Rev. Rul. 80-159

ISSUE

For purposes of determining the amount of the marital deduction allowable under section 2056 of the Internal Revenue Code, is the value of property bequeathed and devised to the surviving spouse reduced by the payment of interest accrued on unpaid federal estate tax, under the circumstances described below?

FACTS

D, a resident of State X, died in 1977. The will provides for a legacy of $50,000 to D's parents and for the balance of the estate to be divided equally between D's child and surviving spouse. The will states that the parents' legacy is to be free of any federal or state taxes imposed as a result of D's death. Aside from this provision, the will does not direct how such taxes, debts, and funeral and administration expenses are to be paid.

Under the law of State X, in the absence of an express contrary direction in a decedent's will, all death taxes are to be equitably apportioned against those beneficial interests in the estate that give rise to such taxes. Any of such taxes that are payable with respect to beneficial interests from which the decedent has expressly removed the tax burden are payable pro rata by those beneficial interests which give rise to such taxes and which are not exonerated. Interest payable to government authorities with respect to death taxes is payable in the same fashion as the death taxes themselves. Such interest is allowable as a probate expense.

The law of State X provides that in the absence of a contrary expression by the testator, all debts of the decedent and all administration expenses are payable from the general assets of the probate estate.

Because ninety percent of D's gross estate consists of the value of a closely held business, the estate has elected, under section 6166A of the Code, to make 10 annual installment payments of that portion of the federal estate tax liability that is attributable to the closely held business. The estate has paid two installments of estate tax and has also paid interest on the deferred tax.

The provisions of the death tax statute in State X are identical to the federal estate tax provisions. Therefore, the property passing to the surviving spouse does not generate any death taxes.

The estate has claimed a deduction, under section 2053 of the Code, with respect to the interest paid with the federal tax installments. Although the interest is treated as an administration expense for estate tax deduction purposes, the interest expense has not been paid from the general probate assets, from which other administration expenses are payable. Instead, the interest payment has been apportioned among the taxable beneficial interests in the estate in the same manner as the underlying taxes.

LAW AND ANALYSIS

Section 2056 of the Code provides for a deduction, with certain limitations, of the value of property that passes from the decedent to the surviving spouse. Section 2056(b)(4) requires that the value of property passing to the spouse shall be determined (A) by taking into account the effect that any estate or inheritance tax has on the net value of the interest passing to the surviving spouse, and (B) by taking into account any encumbrance or obligation with respect to such interest.

In this case, the property passing to the surviving spouse does not generate any death taxes and therefore is not burdened with the payment of the taxes.

Under section 2053(a)(2) of the Code and the applicable regulations, the amount of administration expenses, that are allowable under local law and that are actually and necessarily incurred, is deductible in determining the value of the taxable estate. Accrued interest that is payable on estate tax deferred under section 6166A of the Code is a necessary administration expense and is deductible to the extent allowable under local law. See Estate of Bahr v. Commissioner, 68 T.C. 74 (1977), acq., 1978-1 C.B. 1; Rev. Rul. 78-125, 1978-1 C.B. 292, revoking Rev. Rul. 75-239, 1975-1 C.B. 304.

Although the interest payment is an administration expense for purposes of the federal estate tax deduction, local law governs the source from which the executor must make the interest payment. Under the law of State X, interest payable with respect to death taxes must be apportioned in the same fashion as the taxes themselves. Therefore, the interest paid on deferred federal estate tax in the present case is payable only from those assets that pass to the child.

HOLDING

Pursuant to the application of the law of State X, the interest paid on federal estate taxes deferred under section 6166A of the Code does not require a reduction to the net value of property passing to the surviving spouse, for purposes of determining the amount of the federal estate tax marital deduction allowable under section 2056.