Appeal by taxpayers from decision of the United States Tax Court, Tannenwald, Judge, disallowing certain administration expenses as deductions in computing federal estate tax.
Kaufman, Chief Judge, Anderson, Circuit Judge and Mulligan, Circuit Judge dissenting.
David Smith, a sculptor, died on May 23, 1965 possessed of 425 pieces of sculpture, which he had created, along with cash and other liquid assets totalling $210,647.08. His will, dated January 21, 1965, was admitted to probate by the Surrogate's Court of Warren County, New York, and Ira M. Lowe, Clement Greenberg, and Robert Motherwell were duly appointed and qualified as co-executors.
Had the large number of artistic works which he left at his death been generally known and had all of these works been immediately placed on the market they would have brought substantially less than could be received by feeding them slowly into the market over a period of time. Shortly after Smith's death, therefore, the executors began an orderly process of gradual liquidation of the Estate's holdings of sculpture through Marlborough-Gerson Galleries, which was entitled to a commission on each piece of sculpture sold in accordance with a 1963 contract that was subsequently renewed by the executors in 1968 and 1970. From May 23, 1965 through April 30, 1970, an aggregate of $1,187,144.67 in commissions was paid to Marlborough and allowed by the Surrogate's Court. Further commissions of $396,400 were paid by the Estate to Marlborough from May 1, 1970 through August 21, 1973 and the Surrogate's Court allowed these as well.
A federal estate tax return was filed on August 24, 1966 and a deficiency was agreed upon and paid on July 10, 1968. On August 7, 1969, the Commissioner of Internal Revenue (Commissioner) issued a notice of deficiency for $2,444,629.17 based upon a valuation of Smith's estate of $5,256,918 and a disallowance of any payments of commissions in excess of $289,661.65.
Upon a petition by the executors for redetermination, the Tax Court reduced the value of the estate to $2,700,000, and no appeal has been taken from this appraisal. From the time of Smith's death to August 21, 1973, the executors paid to the Galleries, with the approval of the Surrogate's Court*fn1, the total sum of $1,583,544.67 in commissions for sales of Smith's works, but the Tax Court allowed the Estate only $750,447.74 as deductions for sales commissions under § 2053(a)*fn2 of the Internal Revenue Code of 1954 (26 U.S.C. § 2053(a)) and Treas. Reg. § 20.2053-3.*fn3 This allowance was the exact amount necessary to pay the decedent's debts, the expenses of administration, and taxes as finally adjudicated.
Appellants first argue that, given the speculative and volatile market value of the sculptures, which were the Estate's major assets, they were under a duty to liquidate sufficient of these assets as were necessary adequately to preserve their value, provide for debts, anticipated administration expenses and taxes of the Estate and diversify properly the Estate's investments. In particular, they claim to have been put on notice by the Commissioner's Notice of Deficiency dated August 7, 1969 that they had to be prepared to meet a contingent liability of $2,444,629.17 in additional federal estate taxes and $570,193.23 in additional New York estate taxes, and that sales to meet these obligations alone would have incurred more in commissions than the entire $1,602,644.67 which they in fact paid and now seek as a deduction. The disputed sale expenses, they contend, were therefore incurred as necessary steps in the course of their administration of the Estate and are deductible under Treas. Reg. § 20.2053-3(d)(2). The evidence indicates, however, that all of the expenses disputed by the Commissioner were incurred before the notice of deficiency was issued, all commissions incurred subsequent to the notice of deficiency having been allowed. In fact, the $579,323.30 in cash needed to pay the expenses, debts, and taxes incurred by the Estate to April 30, 1970 had been realized by the Estate from the sale of sculpture by February 28, 1967. Under these circumstances the Tax Court's determination that no more than $750,447.74 in sales commissions were necessary either to preserve the estate or pay debts, administrative expenses and taxes is not clearly erroneous. See Commissioner v. Duberstein, 363 U.S. 278, 4 L. Ed. 2d 1218, 80 S. Ct. 1190 (1960).
Appellants further contend that the allowance by the New York Surrogate's Court of all of the sales commissions as administrative expenses is determinative of their deductibility under § 2053(a) of the Internal Revenue Code of 1954 and Treas. Reg. § 20.2053-3(d)(2), and that if Treas. Reg. § 2053-3(d)(2) is read to deny a deduction for administration expenses properly allowed by state law, § 20.2053-3(d)(2) is invalid. This argument is inapposite, however, to the facts of the instant case.
Both § 222 of the New York Surrogate's Court Act and Treas. Reg. § 20.2053-3, like most state laws concerning executors and administrators, require an administrative expense to be "necessary" in order to be allowable. See 31 Am.Jur.2d Executors and Administrators §§ 524, 527 (1967); In re Rosenberg's Estate, 169 Misc. 92, 6 N.Y.S.2d 1009, 1012-1013 (Sur. Ct. 1938). Normally, therefore, a Surrogate's court decree approving expenditures by an executor as proper administrative expenses under New York law will be controlling and will not raise questions concerning possible discrepancies between § 2053 of the Internal Revenue Code of 1954 and Treas. Reg. § 20.2053-3(d)(2). See Treas. Reg. § 20.2053-1(b)(2) ("The decision of a local court as to the amount and allowability under local law of a claim or administration expense will ordinarily be accepted if the court passes upon the facts upon which deductibility depends."); Dulles v. Johnson, 273 F.2d 362 (2 Cir. 1959), cert. den., 364 U.S. 834, 5 L. Ed. 2d 60, 81 S. Ct. 54 (1960); Sussman v. United States, 236 F. Supp. 507 (E.D.N.Y. 1962).
As noted in Pitner v. United States, 388 F.2d 651, 659 (5 Cir. 1967), however, the interest of the federal government in taxing the passage of property from a decedent's estate to individual beneficiaries or to a trustee will not always completely or accurately be reflected in a state's interests in supervising the fiduciary responsibilities of executors. In the present case, appellants' claims for administration expenses were not contested in the Surrogate's Court and there is some question as to whether some of these expenses were in fact incurred for the benefit of the estate in accordance with the general purpose of § 2053 rather than for the benefit of individual beneficiaries. See Commercial Nat. Bank of Charlotte v. United States, 196 F.2d 182, 183-184 (4 Cir. 1952); Cf. United States v. Stapf, 375 U.S. 118, 130-31, 11 L. Ed. 2d 195, 84 S. Ct. 248 (1963), reh. den., 375 U.S. 981, 84 S. Ct. 477, 11 L. Ed. 2d 428 (1964). In such circumstances, the federal courts cannot be precluded from reexamining a lower state court's allowance of administration expenses*fn4 to determine whether they were in fact necessary to carry out the administration of the estate or merely prudent or advisable in preserving the interests of the beneficiaries. Cf. Commissioner v. Estate of Bosch, 387 U.S. 456, 18 L. Ed. 2d 886, 87 S. Ct. 1776 (1967); Commercial Nat. Bank of Charlotte v. United States, 196 F.2d 182, 185 (4 Cir. 1952); Treas. Reg. § 20.2053-1(b)(2). Viewed from this standpoint, the Tax Court's determination that the additional sales of sculpture were not necessary to preserve the estate or to effect its distribution did not involve a refusal to follow New York law, but rather was the result of a de novo inquiry into the factual necessity for these expenditures.
It is, therefore, unnecessary to pass on whether Treas. Reg. § 20.2053-3(d)(2) is invalid if read to deny a deduction properly allowed by state law. As the determination of the Tax Court is not clearly erroneous, it is affirmed.