Estate’s Settlement with Charities - Part Charitable Deduction, Part Taxable

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By Kathleen Ford Bay, Esq.
Potts and Reilly, L.L.P.., Austin, TX

Truism: Charities do not sue - they do not want the bad publicity. Reality: If there is enough money at stake and it appears the charities were significantly harmed by fiduciaries, the charities will not only threaten to sue, they will do so. In Estate of Williams v. Comr., T.C. Memo 2009-5, the estate successfully obtained a partial estate tax refund because a subsequent settlement distributed additional estate assets to several charities under a constructive sale theory.

Estate of Williams provides an in-depth look at complex estate/business planning between two families. Eugenia Williams' father partnered in a bottling enterprise for Coca-Cola in eastern Tennessee and part of Kentucky. Eugenia was the heir to her father's stock. Eugenia Williams had no children or grandchildren. She had a will and she left her stock in the business to the children of her father's business partner's family, the Roddys, and her residuary to four charities.

Eugenia was close to the Roddys and even made various Roddys fiduciaries under a power of attorney and successor trustees of a trust. Before she died a number of developments occurred with a complex sale of the bottling stock. Some of the Roddys sold their stock to Coca-Cola for substantial gains. Eugenia's stock was not sold by her fiduciaries, the Roddys. Instead, Eugenia's fiduciaries made her share subject to a “Right of First Refusal” with Coca-Cola Enterprises. This agreement allowed the Roddy family the right of first refusal. Coca-Cola entered into a subsequent “Conditional Agreement” with the Roddys to purchase any stock at a set price that they purchased from Eugenia. These agreements with Coca-Cola resulted in Eugenia receiving a stream of income during her life for entering into the Right of First Refusal. The same type of agreement was also entered into by an elderly member of the Roddy family. There was credible testimony that the purpose behind the agreements was not to sell Eugenia's interests in order to obtain a step-up in basis at her death; however, if the Roddys had sold her interest, the charities would have received the proceeds as part of Eugenia's residuary estate. The Roddys contend it was Eugenia's intent that they receive the stock, and that she was competent at all times.

At Eugenia's death four charities received about $6.7 million each - much less than if Eugenia's stock had been sold at the same time as her fiduciaries and other Roddy family members sold their stock. The estate later entered into a settlement agreement with the charities for an additional $20 million dollars under the theory that a constructive sale had occurred at the time the fiduciaries sold their own stock. If Eugenia had sold her stock, the stock would have been in the residuary estate, and passed to the charities.

After many hypotheticals and discussion of witnesses' testimony about the basis of the settlement - was the settlement a distribution of the proceeds of a constructive sale or the proceeds of a tort settlement of breach of fiduciary duty against the trustees - the Honorable Mark V. Holmes ruled that 90% of the settlement was deductible, since that portion is attributable to the constructive sale, and 10% was not, since that portion is attributable to other causes of action by the charities. The estate was entitled to a refund once the charitable deduction was applied to 90% of the settlement.

Practice Point: The IRS's position is that it is not bound by a lower court's decision and never bound by a non-adversarial proceeding. This case illustrates the detailed review that will occur if the IRS and taxpayer are unable to reach a compromise.

For more information, in the Tax Management Portfolios, see Beckwith, 839 T.M., Estate and Gift Tax Charitable Deductions, and in Tax Practice Series, see ¶6280, Charitable Deduction -- Section 2055.