IRS Gets Partial Win in $2.3 Million Estate Tax Case

The IRS scored a partial victory in a tax dispute with the estate of a late Kentucky resident, as the Tax Court ruled that a $2 million bequest was not qualified for the marital deduction due to the estate’s failure to make a valid election on its return. (TC Memo 2025-47)

However, the court also ruled partially in favor of the estate regarding a separate $300,000 bequest, which it found fully qualified for the deduction.

Background.

Martin Griffin, a resident of Kentucky, died in July 2019 and was survived by his spouse, Maria Creel.

Griffin created a revocable trust in 2012 and the “MCC Irrevocable Trust” in 2018. In 2018, he also executed a second amendment to the revocable trust agreement, directing two bequests for his wife’s benefit.

First, Griffin directed that $2 million be held for the benefit of Creel, who would receive a monthly amount not exceeding $9,000 from this bequest.

Second, he directed that $300,000 be held as a “living expense reserve” for Creel, to be distributed to her in the amount of $5,000 monthly for up to 60 months. Any undistributed amounts upon Creel’s death would be paid to her estate.

Among the terms of the MCC Trust Agreement was that upon Creel’s death, the trustee would distribute the remaining property in the trust estate for the benefit of Creel’s descendants.

It stated that Creel was not allowed to appoint any part of the trust estate to herself, to her estate, to her creditors, or to the creditors of her estate.

Estate tax return.

In 2020, Griffin’s estate timely filed a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. The Schedule M attached to the form listed a specific bequest of $2.3 million to Creel. However, it did not list any property from the estate as qualified terminable interest property (QTIP), which would have allowed for the marital deduction.

The IRS sent a deficiency notice to the estate in June 2023. This notice determined that the $2 million and $300,000 bequests were includible in Griffin’s estate, resulting in an estate tax deficiency of over $1 million and an accuracy-related penalty of $184,000.

The estate filed a Tax Court petition and the IRS and the estate filed their dueling motions for partial summary judgment in October 2024.

The issue before the Tax Court was whether the two bequests qualified for the marital deduction and, thus, were not includible in Griffin’s estate.

2 million dollar marital deduction disallowed.

The Tax Court noted that when computing the taxable estate, the value of the property transferred to a surviving spouse is generally deductible. However, this marital deduction is typically not allowed for terminable interest property passing to the surviving spouse — unless the property qualifies as QTIP.

This exception is provided under Code Sec. 2056(b)(7), which allows a marital deduction for QTIP even though the surviving spouse receives only an income interest and has no control over the ultimate disposition of the property.

For a terminable interest property to qualify as QTIP, three requirements must be met:

• The property must pass from the decedent;
• The surviving spouse must have a qualifying income interest in the property for life; and
• The executor of the estate of the first spouse to die must make an affirmative election to designate the property as QTIP.

Ruling.

The Tax Court granted the IRS’ motion regarding the $2 million bequest, holding that it was terminable interest property that didn’t qualify for the marital deduction.

To begin with, both the IRS and Griffin’s estate agreed that this bequest was a terminable interest and did not qualify for the marital deduction unless it qualified for an exception.

The court noted that the estate didn’t make a valid QTIP election for the $2 million bequest on Form 706 — one of the three requirements for terminable interest property to qualify as QTIP. In addition, it failed to identify anything on the return that showed that the estate had an “affirmative intent” to make a QTIP election. This alone disqualified the $2 million bequest from being QTIP.

“The $2 million bequest is not QTIP,” the court concluded. “It is terminable interest property that does not qualify for the marital deduction and is includible in the estate.”

On the other hand, the court held that the $300,000 bequest fully qualified for the marital deduction.

The key issue was whether this bequest created a separate trust from the MCC Trust that would pass to Creel’s estate upon her death. If so, this bequest was not terminable interest property.

In Kentucky, whose law governed the dispute, the creation of a trust has five requirements. The court said the $300,000 bequest “clearly met” four of these requirements.

Thus, the only requirement that needed further discussion was whether the settlor indicated an intention to create a new trust. The court said the bequest also satisfied this condition.

The court found that Griffin “intended to create a trust with the $300,000 bequest,” citing the use of the phrase “living expense reserve” and the specification of distinct distribution provisions that clearly conflicted with the existing provisions of the irrevocable MCC Trust agreement.

“We hold that the $300,000 bequest created a trust separate from the MCC Trust. This separate trust did not constitute a terminable interest and fully qualified for the marital deduction,” the court said.

For more information about qualified terminable interest property, see Checkpoint’s Federal Tax Coordinator ¶Q-6302.