CHAPTER 14

ESTATE TAX: DEDUCTIONS FROM GROSS ESTATE

DEDUCTIONS FROM GROSS ESTATE

There are charges which naturally diminish the amount of the inheritance of the heirs. Hence, the law
allows deductions from gross estate. In addition to these charges, the law also allows certain deductions
in the nature of incentives from gross estate.

Presentation of Deductions in the Estate Tax Return

Page 534

Note:

1. For a single decedent, the column common properties will be left blank.

2. The "Conjugal/Communal" column is left blank if the decedent is single.

534

CLASSIFICATION OF DEDUCTIONS
A. Ordinary Deductions
B. Special Deductions
C. Share of the surviving spouse

Ordinary deductions conceptually include items which diminish the amount of the inheritance. The only
exception here is the deduction for "Property previously taxed" which is a tax incentive but is classified
as ordinary deductions in pursuant to the estate tax form.

Special deductions are items which do not reduce the inheritance but are nonetheless allowed by the
law as incentive deductions against gross estate in the determination of the net taxable estate.

Share of the surviving spouse pertains to the interest of the surviving spouse in the net conjugal or
communal properties of the spouses. This portion is not owned by the decedent and will not be
transmitted by the decedent as part of the inheritance; hence, it must be removed in the taxable estate.

GENERAL PRINCIPLES OF ESTATE DEDUCTIONS

1. The substantiation rule

As a rule, items of deduction must be supported with documentary evidence such as receipts, invoices,
contracts, and other proofs that they actually exist or occurred to establish their validity.

2. Matching principle

As a rule, items of deduction must pertain to properties that are part of the gross estate. They must be
proper charges thereto.
Examples:

a. Obligations of the exclusive properties of the surviving spouse cannot be claimed as deductions
because said properties are not included in gross estate.

b. Losses of properties before the death of the taxpayer are not deductible because the properties are
no longer part of the gross estate of the decedent at the date of death.

c. Separate obligations or losses of exclusive properties of the surviving spouse cannot be deducted
against the gross estate.

3. "No double classification" rule

Items of deduction cannot be claimed simultaneously under several deduction categories.

Examples:

a. A family home which is destroyed by any casualty during the settlement of the estate cannot be
simultaneously deducted as a "family home" and a "casualty loss."

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b. Losses claimed in the income tax return of the estate cannot be claimed again as deduction in the
estate tax return.

4. Default presumption on ordinary deduction

In the case of married decedents, ordinary deductions are presumed to be against the common
properties unless proven to be an exclusive property be either spouse. This is in line with the rule that
properties are comma properties unless proven to be exclusive.

ORDINARY DEDUCTIONS

Under current usage, the following are deemed ordinary deductions:

1. Losses, Indebtedness and Taxes (LIT)

2. Transfer for Public Use

3. Vanishing Deductions

LOSSES, INDEBTEDNESS AND TAXES (LIT)

Losses

These pertain to losses of properties of the estate during the settlement of the estate. These may arise
from casualty such as fires, storms, shipwreck, robbery, theft or embezzlement when such losses are not
compensated for by insurance.
Points to Remember:

1. Loss must be a sustained casualty loss.

2. The loss must occur during the settlement of the estate up to the deadline of the estate tax return.

3. The loss must no Abe concurrently claimed in the income tax return.

Illustration 1

Mr. Y died in a fatal car crash on November 2, 2019. The following losses of properties were identified by
his estate administrator:

Losses up to the point of death:

Value of car totally destroyed during the crash P1,200,000

Pilferage loss on merchandise revealed by
the physical inventory count on October 31, 2019 80,000

Losses since the death of the decedent:

Fire loss on an insured building on December 25, 2019 P2,000,000

Theft of personal valuables of Mr. Y on January 1, 2020 180,000

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Value of cash robbed from Mr. Y’s residence on February 14, 2020 620,000
Value of an uninsured car destroyed by a storm on March 1, 2021 800,000
Unpaid loans receivable from a bankrupt customer 100,000

The deductible loss shall be:

Loss on theft of personal valuables P 180,000

Loss on robbery 620,000
Total deductible loss P 800,000

Note:

1. A loss incurred before or at the date of death is non-deductible.

•The value of the car destroyed on the crash is non-deductible because the car will no longer be
included in the gross estate of the decedent.

•If the property is compensated for by insurance, the proceeds of insurance is included in gross
estate, but still no loss deduction is allowed because the same does not affect the hereditary
estate.
 •The pilferage loss on inventory will not be deductible since the inventories were lost before
death and are not part of the gross estate.

2. The fire loss on the building is not deductible because it is insured. The loss is not actual but
temporary which will be recovered by the estate.

3. The loss on an uninsured car caused by a storm is non-deductible as it is beyond 1 year from the date
of death.

4. The unpaid loan receivable from a bankrupt customer is a deductible loss but under a separate
category "Claim against insolvent person."

Illustration 2

Just before filing the return in June 15, 2020, the estate administrator noted the following losses in the
estate of Mr. Wong, a businessman who died June 30, 2019:

1. The $100,000 in Mr. Wong's savings account. He purchased these dollars at P54/$. The Peso is trading
P53/$ on June 30, 2019 and P52/share on June 15, 2020.

2. Mr. Wong had an office equipment with book value of P400,000 on June 30, 2019. The executor sold
this for P350,000 on March 10, 2020 to settle claims against the estate.

3. Mr. Wong's vault containing P300,000 inventories of precious metals was i was claimed as deduction
in the income tax stolen on August 15, 2019. "This return of the estate for 2019. None of these losses is
deductible.

None of these losses is deductible.

The $100,000 cash shall be included in gross estate at P53/$. The decrease in the value of the $100,000
cash from P53/$ to P 52/$ is not deductible since this is an unrealized market loss. The loss in market
value from P54/$ to P53/$ shall already deducted in the amount of gross not be deducted because the
same is already deducted in the amount of gross estate.

537

The office equipment had a realized loss of P50,000 during the settlement of state but this is not a
casualty loss; hence, non-deductible.

The P300,000 theft loss is a realized casualty loss during the settlement of th3estate but the same is
claimed as an ordinary loss in the income tax return of the estate.

Claims against insolvent persons

Claims against insolvent persons is a form of loss but is presented as a separate item of deduction in the
tax return. The deductible amount of claim against insolvent persons is the unrecoverable amount of
claim.
Illustration I

Mr. Kugar died with a total receivable of P200,000 from Mr. Kumag. The latter was adjudged bankrupt
by the court with only P800,000 total assets but with P2,000,000 in total liabilities.

Mr. Kugar would be expected to recover only P200,000/P2,000,000 x P800,000 or P80,000 from Mr.
Kumag. The claim from insolvent person shall be P200,000 - P80,000 = P120,000.

Assuming that there is zero recovery, the entire amount of claim shall be presented as a deduction.
Either way, the P200,000 claim must be included in gross estate.

Illustration 2

Mrs. Shelly died leaving a P 500,000 promissory note from Dye Company a bankrupt company
undergoing liquidation. The note was secured by a small piece of land with current value of P300,000.
The fiduciary of Dye Company estimates a 40% recovery for unsecured creditors.

Mrs. Shelly also loaned Dye Company P 20,000 in a written instrument which prescribed a few years
prior to her death.

The claim against insolvent persons shall be computed as:

Recoverable amount P 380,000

Less: Total claim 500,000
Claim against insolvent person P 120,000

The recoverable amount is computed as:

Total claim P 500,000

Less: Fair value of collateral 300,000 P 300,000
Unsecured portion P 200,000
Multiply by: Recovery ratio 40% 80,000
Recoverable amount P 380,000

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Note: The P20,000 waived loan which prescribed is not a claim against insolvent person since it is no
longer an enforceable right at the point of death.

Classification of Losses

Losses, including claims against insolvent persons, shall be classified based on the "Property
classification Rule." The loss of separate property is presented as a deduction against separate property.
The loss of common property is presented as a deduction against common property.
Illustration

The estate of a Mrs. X, a married decedent under the regime of absolute community of property,
suffered the following losses:

1. P500,000 cash from the family business were robbed from Mrs. X during the night of her murder.

2. A car with P800,000 value which Mrs. X inherited during the marriage from his grandmother was
stolen at the time of her wake.

3. A few months after Mrs. X' death, the P2,000,000 house which was inherited by Mr. X just before
their marriage was totally guttered by a fire

4. P300,000 worth of personal belongings of Mr. X were destroyed by the fire.

The foregoing shall be reported in the estate tax return of Mrs. X as follows:

*page 539

Note:

The P300,000 fire loss on personal belongs of X is non-deductible since these are separate properties of
the surviving spouse and are not part of the gross estate. The house is communal property since the
same is inherited before the marriage.

Claims against the estate (Indebtedness)

The word "claims" as used in the statute is generally construed to mean debts or demands of a
pecuniary nature which could have been enforced against the deceased in his lifetime and could have
been reduced to simple money judgments (RAMO 1-80).

Claims against the estate or indebtedness with respect to property may arise out of contract, tort, or
operations of law.

Unpaid mortgages are claims against the estate but are separately reported under the category "Unpaid
mortgage" in the estate tax return.

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Requisites of deductibility of claims against the estate:

1. The liability represents a personal obligation of the deceased existing at the time of his death except
unpaid medical expenses

2. The liability was contracted in good faith and for adequate and full consideration in money or money's
worth;

3. The claim must be a debt or claim which is valid in law and enforceable in court;
4. The indebtedness must not have been condoned by the creditor or the action to collect from the
decedent must not have prescribed.

Classification Rules for Claims against the Estate

1. Family benefit rule

If the obligation was contracted or incurred for the benefit of the family, the claim shall be classified as
deduction against common property. Otherwise, the property classification rule shall be applied.

Examples:

a. A mortgage which was contracted for the education of the children of the spouses shall be
deducted against common properties even if the same is constituted against a separate property of
either spouse.

b. An unpaid real property tax on the family home shall be deducted against common property
even if the family home is a separate property of either spouse.

c. Obligations constituted for the medication or other support expenses of any family member
shall be considered deductions against common properties.

2. Property classification rule

Claims follow the classification of the relevant property.

Examples:

a. A mortgage or unpaid taxes on property inherited or acquired before marriage shall be classified
following the classification of the property based on the applicable family regime of the spouses.

b. An obligation arising from exclusive property shall be considered as deduction from exclusive
properties unless it accrued or was used for the benefit of the family.

Special rules on certain claims against the estate

1. Unpaid mortgage

This includes mortgage upon, or any indebtedness, with respect to property where the value of the
decedent's interest therein, undiminished by such mortgage or indebtedness, is included in gross estate.

540

Illustration 1

A decedent had a family home worth P1,500000 which was encumbered by a mortagge. Details about
the mortgage were as follows:
*Page 541

The family home is a common property of the decedent and his spouse. The proceeds of the mortgage
were used for the family.

A deductible mortgage, just like other obligations, must have been incurred before death and remain
unpaid at the point of death. Hence, the allowable deduction for "Unpaid mortgage" shall be the
balance of the mortgage at the point of death:

Presentation in the tax return:

Note:

1. The value of the property undiminished by the mortgage is included in gross estate.

2. Only mortgages which were constituted during the lifetime of the decedent which remain
unpaid at the time of his death are deductible.

Illustration 2

During the marriage, Mr. Y inherited a commercial lot with a zonal value of

P4,000,000. When one of his children got sick, he mortgaged the property for P2,000,000. He was able
to pay P400,000 until his death.

Presentation in the tax return:

----------------------------

Note: The mortgage shall be presented under common property because the proceeds of the same is
use for the benefit of the family.

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2. Unpaid taxes

This includes taxes such as income tax, business tax, and property tax which have accrued as of the
death of the decedent and which were unpaid as of the time of death.

It must be emphasized that only obligations existing at the point of death are deductible. Obligations
including taxes which are settled before death and those accruing after death are not deductible from
gross estate.
Hence, the following taxes are non-deductible:

a. Tax on income earned after death

b. Property taxes accruing after death

c. Business taxes accruing after death

d. Estate tax on the transmission of the estate to the heirs

It must be noted also that as contemplated in RR2-2003, "Claims against the estate" are restricted to
private claims enforceable against the decedent's estate.

Although taxes are claims against the estate, taxes should be reported under a separate category, but
since there is no separate category for taxes in the estate tax return, the same shall properly be included
under the category "Others."

3. Accommodation loan

An accommodation loan is one contracted by a person in behalf of another person with the contracting
person merely representing in behalf of the other person who will be the beneficiary of the loan
proceeds.

Accommodation loan are presented as a receivable in the gross estate and is presented as a deduction.
However, if there is a legal impediment to recognize the same as a receivable, it may not be included in
the gross estate. Likewise, it will not be presented as an obligation.

Illustration 1: Claim against the estate - unmarried decedent

The heirs identified the following obligations of Mr. Natoy, a bachelor, who died on September 1, 2019:

*page 542

542

The deductible "claims against the estate" shall be:

*page 543

Presentation in the estate tax return

--

Illustration 2: Claim against the estate-married decedent

The executor of Mr. X compiled the following obligations:

*page 543
Presentation in the estate tax return:

--

Note:

1. Obligations are presumed common unless established as exclusive. Obligations of the surviving
spouse are not deductible because exclusive properties of the surviving spouse not included in gross
estate. (Matching rule)

2. Unpaid funeral expenses are non-deductible because they are debts accruing after death.

3. Unpaid medical expenses are likewise non-deductible even if they are incurred prior to death
because Congress increased the standard deductions from P1M in the N1RC to 135M under the TRAIN
law in lieu of deductions for funeral, judicial and medical expenses.

4. Obligations accruing after death are obligations of the heirs and are not obligations of the
decedent. They are deductible against the share of the heirs in the hereditary estate and are not
deductible from the amount of the hereditary estate. Hence, these are not —d under a separate
classification "Unpaid mortgage".

543

Substantiation Requirements on Claims against the Estate

1. Simple loan and advances

a. The debt instrument must be duly notarized at the time the indebtedness was incurred, such as
a promissory note or contract of loan, except for loans granted by financial institutions where
notarization is not part of the business practice/policy of the financial institution-lender

b. A duly notarized Certification from the creditor as to the unpaid balance of the debt, including
interest as of the time of death.

c. Proof of financial capacity of the creditor to lend the amount at the time the loan was granted,
as well as its latest audited balance sheet with a detailed schedule of its receivable showing the unpaid
balance of the decedent-debtor

d. A statement under oath executed by the administrator or executor of the estate reflecting the
disposition of the proceeds of the loan if said loan was contracted within three (3) years prior to the
death of the decedent;

2. Purchase of goods or services

a. Pertinent documents evidencing the purchase of goods or services as duly acknowledged, executed,
and signed by the decedent and the creditor, such as:
• Sale of goods - sales invoice/delivery receipt

• Sale of services - contract for the services agreed to be rendered

b. Statement of account given by the creditor as duly received by the decedent-debtor

c. Duly notarized Certification from the creditor as to the unpaid balance of the debt including
interest as of the time of death

d. Certified true copy of the latest audited balance sheet of the creditor with a detailed schedule of
its receivable showing the unpaid balance of the decedent-debtor

3. Where the settlement is made through the Court in a testate or intestate proceeding, pertinent
documents filed with the Court evidencing the claims against the estate, and the Court Order approving
the said claims, if already issued, in addition to the documents mentioned in the preceding paragraphs.

TRANSFER FOR PUBLIC USE

Transfer for public use includes the amount of all bequests, legacies, devises or transfer to or for the use
of the Government of the Republic of the Philippines, or any political subdivision thereof, for the
exclusive public purposes. These must be indicated in the decedent's last will and testament-

Illustration

Mr. A devised in his will the following properties: Commercial land, to a public school

-*page 544

544

The P5,000,000 must be included in gross estate. Only the P2,000 000 can be claimed as transfer for
public use. GOCCs are commercial and are not for public purposes.

PROPERTY PREVIOUSLY TAXED (VANISHING DEDUCTION)

There are instances where properties are transferred between persons in short periods of time causing a
series of transfer taxation.

Example:

a. The death of the decedent is preceded by a donation inter-vivos

b. The death of the decedent is preceded by a donation mortis causa

Case 1: Donation before death

Case 2 Series of deaths

-

Note the series of double transfer taxation in both cases. Due to this, a deduction for property
previously taxed is allowed by the law against gross estate to mitigate the impact of successive transfer
taxation. This deduction is commonly known as "Vanishing Deduction."

Requisites of vanishing deduction:

1. The present decedent must have died within five (5) years from date of death of the prior decedent or
date of gift.

2. The property with respect to which the deduction is claimed must have been part of the gross estate
situated in the Philippines prior decedent or taxable gift of the donor.

In short, the property must have been previously subjected to a transfer tax.

545

3. The property must be identified as the same property received from prior decedent or donor or the
one received in exchange thereof.

Deduction is still claimable even if the property transformed into another kind of property.

4. The estate taxes on the transmission of the prior estate or the donor’s tax on the gift must have been
finally determined and paid.

The basis of the vanishing deduction is to mitigate the impact of double taxation. Vanishing deduction
cannot be claimed if the donor's tax or estate tax was not paid in the prior transfer.

5. No vanishing deduction on the property or the property given in exchange thereof was allowed to the
prior estate.

This rule applies in the case of a series of deaths. If the prior estate claimed vanishing deduction, the
second estate cannot claim vanishing deduction because the purpose of vanishing deduction is to
mitigate double taxation.

The double deduction with vanishing deduction

The purpose of vanishing deduction is no other than to minimize the burden of double transfer taxation
that could occur when a decedent dies soon after receiving properties that are previously subjected to
transfer tax.

This noble gesture from the government should not be construed as permit for taxpayers to abuse
claims of deduction. In principle, vanishing deduction can be claimed only if there is an incidence of
double transfer taxation.
Despite the absence of a rule prohibiting double deduction using vanishing deduction, there is no good
reason to claim vanishing deduction if the entire value of the property is already claimed under:

a. Casualty losses

b. Transfer for public purpose

c. Family home

The property is effectively excused from taxation by being deducted under the aforementioned
categories. There would be no double taxation to occur. Hence, further claim of vanishing deduction
should be disallowed.

Illustration 1

Mr. A died on June 3, 2019 with the following properties in his gross estate:

*page 546

546