Deductions from the gross estate a4 Chapter 2 DEDUCTIONS FROM THE GROSS ESTATE The deductions from the gross estate are: J Ordinary deductions: (a) Expenses, losses, indebtedness, taxes, etc.: (1) Funeral expenses; (2) Judicial expenses of testamentary or intestate proceedings; (3) Claims against the estate; (4) Claims against insolvent persons; (5) Unpaid mortgage or indebtedness on property; Taxes; Losses. (b) Transfer for public use; (c) Vanishing deduction; 2. Special deductions: (a) Family home;* (b) Standard deduction;* (c) Medical expenses;* (d) Amount receivable by heirs under Republic Act No. 4917.* *Not available to the estate of a non-resident, not citizen of the Phi- lippines. (See pages 2-22 on Amount under Republic Act No. 4917) Deductions are now classified into ordinary and special by revenue regulation. Looking at the original provision of the law on deductions, one can find only the ordinary deductions. There were no special deductions. Funeral expenses. The deduction for funeral expenses is the amount of actual funeral expenses, or an amount equal to five22 Deductions from the gross estate percent (5%) of the gross estate, whichever is lower, but ec thousand pesos (P200,000). (Figures 2-1 and 2-7). Figure 2-1. Allowable funeral expenses. Case 1 Case 2 Case 3 Gross estate P3,000,000 —P3,000,000 P9,000,000 Actual funeral expenses 120,000 160,000 350,000 5% of gross estate 150,000 150,000 450,000 Statutory maximum 200,000 200,000 200,000 Allowed 120,000 ~ 150,000 200,000 Funeral expenses Are funeral expenses deductible because the payment paid, or stilltobe resultsina physical reduction of cash in the estate? paid, from the es- Yes. If the funeral expenses were already paid even tate are deduct- before death (as in the case of a memorial plan), is ible, at the actual there still a deduction for funeral expenses? Yes (by re- expenses, or 5% venue regulation). Thus, the rule is: Funeral expenses, of the gross es- whether paid or unpaid, are deductions from the gross tate, or P200,000, estate " whichever is the lowest. The term “funeral expenses” includes the mourning ap- parel of the surviving spouse and unmarried minor child- ren of the deceased bought and used on the occasion of the burial, expenses of the decedent's wake, including food and drinks, publication charges of death notices, telecommunication expenses incurred in informing rela- tives of the deceased, cost of burial plot, tombstone, mo- nument or mausoleum, but not their upkeep, interment and/or cremation fees and charges, and all other expen- ses incurred in the performance of the rites and cere- monies incident to interment. In case the deceased owns a family estate or several burial lots, only the value corresponding to the plot where he is buried is deductible.Deductions from the gross estate a / the cut-off point for funeral expen- ses is the point of interment /The cost of ame- morial plan is an actual funeral ex- pense / Deduction for ju- dicial expenses in the settlement of the estate in, or out of, court are allowed if wi- thi six from the date of death. — *In order to be considered as an actual funeral ex- pense, the funeral expense should be paid, or payable out of the estate. Thus, funeral expenses paid by some- body, or out of contributions from friends and relatives, shallot}be considered actual funeral expenses. — The cut-off point is interment. Expenses related to the death which accrue after interment are not considered funeral expenses. Thus, the expenses on the card of thanks, the expenses for the food on the ninth day of prayer for the dead (after interment), and for the mass for the dead after forty days from death are not funeral - expenses. When some of the items which are actual funeral expenses are covered by a memorial plan, the value of the memorial plan shall be included in the gross estate, and the value of the memorial plan plus other actual fu- neral expenses, shall give an aggregate which shall be compared with the five percent -(5%) limitation and with two hundred thousand pesos (P200,000). Can there be funeral expenses if the cadaver was do- nated to the hospital where the decedent died? None. pis icial expenses. The provision of law on this deduction is: “for judicial expenses of the testamentary or intestate proceedings”. The expenses shall not include those that- were in- curred beyond the period provided by law for filing the estate tax return and payment of the estate tax (within six months from the date of death), or the extension pe- riod allowed. What shall judicial expenses include? Judicial expen- ses shall include fees of the executor or administrator, attorney's fees, court fees, accountant’s fees, apprais-24 Alicia! expen- ses include ad- ministration ex- penses on the estate Arattement of the estate out of court has admi- nistration expen- ses that are de- ductible as ‘ju- dicial expenses” aims against the estate are obligations of the decedent, en- forceable if he were alive. Deductions from the gross estate ser's fees, clerk hire, costs of preserving and maintaining the properties, and brokerage fees for selling properties in the estate. Can there be a deduction for “judicial expenses” when there is no special proceeding in court for the settlement of the estate? Asked differently, can there be a deduction from the gross estate for expenses on extrajudicial settlement of the estate (e.g., notarial fees of the lawyer who prepared and notarized the deed of extrajudicial partition of the estate)? Yes. The expenses are within the meaning of administration expenses. And the statutory deduction for judicial expenses should be understood as broad enough to include administration expenses, whe- ther the settlement of the estate is judicial or extra- judicial (Decision of the Supreme Court of the Philip- pines). / attorney's fees on a judicial settlement of an estate normally are paid within as well as beyond the period provided by the law on the filing of the estate tax return. But as long as there was an agreement for such attor- ney’s fees entered into within the allowed period, pay- ments on them shall be deductible as judicial expenses even if actual payments were made beyond the period. Attomays fees paid _by the heirs to theit respective e conf eTiot) as judicial expenses. These expenses should be eones rately borne by them. Claims against the estate. A person, at some time during his ‘lifetime, must have contracted obligations. If enforceable against him when alive, the obligations shall be claims against his estate when he shall be dead. Thus, an obligation that had prescribed already during the lifetime of the decedent, or thet was unenforceable agalnst;himwhen stil sive (¢.¢-26 Receivable from insolvent person: Include the entire receivable in the gross estate, and then deduct the uncollectible por- tion from the gross estate. Deductions from the gross estate the proceeds of the note. Can there be a deduction from the gross estate for the claim of Mr. E? None. Alaims against insolvent persons. A person is insolvent when his properties are not ‘suf- ficient to pay his obligations. The claims of the creditors shall be satisfied out of his available properties. There are two kinds of creditors, namely, the preferred creditors and the ordinary creditors. As the terms imply, the pre- ferred creditors shall first be paid in full from the pro- perties (e.g., the Government, for unpaid taxes), and the balance of the properties shall be available propor- tionately to the ordinary creditors. Claims against insolvent persons are deductions from the gross estate, subject to the condition that the full a- mounts of the receivables are first included in the gross estate. The deduction from the gross estate shall be the uncollectible portion. It shall be wrong to include in the computation of the taxable estate only the realizeable portion of the claims. (See Figure 2-2). Figure 2-2. Treatment of claim against insolvent person. Claim against an insolvent person of P100,000 fully uncollectible. Wrong Correct Other properties P2,000,000 P2,000,000 Claim against insolvent 100,000 Gross estate P2,100,000 Deductions: Funeral expenses - 5% of P2,000,000 P 100,000 5% of P2,100,000 P 105,000 Claim against insolvent | 100,000 Total deductions P 100,000 P 205,000 Net estate before standard deduction P1,900,000 P1,895,000Deductions from the gross estate 25 ‘é fire claim is rom a debt ins- trument, the ins- trument should be notarized. If the loan was wi- thigthrés Years prior to death. the executor or administra- tor must certify on the disposi- tion of the loan. not in writing) shall/not/be a claim against his estate when he shall be dead: If a claim against the estate arose out of a debt instru- ment, the debt instrument must be notarized (except for loans by financial institutions where notarization is not part of the business practice or policy of the financial institution). If the loan was contracted within three years before the death of the decedent, the administrator or executor should submit a statement showing the disposi- tion of the proceeds of the loan. If a monetary claim against the decedent did not arise out of a debt instrument, the requirement on a notarized debt instrument does not apply. Ilustration. Mr. A, during his lifetime, executed a promis- sory note that was not notarized. He died with the note still unpaid. Can there be a claim against his estate arising out of the promissory note? None. Illustration. Mr. B, during his lifetime, executed a nota- tized promissory note, payable within sixty days from the date of issue. He died the day after he executed the promis- sory note. The proceeds of the note were certified by the ad- ministrator of the estate as used for family expenses. The obligation is a claim against the estate. Iilustration. Mr. C, during his lifetime, was sued for da- mages for an act committed by him, and the court ordered him to pay damages. He died before he could comply with the order of the court. The judgment for the sum of money is a claim against the estate. There is no debt instrument in- volved. Mlustration. Mr. D, during his lifetime, had cash of P100,000. He borrowed P100,000 from Mr. E, a friend, and executed a notarized promissory note for it. The aggregate of P200,000 was maintained in a single bank account, from which expenses were paid. One year after the note was executed, and the note still being unpaid, Mr. D died. The administrator of the estate could not trace payments fromDeductions from the gross estate 27 IMustration. Mr. F died leaving an estate, in which re- ceivables from debtors are included, as follows: P10,000 from a brother who died without any property whatsoever, and P15,000 from a friend whose properties are not suffi- cient to pay preferred creditors. The deduction for claims against insolvent persons shall be P25,000. Iustration. Mr. G died leaving an estate, in which there is a receivable of P60,000 from a debtor who has not enough properties to pay all his obligations. The debtor's properties were worth P100,000 and his obligations amount- ed to P300,000. Only one-third (1/3) of the obligations can be satisfied from the properties. The deduction from the gross estate of Mr. G for a claim against an insolvent person shall be 2/3 of P60,000, or P40,000. Jinpaid mortgage or indebtedness on property. jfror property with mortgage, the When a person leaves property encumbered by a property shallbe mortgage or indebtedness, his gross estate shall include included inthe the fair market value of the property, undiminished by the gross estate at | mortgage or indebtedness. The mortgage or indebted- its full fair mar- ness shall be claimed as a deduction from the gross es- ket value, and tate. It shall be wrong to include in the computation for then the mort- the gross estate only the equity of the decedent on the gage shallbe a — property (See Figure 2-3). deduction. Figure 2-3. Treatment of unpaid mortgage or indebtedness. Estate of Miss H: Wrong Correct Other properties P1,000,000 P1,000,000 Mortgaged real estate 400,000 1,000,000 Gross estate P1,400,000 P2,000,000 Funeral expenses - 5% of P1,400,000 P 70,000 5% of P2,000,000 P 100,000 Unpaid mortgage 600,000 Total deductions P 70,000 P 700,000 Net estate before standard deduction P1,330,000 1,300,00028 Sony taxes that accruedbefore death can be deducted Property taxes not accrued be- fore death, in other words, that accrued after death, can be deducted from the gross income of the estate for income tax pur- poses. Deductions from the gross estate Iustration. Miss H died leaving real property with a fair market value of P1,000,000, but subject to a mortgage in fa- vor of Miss | in the amount of P600,000. While the equity of Miss H is P400,000, the gross estate shall include the fair market value of P1,000,000, and the mortgage of 600,000 shall be claimed as a deduction from the gross estate. (See Figure 2-3.) Z If the loan is merely an accommodation loan, where the proceeds of the loan went to another person, the value of the unpaid loan shall be included in the receivable of the estate. Faxes. Taxes are deductions from the gross estate if such taxes accrued prior to the decedent's death. Taxes that accrued after the decedent's death are not deductions from the gross estate. The National Internal Revenue Code has a negative statement on taxes as deductions from the gross estate, as it only enumerates taxes that cannot be deducted, as follows: : (a) Income tax on income received after death; (b) Property taxes not accrued before death; and (c) Estate tax. Mlustration. Mr. | died on March 5, 2011 before he was able to file his income tax retum for the calendar year 2010. The tax accrued before his death. The tax shall be a deduction from his gross estate. Mustration. The real property tax of Mr. J for 2011 was P20,000. He died on June 30, 2011 after paying two of four equal installments on the tax. The deduction from his gross estate shall be P10,000. The real property tax accrues at the beginning of a calendar year, although allowed to be paid in installments. The unpaid amount of P10,000 accrued already ‘on January 1, 2011Deductions from the gross estate — The estate tax accrues after death, hence not de- ductible from the gross estate. However, in the case of a decedent who was a citizen or resident of the Philippines at the time of death, there shall be a Philippine estate tax payment on his properties within and outside the Philippines, and a foreign estate tax payment on his properties outside the Philippines. How are the two es- tate tax payments treated? Are they both not deductible from the gross estate? The answer is “Yes”. However, with respect to the estate tax paid to the foreign country, the law allows him a tax credit to reduce the Philippine estate tax (See Chapter 7). Aosses. Figure 2-4. Period for occurrence of casualty loss. Case 1: Loss can be deducted Settlement of the estate 6 months Case 2: Loss cannot be deducted Date of Death Loss Settlement of the estate 4 6 months Fosses are deductible from the gross estate if: (a) Arising from fire, storm, shipwreck, or other ca- sualty, robbery, theft or embezzlement;2-10 Aalue in the gross ‘estate of the pro- Deductions from the gross estate 6) Not compensated by insurance or otherwise; (ce) Not claimed as a deduction in an income tax return of the estate subject to income tax; (a) Occurring during the settlement of the estate; (8) Occurring before the last day for the payment of the estate tax (Last day to pay: six months after the decedent's death, or the allowed extension) — (See Figure 2-4) Theft is the simple taking of property without the con- sent of the owner. If the taking of property is accompa- nied by force or intimidation, the act is robbery. Em- bezzlement, also called estafa, is the misapplication of entrusted property without the consent of the owner. What is within the meaning of “casualty”? A casualty is an accident, a mishap, or a sudden invasion by a hostile agency, and excludes the gradual deterioration of pro- perty arising from a steadily operating cause. Mustration. During the settlement of the estate and within one month from the date of death, a building included in the report of properties in the gross estate was des- troyed by earthquake. Can there be a deduction from the gross estate for the loss? Yes. Earthquake is within the meaning of “other casualty” for which there can be a deduction for loss. Mlustration. \t took two and one-half (2%) years to settle lost (less) compen- the estate of Mr. K. On the tenth month after his death, a ‘sation by insu- rance or any kind of indemnity that makes good the loss (equals) the deduction for the loss. house which was part of the gross estate and with a fair market value of P880,000 was totally destroyed by fire. There was no insurance recovery. There shall be no de- duction from the gross estate. While the loss took place during the settlement of the estate, the loss took place after the last day for the payment of the estate tax. Mlustration. Assume that in the preceding illustration, an executor was appointed on the third month following the date of death, and there was the building with a fair market value of P880,000 in the gross estate. The fire took place on theDeductions from the gross estate Baa A disposition to the Ni lational Govern- ment, or to any of its political sub- divisions of pro- vinces, cities, mu- nicipalities or ba- rangays, for exclu- sively public pur- poses, is a de- deduction from the gross estate. fourth month following the date of death. There were insu- rance proceeds receivable of P680,000. The deductible casualty loss shall be P200,000 (P880,000 less P680,000) Mlustration. Miss L died with a Mercedes Benz car with a fair market value of P2,000,000, which was reflected in the inventory of properties in her gross estate. The estate was in the process of extrajudicial partition among her heirs when, at a time two months after her death, the car was stolen. The criminal was caught, but, unable to return the car, he paid a compromise amount of P1,800,000. The deduction from the gross estate shall be P200,000 (P2,000,000 less 1,800,000). The requirement on the loss taking place during the settlement of the estate was satisfied even if the settlement of the estate was extrajudicial. And the compen- sation need not be by insurance only. Any compensation that makes good the loss is a downward adjustment in the computation of the deductible loss. Mlustration. Mr. K died and his estate was the subject of judicial settlement. There were income-producing properties in the estate. On the third month after death, there was a loss of property in the estate. In an income tax retum filed for the estate, the loss was deducted from the gross income of the estate. The same loss gafiot bs’deducted from the gross estate. Yansfer for public use. By “transfer for public use” as deduction from the gross estate is meant dispositions in a last will and tes- tament, or transfer to take effect after death, in favor of the Government of the Philippines, or any political sub- division thereof, for exclusively public purposes. What are the political subdivisions of the National Go- vernment? They are: & Provinces; (by Cities; (Sy Municipalities, andDeductions from the gross estate 212 oh Barangays. The inclusion in the gross estate and Ilustration. In his last will and testament, Mr. L left a land the deduction from with a fair market value of P2,000,000 to the City of the gross estate shall Tabaco, Albay, for the city government to build on it a new result in a net tax- City Hall. There shall be a deduction of P2,000,000 from the able estate from gross estate of Mr. L. the property of PO. IMlustration. During his lifetime, Mr. M made a donation mortis causa of a piece of land with a fair market value of P800,000 to Barangay Don Manuel, Quezon City, on which to construct the barangay hall. The value of the property shall be included in the gross estate of Mr. M, and the same value shall be a deduction from the gross estate. Vanishing Deduction. Property may change hands within a very short period of time by reason of the early death of the owner who received it by inheritance or gift. This subjects the pro- perty to a very heavy burden in taxes, because the transfer tax is imposed on each transfer. To provide a relief, vanishing deduction is allowed to reduce the gross estate of the recipient of the inheritance or gift. /Nanishing de- “ duction may be on Vanishing deduction is allowed when (conditions): property received as inheritance, in (ay The present decedent died within five years from re- which case there ceipt of the property from a prior decedent or donor were two deaths, or (See Figure 2-5); on property re- (8 The property on which vanishing deduction is being ceived as gift, in oo The pre must be located in the Philippines; TI which case there he property must have formed part of the taxable might be one estate of the prior decedent, or of the taxable gift of death only. the donor; (gyThe estate tax on the prior succession or the donor's tax on the gift must have been finally determined and paid; (oy The property on which vanishing deduction is being claimed must be identified as the one received fromDeductions from the gross estate oa the prior decedent, or from the donor, or something acquired in exchange therefor; (ff No vanishing deduction on the property was allow- able to the estate of the prior decedent (See Figure 2-5). Figure 2-5. Vanishing deduction in successive estates Held for: 7 Syears s 7 Vanishing deduction in the estate of S. 3years Vanishing deduction in the estate of S No vanishing deduction in the estate of T because T F 4years _there was vanishing deduction in the estate of S. u # 2years Vanishing deduction in the estate of U because no vanishing deduction in the estate of T. v t } 6 years No vanishing deduction in the estate of V be- cause inherited more than five years ago, a vanishing deduction? if the property was ac- quired by the present decdént by inheritance (No/if the property was acquired by donation. The donor may still be alive. Should there be two ness order that there may be IMustration. Mr. O died leaving a piece of land to Mr. P. Two years later, Mr. P died with the same piece of land. There can be a vanishing deduction on this piece of land from the gross estate of Mr. P. The piece of land in the gross estate of Mr. P can be identified as the same piece of land inherited. Ilustration. Mr. Q died leaving a piece of land to Mr. R. Mr. R exchanged this piece of land for a car during his