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When will the use of post-mortem income to pay administration expenses cause a reduction in the marital or charitable deduction? A divided Court and confusing reasoning leave practitioners without the clear guidance they had hoped for A direct invitation to IRS to provide new rules is likely to be accepted. but how far the Service will go to overturn the taxpayer victory is not yet known.

The US Supreme Court's decision in Estate of Hubert suggests some tax planning options regarding the allocation of estate administration expenses against post-death income. Allocation of expenses should be considered when an income tax deduction can be obtained without reducing estate tax deductions, when allocation can increase bypass trust funding and when a specific bequest will trigger estate tax liability. The Court established a test in the middle ground between the IRS' position and the argument that permissible allocation with not reduce marital and charitable deductions.

IRS and some courts require that marital and charitable deductions be reduced for administration expenses whether allocated to principal or income. The Tax Court and at least one circuit have held, however, that those deductions are reduced only by the portion of administration expenses allocated to principal. Various areas of law apply to this issue, and the rationale and conclusions of the courts often are complex and inconsistent. From a practical standpoint, in certain circumstances prudent tax planning may dictate the allocation of administration expenses to income.

The US 6th Circuit Court of Appeals held in Estate of Millikin that the determination of IRC section 2053(a) deductible administration expenses requires the application of a two-part test taking into account federal and state standards. The court condoned the use of the IRS' 'actually and necessarily incurred' standard in addition to standards of the jurisdictions where estates are administered. The ruling is consistent with the majority of the US circuit courts addressing the issue.

The IRS's position that estates cannot deduct expenses after the estate tax return has been filed was overturned by both the Sixth Circuit in Estate of Millikin and by section 646 of the Taxpayer Relief Act of 1997. The IRS's position is based on using state law as the only standard for reasonableness while both Millikin and section 646 name a federal standard to be met. This issue needs to be addressed because the IRS position, combined with section 646 establishes a double standard for estate and income tax deductions.

Tax practitioners can prepare for the US Supreme Court's ruling in Estate of Hubert on the split among the US Courts of Appeals on the effect that estate administration expenses have on the charitable and marital deductions. After the decedent's death, executors should be counseled to file the IRC section 642(g) waiver statement as late as possible. Practitioners still at the estate planning stage should draft wills to allow executors maximum flexibility in allocating expenses between income and principal.