Settlement Paid from Estate Qualifies for Charitable Deduction

A district court has held that almost $12 million paid from an estate to a charity under a settlement agreement between the decedent’s son and the charity qualified for an estate tax charitable deduction even though the bequest was not included in decedent’s Last Will and Testament.

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Estate of Antonio J. Palumbo, (DC PA 03/09/2011) 107 AFTR 2d at 560.

Facts. In 1974, Antonio J. Palumbo established the A.J. and Sigismunda Palumbo Charitable Trust (the “Charitable Trust”).  Mr. Palumbo subsequently executed additional wills, codicils and trust agreements.  At the time of his passing on December 16, 2002, his last will and testament executed in 1999, along with three modifying codicils (the “Will”), was currently in effect.

The Will (and several of the codicils) named the Charitable Trust as the beneficiary of the residuary estate; however, the most recent codicil did not include the Charitable Trust as a beneficiary of the residuary estate.  Based on the inconsistency of the decedent’s documents, the estate and the IRS stipulated that there was no express residuary dispositive provision in the most recent codicil due to a scrivener’s error by the drafting attorney.  Since the Will did not contain a residuary distribution provision, the decedent’s son claimed that he was the sole beneficiary of the intestate estate.  Meanwhile, the trustee of the Charitable Trust claimed that it was the beneficiary of the residuary estate since the lack of residuary clause was caused by scrivener’s error.  Each party retained counsel and negotiated a settlement agreement regarding the distribution of the residuary estate.

According to the settlement agreement, the Charitable Trust was to receive $11,721,141 and the decedent’s son was to inherit $5,600,000 and real property.  The settlement agreement was approved by court order on July 10, 2003 in Elk County, Pennsylvania.  The estate then filed a claim for a federal estate tax charitable deduction for the portion of the residuary estate paid to the Charitable Trust.

The IRS rejected the deduction since the gift to the charity was from a settlement agreement and not actually included in the dispositive provisions of the Will.  The estate filed a claim in district court to pursue its claim for the substantial charitable deduction.

District Court’s Holding.  Despite the arguments made by the IRS and the drafting attorney’s admission to the unintentional exclusion of the proper dispositive provisions in the Will, the court held in favor of the estate since the applicable Code section regarding the deduction was intended to encourage charitable giving.  I.R.C. § 2055.  The court determined that, while Pennsylvania typically only looks to the “four corners” of a document to determine its terms, there is long-standing case law in support of following the intent of the testator in order to avoid creating an intestate estate when a person has executed a will.  The court assumes that, upon the execution of a will, the testator intended to dispose of his entire estate, rather than leaving a portion of his assets to be distributed according to the laws of intestate succession.

In this case, all documents executed prior to the Will included a gift of the residuary estate to the Charitable Trust.  The parties agreed on the decedent’s intent and the lack of the proper language in the Will, which led to the settlement negotiations.  Since the decedent intended to leave a large gift to the Charitable Trust upon his death, and the drafting attorney admitted to the mistake, the IRS must allow the estate to receive the charitable deduction.