Michael Kline writes:
Installment 63 of this blog series reported that New Jersey Tax Court Judge Gail Menyuk, in an unpublished memorandum opinion (Dalton v. Director, Division of Taxation, NJTC Docket No. 020540-2010) (the “Dalton Case”), disagreed with the position of the Division of Taxation of New Jersey (the “Division”) to find that, under the circumstances of the Dalton Case, investors in the long-running Ponzi scheme of Bernard L. Madoff and his related entities (collectively, “Madoff”) could file amended tax returns for income tax refunds applicable to open tax years. Installment 63 pointed out limitations on the value as a precedent of the Dalton Case in that it was an unpublished memorandum opinion and that there may have been other cases pending in the New Jersey Tax Court involving the same or similar facts that can be decided differently.
The Division, undaunted by the outcome of the Dalton Case, continues to try to retain collected tax monies from Madoff victims. The recent opinion and decision of New Jersey Tax Court Judge Joseph M. Andresini in the case of Estate of Theodore Warshaw v. Director, Division of Taxation, No. 4000-2009 (the “Warshaw Case”), like the Dalton Case, found in favor of the taxpayer, the Estate of Warshaw (the “Estate”) and against the Division. There are, however, a number of significant differences from the Dalton Case that can be summarized as follows:
1. Having been approved for publication in the New Jersey Tax Court Reports, the opinion in the Warshaw Case has substantially greater weight as a precedent than the Dalton Case.
2. The Warshaw Case dealt with a refund claim by the Estate of an estimated New Jersey Estate Tax payment of almost $90,000 (the “Tax Payment”), not a New Jersey income tax refund claim as in the Dalton Case.
3. The Warshaw Case was one involving the question of a loss of what was a fictitious value of an account according to Madoff statements as opposed to distribution by Madoff of fictitious profits to an investor as in the Dalton Case.
The area of dispute in the Warshaw Case centered around the valuation for an Individual Retirement Account ("IRA"), as of May 27, 2006, the date of death of the Estate decedent (the "Decedent”). The valuation of the IRA owned by the Decedent as of the date of death that was reported by the Estate in its tax return was $1,463,373. The amount reported was based on figures provided to the Estate in Madoff monthly statements. The IRA had been invested with Madoff, and was supposedly funded with investment securities managed by Madoff. Following Madoff’s December 2008 arrest, the Estate representatives learned that the IRA was worthless and the monthly IRA statements from Madoff were fictitious.
Contrary to the monthly statements from Madoff that showed a single line aggregate fictitious value for the IRA assets, it turned out that there were no securities or other assets ever held by Madoff in the name of the IRA. The elimination from the Estate of any valuation for the IRA had the effect of reducing the value of the Estate at the date of the Decedent’s death from $1,847,893 to $384,520, which was well below the $675,000 New Jersey estate taxable threshold.
Imagine the shock and dismay for the Estate representatives, especially the widow, since the Estate had even received post-death distributions from Madoff of $273,626.34 (the “Distributions”) prior to his arrest. As the Judge observed, however, even if the Distributions were to be added to the shrunken Estate valuation as a deemed value of the IRA, the Estate was still below the $675,000 threshold. The Estate filed a refund claim with the Division for the almost $90,000 balance of the Tax Payment.
After giving his analysis, Judge Andresini agreed with the Estate that the IRA had no value as of the date of death of the Decedent, and without it, the assets fell below the $675,000 threshold for paying New Jersey estate taxes. Furthermore, the discovery of the Madoff scheme within 30 months of the date of was also found to be reasonable by the Judge to allow the Estate to receive a full refund of the Tax Payment.
The significant aspects of the Warshaw Case that enabled Judge Andresini to find in favor of the hapless widow included the following analysis. The Judge relied on precedent and painstakingly distinguished the case of Ithaca Trust Co. v. United States, 279 U.S. 151, 49 S. Ct., 291 (1929), which stood for the long-standing principle that “subsequent events may not be considered to determine date of death value for assets in the taxable estate” (the “Ithaca Trust Rule”). The Judge relied on precedents to reason that the arrest of Madoff and the revelation of the Madoff scheme in December 2008 was not a post date of death event that caused or effected a decline or disappearance of value of the IRA but rather was a subsequent event that “provided evidence of value of the assets on the date of death.” [Emphasis supplied]
Judge Andresini pointed out that valuation for federal estate tax purposes is defined as fair market value at date of death, which is “the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.” 26 C.F.R. Section 20.2031-1(b) (2012). In finding for the Estate, the Judge rejected the Division’s argument that the willing buyer and seller could not have known of the Madoff scheme at the date of death and found that “the hypothetical willing buyer need not discover the Ponzi scheme, but need only discovery [sic] that the Plaintiff had no assets to sell.” The Judge reasoned that a willing buyer would have undertaken due diligence to ascertain what individual securities were the basis of the single line gross amount reflected on what turned out to be fictitious Madoff statements.
While the Warshaw Case may be appealed by the Division, it currently stands as a significant decision in a case to prevent the Division from being a beneficiary of the Madoff scheme at the expense of a widow who, like many Madoff victims, found herself to be much less wealthy than she had believed. Even if the case were to stand or be upheld on appeal, its scope of coverage and facts may be too case-specific to benefit many other Madoff victims. It may, however, be of significant value to other estate tax litigants as it expands the type of post-death evidence that may be adduced for determining valuation at the date of death in the face of the Ithaca Trust Rule. As has been true of so many issues generated by Madoff, more on this matter can be expected to unfold in the future.
[To be continued in Installment 82]
(Michael J. Kline, Esq., the author of this entry and a co-author of this blog, is a partner with Fox Rothschild LLP, based in our Princeton, NJ office, and is a past Chair of the firm’s Corporate Department. He concentrates his practice in the areas of corporate, securities, and health law, and frequently writes and speaks on topics such as corporate compliance, governance and business and nonprofit law and ethics.)