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Billionaire’s Tax Scheme Didn’t Pan Out for Heirs

(CN) - A family cannot deduct $47 million in capital gains from federal estate tax return of the late media mogul Marshall Naify, the 9th Circuit ruled Wednesday.

After Telecommunications Inc. (TCI) merged with AT&T in 1998, Naify predicted that he would see a big profit and lose a lot of it in California taxes. To set off those obligations, amounting to $660 million in capital gains, Naify transferred the TCI notes to a newly created Delaware corporation called Mimosa of which he was the sole shareholder.

When Naify died in 2000, his estate deducted $62 million from its federal estate tax return as an estimate of what it would owe on the $660 million gain if the tax-avoidance plan didn't work.

The trust figured that Mimosa had "a 67 percent likelihood of failure."

Ultimately, the California Franchise Tax Board settled with the estate over the unreported capital gains for $26 million.

A 2003 Internal Revenue Service audited further complicated the matter by disallowing the $62 million estimated deduction. Since the $26 million payment to California qualified as a deduction, however, the estate settled up for $11 million.

Three years later, the estate filed a claim with the IRS to get that $11 million back, asserting this time that $47 million was the correct deduction.

"In order to arrive at the $47 million value, the estate discounted the $62 million that it believed that Naify owed in California income tax on the $660 million by 67 percent, which was the probability, according to the trust's expert, that Naify's tax plan would fail," according to the ruling.

The IRS did not agree, arguing that the estate's estimate was "contingent and disputed."

The trust filed a complaint in California's Northern District seeking a $47 million refund of federal estate taxes. The San Francisco court sided with the government, and as did the 9th Circuit on appeal.

"According to the trust's expert, Naify's California tax avoidance plan had a 67 percent likelihood of failure, which leads to the inescapable conclusion that his plan also had a 33 percent chance of success," Judge Arthur Alarcon wrote for the unanimous three-judge panel. "If his plan succeeded, the California income tax claim might never be asserted or paid. If his plan failed, there is nothing suggesting that the amount of the claim was reasonably certain to be $47 million, as opposed to some other amount. As the District Court recognized, 'it cannot be that simply because one can assign a probability to any event and calculate a value accordingly, any and all claims are reasonably certain and susceptible to deduction. To so hold would read the regulatory restriction out of existence.'"

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