Estate Allowed Theft Deduciton for Estate Tax Purposes for Theft of Asset Held By LLC 99% Owned by the Estate

An estate that owned a 99% interest in an LLC whose only asset was an account with Madoff Securities looked to claim a theft loss deduction on its estate tax return in the case of Estate of Heller v. Commissioner, 147 TC No. 11.

Under IRC §2054 provides:

For purposes of the tax imposed by section 2001, the value of the taxable estate shall be determined by deducting from the value of the gross estate losses incurred during the settlement of estates arising from fires, storms, shipwrecks, or other casualties, or from theft, when such losses are not compensated for by insurance or otherwise.

James Heller died in January of 2008.  Between March 4, 2008 and November 28, 2008 the LLC withdrew funds from the account and distributed them to its interest holders.  The estate’s share ($11,385,000) was used to pay its taxes and administrative expenses.  On December 11, 2008 Bernard Madoff was arrested on charges of running a Ponzi scheme, which effective rendered the remaining balance in the account worthless.

The issue was whether a theft from an LLC that was 99% owned by the estate would qualify for this deduction, since the theft did not take place directly from estate itself.  The IRS argued that because of the indirect nature of the ownership that no theft loss deduction was allowed for estate tax purposes.

The Tax Court did not agree.  The Court held:

Section 2054, however, allows for a broader nexus (i.e., between the theft and the incurred loss) than does respondent's narrow interpretation. “Arise” is generally defined as “to originate from a source”. See Merriam-Webster's Collegiate Dictionary 62 (10th ed. 2001). Pursuant to the phrase “arising from” in section 2054, the estate is entitled to a deduction if there is a sufficient nexus between the theft and the estate’s loss. See White v. Commissioner, 48 T.C. 430, 435 (1967) (finding a similarity between losses caused by direct and proximate damage of a section 165(c)(3) “other casualty” and those arising from the specifically enumerated section 165(c)(3) causes). It is sufficient indeed. The nexus between the theft and the value of the estate's JHF interest is direct and indisputable. The loss suffered by the estate relates directly to its JHF interest, the worthlessness of which arose from the theft. Thus, the estate is entitled to a section 2054 deduction relating to its JHF interest. We need not address whether a mere tangential or more circuitous relationship would suffice.

Note the cautionary statement in the final sentence of the Court’s analysis—this holding is limited to this very clear, direct situation and, for now, the Court is not deciding whether this holding would apply to situations where the estate held an overwhelming large portion of the entity that was defrauded.