Rev. Rul. 75-239

Advice has been requested whether interest expense payable on the unpaid balance of a decedent's Federal estate tax liability, deferred under section 6166 of the Internal Revenue Code of 1954, is deductible under section 2053(a)(2) as an administration expense.

The decedent died on January 1, 1971, and his gross estate included 1000 shares of stock of the X corporation, a closely held business. The decedent's X corporation stock constituted one-third of the outstanding voting shares of the company, and the value of such stock constituted 50 percent of the value of the decedent's gross estate.

The decedent's Federal estate tax return was timely filed nine months after his date of death. Of the total Federal estate tax liability shown on the return, one-half was attributable to property included in the gross estate other than stock in the X corporation. This portion of the tax liability was paid when the return was filed. The other half of the tax liability was attributable to the X corporation stock and under the provisions of section 6166 of the Code a notice of election to pay such tax in ten installments was filed with the return. The first installment of one-tenth of the deferred tax liability was also paid when the return was filed.

Under the laws of the State in which the decedent resided at his date of death, reasonable and necessary expenses, including interest payments, actually paid or payable by an executor are allowable by the court in the settlement of his fiduciary account.

Section 2053(a)(2) of the Code provides that the value of the taxable estate shall be determined by deducting from the value of the gross estate such amounts for administration expenses as are allowable by the laws of the jurisdiction under which the estate is being administered. Deductible administration expenses include attorney fees executor commissions, filing fees, appraisal fees, interest, etc.

Under section 20.2053-3 of the Estate Tax Regulations, the amounts deductible from a decedent's gross estate as administration expenses are limited to such expenses as are actually and necessarily incurred in the administration of the decedent's property--that is, in collecting his assets, paying his debts, and distributing the property to the persons entitled to receive it. Deductible debts include unpaid income taxes for past years to date of death for income received prior to death, and unpaid gift taxes due upon gifts made by the decedent during his lifetime. Neither state inheritance taxes nor Federal estate taxes are deductible.

Section 6166(a) of the Code provides that an extension of time may be granted, up to ten years, for the payment of the estate tax where the value of an interest in a closely held business, that is included in determining the gross estate of a decedent, exceeds 35 percent of the gross or 50 percent of the taxable estate of the decedent. Section 6166(c)(3) defines a qualifying interest in a closely held corporation as one in which 20 percent or more in value of the voting stock of such corporation is included in determining the decedent's gross estate or where the corporation has 10 or less shareholders. If these percentage requirements are met, an allocable portion of the tax may be deferred whether or not the estate has sufficient liquid funds to pay all the tax at the due date.

Section 6601(b) of the Code, as in effect now, provides for an interest rate of four percent per year as an exception to the standard six percent rate for unpaid Federal taxes. This exception applies only to the estate tax and only under certain circumstances. It is afforded an estate in those cases where an extension of time for payment has been granted (1) under the provisions of 6161(a)(2) after a finding of undue hardship, (2) under 6163(a) if the value of a reversionary or remainder interest is included in the value of the decedent's gross estate, and (3) under 6166(a) if the value of a closely held business is included in the estate and such property interest exceeds 35 percent of the gross or 50 percent of the taxable estate of the decedent. Under these circumstances, the estate is entitled to the benefit of the four percent rate on the tax paid within the time limit as exended.

Section 7 of Public Law 93-625, page 510, this Bulletin, enacted January 3, 1975, added section 6621 to the Code, increasing the rate of interest on underpayments and overpayments from 6 to 9 percent a year. It takes effect on July 1, 1975, and applies to underpayments and overpayments outstanding on such date or arising thereafter. Section 6621 also provides for periodic adjustments, if necessary, to increase or decrease the 9 percent rate to keep it approximately equal to 90 percent of the then current prime interest rate.

Section 6601(f)(1) of the 1954 Code provides that interest imposed on deferred tax payments "shall be assessed, collected, and paid in the same manner as taxes." Previously, the 1939 Code counterpart of this section read that such interest shall be collected "as a part of such amount of the tax."

In Ballance v. United States, 347 F. 2d 419 (7th Cir. 1965), a case decided under the 1939 Code, the court held that where an extension to pay the tax as shown on the decedent's Federal estate tax return was granted under the predecessor of section 6161(a)(2) of the 1954 Code, relating to extensions for reasons of undue hardship, the interest incurred on such deferred amounts was not deductible as an administration expense. In reconciling the predecessor of section 2053(a)(2) with the predecessor of section 6161(a)(2), the court noted the observation made by the Supreme Court of the United States in Bruning v. United States, 376 U.S. 358 (1964), Ct. D. 1888, 1964-2 C.B. 500, to the effect that "In most situations, interest is considered to be the cost of the use of the amounts owing a creditor and an incentive to prompt payment and, thus, an integral part of the continuing debt. Interest on a tax debt would seem to fit that description."

The court in Ballance went on to state "[That] in view of the specific requirements of [the Code] that the government be reimbursed by interest for the temporary period of loss of the use of the tax money during an extension after its payment is due, we perceive no basis for imputing to Congress a concomitant intent that the general provisions relating to administration expenses was to afford an avenue through which the amount of the tax itself was to be reduced because of the interest exacted for the delay in its payment." The court's latter statement implies that while the government does not have the use of the money, deferral of the tax permits the taxpayer to continue to enjoy that amount of money or other property. See also Leopold v. United States, 72-1 U.S.T.C. 84716 (1972), disallowing an interest deduction on a Federal estate tax deficiency.

The rationale of Ballance as applied to the predecessor of section 6161(a)(2) of the Code is equally applicable to section 6166(a). From the date a return is filed until the date the tax liability is discharged, the taxpayer has an obligation to pay its tax to the government. During the deferral period, the taxpayer, by reason of a 6166 election, has the use of funds which, but for the election, would rightfully have been in the possession of the government. The interest charge is necessary to preserve intact the amount owing and payable at the due date until such time as the full amount is actually collected, and the interest does not increase the value of the right to receive the tax viewed at the date of death. To allow a deduction for the interest charge would have the effect of reducing the amount of the tax itself.

Further, to allow a deduction for the interest charge attributable to deferred estate taxes could allow the estate to preserve and/or increase its corpus value without paying the Federal estate tax due on its real value.

Items such as attorney fees, executor commissions, filing fees, appraisal fees, and death taxes paid at the due date, have the effect of reducing the net worth or the equity of the estate corpus on which the estate tax is payable, and are for that reason real expenses. In contrast, post-death interest expenses or charges are quite different in effect from conventional administration expenses.

In James S. Todd, 57 T.C. 288 (1971), acq., 1973-2 C.B. 4, and Hipp v. United States, 72-1 U.S.T.C. 84678 (D.S.C. 1971), the Tax Court of the United States in the former case and the district court in the latter held that where an estate lacked sufficient liquid assets to pay Federal estate taxes, interest incurred on a loan from a private lender to pay such taxes was deductible as an administration expense. These cases are distinguishable from Ballance, and the instant case, since there the government did not lose the use of the tax money, and the interest was paid to a private creditor and not to the Government.

Accordingly, the interest expense payable by the executor on the unpaid balance of the decedent's Federal estate tax, which the executor elected to pay in installments under section 6166 of the Code, is not deductible from the decedent's gross estate as an administration expense under section 2053(a)(2).

The conclusion reached in this Revenue Ruling is applicable to section 6161 of the Code, relating to extensions for reasonable cause or undue hardship, and to section 6163, relating to extensions where the estate includes a reversionary or remainder interest in property.