Allen Johnson, Administrator D/b/n C.t.a. of the Estate Ofeleanor Brazelton, Appellee, v. United States of America, Appellant, 742 F.2d 137 (4th Cir. 1984)

The United States appeals from a judgment entered against it based upon the ruling that the plaintiff estate was entitled to an estate tax deduction under Sec. 2053 of the Internal Revenue Code of 1954, 26 U.S.C. § 2053, which had erroneously been disallowed, and hence was entitled to a tax refund to the extent that it had overpaid federal estate taxes as a result of the disallowance. We conclude that on the present record the district court erred in awarding the refund. We reverse and remand for further proceedings.

Eleanor Brazelton died testate on September 10, 1975. Though her husband, Terrill Brazelton, survived her, she left her entire estate to her foster son, Earl Shifflett. Her estate consisted primarily of Beaulassie Farm in Shenandoah County, Virginia, on which Earl Shifflett lived and worked.

Just prior to Eleanor Brazelton's death, the Internal Revenue Service (IRS) had sent a notice of deficiency to her and her husband proposing $481,478.73 in tax deficiencies and $24,073.93 in negligence penalties relating to their joint income tax returns for the taxable years 1968 through 1971. The tax deficiencies were attributable solely to the income of Terrill Brazelton and not to the income of Eleanor Brazelton. Terrill Brazelton ultimately reached a settlement with the IRS in which he and the estate of Eleanor Brazelton were declared jointly liable for tax deficiencies of $278,277.00, penalties of $13,918.85, and interest. Payment of the agreed amount was not immediately forthcoming, and in June 1977, the IRS recorded a lien against Beaulassie Farm, as property of the estate of Eleanor Brazelton. On July 25, 1977, the IRS mailed a final notice before seizure of Beaulassie Farm to Terrill Brazelton and Eleanor Brazelton's estate.

In order to prevent the IRS from selling Beaulassie Farm, Terrill Brazelton, Earl Shifflett, and the administrator of the estate made an agreement among themselves how to make payment to the IRS. Terrill Brazelton agreed to pay $261,250.00 of the tax liability and to release all claims he might have against Beaulassie Farm. The estate agreed to release all rights to contribution that it might have against him and to pay the remaining $179,865.48 of the tax liability. The estate raised the money for its share of the payment by mortgaging Beaulassie Farm.

In September 1978, Terrill Brazelton filed suit in a Virginia state court against the estate and Earl Shifflett to obtain reimbursement for part of the taxes paid by him. The estate and Shifflett counterclaimed for the amount of tax liabilities paid by the estate, contending that their prior agreement as to payment was invalid. The state court found that the estate and Shifflett had effectively relinquished their rights of contribution against Terrill Brazelton, and accordingly found for Terrill Brazelton on the counterclaim. Terrill Brazelton v. Allen D. Johnson, et al., Order-Law No. 368 (Circuit Court of Shenandoah County, Virginia, May 21, 1980).

The estate claimed an estate tax deduction under 26 U.S.C. § 2053(a) for the portion of the joint tax liability of Terrill and Eleanor Brazelton paid by it. The IRS disallowed the deduction and assessed a deficiency of $56,336.00 plus interest, which was paid by the estate. The IRS disallowed a claim for a refund, and on March 3, 1981, the estate filed suit in district court.

The district court decided the case on the basis of stipulated facts. It determined that the estate was entitled to a refund, and granted summary judgment.

This case requires us to interpret 26 U.S.C. § 2053(a)¹  and its accompanying regulation, 26 C.F.R. Sec. 20.2053-6(f).²  In assessing the deficiency against the estate, the IRS contended that the amount of Terrill and Eleanor Brazelton's joint tax liability that the estate had paid was not properly deductible because none of the liability was attributable to Eleanor Brazelton and the amount that the estate had actually paid would have given the estate rights of contribution against Terrill Brazelton.³  The IRS contended that the agreement between Terrill Brazelton, Earl Shifflett and the estate in which the estate relinquished its rights of contribution against Terrill Brazelton for the tax payment did not alter the fact that the original tax payment did give rise to a right of contribution against Brazelton and thus was not a deductible payment under the language of 26 C.F.R. Sec. 20.2053-6(f), which permits deduction of payments of joint tax liability only in an "amount for which the decedent's estate would be liable under local law .... after enforcement of any effective right of reimbursement or contribution."

The estate, for its part, maintained that it did not have an effective right of contribution against Terrill Brazelton because it had relinquished that right in order to secure Terrill Brazelton's agreement to pay at least part of the joint tax liability, delinquency in which threatened the estate's major asset, Beaulassie Farm, with sale to satisfy the liability. Absent an effective right of contribution, the estate contended, the entire amount of its payment on the joint tax liability was deductible. The estate was successful in this argument before the district court.

We think that neither the position adopted by the district court nor that urged on us by the government is correct.

It is clear that the district court's approach cannot be sustained. Essentially, the district court found that whatever amount of the joint tax liability the estate paid would have been deductible so long as the estate in paying it had relinquished its rights of contribution against Terrill Brazelton. While there is no evidence of collusion in the present case, to adopt the rule utilized by the district court would create a great incentive and opportunity for tax avoidance by means of collusive arrangements to shift as large an amount as possible of a joint income tax liability between a living and deceased spouse onto the deceased spouse's estate. More importantly, the approach adopted by the district court conflicts with the provisions of the regulation. Even though the estate, for whatever reason, chose to relinquish its rights of contribution against Terrill Brazelton, its undertaking to pay and payment of a portion of Terrill and Eleanor Brazelton's joint tax liability would have, in the absence of the relinquishment thereof, given its rights of contribution under Virginia law. The relevant portion of 26 C.F.R. Sec. 20.2053-6(f) provides:

.... in a joint income tax return filed by the decedent and his spouse, or by the decedent's estate and his surviving spouse, the portion of the joint liability for the period covered by the return for which a deduction will be allowed is the amount for which the decedent's estate would be liable under local law, as between the decedent and his spouse, after enforcement of any effective right of reimbursement or contribution. (Emphasis added.)

By the terms of the regulation, therefore, the amount covered by these rights of contribution, whether exercised or not, must be excluded from any deduction claimed by the estate. Whether rights of contribution are enforced and, it follows, whether they are retained in the first place, makes no difference to calculating the allowable deduction for liabilities of the estate under Sec. 20.2053-6(f).⁴ 

On the other hand, the government's position is untenable insofar as it suggests that because the estate, in the absence of the agreement with Terrill Brazelton, had rights to contribution from Terrill Brazelton under state law, it cannot deduct any amount of the payment of the joint tax liability for which contribution could have been sought from Terrill Brazelton. The regulation, 26 C.F.R. Sec. 20.2053-6(f), specifies that amounts paid by an estate in satisfaction of joint tax liability may be deducted for estate tax purposes to the extent that they are amounts "for which the decedent's estate would be liable under local law .... after enforcement of any effective right of reimbursement or contribution." The proviso that to limit deductibility, the right of contribution must be "effective" has been interpreted to mean that the party from whom contribution is sought must be solvent. See McClure's Estate v. United States, 288 F.2d 190, 192, 153 Ct. Cl. 226 (1961). The government's position makes no provision for an inquiry into Terrill Brazelton's solvency; rather, the government would maintain that inasmuch as the estate bargained away its right to contribution against Terrill Brazelton, the amount of joint tax liability that it paid was presumptively nondeductible. The government's position thus also contravenes the provisions of 26 C.F.R. Sec. 20.2053-6(f).

Correct disposition of this case requires further factual inquiry than was made by the district court. Under state law, the estate had a right of contribution against Terrill Brazelton, which would have been an effective right of contribution if Terrill Brazelton had sufficient assets to meet it. There are two issues that are determinative regarding the deductibility of the payment made by the estate to satisfy the joint tax liability. The first is the extent of the estate's right to contribution against Terrill Brazelton under applicable local law. The district court, the parties and we are in agreement that there was a right of contribution.⁵  See n. 3, supra. It must be determined, however, whether the right of contribution extended to all or only part of the amount of the payment. The second issue is whether, had the estate pursued any right of contribution that it may have had at the time of its creation, Terrill Brazelton would have had adequate resources to meet the claim for contribution. If Terrill Brazelton had inadequate resources to meet all or part of the claim for contribution, then to that extent the right to contribution would have been ineffective and the estate's payment⁶  to that extent deductible.⁷ 

We reverse the judgment of the district court and remand the case to it for further proceedings consistent with this opinion.

REVERSED AND REMANDED.