The United States Court of Appeals for the Eleventh Circuit recently addressed a critical issue for estate tax practitioners: the deductibility of transfers mandated by a prenuptial agreement as "claims against the estate" under 26 U.S.C. § 2053(a)(3). The case, Estate of Richard D. Spizzirri, Deceased v. Commissioner of Internal Revenue (No. 23-14049), centered on whether a $3 million payment to the decedent’s stepchildren, stipulated in a modification to a prenuptial agreement, qualified for deduction. This opinion from Chief Judge William Pryor provides valuable insight into the application of the "contracted bona fide" requirement for related-party transactions.

Factual Background

The decedent, Richard Spizzirri, entered into a prenuptial agreement in 1997 with his fourth wife, Holly Lueders. At the time, Spizzirri had a significant net worth and four children from a previous marriage, while Lueders had a net worth exceeding $1 million and three children from a previous marriage.

The initial agreement included provisions concerning Lueders’s rights upon Spizzirri’s death, stating that she agreed to accept these provisions "in lieu of all rights in the property and estate of [Spizzirri]... as his wife... or as his widow, heir-at-law, next-of-kin, or distributee upon his death". Article IV detailed Lueders’s waiver of surviving spouse rights in exchange for a marital trust, residency rights, and a percentage of home sale proceeds. Articles V and VI addressed spousal support and property rights upon marital dissolution, with Lueders waiving rights in exchange for potential payments from Spizzirri.

Over their 18-year marriage, the agreement was modified five times. The third modification on November 3, 2005, specifically amended Article IV regarding provisions for Lueders after Spizzirri’s death. In this modification, Lueders waived her right to a marital trust and residency rights. In exchange, Spizzirri agreed to make and keep in effect a will providing for a $9 million cash payment upon his death, which included $6 million to Lueders and $3 million to her adult children. This modification reiterated that Lueders would accept these provisions "in lieu of any other rights which may be available to her as [Spizzirri’s] surviving spouse". Subsequent modifications reaffirmed the promise to pay $1 million to each of the three stepchildren.

Despite these agreements, Spizzirri did not update his 1979 will, which primarily benefited his children from his first marriage. He executed several codicils for children born outside the marriage and a condominium transfer, but none incorporated the terms benefiting Lueders or her children from the prenuptial agreement modifications. Spizzirri and Lueders became estranged before his death in May 2015.

After Spizzirri’s death, the stepchildren filed claims in state court seeking payment under the third modification. The estate paid the three stepchildren $1 million each, plus penalties. The estate then filed a Form 1099-MISC and deducted these $3 million in payments as "claims against the estate".

Taxpayer’s Position and Commissioner’s Deficiency

The Commissioner of Internal Revenue issued a notice of deficiency disallowing the deduction for the payments made to the stepchildren.

The estate petitioned the Tax Court for review. At trial, the estate presented witnesses who testified, among other things, on the enforceability of the agreement and the value of Lueders’s waived marital rights. One witness explained that Spizzirri agreed to make the payments to keep Lueders happy and show largesse to her children, aiming to preserve the marriage and avoid divorce expense. The estate did not call the stepchildren as witnesses or introduce evidence they reported the payments as taxable income.

Before the Eleventh Circuit, the estate argued that it had shifted the burden of proof to the Commissioner by introducing credible evidence of its entitlement to the deduction under 26 U.S.C. § 7491(a). The taxpayer generally bears the initial burden of proving entitlement to a deduction.

Court’s Analysis of Law

The Eleventh Circuit began by explaining that the estate tax is a tax on the transmission of wealth at death. The taxable estate is determined by subtracting allowable deductions from the gross estate. One such deduction is for "claims against the estate" allowable under state law.

Crucially, 26 U.S.C. § 2053(c)(1)(A) requires that, for a claim against the estate to be deductible, it must be "contracted bona fide and for an adequate and full consideration in money or money’s worth". This requirement is designed to prevent gifts and testamentary transfers from being "transformed into deductible claims through collaboration and creative contracting".

The court noted that the determination of whether a deduction for a claim against an estate is allowed is fact-intensive and must be made on a case-by-case basis.

Regarding the burden of proof, the court stated that a taxpayer can shift the burden under § 7491(a) if they introduce "credible evidence" and comply with substantiation and record-keeping requirements. However, the court agreed with the Commissioner that the estate failed to introduce the necessary "credible evidence" to shift the burden. The testimony indicating Spizzirri’s motivations were to keep Lueders happy and show largesse weighed against the estate, as did the failure to call the stepchildren as witnesses.

The court focused its analysis on the "bona fide" requirement. Treasury Regulation § 20.2053-1(b)(2)(i) clarifies that the bona fide requirement bars a deduction if the claim is based on a transfer that is "essentially donative in character (a mere cloak for a gift or bequest)".

Transactions between family members are subject to "particular scrutiny" because a testator is more likely to be making a bequest. The court applied this scrutiny to the payments to Spizzirri’s stepchildren, who are considered "family members" as "lineal descendants of... [his] spouse" under Treas. Reg. § 20.2053-1(b)(2)(iii)(A).

The Treasury Regulations provide five factors to guide the evaluation of whether an intrafamily transfer was contracted bona fide:

The transaction occurs in the ordinary course of business, is negotiated at arm’s length, and is free from donative intent.
The claim is not related to an expectation or claim of inheritance.
The claim originates pursuant to an agreement between the decedent and the family member.
Performance by the claimant stems from an agreement between the decedent and the family member.
All amounts paid are reported by each party for Federal income and employment tax purposes consistently with the claim’s nature.

The court stated that donative intent is evaluated at the time the parties entered into the agreement.

Application of Law to Facts

Applying the five regulatory factors, the court concluded that each factor weighed against finding the payments to the stepchildren were contracted bona fide.

Ordinary Course of Business/Arm’s Length/Donative Intent: The court found the transaction (the third modification) was not in the ordinary course of business and not free from donative intent. Citing the estate’s witness, the court noted Spizzirri’s motivation was to keep his wife happy, show largesse to her children, and avoid divorce. This circumstance did not resemble an arm’s length transaction. Evaluating intent at the time of the modification, Spizzirri’s donative motivation was clear. The court also noted Spizzirri’s history of making gifts to one of the stepchildren shortly before his death as reflecting donative intent.
- The estate’s reliance on Estate of Kosow v. Commissioner was rejected. The court clarified that Kosow did not decide the bona fide issue, and the language suggesting that suing the estate indicated a non-disguised bequest was dictum. Furthermore, the court reiterated that donative intent is assessed at the time of the agreement, not when payment is due.
Related to Expectation/Claim of Inheritance: The court found the payments were related to Lueders’s expectation or claim of inheritance. Although the stepchildren themselves might not have expected to inherit, the payments were negotiated "in lieu of any other rights which may be available to [Lueders] as [Spizzirri’s] surviving spouse," as stated in the third modification. Since the payments were contracted in lieu of Lueders’s spousal rights, they were "related to" her expectation or claim of inheritance.
Claim Origination: The claims did not originate from any transaction between the stepchildren and Spizzirri.
Claimant Performance: The stepchildren were not obligated to perform under any agreement.
Consistent Tax Reporting: The estate failed to introduce any evidence that the stepchildren reported the payments as income.

Based on this analysis, the court determined the payments were not contracted bona fide. Because this determination was sufficient to disallow the deduction, the court did not reach the issue of whether the payments were for adequate and full consideration.

Conclusion

The Eleventh Circuit affirmed the Tax Court’s judgment in favor of the Commissioner. The court held that the $3 million payments made by the Estate of Richard D. Spizzirri to his stepchildren, pursuant to a modification of a prenuptial agreement, were not deductible as "claims against the estate" under 26 U.S.C. § 2053(a)(3) because they were not "contracted bona fide" as required by § 2053(c)(1)(A).

This decision underscores the strict requirements for deducting claims arising from agreements between family members, particularly those tied to prenuptial agreements or testamentary arrangements. The court’s application of the five regulatory factors highlights the importance of demonstrating a transaction is genuinely commercial in nature, free from donative intent evaluated at the time of the agreement, and not merely a substitute for an inheritance or a mechanism to achieve estate tax avoidance through disguised gifts. The failure to satisfy any of these factors, coupled with the estate’s inability to shift the burden of proof, proved fatal to the deduction.

Prepared with the assistance of NotebookLM.