There are some taxpayer wins that I feel particularly good about. The refund claim of the Estate of Theodore Warshaw is one of them. Theodore Warshaw died in May 2006. His estate, which was left in trust for his widow, was valued at $1,848,293. Most of its value was in an IRA account that, according to its statements held securities worth $1,463,733. The estate paid estate tax of $88,677 to the state of New Jersey. In 2007 and 2008, there were distributions of $183,148 and $90,478. Then came the news at the end of 2008. Bernie Madoff had been running one of the largest Ponzi schemes in history. The IRA statements had been entirely fictitious. The distributions had been funded by the latest victims of the scheme. Mr. Warshaw’s executors figured that since there really had not been anything in the IRA, the estate taxes should be refunded. The New Jersey Division of Taxation did not agree.
The Division’s argument was based on something called the Ithaca Trust Rule:
According to the IthacaTrust Rule, events that occur subsequent to the decedent’s death are not considered to determine the date of death value of decedent’s gross estate. In Ithaca Trust Co., “the testator’s trust gave the residue of his estate to his wife for life.”. The trust provided that the wife had the power to use any amount of the principal “necessary to suitably maintain her in as much comfort as she now enjoys.” Six months following the testator’s death, the wife died, and the residue was then transferred to charities. Even though, the executors knew at the time of filing exactly how much had gone to charity, they were still required to use standard mortality tables to value its interest.
The Tax Court of New Jersey saw the matter differently. Subsequent events that affect value are one thing, but later discovered information about conditions at the time of valuation are a different matter:
Subsequent events may be considered to show evidence of value of the estate on the date of death. In the instant matter, approximately 30 months passed from decedent’s death to the arrest of Madoff for his role in the Ponzi scheme. I find this to be a reasonable amount of time. Accordingly, I conclude that the subsequent information regarding the Madoff Ponzi scheme is relevant to the determination of the fair market value of the IRA. The unearthing of the Ponzi scheme exposed that the statements are fictitious. Furthermore, though the public discovery of the Madoff Ponzi Scheme was subsequent to Decedent’s passing, the statements produced by FISERV were fictitious upon creation. The statement produced by FISERV to provide the date of death value of the IRA did not reference any assets in the account, but merely included a “total investment” amount. This information which was acquired subsequent decedent’s death provides evidence that the value of the IRA was worthless on the valuation date.
I found one observation of the Court kind of amusing:
Fair market value of the IRA is determined by what a hypothetical willing buyer would have paid a willing seller. Facts that a hypothetical willing buyer and willing seller could reasonably have expected to know at the time may be considered to determine date of death value. In support of its motion, Plaintiff contends that a willing buyer would have conducted a due diligence investigation and determined that there were no assets in the IRA. In response, Defendant argues that a willing buyer and willing seller could not possibly have known that the IRA did not contain securities. I accord greater weight to Plaintiff’s argument, as a prudent willing buyer would have undertook a due diligence investigation to determine what assets were in the IRA by requesting supporting documents like stock certificates.
How many willing Madoff victims failed to have that basic due diligence done ? Apparently it had not occurred to the executors when they originally filed. Frankly, I don’t think it would have occurred to me either. At any rate, I’m glad the decision came out the way that it did.
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Originally published on Forbes.com on August 27th, 2012