Heckscher, Teillon, Terrill & Sager, P.C.
Home West Conshohocken Attorney About Us Attorneys Client Information Publications Firm News Staff Directory Directions

RECENT CASE ILLUSTRATES IMPORTANCE OF PRECISE TAX CLAUSES

The allocation of death taxes, while often overlooked in estate planning, can have significant effects on the distribution of a decedent's estate. A recent decision by the Superior Court of Pennsylvania serves as a reminder of the importance of mindfulness in planning and drafting in this regard.

InIn Re Estate of Leo I. Davis, 2015 WL 8123895, ___ A.3d ___ (Pa. Super. 2015), the decedent left a $10,000 bequest to a friend, and gave 40 percent of the residue of his estate to his nephew and 60 percent of residue to three charities. The decedent also had a non-probate asset, an annuity, which was payable to his niece and nephew upon his death and which did not pass under his will. For Pennsylvania inheritance tax purposes, the bequests to the decedent's friend, niece and nephew were subject to a 15% tax, and the bequests to the charities were not subject to tax. With respect to the payment of death taxes, the decedent's will provided that "death taxes . . . together with . . . all administration expenses . . . payable in any jurisdiction by reason of my death (including those taxes and expenses payable with respect to assets which do not pass under this Will) shall be paid out of and charged against my estate."

Pennsylvania has a tax apportionment statute, which provides that in the "absence of contrary intent appearing in the will," the ultimate transferees shall be liable for the tax, except that the tax on specific bequests shall be paid out of the residue. 72 P.S. § 9144(a), (f). Accordingly, if the tax clause in the decedent's will did not express a contrary intent, then the shares of the decedent's estate subject to inheritance tax other than the $10,000 specific bequest (i.e., the nephew's 40 percent share of residue and the annuity) would be paid by the recipients. If the tax clause was found to express a contrary intent, then all tax would be paid from the decedent's residuary estate before it was divided between the nephew and the charities.

The executor read the tax allocation provision to require the payment of the Pennsylvania inheritance tax from the residue of the decedent's estate before it was divided into the separate shares for the nephew and the charities. The result of this interpretation was that the charitable shares would bear some of the tax, even though gifts to charities are not otherwise subject to tax. The Commonwealth of Pennsylvania, participating as parens patriae for the public's interest in the charitable gifts, objected to the executor's proposed apportionment of the taxes, arguing that the language of the decedent's will was insufficient to disrupt the default statutory scheme of tax apportionment. (The Commonwealth agreed that the tax on the specific bequest should be paid out of the residue before division into shares.)

The Superior Court disagreed with the Commonwealth's position. After analyzing several other tax apportionment cases, the Superior Court found that the decedent's use of the words "together with" in reference to the other estate administration expenses "unambiguously" conveyed the decedent's intent that the death taxes should be paid in the same manner as the administration expenses – that is, from the residue of the estate, before division of the residue and distribution to the residuary beneficiaries. The decedent's "contrary intent" was sufficiently clear to override the statutory default scheme of apportionment and to cause the taxes to be paid from the residue of the decedent's estate, rather than by the ultimate transferees.

Davis is an example of how the apportionment of death taxes can have a significant impact on the ultimate distribution of a decedent's estate. Consideration of the payment of death taxes is an obligation of both testators and practitioners. In many cases (some of which were cited by the Superior Court), ignoring this aspect of a client's planning and relying on boilerplate tax clauses may lead to unclear intentions, undesired results and unhappy beneficiaries.

Davis reminds us that testators must give measured thought to the source of the payment of death taxes and must convey their wishes in this regard to their estate planning attorneys. At the same time, practitioners must discuss tax allocation with their clients and conscientiously draft testamentary language that will clearly effectuate their clients' intentions.