                               T.C. Memo. 2012-81



                         UNITED STATES TAX COURT



                ESTATE OF DAVID A. KAHANIC, DECEASED,
                 EDWARD M. FIALA, EXECUTOR, Petitioner v.
              COMMISSIONER OF INTERNAL REVENUE, Respondent



       Docket No. 23800-09.                       Filed March 21, 2012.



       David Gerhard Strom, Sharon M. Buccino, and John J. Morrison, for

petitioner.

       H. Barton Thomas, Jr., and Angela B. Friedman, for respondent.
                                          -2-

             MEMORANDUM FINDINGS OF FACT AND OPINION


      VASQUEZ, Judge: Respondent determined a $1,188,974 deficiency in the

Federal estate tax of the Estate of David A. Kahanic (estate). The issues for

decision are: (1) whether David A. Kahanic (decedent) possessed at his death

incidents of ownership in a $2,495,000 life insurance policy, thereby making the

policy proceeds includible in the value of decedent’s gross estate under section

2042(2);1 (2) if so, whether an agreed order entered by the Circuit Court of Cook

County, in effect when decedent died, created an indebtedness in respect of the

policy proceeds that entitles the estate to a deduction of $1,995,000 under section

2053(a)(4);2 (3) whether the estate is entitled to deduct, under section 2053(a)(2),

accrued interest on a loan made by decedent’s ex-wife to the estate to allow the

estate to pay its Federal and Illinois estate taxes; and (4) whether the estate is

entitled to deduct, under section 2053(a)(2), attorney’s and accountant’s fees




      1
         Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the date of decedent’s death, and all Rule references are
to the Tax Court Rules of Practice and Procedure.
      2
         Respondent concedes that the estate is entitled to deduct $500,000 of the
policy proceeds under sec. 2053. Thus, the parties disagree over whether the estate
may deduct the remaining $1,995,000.
                                         -3-

incurred after the estate filed its Form 706, United States Estate (and Generation-

Skipping Transfer) Tax Return.

                                 FINDINGS OF FACT

      Some of the facts have been stipulated and are so found. The stipulation of

facts and attached exhibits are incorporated by this reference. Decedent died on

August 11, 2005, and as of that date he resided in Schaumburg, Illinois.3 On August

23, 2005, and pursuant to decedent’s will, Edward M. Fiala was appointed executor

of the estate.4 Mr. Fiala is the former brother-in-law of decedent and the brother of

Ms. Kahanic, decedent’s ex-wife. Decedent and Ms. Kahanic married on October

22, 1988, and divorced in 2004. They had two children during their marriage.

Decedent, a medical doctor, was the sole owner of Aesthetic Eye Plastic Surgery

(AEPS). Ms. Kahanic worked as the office manager at AEPS for approximately 10

years, ending around 2000 or 2001.


      3
          Schaumburg, Illinois, is in Cook County.
      4
          Decedent’s will named Susan Kahanic, his wife at the time he executed his
will, as executor of the estate and Mr. Fiala as successor executor. Under Illinois
law, a dissolution of marriage of the testator revokes every legacy, interest, or
power of appointment given to the testator’s former spouse in a will executed before
the entry of the judgment for dissolution of marriage. 755 Ill. Comp. Stat. Ann. 5/4-
7(b) (West 2007). Decedent executed his will on August 30, 1996, and he and Ms.
Kahanic divorced in 2004. Thus, Ms. Kahanic could not be executor of the estate,
and Mr. Fiala was appointed executor upon probate of decedent’s will.
                                         -4-

Decedent’s Health Problems

      Decedent was significantly overweight and suffered from high blood pressure.

In 2000 he became severely ill and had to be admitted to the hospital, where he was

diagnosed with an enlarged heart. Decedent was unable to return to work until the

end of 2001.

Decedent’s Life Insurance Policies

      Decedent obtained the following life insurance policies before being

diagnosed with an enlarged heart: (1) Security-Connecticut policy No. XXX491R

with a death benefit of $495,000; (2) Security-Connecticut policy No. XXX013W

with a death benefit of $2 million; (3) American General policy No. XXXXXX112L

with a death benefit of $3 million (AIG policy); and (4) Prudential term life policy

No. XXXX9322 with a death benefit of $2 million that he converted to Prudential

universal life policy No. XXXX6899 on February 20, 2004 (Prudential policy).

Following a merger of Security-Connecticut Life Insurance Co. and Reliastar

Insurance Co., the Security-Connecticut policies were reissued to decedent by

Reliastar as policy No. XXXX15856B with a death benefit of $2,495,000

(Reliastarpolicy or policy).5 At all relevant times the Reliastar and Prudential

      5
       Although the merger between Security-Connecticut and Reliastar had not
been completed at the time of some of the events discussed infra, for simplicity we
                                                                        (continued...)
                                          -5-

policies named Ms. Kahanic the sole beneficiary. The policies were in effect when

decedent died.

Divorce Proceedings and Marital Settlement Agreement

      On February 13, 2002, Ms. Kahanic filed a petition for dissolution of

marriage in the Circuit Court of Cook County, Illinois (circuit court). Around that

time she learned that decedent had missed a deadline to pay a premium on one of his

life insurance policies. This concerned Ms. Kahanic, who believed that decedent’s

poor health would make it difficult for him to acquire life insurance if his policies

lapsed.

      On May 27, 2004, the circuit court entered a judgment for dissolution of

decedent and Ms. Kahanic’s marriage (judgment for dissolution). That same day

the parties entered into a marital settlement agreement (MSA) that was

incorporated verbatim into the judgment for dissolution. The MSA stated, inter

alia, decedent’s child support and spousal maintenance obligations, required

decedent to secure his unpaid child support and spousal maintenance payments

with life insurance proceeds, and included provisions on how decedent would



      5
        (...continued)
will refer to the two Security-Connecticut life insurance policies as the Reliastar
policy throughout the opinion.
                                         -6-

provide proof to Ms. Kahanic that he had secured his unpaid obligations with life

insurance and timely paid the premiums.

      With respect to child support, decedent was obligated under the MSA to pay

Ms. Kahanic $7,000 per month and to secure his unpaid future payments with a life

insurance policy with a minimum death benefit of $1,200,000.6 As for spousal

maintenance, the parties agreed that Ms. Kahanic was to receive $672,000 to be

paid in 96 monthly payments of $7,000. Decedent was required to secure payment

of his unpaid spousal maintenance by naming Ms. Kahanic an irrevocable

beneficiary to $500,000 of the Reliastar Policy7 proceeds for a period of 8 years.

      The terms of the MSA also required decedent to do the following within 10

days of the entry of the judgment for dissolution: (1) provide Ms. Kahanic with a

copy of the AIG policy; (2) notify, in writing, AIG of his obligations under the


      6
          The AIG policy secured decedent’s child support obligation. At some point
that is not clear from the record decedent transferred ownership of the AIG policy to
an irrevocable life insurance trust. Upon decedent’s death Ms. Kahanic received the
$3 million death benefit as trustee of the irrevocable life insurance trust. The parties
agree that the taxation of the AIG policy is not at issue.
      7
          The MSA required decedent to name Ms. Kahanic as an irrevocable
beneficiary on a policy enumerated in “Exhibit 2”, a document attached to the MSA
that listed Ms. Kahanic’s and decedent’s life insurance policies then in effect.
Because decedent listed only the AIG policy, which he used to secure his child
support obligation, and the Reliastar policy (decedent hid from Ms. Kahanic the
Prudential policy), the terms of the MSA obligated decedent to use the Reliastar
policy as security for the spousal maintenance obligation.
                                          -7-

MSA and provide Ms. Kahanic with a copy of the notice; and (3) execute and

deliver documents designating Ms. Kahanic as an irrevocable beneficiary to

$500,000 of life insurance proceeds to secure his unpaid spousal maintenance

payments (collectively, the “insurance requirements”).

      The final page of the judgment for dissolution states that “this Court expressly

retains jurisdiction of this cause for the sole and exclusive purpose of enforcing all

the terms of this Judgment for Dissolution of Marriage, including all the terms of the

[MSA] made in writing.”

Decedent’s Noncompliance With the MSA and the September 16, 2004, Agreed
Order

      By August 2004 decedent had not complied with the insurance

requirements. Ms. Kahanic, knowing that decedent had missed a life insurance

premium payment in 2002,8 worried increasingly that decedent had not been

paying his life insurance premiums. She believed that if decedent let his life

insurance policies lapse and then passed away on account of his illness she might

not be able to collect child support and spousal maintenance. Maricarol Lacy and

Bernard B. Rinella, Ms. Kahanic’s attorneys, attempted to have decedent comply




      8
          See supra p. 5.
                                         -8-

with the insurance requirements on his own volition, but eventually Ms. Kahanic

had to seek resolution through the circuit court.

      On August 16, 2004, Ms. Kahanic filed a petition for a rule to show cause for

indirect civil contempt, motion to compel and for other relief (petition to show

cause). The petition to show cause stated, inter alia, that decedent had not complied

with the insurance requirements. Ms. Kahanic requested that the circuit court find

decedent in indirect civil contempt for his refusal to comply with the insurance

requirements, and upon such finding compel decedent to comply with the insurance

requirements. Ms. Kahanic also asked the circuit court to compel decedent to pay

her attorney’s fees.

      Before the circuit court acted on Ms. Kahanic’s petition to show cause, Ms.

Kahanic and decedent reached an agreement with respect to his noncompliance with

the insurance requirements. Ms. Kahanic agreed to not immediately pursue a

finding of indirect civil contempt against decedent for his noncompliance with the

insurance requirements in exchange for decedent’s entering into an agreed order

stating that (1) Ms. Kahanic and the children remained the sole beneficiaries on the

AIG and Reliastar policies and (2) decedent would not alter the policies until he

complied with the insurance requirements. Ms. Kahanic’s decision was based in

part on her understanding that if decedent died without complying with the
                                        -9-

insurance requirements she would receive the Reliastar policy’s full $2,495,000

death benefit.

       On September 9, 2004, Ms. Kahanic filed a motion for entry of agreed order

relating to her petition to show cause and her and decedent’s agreement. On

September 16, 2004, the circuit court entered an agreed order (September 16 agreed

order), which read as follows:

             This matter having come before the Court for enforcement and
       compliance with the Marital Settlement Agreement and Judgment for
       Dissolution of Marriage:

       IT IS HEREBY ORDERED;

              * * * [Decedent] represents that * * * [Ms. Kahanic] and the
       children remain as sole beneficiaries on each of his life insurance
       policies as identified specifically in the parties’ executed Marital
       Settlement Agreement at Articles V [Life Insurance Coverage For The
       Children] and VI [Life Insurance Coverage to Secure Maintenance]
       and attached as Exhibit “2” to said Agreement and that these policies
       have not been transferred, modified[,] altered or encumbered in any
       way, shape or form, and no transfers, modifications, alterations or
       encumbrances on said policies will occur until * * * [decedent]
       complies with the terms of the Settlement Agreement regarding these
       policies.

The attorneys for decedent and Ms. Kahanic signed the September 16 agreed order

on their clients’ behalf.
                                        - 10 -

      On August 11, 2005, decedent passed away. He had not complied with the

insurance requirements, and the September 16 agreed order had not been vacated.9

Reliastar Policy

      The Reliastar policy was a universal life insurance policy. Ms. Kahanic was

the Reliastar policy’s primary beneficiary when decedent passed away, and

accordingly she received the $2,495,000 death benefit upon his death. As of the

date of decedent’s death the Reliastar policy had an accumulated value of




      9
          During the nearly 11 months between the time the circuit court entered the
September 16 agreed order and decedent’s death the circuit court continued the
matter of Ms. Kahanic’s petition to show cause numerous times. The circuit court
first continued the matter until November 16, 2004, and then did so again until
December 20, 2004. On December 20, 2004, the circuit court entered an order
requiring decedent to, inter alia, demand copies of his life insurance policies and
setting a status conference for Ms. Kahanic’s petition to show cause for January 24,
2005. Decedent complied with the circuit court’s order to demand copies of his life
insurance policies, but by the status conference he had received information on only
one policy. The circuit court then entered an agreed order requiring decedent to
continue to gather the life insurance policies and setting a status conference on Ms.
Kahanic’s petition to show cause for March 3, 2005. The circuit court continued
the status conference to April 7, 2005, and continued it again to May 16, 2005. At
the May 16, 2005, status conference the circuit court set Ms. Kahanic’s petition to
show cause for hearing on July 26, 2005. At the July 26, 2005, hearing the circuit
court continued the “issue as to finalizing life insurance terms as required by the
judgment” until August 25, 2005, and required decedent to provide Ms. Kahanic
with beneficiary information within 21 days.
                                        - 11 -

$31,165.8410 and a surrender charge of $43,573.16.11 Decedent’s premium

payments provided him with coverage through September 1, 2005.

      The Reliastar policy contained a no-lapse provision. The terms of the policy

stated that so long as decedent’s total premium payments exceed the “cumulative

total of the ‘Minimum Monthly Premiums’ in effect from the ‘Policy Date’ to the

end of the current period” the Reliastar policy would remain in effect, regardless of

net cash surrender value. When decedent died he had made premium payments of

$43,573.16. The policy’s minimum monthly premium was $1,024.22, and the

cumulative total of the monthly premiums beginning on the policy date (March 1,

2004) to the end of the current period (August 31, 2005) was $18,435.96.

Decedent’s Will and Declaration of Trust

      Decedent’s will was admitted to probate by the circuit court. Mr. Fiala was

appointed executor of the estate on August 23, 2005, and continues to act in that




      10
         The policy’s accumulated value was calculated by totaling all premium
payments made, subtracting all monthly fees and expenses incurred, and adding
earned interest.
      11
         The policy’s surrender charge was the lesser of (1) total premium
payments made, i.e., $43,573, or (2) approximately $66,292, the amount calculated
by multiplying the policy’s stated value of $2,495,000 by the policy’s “maximum
surrender fee per $1,000” of $26.57 and dividing by 1,000.
                                             - 12 -

role.12 Decedent’s children received certain personal property under the will, and

decedent’s will named the Declaration of Trust of David Kahanic (Declaration of

Trust) the residuary legatee. The Declaration of Trust was never funded, and its

value was zero on the date of decedent’s death. Decedent’s children are the

beneficiaries of the Declaration of Trust.

       Decedent’s will stated that all Federal and Illinois estate taxes were to be paid

from the residuary estate, and if the residuary estate did not contain sufficient assets

to cover the tax liabilities, from the Declaration of Trust. The will did not mention

how taxes were to be paid if the residuary estate and the Declaration of Trust lacked

the necessary assets to pay the estate’s taxes. Both decedent’s will and the

Declaration of Trust waived contribution from third-party transferees toward the

payment of the estate’s tax liabilities.13

The Estate’s Tax Returns

       Mr. Fiala hired the accounting firm Levine Hahn Kilcoyne, LLP (Levine

Hahn), to handle the estate’s finances and prepare its Form 706 and Form 700,

State of Illinois Estate & Generation Skipping Transfer Tax Return. The estate’s



       12
            See supra note 4.
       13
         Pursuant to decedent’s will and the Declaration of Trust Mr. Fiala did not
seek contribution from Ms. Kahanic with respect to the estate’s tax liabilities.
                                          - 13 -

Federal and Illinois estate taxes and tax returns were due on May 11, 2006. The

estate filed Form 4768, Application for Extension of Time To File a Return and/or

Pay U.S. Estate (and Generation-Skipping Transfer) Taxes, requesting an automatic

six-month extension to file its Form 706. At the same time the estate filed a copy of

its Form 4768 with the State of Illinois and obtained a six-month extension to file its

Form 700.

       Notwithstanding the automatic six-month extensions, the estate was required

to pay the taxes owed by May 11, 2006, to avoid penalties. Levine Hahn prepared

draft returns and determined that the estate should pay Federal estate taxes of

$775,000 and Illinois estate taxes of $195,000. These amounts exceeded what

Levine Hahn believed to be the estate’s true tax liabilities, but Levine Hahn wanted

to ensure that if the estate recovered additional assets before it filed its tax returns

the estimated tax payments would cover any additional tax liabilities and prevent the

imposition of penalties.

Collecting the Estate’s Assets

       In early May 2006 the estate did not have sufficient liquid assets to pay the

$970,000 in estimated Federal and Illinois estate taxes. The estate did hold

illiquid assets that, coupled with the liquid assets, would have allowed the estate to
                                         - 14 -

pay the estimated taxes without borrowing funds. When the taxes became due,

however, the illiquid assets were not yet available to pay the estate’s taxes.14

      14
          Immediately before receiving a loan and paying the estate’s estimated
Federal and Illinois estate taxes, the estate believed that it had the following assets,
asset values, and liabilities:

                           Assets                                Values

      Liquid assets:
        Cash                                                    $406,430
      Illiquid assets:
        AEPS--net asset value per 706                             230,753
        Income tax refund receivable (2005)
          Federal                                                  32,711
          Illinois                                                  1,178
        Due from AEPS
          Unpaid compensation for 2005                            171,111
          Shareholder net advances to corporation                  33,415
        AEPS defined benefit plan                                 163,876
        AEPS money purchase pension plan                           68,742
        Unclaimed property receivable (Ill.)                          147
        Federal estate tax refund receivable                      139,032
        Illinois estate tax refund receivable                      27,150
           Total illiquid assets                                  868,115

               Total assets                                     1,274,545

                           Liabilities

     Federal and Illinois estate tax liabilities (estimated)
970,000
     Federal and Illinois income tax liabilities                  89,095
      on income in respect of decedent
     Amount owed to AEPS for the estate’s                         43,352
                                                                            (continued...)
                                         - 15 -

      The estate’s two most valuable nonliquid assets, the net value of AEPS and

decedent’s unpaid compensation for 2005, were tied up in decedent’s medical

practice. John Argo, decedent’s former business adviser, advised Mr. Fiala that

selling AEPS as a going concern would bring the estate the most money. By the

time the estate needed to pay its tax liabilities Mr. Fiala had not been able to find a

buyer for AEPS despite assurances from Mr. Argo that the estate would be able to

sell the practice as a going concern.

      Additionally, Mr. Fiala, acting on the advice of Levine Hahn and Mr. Argo,

had not disbursed to the estate any of AEPS’ available funds.15 He made this

decision in part after learning of two potential medical malpractice claims against

decedent. Although decedent carried medical malpractice insurance, Mr. Fiala was

not sure at that time whether decedent’s medical malpractice insurance was in

      14
       (...continued)
       expenses paid by AEPS
      Accrued accounting and legal fees                           22,600

               Total liabilities                               1,125,047
      15
           AEPS had only $117,364 in cash. Its most valuable asset was $443,396 in
accounts receivable which were in the process of being collected. As for significant
liabilities, AEPS owed Harris Bank $115,000 on a line of credit and decedent
$212,269 (comprising his 2005 compensation and a loan he had made to AEPS) and
was aware of two potential medical malpractice lawsuits and the possibility of
decedent’s former staff suing the practice. Mr. Fiala did not collect decedent’s
unpaid compensation, the advances that he had made to AEPS, and the money in
decedent’s defined benefit and pension plans until November 2006.
                                         - 16 -

effect. Mr. Fiala also learned that decedent’s former employees were considering a

potential lawsuit related to Mr. Fiala’s attempts to sell AEPS as a going concern.

All of this factored into Mr. Fiala’s decision to not disburse to the estate the limited

funds AEPS had.

       Thus, with limited cash on hand and desiring to avoid a forced sale of AEPS,

the estate made the decision that it needed to borrow money in order to timely pay

its Federal and Illinois estate taxes.

Ms. Kahanic Lends the Estate $700,000

       Levine Hahn, knowing that Ms. Kahanic had funds available to lend to the

estate, advised Mr. Fiala to seek a loan from her. Mr. Fiala also believed that

borrowing money from Ms. Kahanic made sense because the estate was still

gathering information as to its assets, the estate’s taxes were almost due, and

borrowing money from a bank or other commercial lender would take time. Mr.

Fiala thought that borrowing from Ms. Kahanic was the “only practical solution        *

* * [the estate] had”.
                                            - 17 -

        On May 5, 2006, Ms. Kahanic agreed to lend the estate $700,00016 at the

short term applicable Federal rate (4.85%).17 Ms. Kahanic and Mr. Fiala18 signed a

promissory note and security agreement (note) containing the terms of the loan. The

note stated that the loan could be prepaid at any time without penalty and all

repayments would be applied first to interest. The note also stated that unpaid

interest would be added to principal each year and all unpaid interest and principal

would be due on May 5, 2009. If the loan was not repaid by May 5, 2009, the

interest rate would be reset to the short term applicable Federal rate as of May 5,

2009.

        To secure repayment of the debt, the estate granted Ms. Kahanic a security

interest in all of its “accounts, deposit accounts, securities, securities accounts,

investment property, promissory notes, payment intangibles, general intangibles,

proceeds of the above, and all such collateral hereafter acquired”. The estate also

granted Ms. Kahanic a security interest in any future Federal or Illinois estate tax

refunds due to the estate and agreed to immediately transfer any such refund to

Ms.Kahanic. On May 15, 2006, Ms. Kahanic filed a Uniform Commercial Code

        16
             Levine Hahn advised Mr. Fiala as to the amount of the loan.
        17
          The estate used the borrowed funds and $270,000 of its own available
cash to timely pay its estimated Federal and Illinois estate taxes.
        18
             Mr. Fiala signed the note on the estate’s behalf.
                                         - 18 -

financing statement with the Illinois secretary of state perfecting her security interest

in the collateral stated in the note.

The Estate’s Tax Returns and Respondent’s Deficiency Determination

       On November 13, 2006, the estate timely filed its Form 706.19 The estate

reported on Schedule D, Insurance on the Decedent’s Life, the $2,495,000 Reliastar

policy and included the full amount in calculating the value of the gross estate. The

estate also reported the $2,495,000 Reliastar policy on Schedule K, Debts of the

Decedent, and Mortgages and Liens, and reduced the value of the gross estate by

such amount. On the Schedule K the estate stated “indebtedness in respect of

property included in the gross estate pursuant to Internal Revenue Code Sections

2053(a)(4), 2053(e), 2043(b)(2) and 2516” as its reason for entitlement to the

deduction. Respondent determined that the estate was not entitled to deduct any of

the $2,495,000 that Ms. Kahanic received as beneficiary of the Reliastar policy, but

has since conceded that the estate may deduct the $500,000 as to which the MSA

obligated decedent to name Ms. Kahanic irrevocable beneficiary.




       19
           The Federal estate tax return reported a tax liability of $635,968. Because
the estate had previously paid $775,000, it requested a refund of $139,032, which
the IRS issued to the estate on December 18, 2006. The estate also timely filed its
Illinois return. The Illinois return indicated that the estate had previously overpaid
its taxes by $27,150.
                                        - 19 -

      Additionally, the estate reported on Schedule J, Funeral Expenses and

Expenses Incurred in Administering Property Subject to Claims, one year’s worth of

interest on the loan, $34,730, and claimed a deduction in that amount under section

2053(a)(2).20 The description of the expense states that the loan was necessary “to

provide cash for payment of Federal and Illinois estate taxes.” Respondent

determined that the interest on the loan was not an allowable deduction because the

loan could be prepaid and the actual amount of interest the estate might pay could

not be determined with certainty.

Loan Repayment and Condition of the Estate at Time of Trial

      When Ms. Kahanic lent the estate $700,000 to allow the estate to pay its

taxes, she expected to be repaid and believed that the estate had sufficient assets to

repay the loan in full. However, the position of the estate has deteriorated

significantly since May 5, 2006, and as of the date of trial the estate had not made a

single payment toward the loan.21 Specifically, the estate was unable to sell


      20
         The interest was calculated for the period beginning May 5, 2006, and
ending May 13, 2007 (six months after the filing of the Federal return). As of July
31, 2010, the accrued interest totaled $100,756.
      21
          For 12 months after decedent died, decedent’s bank account continued to
automatically transfer to Ms. Kahanic’s his $7,000 monthly maintenace obligation.
As a result, Ms. Kahanic owed the estate $84,000. When Ms. Kahanic and Mr.
Fiala realized the mistake, they agreed to reduce the principal amount of the loan
                                                                        (continued...)
                                           - 20 -

AEPS as a going concern and instead was forced to liquidate the practice for

substantially less money than the estate believed it would receive at the time Ms.

Kahanic made the loan. Additionally, the estate owed significant legal and

accounting fees that it did not expect to be responsible for when it agreed to the

terms of the loan.22 Ms. Kahanic has not demanded repayment of the loan.


      21
       (...continued)
from $700,000 to $616,000.
      22
           The estate’s assets and liabilities as of July 31, 2010, were as follows:

                             Assets                           Values

      Cash                                                    $417,328
      Illinois estate tax refund receivable                     27,150
      Federal income tax receivable (7/31/07)                   24,349
      Illinois income tax refund receivables:
        July 31, 2007                                             2,087
        July 31, 2009                                               300
      Estate tax benefits (estimated) of
        deductible expenses not reported
        on the estate’s tax returns:
          Incurred legal and accounting                         98,985
           fees of $193,000
          Accrued interest of $66,025 on loan                   33,694
           from Ms. Kahanic

              Total assets                                     603,893

                             Liabilities

      Loan from Ms. Kahanic:
                                                                           (continued...)
                                         - 21 -

                                      OPINION

       We are asked to decide whether the estate must include in the value of the

gross estate the Reliastar policy’s $2,495,000 life insurance proceeds, and, if so,

whether the estate is entitled to deduct the same amount as indebtedness owed to

Ms. Kahanic.23 We also must decide whether the estate may deduct the accrued

interest on the loan Ms. Kahanic made to the estate and whether the estate may

deduct accountant’s and attorney’s fees that the estate incurred after it filed its Form

706.

I. Agreed Order and the Circuit Court’s Jurisdiction

       We begin with the standards governing agreed orders and an Illinois trial

court’s jurisdiction to enter such orders. Under Illinois law, “An agreed order,

also termed a consent order or a consent decree, is not an adjudication of the

       22
        (...continued)
        Principal                                            616,000
        Accrued interest                                     100,756
       Due to the [child] Kahanic Trust                       20,864
       Due to the [child] Kahanic Trust                       20,864
       Accrued accounting fees (estimated)                    10,000
       Accrued legal fees (estimated)                         10,000

             Total liabilities                               778,484
       23
         As mentioned supra p. 18, respondent concedes that the estate is entitled
to deduct, under sec. 2053, the $500,000 as to which decedent was obligated under
the MSA to name Ms. Kahanic irrevocable beneficiary.
                                         - 22 -

parties’ rights but, rather, a record of their private, contractual agreement. Once

such an order has been entered, it is generally binding on the parties”. In re

Marriage of Rolseth, 907 N.E.2d 897, 900 (Ill. App. Ct. 2009) (citations omitted).

“A consent decree reflects the determination of the parties to end their controversy.

It is like a written contract and should be enforced as written.” Filosa v. Pecora,

309 N.E.2d 356, 359 (Ill. App. Ct. 1974). “A valid consent decree is binding upon

the parties and is enforceable as are other judgments.” Comet Cas. Co. v.

Schneider, 424 N.E.2d 911, 915 (Ill. App. Ct. 1981). However, an agreed order “is

void if the court lacked jurisdiction over either the subject matter or the parties to a

suit.” Filosa, 309 N.E.2d at 360.

      In In re Marriage of Adamson, 721 N.E.2d 166, 172 (Ill. App. Ct. 1999), the

Appellate Court of Illinois, Second District, discussed a trial court’s jurisdiction in a

dissolution proceeding:

              Generally, a trial court loses jurisdiction in a dissolution action 30 days
      after it enters a final order. However, a trial court retains jurisdiction to
      enforce its order past 30 days when the judgment orders or contemplates
      further performance by the parties. In a dissolution action the trial court
      retains extraordinary continuing jurisdiction not applicable to civil cases
      generally. * * * [Citations omitted.]

      Despite a trial court’s jurisdictional reach to enforce its own orders, the

court does not have jurisdiction “to engraft new obligations onto the” divorce
                                        - 23 -

decree. Id. However, if a party invokes the trial court’s continuing jurisdiction to

enforce the terms of the divorce decree, for example by petitioning the court for a

rule to show cause against the other party, and the parties subsequently agree to a

modification of the divorce decree that imposes new obligations, the trial court has

jurisdiction to enter the modified agreement and enforce it as part of its continuing

power to enforce the divorce decree. Id. at 173. “The parties are in the best

position to evaluate their own circumstances, and they should be allowed to resolve

their dispute by agreement even when the trial court would not, or could not, order

the same resolution.” Id.

      The estate argues that the September 16 agreed order was an agreement

between decedent and Ms. Kahanic that modified the provision in the MSA

requiring decedent to secure his unpaid spousal maintenance with $500,000 of life

insurance proceeds. Respondent counters that the September 16 agreed order was a

civil contempt order or a security agreement and not a modification of the MSA.

Respondent also argues that even if we consider the September 16 agreed order to

be a modification of the MSA, In re Marriage of Arkin, 438 N.E.2d 957 (Ill. App.

Ct. 1982), and In re Marriage of Hubbard, 574 N.E.2d 860 (Ill. App. Ct. 1991),

hold that a court does not have jurisdiction to enter an order modifying the parties’

obligations in a proceeding for enforcement of that decree. Respondent
                                         - 24 -

acknowledges the holding of In re Marriage of Adamson, but contends that the

decision by the Appellate Court, Second Division, in that case did not expressly

overrule the holdings of In re Marriage of Arkin and In re Marriage of Hubbard.24

      While we agree with respondent that the September 16 agreed order was

intended to force decedent to comply with the insurance requirements as originally

stated in the MSA, we also believe that the September 16 agreed order modified

the MSA. Before the circuit court entered the September 16 agreed order, Ms.

Kahanic had, pursuant to the MSA, an enforceable claim to receive at most

$500,000 had decedent died before completing his spousal maintenance

obligation. Additionally, decedent had the legal right to name someone other than

Ms. Kahanic as beneficiary to the remaining policy proceeds. However, once the

circuit court entered the September 16 agreed order and until decedent complied




      24
          We find respondent’s reliance on In re Marriage of Arkin, 438 N.E.2d 957
(Ill. App. Ct. 1982), and In re Marriage of Hubbard, 574 N.E.2d 860 (Ill. App. Ct.
1991), to be misplaced. Neither case cited by respondent involved a trial court
entering or enforcing an agreement of the parties. See In re Marriage of Hubbard,
574 N.E.2d at 860 (trial court’s order requiring husband to pay a portion of ex-
wife’s home repair costs amounted to a modification of the parties’ judgment for
dissolution that the trial court lacked jurisdiction to enter); In re Marriage of Arkin,
438 N.E.2d at 957 (trial court could not modify property settlement to force wife to
pay one-half of the mortgage after she vacated the marital residence). Thus, while
In re Marriage of Adamson, 721 N.E. 2d 166 (Ill. App. Ct. 1999), may not have
expressly overruled either case, the facts of the matter before us clearly fall within
the framework of In re Marriage of Adamson. Accordingly, we follow its analysis.
                                         - 25 -

with the insurance requirements, Ms. Kahanic was entitled to receive the full

amount of the policy proceeds and decedent had no legal right to amend the

Reliastar policy in any way. Viewing the parties’ legal rights before and after the

circuit court entered the September 16 agreed order leads us to conclude that the

September 16 agreed order modified the MSA.

      We also find that the circuit court had jurisdiction to enter the September 16

agreed order as a modification of the MSA. Ms. Kahanic invoked the circuit

court’s jurisdiction when she filed the petition to show cause, which, among other

things, asked the circuit court to use its compel powers to force decedent to

comply with the insurance requirements stated in the MSA. See In re Marriage of

Adamson, 721 N.E.2d at 173 (“Respondent invoked the trial court’s continuing

jurisdiction to enforce petitioner’s obligation to refinance the home equity loan

secured by the marital residence”). Decedent and Ms. Kahanic then agreed to the

terms of the September 16 agreed order and asked the circuit court to enter the

agreement, which it did. Although the September 16 agreed order imposed

additional obligations on decedent that the circuit court lacked jurisdiction to

impose on its own, the circuit court had jurisdiction to enter and enforce the

September 16 agreed order because the parties agreed to its terms. See id. Thus,

the circuit court properly entered the September 16 agreed order as part of its
                                         - 26 -

continuing power to enforce the judgment for dissolution and as a modification of

the MSA. See id. (“[W]hen the parties agree to settle a postdecree dispute by

modifying the underlying judgment or martial settlement agreement, the trial court

should enforce the new agreement unless it is unconscionable.”).

II. Whether the Estate Must Include the Reliastar Policy Proceeds in the Value of
    the Gross Estate

      A. General Rules and Section 2042(2)

      Section 2001(a) imposes a tax “on the transfer of the taxable estate of every

decedent who is a citizen or resident of the United States.” Section 2051 defines

the taxable estate as “the value of the gross estate” less applicable deductions.

Section 2031(a) specifies that the gross estate comprises “all property, real or

personal, tangible or intangible, wherever situated”, to the extent provided in

sections 2033 through 2046. Section 2033 broadly provides: “The value of the

gross estate shall include the value of all property to the extent of

the interest therein of the decedent at the time of his death.” Sections 2034 through

2046 explicitly mandate the inclusion of several more narrowly defined classes of

interests in property. Among those specific sections is section 2042, which governs

the treatment of life insurance proceeds and provides in pertinent part as follows:
                                         - 27 -

      SEC. 2042. PROCEEDS OF LIFE INSURANCE.

              The value of the gross estate shall include the value of all property--

                    *      *      *      *        *   *      *

                    (2) Receivable by other beneficiaries.--To the extent of the
      amount receivable by all other beneficiaries as insurance under policies on the
      life of the decedent with respect to which the decedent possessed at his death
      any of the incidents of ownership, exercisable either alone or in conjunction
      with any other person. For purposes of the preceding sentence, the term
      “incident of ownership” includes a reversionary interest (whether arising by
      the express terms of the policy or other instrument or by operation of law)
      only if the value of such reversionary interest exceeded 5 percent of the value
      of the policy immediately before the death of the decedent. As used in this
      paragraph, the term “reversionary interest” includes a possibility that the
      policy, or the proceeds of the policy, may return to the decedent or his estate,
      or may be subject to a power of disposition by him. The value of a
      reversionary interest at any time shall be determined (without regard to the
      fact of the decedent’s death) by usual methods of valuation, including the use
      of tables of mortality and actuarial principles, pursuant to regulations
      prescribed by the Secretary. In determining the value of a possibility that the
      policy or proceeds thereof may be subject to a power of disposition by the
      decedent, such possibility shall be valued as if it were a possibility that such
      policy or proceeds may return to the decedent or his estate.

Section 20.2042-1(c)(2), Estate Tax Regs., expounds on the term “incidents of

ownership”:

      For purposes of this paragraph, the term “incidents of ownership” is not
      limited in its meaning to ownership of the policy in the technical legal
       sense. Generally speaking, the term has reference to the right of the insured
      or his estate to the economic benefits of the policy. Thus, it includes the
      power to change the beneficiary, to surrender or cancel the policy, to assign
      the policy, to revoke an assignment, to pledge the policy for a loan, or to
                                         - 28 -

      obtain from the insurer a loan against the surrender value of the policy, etc.
       ***

Thus, if decedent possessed at his death any incidents of ownership in the Reliastar

policy, the entire $2,495,000 death benefit is includible in the value of the gross

estate pursuant to section 2042(2).

      B. Parties’ Arguments

      The estate argues that at the time of decedent’s death he did not possess any

incidents of ownership in the Reliastar policy and therefore the proceeds are not

includible in the value of the gross estate. See sec. 2402(2). The estate reasons that

as a result of the September 16 agreed order (1) decedent could not exercise the

economic benefits of the policy (e.g., change the beneficiary or cancel the policy)

and (2) the value of decedent’s reversionary interest did not exceed 5% of the value

of the policy. Respondent argues that decedent had a reversionary interest and the

estate has not shown that the value of decedent’s reversionary interest did not

exceed 5% of the value of the Reliastar policy. See id.

      C. Decedent’s Reversionary Interest

      Regardless of the limitations imposed on decedent by the September 16

agreed order, if the value of decedent’s reversionary interest in the Reliastar policy

exceeded 5% of the policy’s value, the policy proceeds are includible in the gross
                                         - 29 -

estate under section 2042(2). See supra p. 27. The estate concedes that decedent

had a reversionary interest. The estate also concedes that if we determine that the

Reliastar policy had a fair market value in excess of zero, it has not introduced

evidence that would allow us to find that the value of decedent’s reversionary

interest did not exceed 5% of the policy’s value.25

      The estate argues, however, that the best approximation of the Reliastar

policy’s value is its net cash-surrender value of zero. Thus, the estate contends that

a 5-percent or more reversionary interest would have no value, and decedent’s

reversionary interest would not constitute an “incident of ownership”. See Estate of

Beauregard v. Commissioner, 74 T.C. 603, 610 n.5 (1980) (“Since * * * [the

decedent’s] coverage in the group policy had no ascertainable value prior to death, a

5-percent or more reversionary interest would have no value.”) Respondent argues

that net cash-surrender value is not the fair market value of the policy.

      Generally, the value of every item of property includible in the decedent’s

gross estate is its fair market value at the time of the decedent’s death. Sec.

20.2031-1(b), Estate Tax Regs. “The fair market value is the price at which the


      25
         Generally, taxpayers bear the burden of proving, by a preponderance of the
evidence, that the determinations of the Commissioner are incorrect. Rule 142(a);
Welch v. Helvering, 290 U.S. 111, 115 (1933). The estate does not argue that
respondent should bear the burden of proof.
                                        - 30 -

property would change hands between a willing buyer and a willing seller, neither

being under any compulsion to buy or to sell and both having reasonable knowledge

of the relevant facts.” Id. The fair market value is not to be determined by a forced

sale price. Id. When valuing a life insurance policy that has been in force for some

time and requires further premium payments to be made, the value may be

approximated by making adjustments to the interpolated terminal reserve.26 See sec.

20.2031-8(a)(2), Estate Tax Regs.; sec. 25.2512-6(a), Gift Tax Regs. This method

may not be used, however, if “because of the unusual nature of the contract such an

approximation is not reasonably close to the full value of the contract”. Sec.

20.2031-(8)(a)(2), Estate Tax Regs.

      The estate claims that “The [interpolated terminal] reserve value of the

policy is essentially the ‘Accumulated Value’ of the policy.” As of August 15,

2005, the accumulated value of the policy was $31,165.84. The estate argues,




      26
          The valuation calls for “adding to the interpolated terminal reserve at the
date of the decedent’s death the proportionate part of the gross premium last paid
before the date of the decedent’s death which covers the period extending beyond
that date.” Sec. 20.2031-8(a)(2), Estate Tax Regs. The interpolated terminal
reserve “‘is not cash surrender value; it is the reserve which the insurance company
enters on its books against its liability on the contracts. * * * The word
“interpolated” simply indicates adjustment of the reserve to the specific date in
question.’” Matthies v. Commissioner, 134 T.C. 141, 153 n. 12 (2010) (quoting
Commissioner v. Edwards, 135 F.2d 574, 576 (7th Cir. 1943), affg. 46 B.T.A. 815
(1942)).
                                         - 31 -

however, that because decedent’s policy was in force for only 18 months before

his death and had a surrender charge of $43,573.16, the policy should be valued at

its net cash-surrender value of zero and not its accumulated value of $31,165.84.

      Respondent argues that net cash-surrender value represents the policy’s

forced sale or liquidation value and not the fair market value of the policy.

Respondent contends that the policy’s interpolated terminal reserve, which the

estate claims is the same as the policy’s accumulated value, is the proper value for

the Reliastar policy.

      Initially, we note that our obligation does not extend to determining the

exact value of the Reliastar policy, but only to deciding whether the Reliastar

policy was worthless at the time decedent died.27 We also note that despite the

estate’s claim that the Reliastar policy’s accumulated value “is essentially the”

interpolated terminal reserve of the policy, we find no evidence of this in the terms

of the policy or in any of the documents provided to the estate by AIG after

decedent’s death. The policy generally defines “accumulated value” as the total

premium payments made minus all monthly fees and expenses plus earned

interest. While the accumulated value may approximate the amount which the


      27
           See supra p. 29.
                                         - 32 -

company enters on its books against its liability on the contracts, neither party has

presented evidence that suggests this is the case.

      The estate’s main argument is that if we do not consider the surrender charges

in valuing the Reliastar policy we will overstate the fair market value of the policy.

In any event, the fact that decedent (or any other owner) had no access to the

savings or investment portion of the policy as of the date of his death does not make

the policy worthless. See Schwab v. Commissioner, 136 T.C. 120 (2011) (finding

life insurance policies to have fair market values despite the polices’ net cash-

surrender values of zero). “Surrender of a policy represents only one of the rights of

the insured”, albeit a significant one. Guggenheim v. Rasquin, 312 U.S. 254, 257

(1941).

      In Schwab v. Commissioner, 136 T.C. 120, we were faced with deciding the

“amounts actually distributed” under section 402(b) when taxpayers received life

insurance policies from a nonqualified employee-benefit plan that, like the life

insurance policy here, had surrender charges in excess of their stated values. Id. at

125. The policies in Schwab also were similar to the Reliastar policy in that the

policies were universal life insurance policies, had been in effect before the date of

disposition, and required further premium payments. Id. at 123-124.
                                        - 33 -

      In Schwab we first decided that the policies’ fair market values constituted

the “amounts actually distributed”. Id. at 131. We then concluded that the only

significant value the policies had was the amount of insurance coverage that was

attributable to the premium payments previously made by the employer,28 and we

determined that the fair market values of the life insurance policies were $1,900.33

and $765.62 by multiplying the number of remaining days the policies covered the

taxpayers as of the date of distribution by the base rates for the guaranteed

maximum monthly cost of insurance rates. Id. at 135-136.

      Here, decedent’s final premium payment provided him with coverage until

September 1, 2005. Thus, as of the date of decedent’s death, the Reliastar policy

would have provided 20 days’ more coverage. Following our reasoning in Schwab,

the Reliastar policy’s fair market value as of August 11, 2005, would at least be the

cost of insuring decedent for 20 days, or $390.79.29


      28
          Similar to the situation before us, in Schwab v. Commissioner, 136 T.C.
120 (2011), we lacked evidence in the record of the insurer’s policy reserves. See
id. at 133.
      29
          The cost of insuring decedent for 20 days is determined as follows:
.23833 (base rate per thousand dollars of coverage for the guaranteed maximum
monthly cost of insurance) x 2,495 (amount of coverage divided by $1,000) gives
us a monthly benefit of $594.63. Multiplying the monthly benefit by 12 months
results in an annual benefit of $7,135.56. We then determine the benefit of
insuring decedent for 20 days by taking the annual benefit and multiplying it by
                                                                        (continued...)
                                        - 34 -

      Moreover, unlike the policies in Schwab, the Reliastar policy’s no-lapse

provision had not expired (or even kicked in) at the time of decedent’s death. The

terms of the Reliastar policy stated that so long as decedent’s total premium

payments exceed the “cumulative total of the ‘Minimum Monthly Premiums’ in

effect from the ‘Policy Date’ to the end of the current period” the Reliastar policy

would remain in effect, regardless of net cash surrender value. When decedent

died he had made premium payments of $43,573.16. The policy’s minimum

monthly premium was $1,024.22, and the cumulative total of the minimum

monthly premiums beginning on the Policy Date (March 1, 2004) to the end of the

current period (August 31, 2005) was $18,435.96. Thus, because of the no-lapse

provision and decedent’s total premium payments, the Reliastar policy would have

remained in effect until September 1, 2007--more than two years after decedent




      29
         (...continued)
the fraction of 20/365. This calculation results in a value of $390.79. See Schwab
v. Commissioner, 136 T.C. at 135 n.21.
                                           - 35 -

died--without a premium payment being made.30 We believe this adds a significant

amount of value to the Reliastar policy.

      The estate’s only argument with respect to the value of decedent’s

reversionary interest is that the policy was worthless. The estate admits that it did

not introduce any evidence that would allow us to conclude that the value of

decedent’s reversionary interest was less than 5% of the value of the Reliastar

policy. Thus, having determined that the Reliastar policy had a fair market value in

excess of zero, it follows that the full amount of the Reliastar policy proceeds are

includible in the value of the gross estate under section 2042(2).

III. Whether the Estate Is Entitled to Deduct the Reliastar Policy Proceeds
     Under Section 2053(a)(4)

      Generally, section 2053(a)(4) allows a deduction from the gross estate for

indebtedness that encumbers property the value of which, undiminished by such

indebtedness, is included in the gross estate.31 In Estate of Robinson v.


      30
         It would have taken more than 24 months for the cumulative total of the
minimum monthly payments to exceed the total premium payments made and cause
the Reliastar policy to lapse. This is shown by dividing $25,137.20 (total premium
payments made of $43,573.16 - cumulative total of minimum monthly payments as
of August 31, 2005, of $18,435.96) by $1,024.22 (the Reliastar policy’s minimum
monthly premium) for a total of 24.543 months.
      31
           Sec. 2053(a)(4) provides in part as follows:

                                                                         (continued...)
                                         - 36 -

Commissioner, 63 T.C. 717 (1975), we held that where (1) a property settlement

agreement entered into in the context of divorce proceedings obligates one party to

name the other party as a beneficiary to life insurance proceeds; (2) the obligee

receives the life insurance proceeds upon the death of the obligor; and (3) the

obligor’s estate includes the life insurance proceeds in the value of the gross estate,

the obligor’s estate may deduct as indebtedness under section 2053(a)(4) the

amount of the life insurance proceeds the obligor was required to provide under the

divorce decree. See sec. 2053(a)(4); see also Rev. Rul. 76-113, 1976-1 C.B. 276.

      The estate argues that it is entitled to deduct the full amount of the Reliastar

policy proceeds as indebtedness in respect of property included in the gross estate.

See sec. 2053(a)(4). The estate reasons that the September 16 agreed order

increased the indebtedness encumbering the policy from $500,000 to $2,495,000

and the estate included the full value of the Reliastar policy in the gross estate.




      31
        (...continued)
      For purposes of the tax imposed by sec. 2001, the value of the taxable estate
      shall be determined by deducting from the value of the gross estate such
      amounts for * * * any indebtedness in respect of[] property where the value of
      the decedent’s interest therein, undiminished by such * * * indebtedness, is
      included in the value of the gross estate, as are allowable by the laws of the
      jurisdiction * * * under which the estate is being administered.
                                        - 37 -

      Section 2053(c)(1)(A) limits the deduction for indebtedness in respect of

property included in the gross estate when the indebtedness was founded on a

promise or agreement. In such a situation the deduction under section 2053(a)(4) is

permitted only to the extent that the indebtedness was contracted bona fide and for

an adequate and full consideration in money or money’s worth. Sec. 2053(c)(1)(A).

      An exception to the “adequate and full consideration in money or money’s

worth” requirement exists where the transfer of property occurs pursuant to certain

property settlements. Secs. 2043(b)(2), 2516. Section 2043(b)(2) provides that for

purposes of the deduction provided by section 2053(a)(4), a transfer of property that

satisfies section 2516(1) shall be considered to be made for an adequate and full

consideration in money or money’s worth. Section 2516 provides in part as follows:

             Where a husband and wife enter into a written agreement relative to
      their marital and property rights and divorce occurs within the 3-year period
      beginning on the date 1 year before such agreement is entered into (whether
      or not such agreement is approved by the divorce decree), any transfers of
      property or interests in property made pursuant to such agreement * * * to
      either spouse in settlement of his or her marital or property rights * * * shall
      be deemed to be transfers made for a full and adequate consideration in
      money or money’s worth.
                                        - 38 -

      The estate argues that “The September 16, 2004 Agreed Order constitutes an

agreement settling Decedent’s and * * * [Ms. Kahanic’s] marital and property rights

entered into within the time frame required by * * * [section] 2516.” Therefore, the

estate argues that decedent’s obligation to maintain Ms. Kahanic as the sole

beneficiary of the Reliastar policy proceeds and subsequent transfer to her of the

policy proceeds is deemed to be made for a full and adequate consideration in

money or money’s worth under section 2043(b)(2). We agree.

      To begin, we believe that the September 16 agreed order is a settlement

agreement relative to decedent’s and Ms. Kahanic’s marital and property rights.32

Moreover, as discussed supra, the September 16 agreed order modified the MSA.

Thus, regardless of whether we view the transfer of the Reliastar policy proceeds to

Ms. Kahanic as being made pursuant to the MSA (as amended by the September 16

agreed order) or the September 16 agreed order, it would be made pursuant to an

agreement in settlement of marital or property rights within the purview of section

2516(1). Accordingly, the exception under section 2043(b)(2) is met, and the




      32
         The September 16 agreed order was entered into within the timeframe
required by sec. 2516(1).
                                         - 39 -

transfer of the Reliastar policy proceeds is considered to be made for an adequate

and full consideration in money or money’s worth.33

      As we have decided that the September 16 agreed order created an

indebtedness to Ms. Kahanic in the full amount of the policy proceeds and that the

subsequent transfer of the policy proceeds is deemed to satisfy the consideration

requirement of section 2053(c)(1)(A), it follows that, pursuant to our holding in

Estate of Robinson v. Commissioner, 63 T.C. 717 (1975), the estate is entitled to

deduct the full amount of the policy proceeds under section 2053(a)(4).

IV. Whether the Estate Is Entitled To Deduct Accrued Interest on the $700,000
    Loan From Ms. Kahanic

      Generally, section 2053(a)(2) authorizes an estate to deduct administration

expenses that are allowable by the law of the jurisdiction in which the estate is being

administered. Subject to limitations, an estate may borrow money to satisfy its

Federal estate tax liability and deduct the interest incurred on the debt as an




      33
         We note that the purpose of the "adequate and full consideration"
requirement is to prevent the depletion of the estate by the use of agreements which
would ultimately serve to avoid the estate tax. Bank of New York v. United States,
526 F.2d 1012, 1016 (3d Cir. 1975); see Estate of Hartshorne v. Commissioner, 402
F.2d 592, 594 n.2 (2d Cir. 1968); Latty v. Commissioner, 62 F.2d 952, 953-954 (6th
Cir. 1933). There is no evidence that decedent and Ms. Kahanic intended to use the
September 16 agreed order as a way to minimize the estate’s Federal tax liability.
                                         - 40 -

administration expense under section 2053(a)(2). Estate of Bahr v. Commissioner,

68 T.C. 74 (1977); Estate of Todd v. Commissioner, 57 T.C. 288 (1971).

      Illinois law provides that “all expenses incurred in connection with the

settlement of a decedent’s estate, including debts, * * * estate taxes, * * * [and] fees

of attorneys and representatives * * * shall be charged against the principal of the

estate.” 760 Ill. Comp. Stat. Ann. 15/6(a) (West 2007). Illinois law further

provides that, as long as the executor is acting within the best interests of the estate

and consistent with the decedent’s will, he or she has the power to borrow money.

755 Ill. Comp. Stat. Ann. 5/28-8(b) (West 2011). Decedent’s will specifically

grants to the executor of his estate the power “to borrow money for any purpose, at

interest rates then prevailing, from any individual”.

      Respondent argues that the estate is not entitled to deduct the accrued interest

on the $700,000 loan from Ms. Kahanic because the loan was not a bona fide debt

and the loan was not actually and reasonably necessary to the administration of the

estate. Respondent also argues that the estate is not entitled to deduct the accrued

interest because the estate has not proved that the interest will be paid. We consider

each of these arguments in turn.
                                        - 41 -

      A. Whether the Loan Was a Bona Fide Debt

      Whether a particular transaction is to be properly characterized as a loan

depends on the facts and circumstances. Busch v. Commissioner, 728 F.2d 945 (7th

Cir. 1984), aff’g T.C. Memo. 1983-98. Respondent’s argument that the loan made

by Ms. Kahanic to the estate is not a bona fide debt is based upon his analysis of six

factors taken from Estate of Graegin v. Commissioner, T.C. Memo. 1988-477. We

recently discussed the significance of the factors mentioned in Estate of Graegin and

what the Court looks for in deciding whether a bona fide debt has been created:

              While the factors taken from Estate of Graegin may provide helpful
      guidance, they are not exclusive, and no single factor is determinative. See
      Patrick v. Commissioner, T.C. Memo. 1998-30, affd. without published
      opinion 181 F.3d 103 (6th Cir. 1999). The factors are simply objective
      criteria helpful to the Court in analyzing all relevant facts and circumstances.
      Id. The ultimate questions are whether there was a genuine intention to
      create a debt with a reasonable expectation of repayment and whether that
      intention fits the economic reality of creating a debtor-creditor relationship.
      Litton Bus. Sys., Inc., v. Commissioner, 61 T.C. 367, 377 (1973).

Estate of Duncan v. Commissioner, T.C. Memo. 2011-255.

      Respondent contends that there is no indication that Ms. Kahanic intended

to create a genuine debt and that the estate intended to repay the loan. With

respect to the former, respondent argues that Ms. Kahanic had no intention of
                                           - 42 -

collecting the $700,000 that she lent the estate. As support respondent points out

that Ms. Kahanic has not demanded repayment of the loan despite the fact that the

note became due in May 2009. Respondent also argues that Ms. Kahanic benefited

from the estate’s timely payment of its Federal estate tax liability. Respondent

reasons that if the estate was unable to pay in full its Federal estate taxes the IRS

could have collected a portion of the estate’s tax liability from Ms. Kahanic. See

secs. 6324(a)(2), 6901(a). The estate counters that respondent fails to consider the

facts known by the estate and Ms. Kahanic when the loan was made in May 2006.

       Before receiving the loan in May 2006, the estate believed that it had assets

valued at $1,274,545, $406,430 of which were in liquid form, to pay liabilities of

$1,125,047.34 When the estate received the loan and used the proceeds to pay its

estate tax liabilities, it believed that it had total assets of $1,004,545 to pay off total

liabilities (including the loan principal), of $855,047. This left the estate with nearly

$150,000 to pay interest on the loan as well as any other liabilities.

       The estate admits that Ms. Kahanic benefited from the estate’s timely

paying of its estate tax liabilities. It argues, however, that Ms. Kahanic’s




       34
            See supra note 14.
                                        - 43 -

benefiting from the estate’s payment and her intention to collect the loan are not

exclusive of each other. We agree.

      Ms. Kahanic credibly testified that Mr. Levine and the other accountants in

his group assured her that she would be paid back and that the estate had sufficient

assets to repay the loan. We believe the facts as of May 2006 support Mr. Levine’s

assurances to Ms. Kahanic. Additionally, Jeffrey Smith, an accountant with Levine

Hahn who advises clients with respect to lending money, credibly testified that as of

May 2006 the estate had sufficient assets to secure the $700,000 loan.

      Respondent argues that if Ms. Kahanic intended to recover the loan she

would have demanded repayment when the loan became due in May 2009. While

we believe that Ms. Kahanic’s demanding repayment in 2009 may have been an

indication that she intended to collect the loan, we do not think the absence of such

a demand shows that when she made the loan in May 2006 she did not intend to

create a genuine debt. Ms. Kahanic did not demand repayment because doing so

would have exhausted the estate’s funds, thereby preventing the estate from

challenging the IRS’ deficiency determinations and potentially subjecting her to

transferee liability. When the loan was made Ms. Kahanic intended to be repaid in

full and was advised by Levine Hahn that the estate had sufficient assets to repay
                                         - 44 -

the principal of the loan and any accrued interest. Thus, we believe that Ms.

Kahanic intended to create a genuine debt when she lent the estate $700,000.

      Respondent also argues that the estate never intended to repay the loan. He

contends that when the estate agreed to the terms of the loan it knew that it would

be unable to repay the loan. We disagree.

      The estate believed that it had total assets of $1,004,545 to repay the loan

plus any interest, $155,047 of the estate’s other liabilities, and any additional legal

fees and/or damages resulting from the defense of potential medical malpractice

claims. Had the assets retained their estimated values and there was no deficiency

proceeding brought against the estate, the estate would have been able to repay the

loan along with any interest. We find that neither Mr. Fiala nor Levine Hahn had

any knowledge that the estate’s assets’ values would dissipate in such a way as to

make repayment of the loan difficult.

      Additionally, Mr. Fiala credibly testified that when the loan was made he, as

executor, intended to repay Ms. Kahanic. When asked why he had not made any

payments on the loan, he stated that “[t]he position of the estate has deteriorated

significantly since May 5 when [the note] was executed.” Mr. Fiala also explained

that John Argo, decedent’s former business adviser, assured Mr. Fiala that the

estate would be able to sell decedent’s medical practice as a going concern.
                                             - 45 -

Ultimately, however, “[t]he estate simply was forced to liquidate what was left of

the practice for literally pennies, for the value of the equipment and furniture within

the office.” Finally, unexpected legal fees incurred as a result of this deficiency

proceeding reduced the estate’s assets even further. We find that the estate intended

to repay the note and has not done so only because of unforeseen circumstances that

have reduced the values of the estate’s assets.

       Taking into consideration all of the facts and evidence, specifically the

testimony of the relevant parties to the loan and the estate’s financial picture as of

May 5, 2006, we believe that a bona fide debt was created between Ms. Kahanic

and the estate.

       B. Whether The Loan Was Actually And Reasonably Necessary

       The amount of deductible administration expenses is limited to those

expenses which are actually and necessarily incurred in the administration of the

estate. Estate of Todd v. Commissioner, 57 T.C. at 296; sec. 20.2053-3(a), Estate

Tax Regs. Respondent argues that the loan was not actually and reasonably

necessary because the estate (1) had the right to recover from Ms. Kahanic a portion

of the estate’s tax liabilities and (2) could have collected and sold nonliquid assets

in time to pay its estate tax liabilities.
                                          - 46 -

              1. Right to Contribution From Ms. Kahanic

      Unless the decedent directs otherwise in his will, section 2206 allows for the

executor to recover from a beneficiary of life insurance proceeds on the decedent’s

life the portion of tax paid by the estate as the proceeds of the policy bear to the

taxable estate.35 Decedent’s will expressly provides that the estate tax liabilities are

to be paid first out of his residuary estate and, if insufficient, out of the Declaration

of Trust. Decedent’s will also waives “any right of reimbursement for, recovery of,

or contribution toward the payment of * * * taxes.”

      Respondent argues that the estate had a right to request contribution from Ms.

Kahanic, notwithstanding decedent’s will, because the residuary estate and the

Declaration of Trust did not contain sufficient assets to pay the estate’s tax

liabilities.36 We disagree. The estate had sufficient assets to pay its estate tax


      35
           Sec. 2206 provides in pertinent part:

             Unless the decedent directs otherwise in his will, if any part of the
      gross estate on which tax has been paid consists of proceeds of policies of
      insurance on the life of the decedent receivable by a beneficiary other than the
      executor, the executor shall be entitled to recover from such beneficiary such
      portion of the total tax paid as the proceeds of such policies bear to the
      taxable estate.
      36
         Respondent contends that in In re Estate of Williams, 853 N.E.2d 79 (Ill.
App. Ct. 2006), the Appellate Court of Illinois held that in such a scenario the
excess tax liabilities are to be apportioned between the beneficiaries of the
                                                                          (continued...)
                                         - 47 -

liabilities when it received the loan proceeds; the assets simply were in illiquid

form. 37 Respondent concedes that the estate could not seek contribution from Ms.

Kahanic if decedent’s residuary estate and/or Declaration of Trust had sufficient

assets to pay the estate’s tax liabilities. Thus, the estate had no right seek

contribution from Ms. Kahanic when it made the decision to borrow $700,000.

              2. Whether the Estate’s Assets Could Have Been Liquidated in Time
                 To Pay its Estate Tax Liabilities

      Respondent next argues that the estate could have liquidated its assets before

its taxes were due, thereby making the loan unnecessary.38 Specifically, respondent

argues that the estate could have recovered more than $400,000 by liquidating

AEPS and collecting decedent’s unpaid compensation.




      36
         (...continued)
decedent’s probate and nonprobate assets. In In re Estate of Williams the
decedent’s will directed that her estate tax liability was to be paid out of her
residuary estate “without apportionment or reimbursement”, but her will did not
mention who would be responsible for the tax liability if the residuary estate lacked
the assets necessary to pay the liability. Id. at 81. The Appellate Court decided that
the tax liability should be apportioned among those who received probate and
nonprobate assets. Id. at 84.
      37
           See supra note 14.
      38
          We note that this argument is inconsistent with respondent’s position that
the estate could have sought contribution from Ms. Kahanic because it did not have
sufficient assets to pay its estate tax liabilities. See supra pp. 46-47.
                                          - 48 -

      Expenses incurred to prevent financial loss to an estate resulting from a

forced sale of its assets in order to pay estate taxes are deductible administrative

expenses. See Estate of Todd v. Commissioner, 57 T.C. 288; Estate of Graegin v.

Commissioner, T.C. Memo. 1988-477. Instead of liquidating AEPS and selling its

assets one by one, Mr. Fiala acted on the advice of Mr. Argo and attempted to

maximize AEPS’ value by selling it as a going concern. By the time the taxes

became due, the estate had not sold AEPS and needed to borrow money.

Additionally, liquidating AEPS and selling its individual assets in a forced sale

would have resulted in financial loss. Of AEPS’ $580,824 of total assets, $443,396

were in the form of accounts receivable. If the estate chose to sell the accounts

receivable it likely would have been at a deep discount to reflect the present values

of the receivables and possibility of uncollectibility.

      With respect to decedent’s unpaid compensation, AEPS lacked the cash

necessary to pay the estate. AEPS had only $117,364 in a Harris Bank checking

account when decedent died and still owed expenses related to the winding up of

AEPS and $115,000 on a line of credit with Harris Bank. Also, Mr. Fiala had to

consider the possibility of two medical malpractice lawsuits and a lawsuit brought

by decedent’s former employees. We do not find it unreasonable that the estate
                                           - 49 -

had yet to collect decedent’s unpaid compensation, especially considering the large

amounts of uncollected accounts receivable.

        On the facts of this case, we are satisfied that the interest on the loan was

“actually and necessarily incurred”, as required by section 20.2053-3(a), Estate Tax

Regs.

                3. Whether the Accrued Interest Will Be Paid

        The remaining issue is whether the estate will pay the accrued interest. See

sec. 20.2053-1(b)(3), Estate Tax Regs. Respondent contends that the estate has not

shown that the accrued interest will be paid, and therefore the estate is not entitled

to deduct the interest. The estate counters that if it prevails as to the deductibility of

the Reliastar policy proceeds it will have the funds necessary to repay the interest.

        As of July 31, 2010, the estate’s liabilities ($778,484) exceeded its assets

($603,893) by roughly $175,000.39 However, when we remove the loan’s

principal amount (which will not be paid off until after the accrued interest is

satisfied)40 from the estate’s liabilities, the estate’s assets exceed its liabilities by




        39
             See supra note 22.
        40
             See supra p. 17.
                                          - 50 -

more than $440,000.41 Thus, the estate has the funds necessary to repay the accrued

interest, and we believe that the estate has credibly stated that it will do so.42

      The estate has shown that: (1) a bona fide debt was created; (2) the loan and

accrued interest were actually and reasonably necessary to the administration of the

estate; and (3) the accrued interest will be paid. Accordingly, the estate is entitled

to deduct the accrued interest under section 2053(a)(2).

V. Deduction For Additional Accountant’s and Attorney’s Fees

      The estate contends that it is entitled to deduct additional reasonable

attorney’s fees, accountant’s fees, and other administrative expenses under Rule

155. The parties stipulated that “[t]o the extent that they are reasonably incurred in

the administration of [d]ecedent’s estate, and have been or will be paid, such

additional fees and expenses will be taken into account in the computations to be

made pursuant to U.S. Tax Court Rule 155.” There is nothing in the record to

suggest that the foregoing expenses were not reasonably incurred in the


      41
           As of July 31, 2010, the estate’s assets totaled $603,893, and the estate’s
liabilities, excluding the loan’s principal amount, totaled $162,484.
      42
         We do not find, as respondent contends, that the estate’s failure to make
any payments on the loan as of the date of trial indicates that the estate will not now
repay the interest. As discussed supra pp. 44-45, the estate failed to repay the loan
on account of the unexpected reductions in the values of its assets and the
uncertainty stemming from the proceedings before the Court.
                                        - 51 -

administration of decedent’s estate or will not be paid, and the parties may take

them into consideration in the Rule 155 computations.

      In reaching our holdings, we have considered all arguments made, and to the

extent not mentioned, we consider them irrelevant, moot, or without merit.

      To reflect the foregoing,


                                                       Decision will be entered

                                                 under Rule 155.
