In Koons v. Commissioner Case No. 16-10646 (4/27/2017) the 11th Circuit denied the interest deduction for interest on loan to pay estate tax.
Decedent’s revocable trust included a 70% interest in an LLC which had over $200 million in liquid assets. The estate’s liquid assets were insufficient to pay the estate tax. The executors refused the offer of a distribution from the LLC to pay taxes and instead, borrowed $10,750,000 from the LLC at 9.5% interest to pay the tax. No payment was due for 18 years and the principal and interest were scheduled to be repaid in 14 installments between August 2024 and February 2031. No prepayments were permitted.
The projected interest was $71,419,497 which was taken as a deduction on the estate tax return.
The IRS claimed a $42,771,586.75 estate tax deficiency and a $15,899,463 generation-skipping tax deficiency.
The estate relied on the Estate of Graegin v. Commissioner, 56 T.C.M. (CCH) 387 (1988) which permitted interest deductions, holding that “expense incurred to prevent financial loss to an estate resulting forced sale of its assets to pay estate taxes are deductible administration expenses.”
In Koons, the 11th Circuit held that the interest deduction is properly denied if the estate can pay its tax liability using the liquid assets of an entity but elects to obtain a loan from the entity and then repay the loan using those same liquid assets.