision.