Wealth Transfer Tax

Fall 2007

Professor Gillett

Wealth Transfer TaxFall 2007

Professor Gillett

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ASSIGNMENT 1

Code: §§2001(a), (b) and (c), 2010SKIM §2031(a), 2051, 2501(a)(1), 2502(a), and 2505(a)

S,M,L & C: ¶¶ 1.01 - 1.03

Questions:

1. T, never having made any prior inter vivos gifts, made a taxable gift of real estate to his son in1992. At the time of the gift, the real estate had a value of $860,000. After taking into considerationthe $10,000 gift tax annual exclusion (see §2503(b)), it resulted in a taxable gift of $850,000. In 1992,the unified credit was $192,800, sufficient to exclude from taxation a gift of $600,000.

T died in 2007, owning other property with a value of $3,000,000. For purposes of this problem,assume that there were no deductions, so that the taxable estate was also $3,000,000 (see §2051). Atthe time of his death, the real estate which he gave away in 1992 had appreciated in value to $1,200,000.

a. Using the proper rate computation provided by §2502 and considering the §2505 unifiedcredit, what is T’s gift tax liability for 1992?

b. Determine the estate tax payable on T’s death in 2007, using the §2001 computation andthe §2010 unified credit.

c. Assuming that T retained sufficient interest in the real estate so that it was also includedin his gross estate, determine the estate tax liability on T’s death in 2007.

d. Consider the §2001(b) statutory method for computation of estate tax liability. Are thetaxable gifts being taxes twice?

e. Proper calculation in (a) and (b) above both make use of the applicable credit amount in§2010(c). Does that amount protect from taxation more than $2,000,000 of transfers?

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ASSIGNMENT 2

Code: §§2031(a), 2033 and 7520(a)

Regulations: §§20.2031-1(b), 20.2031-7A(d)(6), Table A, and 20.2033-1

S,M,L & C: ¶¶ 4.01, 4.02[1] and [2], and 4.05

Readings: Goodman v. GrangerEstate of Moss

Questions:

1. D transferred property to T (Trustee) in trust, the income to be paid to A for A’s life, remainderto B if living at A’s death, and, if not, to C or C’s estate.

a. At T’s death, will the value of the trust corpus be included in T’s estate?

b. At A’s death, will the value of the trust corpus be included in A’s estate? Is any wealthtransfer tax possibly applicable on A’s death?

c. Will part of the value of the trust corpus be included in B’s estate if B dies, survived byA?

d. Will part of the value of the trust corpus be included in C’s estate if C dies, survived byA but not by B? What would be included in C’s estate if the trust corpus is worth$100,000 on C’s death, A is a 60 year old male, and C’s estate uses date of deathvaluation?

e. Will part of the value of the trust corpus be included in C’s estate if C dies, survived byA and B?

f. Will part of the value of the trust corpus be included in C’s estate under the facts of (d)

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if the trust was an inter vivos trust created by D subject to his power of revocation andC was also survived by D?

g. If D had provided for a reversion to D or D’s estate (rather than a remainder to C or C’sestate) if B were not living at A’s death, will anything be included in D’s estate if Dpredeceases A and B?

2. Consider the extent to which state law may affect federal tax liability.

a. D died owning a residence that is protected from the claims of creditors by the state’shomestead law. Is it includible under §2033?

b. Under state law, D’s wife is the owner of one-half of their community property. Is herinterest in such property a part of D’s gross estate?

c. D and his wife own property as tenants in common which, under state law, involves noright of survivorship. What part of D’s interest, if any, is included in his gross estateunder §2033 if D dies survived by his wife?

d. What result in (c) under §2033 if D and his wife own the property as joint tenants and,under a decision by the state supreme court, they enjoy rights of survivorship? Whatresult if the state courts disagree as to whether there are rights of survivorship and thesupreme court has not yet resolved the issue?

3. D’s employer owed him $1,000 in salary that had not been paid at death.

a. Is D’s right to that amount included in his gross estate?

b. What result if the $1,000 is a benefit which D’s employer agrees to pay to D or D’s estateonly if he continued to work for him until his retirement or death and D works until the

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day he dies? (Goodman v. Granger)

c. What result if the employer pays to the surviving spouse a salary benefit representing apayment for the remaining portion of the salary period in which the decedent died butduring which he did not work?

d. Are Social Security benefits paid to D’s family at this death includible in his gross estateunder §2033?

4. W kills her husband H after a heated argument. After depositing his body in the dumpster, sheimmediately turns the gun on herself. W was the owner and named beneficiary of a life insurance policyon H’s life. Under state law, the proceeds were held for the benefit of H’s heirs and paid over to them.

a. What is included in W’s estate under §2033?

b. What is included in H’s estate under §2033?

5. D owns 39% of the stock of XYZ Corporation. The remainder of the stock is owned by itsemployees. D agrees to sell his stock to the corporation for $250,000. The note provides that on hisdeath, the remaining balance will be canceled.

a. Is anything included in D’s estate under §2033? What additional facts might be helpful?(Moss v. Comm’r)

b. What result if D canceled the outstanding note in his will?

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Eleanor D. Goodman, Administratrix of the Estate

of Jacques Blum, Deceased,

v.

Stanley Granger, Collector of Internal Revenue

243 F.2d 264 (1957)

KALODNER, Circuit Judge.

When does the federal estate tax attach?

More specifically stated, when does such tax attach

to a decedent-employee's contractual right to annual

deferred compensation payments from his employer,

payable to his estate after his death?

That problem, of first impression, is presented by this

appeal by the government from a judgment in favor of the

taxpayer, Eleanor D. Goodman, administratrix of the

estate of Jacques Blum, deceased, in a suit brought by her

in the District Court for the Western District of

Pennsylvania to recover estate taxes and interest alleged

to have been erroneously assessed and collected.

The District Court, subscribing to the taxpayer's

contention, concluded as a matter of law that the

decedent's contractual right was to be '* * * valued during

decedent's lifetime and at the moment before death * * *'

and made the factual finding that at such moment the

contractual right was 'valueless', for reasons which will

subsequently be discussed. In its opinion the District

Court stated 'It must be admitted that if the value in the

contracts is to be fixed the moment after death, then the

Government is correct in its contention in this case.

(Emphasis supplied)'

The undisputed facts may be summarized as follows:

The decedent, Jacques Blum, for several years prior

to his sudden death of a heart attack at the age of 52 on

May 2, 1947, was executive vice-president of Gimbel

Brothers, Inc. ('Gimbels') in charge of its Pittsburgh store.

On October 19, 1944, June 1, 1945 and May 26,

1946, decedent entered into identical contracts of

employment with Gimbel Brothers covering the years

ending January 31, 1945, January 31, 1946 and January

31, 1947, respectively. Each contract provided for a basic

salary of $50,000 per year, and for additional 'contingent

benefits' of $2,000 per year for fifteen years 'after the

employee ceases to be employed by the employer' by

reason of death or otherwise. The post-employment

'contingent payments' were to be made only if the

employee duly performed the services agreed upon and

did not engage in a competing business within a specified

period after termination of his employment; and they were

to be reduced if his post-employment earnings from a

non-competing business plus the contingent payments

exceeded seventy-five percent of his yearly average

compensation under the contracts. Any of the fifteen

annual contingent payments which fell due after the

employee's death were to be paid to his estate, or to a

nominee designated in his will.

The third contract for the period of employment

ending January 31, 1947 was, by its terms, renewed on a

month-to-month basis and was in effect at the time of

decedent's death. At the latter time there was every

prospect that he would continue to advance in his highly

successful career in retailing.

After the decedent's death Gimbels paid the $6,000

annual installments provided by the three separate

contracts ($2,000 each) to the taxpayer in her capacity as

administratrix as they became due. She filed with the

Collector a timely federal estate tax return and included

the three contracts at a value of $15,000. Upon audit of

the return the Internal Revenue Agent in Charge,

Pittsburgh, increased the value of the three contracts from

$15,000 to $66,710.34, the present worth of $90,000,

payable in equal annual installments of $6,000 a year over

a period of fifteen years. The increase in the value of the

contracts resulted in a deficiency of $15,958.18, including

interest, which was assessed against and paid by the

taxpayer, and for the recovery of which she brought the

suit here involved.

At the trial the taxpayer offered the testimony of three

witnesses to the effect that the three contracts created no

property right having any market value in the decedent

while he lived.

The government offered the testimony of one witness

who testified that the deficiency assessment was based

upon his conclusion that the contracts created in the

decedent valuable vested interests, subject to being

divested, and on that theory the contracts were considered

by the government to have the marketable monetary value

which it had determined and assessed.

The federal estate tax is imposed upon 'the transfer'

of a decedent's property, Internal Revenue Code of 1939,

sec. 810, and the gross estate of the decedent is

determined by including 'the value at the time of his death

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of all property' to 'the extent of the (decedent's) interest

therein.' Sec. 811(a). Treasury Regulations 105, sec.

81.10 provide that the measure of value for the purpose of

determining the gross estate in federal estate taxation is

the fair market value of the estate.

The sum of the taxpayer's position is (1) what is taxed

is 'the value' of the decedent's interest in his contract that

'ceased by reason of death', not the value of what is

received by the recipient (the administratrix); otherwise

stated, 'the value' of the decedent's interest in his contract

was to be determined as 'of the moment before death.'

The government's position may be summarized as

follows: (1) the estate tax is measured by the value of

property transferred by death and here an absolute right to

the fifteen deferred compensation payments passed by

decedent's death to the taxpayer inasmuch as the

possibility of forfeiture was extinguished by decedent's

death; (2) the government properly valued the right to the

deferred compensation payments in the same manner as

an annuity for a term certain, i.e. at the commuted value

in accordance with the applicable Treasury Regulations.

As earlier noted, the District Court agreed with the

taxpayer's view. In doing so it stated:

'It seems clear under the authorities and the statute

and the regulations that the value of the contract

rights is limited to the interest of the decedent during

his lifetime. That interest, under the testimony and by

a fair preponderance of the evidence, is valueless.

There was no fair market value on which to base a

deficiency assessment.' (Emphasis supplied.) It may

be noted parenthetically that the taxpayer's testimony

as to lack of value, adverted to by the District Court,

was premised on the circumstance that the

employment contracts specified four contingencies

which, if any of them had occurred, would have

forfeited the decedent's right to the deferred

compensation payments.

It is clear that the decedent's interest in the

employment contracts was 'property' includible in his

gross estate under Section 811(a) of the Internal Revenue

Code of 1939. Determination of the time when that

interest is to be valued is the crux of the dispute.

We have had the benefit of thorough discussions by

both the government and the taxpayer of the nature of the

federal estate tax. Both parties cited Knowlton v. Moore,

1900, 178 U.S. 41, 20 S.Ct. 747, 44 L.Ed. 969; Young

Men's Christian Association of Columbus, Ohio v. Davis,

1924, 264 U.S. 47, 44 S.Ct. 291, 68 L.Ed. 558; and

Edwards v. Slocum, 1924, 264 U.S. 61, 44 S.Ct. 293, 68

L.Ed. 564. The government cited them for the proposition

that the subject of the tax is neither the property of the

decedent, nor the property of the legatee, but rather the

transfer of assets affected by death. The taxpayer

emphasizes the language in these cases which supports the

theory that what is taxed is the value of the interest that

ceased by reason of death, not the value of what is

received by the recipient. We are in accord with both of

these general axioms which aid in clarifying the nature of

the federal estate tax. However, the cases cited and the

principles drawn therefrom are not decisive of the

question posed by this case. While the nature of the tax

has been discussed in numerous Supreme Court cases, the

question of the proper time to determine the nature of a

decedent's interest and the value thereof requires a more

particularized analysis.

The taxpayer has ignored the very nature of the tax

which it is urged is dispositive of this case. True, the tax

reaches the "* * * interest which ceased by reason of the

death", Knowlton v. Moore, supra, 178 U.S. at page 49,

20 S.Ct. at page 751 but the reference there was to the

distinction between an estate tax and an inheritance tax.

The inheritance tax is levied upon the individual shares of

the decedent's estate after distribution to the legatees; the

estate tax is imposed upon the total estate of the decedent

which is transferred to the legatees. Int.Rev.Code of 1939,

Sec. 810. The estate tax has been characterized as 'an

excise imposed upon the transfer of or shifting in

relationships to property at death.' United States Trust Co.

of New York v. Helvering, 1939, 307 U.S. 57, 60, 59

S.Ct. 692, 693, 83 L.Ed. 1104. The estate and inheritance

taxes have the common element of being based upon the

transmission of property from the dead to the living. New

York Trust Co. v. Eisner, 1921, 256 U.S. 345, 41 S.Ct.

506, 65 L.Ed. 963. In Knowlton v. Moore, supra, the

Supreme Court recognized this basic principle when it

said 178 U.S. at page 56, 20 S.Ct. at page 753:

'* * * tax laws of this nature in all countries rest in

their essence upon the principle that death is the

generating source from which the particular taxing

power takes its being, and that it is the power to

transmit, or the transmission from the dead to the

living, on which such taxes are more immediately

rested.'

Since death is the propelling force for the imposition

of the tax, it is death which determines the interests to be

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includible in the gross estate. Interests which terminate on

or before death are not a proper subject of the tax. Assets

may be acquired or disposed of before death, possibilities

of the loss of an asset may become actualities or may

disappear. Upon the same principle underlying the

inclusion of interests in a decedent's gross estate,

valuation of an interest is neither logically made nor

feasibly administered until death has occurred. The

taxpayer's theory of valuing property before death

disregards the fact that generally the estate tax is neither

concerned with changes in property interests nor values

prior to death. The tax is measured by the value of assets

transferred by reason of death, the critical value being that

which is determined as of the time of death.

As was so succinctly stated by Judge Hartshorne in

Christiernin v. Manning, D.C.D.N.J.1956, 138 F.Supp.

923, 925:

'There can not be a decedent, till death has occurred.

A decedent's estate is not transferred either by his

will or by intestacy, till death has occurred. * * * And

the decedent's interest in the property taxable is to be

such interest 'at the time of his death' * * *.'

Here the employment contracts provided for

additional 'contingent' compensation of $6,000 per year

for fifteen years to be paid to Blum or his estate after the

termination of his employment by reason of death or

otherwise. True, the right to these payments was

forfeitable upon the occurrence of any of the specified

contingencies. However, forfeiture as a result of the

contingencies never occurred during Blum's lifetime, and

any possibility of their occurrence was extinguished by his

death. Gimbels has been making and the estate has been

collecting the payments provided by the contracts.

Valuation of the right to these payments must be

determined as of the time of Blum's death when the

limiting factor of the contingencies would no longer be

considered. Death ripened the interest in the deferred

payments into an absolute one, and death permitted the

imposition of the tax measured by the value of that

absolute interest in property.

In Mearkle's Estate v. Commissioner of Internal

Revenue, 3 Cir., 1942, 129 F.2d 386, we considered the

proper method of valuing an annuity upon the death of the

decedent which by its terms was payable to the decedent

during his life and to his wife for her life. The criterion

adopted was the purchase price of an annuity contract

upon the life of the wife measured by her life expectancy

on the date of her husband's death. There is no reference

in this test to the husband's life expectancy upon the date

of his death or to the joint expectancies of the decedent

and his wife. See Christiernin v. Manning, supra. The

value of decedent's interest in the annuity up to the time of

his death is not considered, and, as in the situation here

involved, death cuts off prior limiting factors.

For the reasons stated the judgment of the District

Court will be reversed with directions to proceed in

accordance with this opinion.

Estate of John A. Moss, Deceased, Bank of

Clearwater, Personal Representative

v.

Commissioner of Internal Revenue

74 TC 1239 (1980)

IRWIN, Judge:

Respondent determined a deficiency of $87,077.02 in

petitioner's estate tax.

The issues presented for our consideration are: (1)

Whether promissory notes held by decedent but which

were extinguished upon his death are includable in his

gross estate; (other issues are omitted).

FINDINGS OF FACT

Some of the facts have been stipulated. The

stipulation of facts and the exhibits attached thereto are

incorporated herein by this reference.

Petitioner, the Bank of Clearwater, is the personal

representative of the Estate of John A. Moss. At the time

it filed its petition herein, petitioner's principal office was

located in Clearwater, Fla. The Federal estate tax return

for the Estate of John A. Moss was filed with the Office

of the Internal Revenue Service at Chamblee, Ga.

John A. Moss (hereafter decedent) died on February

24, 1974. He was survived only by his wife, Dorothy.

Prior to his death, decedent was president of Moss

Funeral Home, Inc., a Florida corporation engaged in the

funeral home services business. As of September 11,

1972, decedent owned 231 shares of the 586 issued and

outstanding shares of Moss Funeral Home. He also owned

property (known as the North Fort Harrison property and

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parking areas) which was rented by Moss Funeral Home

for use as one of its funeral homes.

All of the remaining stock of Moss Funeral Home

was held by its employees who had either purchased the

stock or been given shares as gifts from decedent over the

years. All of the employee-shareholders were part of an

agreement that upon their retirement or resignation from

the corporation they would sell their shares of stock in

Moss Funeral Home either to the corporation or pro rata

to the remaining shareholders at a per-share value which

approximated the per- share book value attributable to the

corporation's capital account.

On September 11, 1972, a special meeting of the

stockholders and directors of Moss Funeral Home was

held to consider decedent's offer to sell the corporation his

231 shares of Moss Funeral Home and the North Fort

Harrison property and parking areas. The decedent

offered to sell the stock for $184,800 [FN1] and the North

Fort Harrison property and parking area for $290,000,

each to be paid by the issuance of a note by the

corporation to the decedent.

FN1. As of Sept. 1, 1972, the book value of Moss

Funeral Home stock was approximately $440.30 per

share. The offer to sell was at $800 per share.

The special meeting also considered decedent's

proposal that the corporation issue him a promissory note

in the amount of $176,532.33, the then-current

indebtedness of the corporation to decedent. The three

proposed notes would be secured by a stock pledge

agreement to be executed by the stockholders. The

corporation agreed to these terms and the sale was

consummated.

It was also understood at the time of sale that

decedent would remain as president of the corporation

and a member of its board of directors during the period

in which the notes were outstanding. The sale of the 231

shares of Moss Funeral Home, Inc., stock and the North

Fort Harrison Chapel and parking areas was a bona fide

sale for adequate and full consideration.

The notes issued for the purchase of the stock

(hereafter Note B) and for the purchase of the North Fort

Harrison property (hereafter Note C) provided for interest

of 4 percent and equal monthly payments ($1,936.08 on

Note B, and $3,053.92 on Note C) commencing October

1972, until paid in full, 9 years and 7 months from the

first payment. The notes also contained the following

clause: "Unless sooner paid, all sums, whether principal

or interest, shall be deemed cancelled and extinguished as

though paid upon death of J. A. Moss."

Decedent's will executed on December 18,

bequeathed the North Fort Harrison property and the

proceeds to be received from the sale of his 231 shares in

Moss Funeral Home to the corporation on his death under

the buy-sell agreement to the shareholder-employees of

the corporation in proportion to the percentage of their

stock ownership (less estate tax attributable to these

assets). After the sale of the property and stock on

September 11, 1972, decedent revoked his will with a new

will dated November 6, 1972, in which he eliminated the

bequests to the shareholder-employees of Moss Funeral

Home.

On September 11, 1972, the physical and mental

condition of decedent was average for a man of 72 years

of age. There was nothing to indicate that his life

expectancy would be shorter than the approximate 10

years of life expectancy which was indicated by generally

accepted mortality tables. Decedent was admitted to the

hospital on May 10, 1973, at which time it was discovered

that he had cancer of the lymph nodes. Petitioner was told

by his doctor at that time that his condition was probably

terminal although treatment was prescribed. During the

few days before his death on February 23, 1974, it was

apparent that decedent was critically ill.

Decedent timely received each payment due under

the notes from October 1972 until his death. At that time,

there remained unpaid balances of $257,396.08 on Note

A-1, $161,575.50 on Note B, and $253,554.52 on Note C.

No payments were made on Notes B and C subsequent to

decedent's death.

The Bank of Clearwater, as personal representative of

decedent, delivered the originals of Notes B and C to

Moss Funeral Home, Inc., in accordance with their terms

and with a notation on the reverse side of the notes that it

recognized the termination of the notes.

The balances on Notes B and C were determined by

the executor to have no value as of the date of death.

Respondent determined in the notice of deficiency

that Notes B and C should be included in decedent's estate

for Federal estate tax purposes and had a value at

decedent's death of $139,060.88 and $218,223.70,

respectively.

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OPINION

We must first decide whether the promissory notes

which were extinguished upon decedent's death are

includable in his gross estate.

Initially, we will discuss the cases relied on by the

parties to support their respective position; petitioner cites

Austin v. Commissioner, 26 B.T.A. 1216 (1932), affd. 73

F.2d 758 (7th Cir. 1934), as controlling, while respondent

cites Estate of Buckwalter v. Commissioner, 46 T.C. 805

(1966), as controlling.

In Austin, at the time of the decedent's death, she held

unmatured notes which by their terms and the terms of a

contract executed at the same time were payable only in

the event that she was alive on the due date. If not, the

obligation of the maker was to cease. Respondent there

argued that the cancellation provision amounted only to

an agreement to make a gift and thus the decedent died

possessed of property which should have been included in

her estate. In response, the Board noted that the

forgiveness provision in the notes was inserted by the

maker, the notes were accepted by the payee subject to

that condition, and the notes held by decedent at her death

were not then due and payable. At no time during her life

could the decedent have enforced payment and at her

death all obligations on the part of the maker ceased. The

Board held that "when the obligation of the maker thus

terminated there was nothing which could be subjected to

payment of charges against the estate and expenses of

administration and which was subject to distribution as a

part of the estate. All of these elements must exist with

respect to property that may be included in the gross

estate." Austin v. Commissioner, supra at 1120. It noted

further that "it is not enough that at the moment of death

there may be property in which the decedent technically

has an interest" (Austin v. Commissioner, supra at 1120)

and that "the situation * * * (was) somewhat like that of

an interest or estate limited for the life of the decedent."

Austin v. Commissioner, supra at 1120.

Respondent agrees that Austin may not be factually

distinguished. But respondent correctly notes that the

holding in the case was premised upon a definition of

gross estate that is no longer applicable. Austin was

decided under section 402(a) of the Revenue Act of 1921,

42 Stat. 278. That section provided that the value of an

interest held by decedent was not included in the gross

estate unless it was (1) an interest of the decedent at the

time of death, (2) subject to the payment of charges

against the estate and expenses of administration, and (3)

subject to distribution as part of the estate. Unless all

three conditions were met, the interest was not taxable.

Crooks v. Harrelson, 282 U.S. 55 (1930).

Section 2033 is not so limited. It provides that "the

value of the gross estate shall include the value of all

property to the extent of the interest therein of the

decedent at the time of his death." There is no

requirement under section 2033 that the property interest

be subject to the payment of charges against the estate and

expenses of administration or that the interest be subject

to distribution as a part of the estate. Therefore, although

the facts in Austin may be indistinguishable, it is no

longer authority for the proposition for which petitioner

cites it. There is language in the decision, however, which

although dicta supports petitioner's position; the Board

stated that "the situation here is somewhat like that of an

interest or estate limited for the life of the decedent."

In Estate of Buckwalter, decedent's son was indebted

to a bank on a 20-year note due in 1971 bearing 4 1/2

percent interest. Decedent proposed that he and his son

enter into an arrangement whereby decedent would pay

off the unamortized principal of his son's note on

December 31, 1954. The son would pay him the identical

monthly amounts which would have been due the bank,

except that interest would be computed at 2 1/2 percent so

that the entire loan would be repaid in 1968 rather than in

1971. The son was instructed to keep the transaction

secret, the payments were to be a "matter of honor" and

the decedent stated that it was intention not to show "in

any way that (the son was) in any way indebted to me,

otherwise (decedent) would be required to pay in Penna.

a personal property tax each year." Decedent recognized

that he probably would not be alive at the end of the

amortization period, and stated that his son was to be

entirely free of any obligation to his estate. He added a

long postscript to the letter setting forth a summary

schedule of 30-day payments, showing components of

interest and principal in each such payment in December

of each year as well as "balance of amortized principal"

until final payment in 1968. He also stated that his son

might "cut away" the schedule and "destroy the rest of the

letter after all details are consummated."

In a second letter to his son about a week later, after

the proposal had been accepted, decedent stated that he

was sending his son a schedule for payments and credits

for the period January 1, 1955, to May 23, 1962, and that

for the period thereafter he had "a schedule made up to

show complete amortization of an honor loan," which he

intended to seal and enclose in his lock box with a legend

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on the envelope in his son's handwriting reading "Personal

Property of Abraham L. Buckwalter, Jr." In a single

sentence, decedent informed his son that he could

"consider the proposition on my part as a form of annuity

at 2 and 1/2%."

We held that decedent had an interest in a debt owed

to him by his son at the time of his death and that the

unpaid principal was includable in his gross estate under

section 2033. The taxpayer there argued that in substance,

decedent merely had purchased an annuity from his son

which terminated with his death, and therefore, nothing

should be included in his gross estate. We disagreed with

the contention that the substance of the transaction was an

annuity and held that decedent had an interest in the loan

at the time of his death.[FN6]

FN6. In this Court's opinion in Estate of Buckwalter

v. Commissioner, 46 T.C. 805 (1966), we noted at

page 816 that this was a "clear case of planned tax

evasion." This reference was made in regard to the

evasion of Pennsylvania property taxes, not Federal

estate taxes (as petitioner contends), and was cited to

support our finding that there was a bona fide debt

between decedent and his son, rather than an annuity.

Respondent contends that decedent, in this case,

simply chose to pass the funeral home business to his

employees under the guise of the notes which were

canceled upon death rather than through his will as he had

planned prior to 1972 and, therefore, this case is no

different than the situation in Buckwalter.

Petitioner argues that the case at bar is factually

distinguishable. We agree. In Buckwalter, the decedent

retained control of the entire debt until his death. The son

was not relieved of the debt until he removed the evidence

of the loan after the decedent's death. Therefore, at any

time prior to his death, decedent could have revoked his

decision to cancel the debt at his death and required the

son to be obligated to his estate. The decedent sought to

achieve the same result as a bequest in a will by keeping

the details of the loan contained in a sealed envelope in

his own lock box and permitting the son to cancel the debt

at his death.

This is not the case here. The parties have stipulated

that decedent's sale of stock for which the notes were

issued was a bona fide sale for adequate and full

consideration. The cancellation provision was part of the

bargained for consideration provided by decedent for the

purchase price of the stock. [FN7] As such, it was an

integral provision of the note. We do not have a situation,

therefore, where the payee provided in his will or

endorses or attaches a statement to a note stating that the

payor is to be given a gift by the cancellation of his

obligation on the payee's death.

FN7. We are aware, as respondent points out, that

decedent's will executed prior to the sale bequeathed

the proceeds from the sale of his stock to the

corporation upon his death to the employees of Moss

Funeral Home (apparently to be made at book value

under the buy-sell agreement). The book value of the

stock was only $440.30 per share as of Sept. 1, 1972,

but decedent sold the stock to the corporation on

Sept. 11 at $800 per share. This supports our

conclusion that the cancellation clause was not

intended as a will substitute and provided part

consideration for the purchase price.

We believe there are significant differences between

the situation in which a note contains a cancellation

provision as part of the terms agreed upon for its issue and

where a debt is canceled in a will. The most significant

difference for purposes of the estate tax is, as petitioner

points out, that a person can unilaterally revoke a will

during his lifetime, and, therefore, direct the transfer of

his property, at his death. All interest that decedent had in

the notes lapsed at his death.

Respondent next contends that the cancellation

provision can be considered an assignment of the notes by

the decedent to his employees to become effective upon

his death. We believe that this is simply a variation of his

argument that the cancellation provision is similar to a

bequest in a will, and we reject it for the same reasons that

we rejected that argument.

We agree, therefore, with the statement in Austin that

the situation here is analogous to that of an annuity or an

interest or estate limited for decedent's life. Since there is

not interest remaining in decedent at his death, we hold

that the notes are not includable in his gross estate.

Respondent also relies on Stewart v. United States,

158 F. Supp. 25 (N.D. Cal. 1957), affd. in part and revd.

in part 270 F.2d 894 (9th Cir. 1959), cert. denied 361

U.S. 960 (1960), as presenting an analogous situation. In

that case, the decedent purchased annuities providing for

the payment of monthly sums to her for life, beginning

when she reached a designated age. The policies also

provided that in the event the decedent died before

payment of any annuities or before the amount paid in had

11

been returned, payment was to be made to certain named

beneficiaries. A few months prior to her death, the

decedent exercised an option in the policy under which

the companies would pay her a designated sum for 240

months, and decedent relinquished her right to make

payment contingent on her life. In the event of her death

prior to the expiration of the 240 months, payment was to

be made to her grandchildren. The decedent, either solely

or with her husband, had the right to change the

beneficiaries. The Court held that the annuities were

includable in the decedent's estate under section 811(a) of

Internal Revenue Code of 1939, the predecessor to section

2033.

Stewart is obviously distinguishable. In that case, the

decedent had the right to receive 240 monthly payments.

If she died prior to receiving all the payments, the

payments continued to be paid to named third parties. The

payor was obligated, therefore, to continue making

payments under the contract. Moreover, the decedent

retained the right to designate the beneficiaries under the

contract.

Decision will be entered under Rule 155.

12

ASSIGNMENT 3

Code: §2035 SKIM §§2042 and 2043(a)

Regulations: §20.2043-1(a)

S,M,L & C: ¶¶ 4.07[1]-[3], 4.15[2][a]

Readings: Rev. Rul. 72-282

Questions:

1. In 2004, the decedent gave his son $50,000 in cash. The decedent dies in 2007.

a. What is included in the decedent's gross estate?

b. What result in (a) if, instead of cash, decedent gave the son a life insurance policy worth$6,000 which had a face value of $50,000?

c. What result in (b) if, after the gift, the son made annual premium payments totalling$2,000? Assume that the decedent's total premium payments were $8,000.

d. What result in (b) if, during the time between the gift and the decedent's death, theinsurance policy paid dividends to the son totaling $500?

e. What result in (b) if, during the time between the gift and the decedent's death, soncashes the policy and receives $7,000? (Rev. Rul. 72-282)

f. What result in (b) if the son paid the decedent $6,000 for the policy at the time of thetransfer when the policy was worth $6,000?

13

g. What result in (b) if the son paid the decedent $3,000 for the policy at the time of thetransfer when the policy was worth $6,000?

2. In year one, Mr. Deathbed made a $500,000 gift of cash to his daughter, and in year two, he paida $200,000 gift tax on the transfer.

a. On his death later in year two, what is included in his gross estate under §2035?

b. If Mr. Deathbed had not made the gift (and therefore had not paid the tax), what wouldhave been included in his gross estate?

14

Rev. Rul. 72-282

Advice has been requested as to the valuation of

property required to be included in the donor-decedent's

gross estate under section 2035 of the Internal Revenue

Code of 1954 where the property transferred was sold by

the donee prior to the donor's death.

Two years before her death, decedent transferred

5000 shares of Y Company stock to her son. At the time

of the transfer, the value of this stock was 50x dollars.

The son thereupon sold the entire 5000 shares. With the

proceeds he purchased 2500 shares of stock in another

corporation for 50x dollars. The transfer from the

decedent to her son was determined to have been made in

contemplation of death. The value of the decedent's

interest in the transferred stock was therefore includible in

her gross estate under section 2035 of the Code.

At date of death the fair market value of the stock

transferred by the decedent was 55x dollars. The stock

purchased by the son with the proceeds of his sale of the

Y Company stock had increased in value to 75x dollars.

Section 2035 of the Code provides:

The value of the gross estate shall include the

value of all property to the extent of any interest

therein of which the decedent has at any time

made a transfer (except in the case of a bona fide

sale for an adequate and full consideration in

money or money's worth), by trust or otherwise,

in contemplation of his death.

The value of the transferred property as of the proper

valuation date is the amount includible in the decedent's

gross estate. Any increase in value resulting from actions

of the donee is not taken into consideration in determining

the value of the included interest. Estate Tax Regulations,

section 20.2035-1(e). Where the donee has dissipated the

property so that there is nothing left as of the date of the

transferor's death, the amount includible is not what

actually exists but rather the present value of the property

originally transferred. Humphrey's Estate v.

Commissioner, 162 F.2d 1 (1947), certiorari denied, 332

U.S. 817. In that case, the court stated:

* * * The evident purpose [of the contemplation

of death provision] is to make the transferred

property cause the same tax result as if the

decedent had kept it till he died instead of

transferring it. We do not accede to the

argument that if the transferee injures or makes

way with it, it shall be considered that he has

acted as the agent of the decedent, or that he

may substitute it by other property of less value.

What is to be valued at the time of decedent's

death is the very property which the decedent

transferred * * *

In the present case, the transferred property has been

sold by the donee. He has substituted therefor property

that has increased in value. The fair market value of the

2500 shares of stock actually owned by the decedent's son

on the date of death was considerably greater than the

value of the shares originally transferred. The value of

stock acquired by subsequent independent actions of the

donee is not that which is includible in the decedent's

gross estate, despite the fact that the stock now owned by

the donee can be attributed to the proceeds of sale of the

transferred property. Rather, what is includible is the

present value of the property originally transferred by the

decedent.

Accordingly, it is held that the value includible in the

decedent's gross estate under section 2035 of the Code is

the fair market value as of the decedent's death of 5000

shares of Y Company stock, or 55x dollars.

15

ASSIGNMENT 4

Code: §§2035(a), 2036(a), and 2043(a)

Regulations: §20.2036-1

S,M,L, & C: ¶ 4.08 (Omit [6][c], [d], and [e], [7][a], [b], and [c], [9])

Readings: U.S. v. O'MalleyWheeler v. U.S.

Questions:

1. D transfers stock to a trust retaining certain rights. What is included in D's estate under §2036in the following alternatives?

a. One third of the income is paid to D for his life, the remainder of the income is paid toS (Son), and on D's death, the corpus passes outright to S or S's estate.

b. All the income is paid to D for his life, but D is entitled to no trust income earned in thesix-month period preceding his death. The corpus and undistributed income passesoutright to S or S's estate.

c. All the income is paid to D for ten years, when the corpus passes outright to S or S'sestate. D dies after eight years.

2. D creates a trust naming Security Bank as trustee. The trust income is to be used to support D'stwo daughters during their minority (which under state law is age 21). As each daughter attains age 21,she is entitled to receive income from one-half of the trust until she attains age 30, at which time hershare of the trust corpus is distributed to her outright. D dies when one of his children is fifteen and theother twenty two. What, if anything, is included under §2036?

3. Several years ago, D created a trust which paid the income to W (Wife) for her life (but not forher support), and then to D for his life. Upon the death of the survivor of D and W, the corpus passes

16

outright to S or S's estate. Upon creation of the trust, the property transferred had a value of $100,000 and the respective

interests were properly valued as follows: D's interest, $20,000; W's interest, $30,000; and S's interest,$50,000. At D's death, more than three years after the trust's creation, he was survived by W and S. Thecorpus of the trust was worth $180,000, with W and S's interests worth $60,000 and $120,000,respectively. What amount, if any, should be included in D's gross estate under §2036?

4. D creates a trust with income payable to A or A's estate for D's life, and the remainder outrightto B or B's estate. D predeceases A, B, and C. What amount, if any, should be included in D's grossestate in the following situations:

a. D, as trustee, retains a power to give income to C.

b. D, as trustee, retains a power to invade corpus for C.

c. D, as trustee, retains a power to give the remainder to C.

d. D, as trustee, retains a power to invade the corpus of the trust for A.

e. D names his friend E trustee and E holds a power to give income to C.

f. D creates the trust in (e) and retains a power to remove E as trustee at any time and namehimself trustee, holding all powers that E held.

g. D names himself trustee and provides that the trustee is required to give C as muchincome as needed for C's support and maintenance, with any excess income to go to A.

h. D names his friend E trustee and provides that the trustee is required to give D as much

17

income as is needed each year for D's support and maintenance, with any excess incometo go to A.

i. Same facts as (h), but assume that E had complete discretion with respect to makingdistributions to D.

5. D agrees with his Brother to transfer $100,000 in trust, with income to Brother for Brother's lifeand a remainder to Brother's children or their estates. In return, Brother transfers $100,000 to a trustwith income to D for D's life and a remainder to D's children or their estates.

a. What, if anything, will be included in D's estate under §2036 when he dies?

b. Same as (a), except that Brother places only $80,000 in the trust that he creates?

6. D transfer $200,000 of stock in trust with income to A for ten years and a remainder to B or B'sestate. D retains the power to accumulate dividends, adding them to corpus. At D's death, six yearslater, the stock was worth $250,000 and the trust had accumulated $40,000 of dividend income.

a. What is included in D's gross estate under §2036? (U.S. v. O'Malley)

b. What result in (a) if the remainder had been to A or A's estate, rather than to B or B'sestate?

7. D transfer $200,000 to a trust with income to D for life and the remainder to his children or theirestates. Assume that at all times, the trust assets are worth $200,000.

a. What is included in D's gross estate if, five years prior to his death, D sells his incomeinterest worth $50,000 (based on his life expectancy) to his son for $50,000?

b. What would be included if the sale of the income interest in (a) occurred two years priorto his death (for its then fair market value)? (Wheeler v. U.S.)

18

UNITED STATES, Petitioner,

v.

Charles E. O'MALLEY et al.

383 U.S. 627 (1966)

Mr. Justice WHITE delivered the opinion of the

Court.

The Internal Revenue Code of 1939 imposes an

estate tax 'upon the transfer of the net estate of every

decedent.' s 810. The gross estate is to include not only

all property '(t)o the extent of the interest therein of the

decedent at the time of his death,' s 811(a), but also,

under s 811(c)(1), all property

'To the extent of any interest therein of which the

decedent has at any time made a transfer (except in

case of a bona fide sale for an adequate and full

consideration in money or money's worth), by trust

or otherwise--

'(A) in contemplation of his death; or

'(B) under which he has retained for his life or for

any period not ascertainable without reference to

his death or for any period which does not in fact

end before his death (i) the possession or

enjoyment of, or the right to the income from, the

property, or (ii) the right, either alone or in

conjunction with any person, to designate the

persons who shall possess or enjoy the property or

the income therefrom; or [FN1]

FN1. Section 2036 of the Int.Rev.Code of 1954, as

amended, 26 U.S.C. s 2036 (1964 ed.), is

materially the same as s 811(c)(1)(B) of the

Int.Rev.Code of 1939.

'(C) intended to take effect in possession or

enjoyment at or after his death,'

and, under s 811(d), property which has been the

subject of a revocable transfer described in that section.

[FN2]

FN2. Section 811(d)(1) provides:

'To the extent of any interest therein of which the

decedent has at any time made a transfer (except in

case of a bona-fide sale for an adequate and full

consideration in money or money's worth), by trust

or otherwise, where the enjoyment thereof was

subject at the date of his death to any change

through the exercise of a power (in whatever

capacity exercisable) by the decedent alone or by

the decedent in conjunction with any other person

(without regard to when or from what source the

decedent acquired such power), to alter, amend,

revoke, or terminate, or where any such power is

relinquished in contemplation of decedent's death.'

Edward H. Fabrice, who died in 1949, created five

irrevocable trusts in 1936 and 1937, two for each of two

daughters and one for his wife. He was one of three

trustees of the trusts, each of which provided that the

trustees, in their sole discretion, could pay trust income

to the beneficiary or accumulate the income, in which

event it became part of the principal of the trust. [FN3]

Basing his action on s 811(c)(1)(B)(ii) and s 811(d)(1),

the Commissioner included in Fabrice's gross estate

both the original principal of the trusts and the

accumulated income added thereto. He accordingly

assessed a deficiency, the payment of which prompted

this refund action by the respondents, the executors of

the estate. The District Court found the original corpus

of the trusts includable in the estate, a holding not

challenged in the Court of Appeals or here. It felt

obliged, however, by Commissioner of Internal

Revenue v. McDermott's Estate, 7 Cir., 222 F.2d 665,

55 A.L.R.2d 410, to exclude from the taxable estate the

portion of the trust principal representing accumulated

income and to order an appropriate refund. D.C., 220

F.Supp. 30. The Court of Appeals affirmed, 340 F.2d

930, adhering to its own decision in McDermott's Estate

and noting its disagreement with Round v.

Commissioner of Internal Revenue, 332 F.2d 590, in

which the Court of Appeals for the First Circuit

declined to follow McDermott's Estate. Because of

these conflicting decisions we granted certiorari. 382

U.S. 810, 86 S.Ct. 35, 15 L.Ed.2d 58. We now reverse

the decision below.

FN3. The following provision in the trust for Janet

Fabrice is also contained in the other trusts:

'The net income from the Trust Estate shall be

paid, in whole or in part, to my daughter, JANET

FABRICE, in such proportions, amounts and at

such times as the Trustees may, from time to time,

in their sole discretion, determine, or said net

income may be retained by the Trustees and

credited to the account of said beneficiary, and any

income not distributed in any calendar year shall

become a part of the principal of the Trust Estate.'

The applicability of s 811(c)(1)(B)(ii), upon which the

United States now stands, depends upon the answer to

two inquiries relevant to the facts of this case: first,

19

whether Fabrice retained a power 'to designate the

persons who shall possess or enjoy the property or the

income therefrom'; and second, whether the property

sought to be included, namely, the portions of trust

principal representing accumulated income, was the

subject of a previous transfer by Fabrice.

Section 811(c)(1)(B)(ii), which originated in 1931,

was an important part of the congressional response to

May v. Heiner, 281 U.S. 238, 50 S.Ct. 286, 74 L.Ed.

826, and its offspring and of the legislative policy of

subjecting to tax all property which has been the subject

of an incomplete inter vivos transfer. Cf.

Commissioner of Internal Revenue v. Estate of Church,

335 U.S. 632, 644--645, 69 S.Ct. 322, 328--329, 93

L.Ed. 288; Helvering v. Hallock, 309 U.S. 106, 114, 60

S.Ct. 444, 449, 84 L.Ed. 604. The section requires the

property to be included not only when the grantor

himself has the right to its income but also when he has

the right to designate those who may possess and enjoy

it. Here Fabrice was empowered, with the other

trustees, to distribute the trust income to the income

beneficiaries or to accumulate it and add it to the

principal, thereby denying to the beneficiaries the

privilege of immediate enjoyment and conditioning

their eventual enjoyment upon surviving the termination

of the trust. This is a significant power, see

Commissioner of Internal Revenue v. Estate of Holmes,

326 U.S. 480, 487, 66 S.Ct. 257, 260, 90 L.Ed. 228,

and of sufficient substance to be deemed the power to

'designate' within the meaning of s 811(c)(1)(B)(ii).

This was the holding of the Tax Court and the Court of

Appeals almost 20 years ago. Industrial Trust Co. v.

Commissioner of Internal Revenue, 1 Cir., 165 F.2d

142, 1 A.L.R.2d 144, affirming in this respect Estate of

Budlong v. Commissioner, T.C. 756. The District

Court here followed Industrial Trust and affirmed the

includability of the original principal of each of the

Fabrice trusts. That ruling is not now disputed. By the

same token, the first condition to taxing accumulated

income added to the principal is satisfied, for the

income from these increments to principal was subject

to the identical power in Fabrice to distribute or

accumulate until the very moment of his death.

The dispute in this case relates to the second

condition to the applicability of s 811(c)(1)(B)(ii)--

whether Fabrice had ever 'transferred' the income

additions to the trust principal. Contrary to the

judgment of the Court of Appeals, we are sure that he

had. At the time Fabrice established these trusts, he

owned all of the rights to the property transferred, a

major aspect of which was his right to the present and

future income p roduced by that property.

Commissioner of Internal Revenue v. Estate of Church,

335 U.S. 632, 644, 69 S.Ct. 322, 328, 93 L.Ed. 288.

With the creation of the trusts, he relinquished all of his

rights to income except the power to distribute that

income to the income beneficiaries or to accumulate it

and hold it for the remaindermen of the trusts. He no

longer had, for example, the right to income for his own

benefit or to have it distributed to any other than the

trust beneficiaries. Moreover, with respect to the very

additions to principal now at issue, he exercised his

retained power to distribute or accumulate income,

choosing to do the latter and thereby adding to the

principal of the trusts. All income increments to trust

principal are therefore traceable to Fabrice himself, by

virtue of the original transfer and the exercise of the

power to accumulate. Before the creation of the trusts,

Fabrice owned all rights to the property and to its

income. By the time of his death he had divested

himself of all power and control over accumulated

income which had been added to the principal, except

the power to deal with the income from such additions.

With respect to each addition to trust principal from

accumulated income, Fabrice had clearly made a

'transfer' as required by s 811(c)(1)(B)(ii). Under that

section, the power over income retained by Fabrice is

sufficient to require the inclusion of the original corpus

of the trust in his gross estate. The accumulated income

added to principal is subject to the same power and is

likewise includable. Round v. Commissioner of

Internal Revenue, 332 F.2d 590; Estate of Yawkey v.

Commissioner, 12 T.C. 1164.

Respondents rely upon two cases in which the Tax

Court and two circuit courts of appeals have concluded

that where an irrevocable inter vivos transfer in trust,

not incomplete in any respect, is subjected to tax as a

gift in contemplation of death under s 811(c), the

income of the trust accumulated prior to the grantor's

death is not includable in the gross estate.

Commissioner of Internal Revenue v. Gidwitz' Estate,

7 Cir., 196 F.2d 813, affirming 14 T.C. 1263; Burns v.

Commissioner of Internal Revenue, 5 Cir., 177 F.2d

739, affirming 9 T.C. 979. The courts in those cases

considered the taxable event to be a completed inter

vivos transfer, not a transfer at death, and the property

includable to be only the property subject to that

transfer. The value of that property, whatever the

valuation date, was apparently deemed an adequate

reflection of any income rights included in the transfer

since the grantor retained no interest in the property and

20

no power over income which might justify the addition

of subsequently accumulated income to his own gross

estate. Cf. Maass v. Higgins, 312 U.S. 443, 61 S.Ct.

631, 85 L.Ed. 940.

This reasoning, however, does not solve those

cases arising under other provisions of s 811. The

courts in both Burns, 9 T.C. 979, 988--989 and

Gidwitz, 196 F.2d 813, 817--818, expressly

distinguished those situations where the grantor retains

an interest in a property or its income, or a power over

either, and his death is a significant step in effecting a

transfer which began inter vivos but which becomes

final and complete only with his demise. McDermott's

Estate failed to note this distinction and represents an

erroneous extension of Gidwitz. In both McDermott

and the case before us now, the grantor reserved the

power to accumulate or distribute income. This power

he exercised by accumulating and adding income to

principal and this same power he held until the moment

of his death with respect to both the original principal

and the accumulated income. In these circumstances, s

811(c)(1)(B)(ii) requires inclusion in Fabrice's gross

estate of all of the trust principal, including those

portions representing accumulated income.

Reversed.

John Michael WHEELER,

Independent Executor of the Estate of

Elmore K. Melton, Jr., Plaintiff-Appellant,

v.

UNITED STATES of America,

Defendant-Appellee.

116 F.3d 749 (5th Cir. 1997)

GARWOOD, Circuit Judge:

This case involves the determination of the federal

estate tax due from the estate of Elmore K. Melton, Jr.

(Melton). On July 13, 1984, Melton, then age sixty,

sold to his two adopted sons, John Wheeler and David

Wheeler, the remainder interest in his ranch located in

Bexar County, Texas. Melton retained a life estate in

the ranch and used the actuarial tables set forth in the

Treasury Regulations to determine the price to be paid

by the Wheelers for the remainder interest. On May

25, 1991, Melton, then age sixty-seven, died. Melton's

federal estate tax return did not include any value for

the ranch. The Internal Revenue Service (IRS) issued a

notice of deficiency, claiming that the sale of the

remainder interest in the ranch to the Wheelers for its

actuarial value did not constitute adequate and full

consideration, and that accordingly the fair market

value of the fullfee simple interest in the ranch, less the

consideration paid by the sons, should have been

included in Melton's gross estate. The court below

agreed and, following a line of cases stating that the

sale of a remainder interest for less than the value of the

full fee simple interest in the property does not

constitute adequate consideration for the purposes of

section 2036(a) of the Internal Revenue Code,

determined that Melton's estate had been properly

assessed an additional $320,831 in federal estate tax.

We reverse.

Facts and Proceedings Below

I.

In the mid-1970s, Melton, who was born April 16,

1924, and never married, adopted two children, John

Wheeler (John), who was born in 1956, and David

Wheeler (David), who was born in 1958.

On July 13, 1984, Melton executed a warranty

deed conveying to John and David his 376-acre ranch,

located in Bexar County, Texas. The deed reserved to

Melton a life estate in the ranch. For many years prior

to the sale, and until the time of his death, Melton used

the ranch as his personal residence. John and David

paid for the remainder interest with a personal liability

real estate lien note in the amount of $337,790.18,

secured by a vendor's lien expressly retained in the deed

and additionally by a deed of trust on the ranch. The

deed and deed of trust were promptly recorded. The

purchase price for the remainder interest in the ranch

was determined by multiplying the sum of the appraised

fair market value of the ranch's fee simple interest,

$1,314,200, plus $10,000, by 0.25509, the factor set

forth in the appropriate actuarial table in the Treasury

Regulations for valuing future interests in property

where the measuring life was that of a person of

Melton's age. See Treas. Reg. § 25.2512-5(A).

On February 12, 1985, the initial note, which bore

interest at the rate of 7 percent and called for annual

payments of at least $10,000 principal plus accrued

interest, was revised to provide for monthly payments

of $833.33 principal plus accrued interest, which

remained at 7 percent. On that date, John and David

paid the amount due under the revised terms.

In December 1986, Melton gave $10,000 each to

21

John and David by forgiving that amount of each son's

indebtedness under the note. On December 23, 1986,

John and David received bonuses from The Melton

Company of $50,000 and $55,000, respectively. Each

son used $35,000 of his bonus to reduce the principal

owed on the note to Melton. John and David each paid

income taxes on their bonus. On December 29, 1986,

Melton assigned the note to The Melton Company in

partial payment of an existing debt that he owed the

company.

On January 28, 1988, both John and David

received a 1987 year-end bonus of $250,000 from The

Melton Company. They each paid income taxes on

their bonus. John and David paid the remaining

balance due on the note the same day. Throughout the

course of the indebtedness under the note, John and

David had continued to make monthly payments. The

Melton Company continued to make annual, year-end

bonuses to both John and David long after the note was

retired.

Melton died testate on May 25, 1991, at the age of

sixty-seven, more than six years after the sale of the

remainder interest to the Wheelers and more than three

years after the note had been paid in full. The cause of

death was heart failure. Melton had suffered from

coronary artery disease and arteriosclerosis for

approximately ten years. The undisputed evidence,

however, was that Melton's death was not (and was not

thought to be) imminent in July 1984 when he sold the

remainder interest to the Wheelers (nor is there any

evidence that it was ever imminent before 1991).

Melton's will and codicil were admitted to probate

and John was appointed the independent executor of the

estate. John timely filed an estate tax return reporting

a gross estate of $581,106, and an estate tax liability of

$199,936 (which was tendered with the return). The

gross estate, as reported on the return, did not include

any amount for the ranch, thus reflecting the estate's

position that Melton had no interest in the ranch at his

death.

The IRS subsequently issued its "Report of Estate

Tax Examination Changes," taking the position that,

under sections 2036(a) and 2043(a) of the Internal

Revenue Code (IRC or Code), the Melton estate should

have included in the gross estate the difference between

the date-of-death value of the ranch, $1,074,200, and

the consideration paid by the sons for the remainder

interest, $337,790.18 (treated by the IRS as $338,000).

Accordingly, the IRS determined that an additional

$736,200 ($1,074,200 less $338,000) should have been

included in the gross estate for the ranch. As a result,

the IRS issued an estate tax notice of deficiency in the

amount of $320,831. The Melton estate paid the

asserted deficiency and filed a timely claim for refund.

Discussion

I.

Central to this case is section 2036(a) of the Code,

which provides:

"The value of the gross estate shall include the value

of all property to the extent of any interest therein of

which the decedent has at any time made a transfer

(except in case of a bona fide sale for an adequate

and full consideration in money or money's worth ),

by trust or otherwise, under which he has retained for

his life or for any period not ascertainable without

reference to his death or for any period which does

not in fact end before his death----

(1) the possession or enjoyment of, or the right to the

income from, the property, or

(2) the right, either alone or in conjunction with any

person, to designate the persons who shall possess or

enjoy the property or the income therefrom."

(Emphasis added).

The estate concedes that the fee simple value of the

ranch would have to have been brought back into the

estate had the remainder been transferred to the

Wheelers without consideration or for an inadequate

consideration. However, the Wheelers paid Melton for

the remainder interest transferred an amount which the

government concedes is equal to (indeed slightly in

excess of) the then fair market value of the fee simple

interest in the ranch multiplied by the fraction listed in

the Treasury Regulations for valuing a remainder

following an estate for the life of a person of Melton's

age. See 26 C.F.R. § 25.2512-5(A). The estate

contends that accordingly under the parenthetical clause

of section 2036(a) the ranch is not brought back into the

estate, as Melton was paid full value for the transferred

remainder. Indeed, there is no evidence to the

contrary. The government, however, contends that

because Melton was paid for the remainder interest an

amount indisputably less than the value of the full fee

interest, that therefore the parenthetical clause of

section 2036(a) cannot apply, and hence the ranch must

be brought back into the estate.

22

This case thus ultimately turns on whether the

phrase "adequate and full consideration" as used in the

italicized parenthetical clause of section 2036(a) is to

be applied in reference to the value of the remainder

interest transferred, as the estate contends, or in

reference to the value of the full fee simple interest

which the transferor had immediately before the

transfer, as the government contends. We note that for

this purpose the language of section 2036(a) makes no

distinction between transfers of remainders following

retained life estates and transfers of remainders

following retained estates for a specified term of years

(or other period ascertainable without reference to the

transferor's death) where the transferor dies before the

end of the term. Similarly, no such distinction is made

between transfers to natural objects of the transferor's

bounty and transfers to those who are strangers to the

transferor.

That the proper construction of section 2036(a)'s

"adequate and full consideration" has presented

taxpayers, the IRS, and the courts with such persistent

conceptual difficulty can be explained, in large part, by

the absence of a statutory definition of the phrase

combined with the consistently competing interests of

all tax litigants----the government and the taxpayer. The

crux of the problem has been stated as follows:

"Because the actuarial value of a remainder interest

is substantially less than the fair market value of

the underlying property, the sale of a remainder

interest for its actuarial value is viewed by many as

allowing the taxpayer to transfer property to the

remainderman for less consideration than is

required in an outright sale. Consequently, the

sale of a remainder interest for its actuarial value,

although such value represents the fair market

value of the remainder interest, raises the question

of whether the seller has been adequately

compensated for the transfer of the underlying

property to the remainderman. If the actuarial

value of the remainder interest does not represent

adequate compensation for the transfer of the

underlying property to the remainderman, the

taxpayer may be subject to both the gift tax and the

estate tax.... If the taxpayer holds the retained

interest until death, section 2036(a) of the [Code]

pulls the underlying property back into the

taxpayer's gross estate, unless the transfer is a bona

fide sale for adequate and full consideration."

Martha W. Jordan, Sales of Remainder Interests:

Reconciling Gradow v. United States and Section

2702, 14 Va. Tax Rev. 671, 673 (1995).

Both parties agree that, for the purposes of the gift

tax (section 2512 of the Code), consideration equal to

the actuarial value of the remainder interest constitutes

adequate consideration. See also Treas. Reg. §

25.2512- 5(A). For estate tax purposes, however,

authorities are split. Commentators have generally

urged the same construction should apply, see, e.g.,

Jordan, supra; Steven A. Horowitz, Economic Reality

In Estate Planning: The Case for Remainder Interest

Sales, 73 Taxes 386 (1995); Jeffrey N. Pennell, Cases

Addressing Sale of Remainder Wrongly Decided, 22

Est. Plan. 305 (1995), and the Third Circuit has held

that "adequate and full consideration" under section

2036(a) is determined in reference to the value of the

remainder interest transferred, not the value of the full

fee simple interest in the underlying property.

D'Ambrosio v. Commissioner, 101 F.3d 309 (3d

Cir.1996), cert. denied, 520 U.S. 1230, 117 S.Ct. 1822,

137 L.Ed.2d 1030 (1997). On the other hand, Gradow

v. United States, 11 Cl.Ct. 808 (1987), aff'd, 897 F.2d

516 (Fed.Cir.1990), and its faithful progeny Pittman v.

United States, 878 F.Supp. 833 (E.D.N.C.1994), and

D'Ambrosio v. Commissioner, 105 T.C. 252, 1995 WL

564078 (1995), rev'd 101 F.3d 309 (3d Cir.1996), cert.

denied, 520 U.S. 1230, 117 S.Ct. 1822, 137 L.Ed.2d

1030 (1997), have stated that a remainder interest must

be sold for an amount equal to the value of the full fee

simple interest in the underlying property in order to

come within the parenthetical exception clause of

section 2036(a). This Court has yet to address the

precise issue.

II.

A. Gradow v. United States and the Widow's

Election Cases

As the government's position rests principally on an

analogy offered by the Claims Court in Gradow, a

preliminary summary of the widow's election

mechanism in the community property context is

appropriate.

In a community property state, a husband and wife

generally each have an undivided, one-half interest in

the property owned in common by virtue of their

marital status, with each spouse having the power to

dispose, by testamentary instrument, of his or her share

of the community property. Under a widow's election

will, the decedent spouse purports to dispose of the

entire community property, the surviving spouse being

23

left with the choice of either taking under the scheme of

the will or waiving any right under the will and taking

his or her community share outright. One common

widow's election plan provides for the surviving spouse

to in effect exchange a remainder interest in his or her

community property share for an equitable life estate in

the decedent spouse's community property share.

In Gradow, Mrs. Gradow, the surviving spouse,

was put to a similar election. If she rejected the will,

she was to receive only her share of the community

property. Id. 11 Cl.Ct. at 809. If she chose instead to

take under her husband's will, she was required to

transfer her share of the community property to a trust

whose assets would consist of the community property

of both spouses, with Mrs. Gradow receiving all the

trust income for life and, upon her death, the trust

corpus being distributed to the Gradows' son. Id. Mrs.

Gradow chose to take under her husband's will and,

upon her death, the executor of her estate did not

include any of the trust assets within her gross estate.

Id. The executor asserted that the life estate received by

Mrs. Gradow was full and adequate consideration under

section 2036(a) for the transfer of her community

property share to the trust, but the IRS disagreed. Id.

Before the Claims Court, the parties stipulated that the

value of Mrs. Gradow's share of the community

property exceeded the actuarial value of an estate for

her life in her husband's share. Id. However, the estate

contended that the value of the life estate in the

husband's share equaled or exceeded the value of the

remainder interest in Mrs. Gradow's share. The Claims

Court did not clearly resolve that contention because it

determined that the consideration flowing from Mrs.

Gradow was "the entire value of the property she placed

in the trust, i.e., her half of the community property,"

and that thus the life estate was inadequate

consideration, so the exception to section 2036(a) was

unavailable. Id. at 810.

The court in Gradow concluded that the term

"property" in section 2036(a) referred to the entirety of

that part of the trust corpus attributable to Mrs. Gradow.

Id. at 813. Therefore, according to the court, if the

general rule of section 2036(a) were to apply, the date-

of-death value of the property transferred to the trust

corpus by Mrs. Gradow----rather than the zero date-of-

death value of her life interest in that property----would

be included in her gross estate. Id. Citing

"[f]undamental principles of grammar," the court

concluded that the bona fide sale exception must refer

to adequate and full consideration for the property

placed into the trust and not the remainder interest in

that property. Id.

Fundamental principles of grammar aside, the

Gradow court rested its conclusion equally on the

underlying purpose of section 2036(a), observing that:

"The only way to preserve the integrity of the section,

then, is to view the consideration moving from the

surviving spouse as that property which is taken out

of the gross estate. In the context of intra-family

transactions which are plainly testamentary, it is not

unreasonable to require that, at a minimum, the sale

accomplish an equilibrium for estate tax purposes."

Id. at 813-14.

In support of its equilibrium rule, the Gradow court

cited precedent in the adequate and full consideration

area, most notably United States v. Allen, 293 F.2d 916

(10th Cir.), cert. denied, 368 U.S. 944, 82 S.Ct. 378, 7

L.Ed.2d 340 (1961).

It is not our task to address the merits of Gradow 's

analysis of how section 2036(a) operates in the

widow's election context but rather to determine

whether the Gradow decision supports the construction

urged by the government in the sale of a remainder

context. We conclude that the widow election cases

present factually distinct circumstances that preclude

the wholesale importation of Gradow 's rationale into

the present case.

As noted, a widow's election mechanism generally

involves an arrangement whereby the surviving spouse

exchanges a remainder interest in her community

property share for a life estate in that of her deceased

spouse. Usually, as in Gradow, the interests are in

trust. Necessarily, the receipt of an equitable life estate

in the decedent-spouse's community property share does

little to offset the reduction in the surviving spouse's

gross estate caused by the transfer of her remainder

interest. It is precisely this imbalance that the

commentators cited in Gradow----and the "equilibrium

rule" gleaned from United States v. Allen----recognized

as the determinative factor in the widow's election

context. Because a surviving spouse's transfer of a

remainder interest depletes the gross estate, there can be

no "bona fide sale for an adequate and full

consideration" unless the gross estate is augmented

commensurately. Accordingly, we need not address the

issue whether the value or income derived from a life

estate in the decedent- spouse's community property

24

share can ever constitute adequate and full

consideration. For our purposes it is enough to observe

that, in most cases, the equitable life estate received by

the surviving spouse will not sufficiently augment her

gross estate to offset the depletion caused by the

transfer of her remainder interest. This depletion of the

gross estate prevents the operation of the adequate and

full consideration exception to section 2036(a). Had the

court in Gradow limited its discussion of section

2036(a)'s adequate and full consideration exception to

the widow's election context, the nettlesome task of

distinguishing its blanket rule of including the value of

the full fee interest on the underlying property when a

remainder interest is transferred might be somewhat

easier. In dicta, however, and apparently in response

to a hypothetical posed by the taxpayer, the Gradow

court let loose a response that, to say the least, has since

acquired a life of its own. The entire passage----and

the source of much consternation----is as follows:

"Plaintiff argues that the defendant's construction

would gut the utility of the 'bona fide sales' exception

and uses a hypothetical to illustrate his point. In the

example a 40-year-old man contracts to put

$100,000.00 into a trust, reserving the income for life

but selling the remainder. Plaintiff points out that

based on the seller's life expectancy, he might receive

up to $30,000.00 for the remainder, but certainly no

more. He argues that this demonstrates the unfairness

of defendant insisting on consideration equal to the

$100,000.00 put into trust before it would exempt the

sale from § 2036(a).

There are a number of defects in plaintiff's

hypothetical. First, the transaction is obviously not

testamentary, unlike the actual circumstances here.

In addition, plaintiff assumes his conclusion by

focusing on the sale of the remainder interest as the

only relevant transaction. Assuming it was not

treated as a sham, the practical effect is a transfer of

the entire $100,000.00, not just a remainder. More

importantly, however, if plaintiff is correct that one

should be able, under the 'bona fide sale' exception to

remove property from the gross estate by a sale of the

remainder interest, the exception would swallow the

rule. A young person could sell a remainder interest

for a fraction of the property's worth, enjoy the

property for life, and then pass it along without estate

or gift tax consequences." Gradow, 11 Cl.Ct. at 815.

The Claims Court went on to conclude that "[t]he

fond hope that a surviving spouse would take pains to

invest, compound, and preserve inviolate all the life

income from half of a trust, knowing that it would

thereupon be taxed without his or her having received

any lifetime benefit, is a slim basis for putting a

different construction on § 2036(a) than the one

heretofore consistently adopted." Id. at 816.

One can only imagine the enthusiasm with which

the IRS received the news that, at least in the view of

one court, it would not have to consider the time value

of money when determining adequate and full

consideration for a remainder interest. Subsequent to

the Gradow decision, the government has successfully

used the above quoted language to justify inclusion in

the gross estate of the value of the full fee interest in the

underlying property even where the transferor sold the

remainder interest for its undisputed actuarial value.

See Pittman v. United States, 878 F.Supp. 833

(E.D.N.C.1994). See also D'Ambrosio v.

Commissioner, 105 T.C. 252, 1995 WL 564078 (1995),

rev'd, 101 F.3d 309 (3d Cir.1996), cert. denied, 520

U.S. 1230, 117 S.Ct. 1822, 137 L.Ed.2d 1030 (1997).

Pittman (and the Tax Court's decision in

D'Ambrosio) presents a conscientious estate planner

with quite a conundrum. If the taxpayer sells a

remainder interest for its actuarial value as calculated

under the Treasury Regulations, but retains a life estate,

the value of the full fee interest in the underlying

property will be included in his gross estate and the

transferor will incur substantial estate tax liability under

section 2036(a). If the taxpayer chooses instead to

follow Gradow, and is somehow able to find a willing

purchaser of his remainder interest for the full fee-

simple value of the underlying property, he will in fact

avoid estate tax liability; section 2036(a) would not be

triggered. The purchaser, however, having paid the

fee-simple value for the remainder interest in the estate,

will have paid more for the interest than it was worth.

As the "adequate and full consideration" for a

remainder interest under section 2512(b) is its actuarial

value, the purchaser will have made a gift of the amount

paid in excess of its actuarial value, thereby incurring

gift tax liability. Surely, in the words of Professor

Gilmore, this "carr[ies] a good joke too far."

C. In Pari Materia

As alluded to above, significant problems arise

when "adequate and full consideration" is given one

meaning under section 2512 and quite another for the

purposes of section 2036(a). In a pair of companion

cases in 1945, the Supreme Court set forth the general

25

principle that, because the gift and estate taxes

complement each other, the phrase "adequate and full

consideration" must mean the same thing in both

statutes. See Merrill v. Fahs, 324 U.S. 308, 309-11, 65

S.Ct. 655, 656, 89 L.Ed. 963 (1945) (" 'The gift tax was

supplementary to the estate tax. The two are in pari

materia and must be construed together.'

The "purpose" of gift and estate taxes was

articulated clearly in Wemyss: "The section taxing as

gifts transfers that are not made for 'adequate and full

[money] consideration' aims to reach those transfers

which are withdrawn from the donor's estate."

Wemyss, 324 U.S. at 307, 65 S.Ct. at 655. In Wemyss,

the donor received no consideration in money's worth

to replenish his estate for the transfer of stock to his

bride, and therefore his estate was depleted by the

amount of the transfer. The bride's relinquishment of

her interest in an existing trust provided no

augmentation *762 to the donor's estate. The

following rule emerges: unless a transfer that depletes

the transferor's estate is joined with a transfer that

augments the estate by a commensurate (monetary)

amount, there is no "adequate and full consideration"

for the purposes of either the estate or gift tax. We

thus come full circle to the "equilibrium rule" set forth

in United States v. Allen and cited in Gradow.

The sale of a remainder interest for its actuarial

value does not deplete the seller's estate. "The actuarial

value of the remainder interest equals the amount that

will grow to a principal sum equal to the value of the

property that passes to the remainderman at termination

of the retained interest. To reach this conclusion, the

tables assume that both the consideration received for

the remainder interest and the underlying property are

invested at the table rate of interest, compounded

annually." Jordan, Sales of Remainder Interests, at

692-93 (citing Keith E. Morrison, The Widow's

Election: The Issue of Consideration, 44 Tex. L.Rev.

223, 237-38 (1965)). In other words, the actuarial

tables are premised on the recognition that, at the end of

the actuarial period, there is no discernible difference

between (1) an estate holder retaining the full fee

interest in the estate and (2) an estate holder retaining

income from the life estate and selling the remainder

interest for its actuarial value----in either case, the estate

is not depleted. This is so because both interests, the

life estate and the remainder interest, are capable of

valuation. Recognizing this truism, the accumulated

value of a decedent's estate is precisely the same

whether she retains the fee interest or receives the

actuarial value of the remainder interest outright by a

sale prior to her actual death. Id. at 691-92; Morrison,

The Issue of Consideration, at 237-38.

Two possible objections----which are more

properly directed at the wisdom of accepting actuarial

factors than at the result just described----should be

addressed. The first, to paraphrase the Claims Court in

Gradow, is that the fee interest holder, in such a

situation, might squander the proceeds from the sale of

the remainder interest and, therefore, deplete the estate.

See Gradow, 11 Cl.Ct. at 816 (noting that "[t]he fond

hope that a surviving spouse would take pains to invest,

compound, and preserve inviolate all [proceeds from a

sale of the remainder interest], knowing that it would

thereupon be taxed without his or her having received

any lifetime benefit, is a slim basis" for holding the

actuarial value of a remainder interest is adequate and

full consideration under section 2036(a)). This

objection amounts to a misapprehension of the estate

tax. Whether an estate holder takes the "talents"

received from the sale of the remainder interest and

purchases blue chip securities, invests in highly volatile

commodities futures, funds a gambling spree, or

chooses instead to bury them in the ground, may speak

to the wisdom of the estate holder, see Matthew 25:14-

30, but it is of absolutely no significance to the proper

determination of whether, at the time of the transfer, the

estate holder received full and adequate consideration

under section 2036(a). If further explanation is

required, we point out that Gradow itself seems to have

reached the same conclusion in an earlier portion of the

opinion. See Gradow, 11 Cl.Ct. at 813 ("Even if the

consideration is fungible and easily consumed, at least

theoretically the rest of the estate is protected from

encroachment for lifetime expenditures."). See also

Jordan, Sales of Remainder Interests, at 695- 96 &

n.105; Morrison, The Issue of Consideration, at 236-

44.

The second objection is no more availing. If a sale

of a remainder interest for its actuarial value----an

amount, it is worth noting, that is nothing more than the

product of the undisputed "fair market value" of the

underlying estate multiplied by an actuarial factor

designed to adjust for the investment return over the

actuarial period----constitutes adequate and full

consideration under section 2036(a), then the estate

holder successfully "freezes" the value of the

transferred remainder at its date-of-transfer value.

Accordingly, any post-transfer appreciation of the

remainder interest over and above the appreciation

percentage anticipated by the actuarial tables passes to

26

the remainderman free of the estate tax. But, of course,

this is a problem only if the proceeds of the sale are not

invested in assets which appreciate as much (or

depreciate as little) as the remainder. Moreover, those

who recall the Great Depression, as well as more recent

times, know that assets frequently do not appreciate.

Indeed, Melton's ranch did not appreciate, but rather at

his death was worth less than eighty-two percent of its

value when the remainder was sold. Finally, to the

extent that this "freeze" concern is legitimate, we note,

as discussed infra, that Congress, through the passage

in 1987 of former section 2036(c) and, later, its 1990

repeal and the enactment then of section 2702, has

spoken to the issue.

For the foregoing reasons, we REVERSE the

judgment of the district court and REMAND for entry

of judgment in favor of the Melton Estate reflecting its

entitlement to a refund of all federal estate taxes paid on

the basis of the inclusion of the ranch in Melton's gross

estate, plus interest.

REVERSED and REMANDED with directions.

27

ASSIGNMENT 5

Code: §§2035(a)(2), 2037, 7520

Regulations: §§20.2037-1(a) through 20.2037-1(d), 1.7520-3(b)(3) S,M,L & C: ¶ 4.09 (except 4.09[7])

Questions:

1. D creates a trust with income payable to W for her life, remainder to S, if living, and, if not,to D or his estate.

a If D predeceases W and S, is §2037 applicable?

b. Is any part of the value of the trust corpus included in D's gross estate.

2. D creates a trust with income to A for D's life, remainder to B if he is then living, and, if not,to C or C's estate. If D predeceases A and B, is anything includable in D's gross estate?

3. What interest or interests, if any, are included in D's gross estate under §2037 (assuming the5% test is satisfied) in the following situations:

a. D creates a trust with income to W for her life, reversion to D if living and, if not, toC or C's estate. D predeceases W.

b. D creates a trust with income to W for her life, remainder to A if living, and if not,reversion to D if living, and if not to C or C's estate. D predeceases W and A.

c. Same as (b), except that W is also given a general power of appointment over thecorpus.

28

d. Same as (b), except that X is given a power to appoint to himself but NOT to thecurrent beneficiaries of the trust.

4. D, age 50, creates a trust with income to be accumulated for twenty years or until D's death,whichever is earlier, then principal and accumulated income to S if living. D dies 10 yearslater survived by S. Assume that if S were not living, local law would effect a reversion toD's estate.

a. Same as above except that D is ninety years old at the time of the transfer.

5. D creates a trust with income to A and B equally for D's life, remainder to A and B.

a. What if D reserves the right to allocate the remainder between A and B or theirestates in any portions which D determines and, on failure to allocate remainder, to Aor B or their estates equally. D predeceases A and B without allocating theremainder.

b. What if D reserves the ability to add additional remaindermen?

c. Same as (b), but D releases (surrenders) his power within three years of death?

d. What if D reserves the right to add additional income beneficiaries?

e. What if D can only exercise the power in (b) with the consent of both A or B or theirestates?

29

ASSIGNMENT 6

Code: §§2035 and 2038(a)(1) and (b)

Regulations: §20.2038-1(a) and (b)

S,M,L, & C: ¶ 4.10 (Note: 4.10[10] provides review of lifetime transfer sections)

Readings: Old Colony Trust Co. v. United States

Questions:

1. D creates a trust with income payable to A or A's estate for D's life, and the remainder to B orB's estate. What amount, if any, should be included in D's gross estate under §2038 when Dpredeceases all other parties in the following situations? (This problem is similar to problem 4 inAssignment 4 relating to §2036. Compare your results!)

a. D, as trustee, retains a power to give income to C.

b. D, as trustee, retains a power to invade corpus for C.

c. D, as trustee, retains a power to give the remainder to C.

d. D, as trustee, retains a power to accumulate income and add it to corpus.

e. D, as trustee, retains a power to invade the corpus of the trust for A.

f. D names his friend E trustee and E holds a power to give income to C.

30

g. D names himself trustee and provides that the trustee is required to give C as muchincome as is needed each year for C's support and maintenance, with any excessincome to go to A. (Old Colony Trust v. U.S.)

h. D names his friend E trustee and provides that the trustee is required to give D asmuch income as is needed each year for D's support and maintenance, with anyexcess income to go to A.

i. Same facts as (h), but assume that E had complete discretion with respect to makingdistributions to D.

2. D creates a trust with income payable to A for A's life, and the remainder to B or B's estate. What amount, if any, should be included in D's gross estate under §2038 when D predeceases allother parties in the following situations?

a. D retains a testamentary power to order the third-party trustee to return all of the trustcorpus to grantor.

b. What result in (a) if the trustee was not required to return the property to thedecedent's estate until 1 year after D's notice that he intends to execute the power.

c. D names A as trustee and retains a power in conjunction with A to direct that all ofthe trust corpus be returned to D.

d. D retains a power subject to A and B's approval to require the third-party trustee toreturn the trust corpus to D.

e. D, as trustee, retains a power to invade corpus for C if C marries D's daughter, but Cdoes not marry D's daughter prior to D's death.

31

3. D creates a trust with income to A (not a dependent) for ten years and remainder to A or A'sestate. D dies after five years, A surviving.

a. What is included under §2038 if grantor retained a power to invade corpus for A?

b. What is included under §2038 if D retained a power to accumulate income?

4. D transfers stock to a trust and provides for the payment of income to A for A's life and aremainder to B or B's estate. D names himself trustee and, as trustee, holds the power (1) tovote the stock; (2) to sell the stock and reinvest in other stock even though it was speculativeor unproductive of income; and (3) to allocate receipts other than cash dividends either toincome or to principal. Is anything included in D's gross estate under §§2036(a)(2) and2038? (Old Colony Trust v. U.S.)

5. D creates a trust with income to A for A's life and a remainder to A's children or their estates,but D retains a power to give the income from the trust to A's father.

a. What result under §§2036(a)(2) and 2038 on D's death if he is survived by A and A'sfather?

b. What if D had a stroke three months before his death at which time he relinquishedall powers over the trust, and, at death, D was survived by A and A's father?

c. What result in (b) if D became incompetent as a result of the stroke, and, under statelaw, neither D nor his conservator could legally exercise the power.

32

OLD COLONY TRUST COMPANY,

v.

UNITED STATES of America

423 F.2d 1970 (8th. Cir.)

ALDRICH, Chief Judge.

The sole question in this case is whether the

estate of a settlor of an inter vivos trust, who was a trustee

until the date of his death, is to be charged with the value

of the principal he contributed by virtue of reserved

powers in the trust. The executor paid the tax and sued

for its recovery in the district court. All facts were

stipulated. The court ruled for the government, 300

F.Supp. 1032, and the executor appeals.

The initial life beneficiary of the trust was the

settlor's adult son. Eighty per cent of the income was

normally to be payable to him, and the balance added to

principal. Subsequent beneficiaries were the son's widow

and his issue. The powers upon which the government

relies to cause the corpus to be includible in the settlor-

trustee's estate are contained in two articles. A third

article, purporting to limit the personal liability of the

trustees for acts of mismanagement, although relied on by

the government, has no bearing on the questions in this

case because it does not affect the meaning, extent or

nature of the trustees' duties and powers. Briggs v.

Crowley, 1967, 352 Mass. 194, 224 N.E.2d 417. We will

not consider it further.

Article 4 permitted the trustees to increase the

percentage of income payable to the son beyond the

eighty per cent,

'in their absolute discretion * * * when in their

opinion such increase is needed in case of

sickness, or desirable in view of changed

circumstances.'

In addition, under Article 4 the trustees were

given the discretion to cease paying income to the son,

and add it all to principal,

'during such period as the Trustees may decide

that the stoppage of such payments is for his best

interests.'

Article 7 gave broad administrative or

management powers to the trustees, with discretion to

acquire investments not normally held by trustees, and the

right to determine, what was to be charged or credited to

income or principal, including stock dividends or

deductions for amortization. It further provided that all

divisions and decisions made by the trustees in good faith

should be conclusive on all parties, and in summary,

stated that the trustees were empowered, 'generally to do

all things in relation to the Trust Fund which the Donor

could do if living and this Trust had not been executed.'

The government claims that each of these two

articles meant that the settlortrustee had 'the right * * * to

designate the persons who shall possess or enjoy the

(trust) property or the income therefrom' within the

meaning of section 2036(a)(2) of the Internal Revenue

Code of 1954, 26 U.S.C. § 2036(a)(2), and that the

settlor-trustee at the date of his death possessed a power

'to alter, amend, revoke, or terminate' within the meaning

of section 2038(a)(1) (26 U.S.C. § 2038(a)(1)).

If State Street Trust Co. v. United States, 1 Cir.,

1959, 263 F.2d 635, was correctly decided in this aspect,

the government must prevail because of the Article 7

powers. There this court, Chief Judge Magruder

dissenting, held against the taxpayer because broad

powers similar to those in Article 7 meant 'as long as he

lived, in substance and shift the economic benefits of the

trusts between the life tenants and the remaindermen,' so

that the settlor 'as long as he lived, in substance and effect

and in a very real sense * * * 'retained for his life * * * the

right * * * to designate the persons who shall possess or

enjoy the property or the income therefrom; * * *.'' 263

F.2d at 639-640, quoting 26 U.S.C. § 2036(a)(2). We

accept the taxpayer's invitation to reconsider this ruling.

It is common ground that a settlor will not find

the corpus of the trust included in his estate merely

because he named himself a trustee. Jennings v. Smith, 2

Cir., 1947, 161 F.2d 74. He must have reserved a power

to himself that is inconsistent with the full termination of

ownership. The government's brief defines this as

'sufficient dominion and control until his death.' Trustee

powers given for the administration or management of the

trust must be equitably exercised, however, for the benefit

of the trust as a whole. Blodget v. Delaney, 1 Cir., 1953,

201 F.2d 589; United States v. Powell, 10 Cir., 1962, 307

F.2d 821; Scott, Trusts §§ 183, 232 (3d ed. 1967); Rest.

2d, Trusts §§ 183, 232. The court in State Street

conceded that the powers at issue were allsuch powers,

but reached the conclusion that, cumulatively, they gave

the settlor dominion sufficiently unfettered to be in the

nature of ownership. With all respect to the majority of

33

the then court, we find it difficult to see how a power can

be subject to control by the probate court, and exercisable

only in what the trustee fairly concludes is in the interests

of the trust and its beneficiaries as a whole, and at the

same time be an ownership power.

The government's position, to be sound, must be

that the trustee's powers are beyond the court's control.

Under Massachusetts law, however, no amount of

administrative discretion prevents judicial supervision of

the trustee. Thus in Appeal of Davis, 1903, 183 Mass.

499, 67 N.E. 604, a trustee was given 'full power to make

purchases, investments and exchanges * * * in such

manner as to them shall seem expedient; it being my

intention to give my trustees * * * the same dominion and

control over said trust property as I now have.' In spite of

this language, and in spite of their good faith, the court

charged the trustees for failing sufficiently to diversify

their investment portfolio.

The Massachusetts court has never varied from

this broad rule of accountability, and has twice criticized

State Street for its seeming departure. Boston Safe

Deposit & Trust Co. v. Stone, 1965, 348 Mass. 345, 351,

n. 8, 203 N.E.2d 547; Old Colony Trust Co. v. Silliman,

1967, 352 Mass. 6, 8-9, 223 N.E.2d 504. See also, Estate

of McGillicuddy, 54 T.C. No. 27, 2/17/70, CCH Tax

Ct.Rep. Dec. 29, 1965. We make a further observation,

which the court in State Street failed to note, that the

provision in that trust (as in the case at bar) that the

trustees could 'do all things in relation to the Trust Fund

which I, the Donor, could do if * * * the Trust had not

been executed,' is almost precisely the provision which

did not protect the trustees from accountability in Appeal

of Davis, supra.

We do not believe that trustee powers are to be

more broadly construed for tax purposes than the probate

court would construe them for administrative purposes.

More basically, we agree with Judge Magruder's

observation that nothing is 'gained by lumping them

together.' State Street Trust Co. v. United States, supra,

263 F.2d at 642. We hold that no aggregation of purely

administrative powers can meet the government's

amorphous test of 'sufficient dominion and control' so as

to be equated with ownership.

This does not resolve taxpayer's difficulties

under Article 4. Quite different considerations apply to

distribution powers. Under them the trustee can,

expressly, prefer one beneficiary over another.

Furthermore, his freedom of choice may vary greatly,

depending upon the terms of the individual trust. If there

is an ascertainable standard, the trustee can be compelled

to follow it. If there is not, even though he is a fiduciary,

it is not unreasonable to say that his retention of an

unmeasurable freedom of choice is equivalent to retaining

some of the incidents of ownership. Hence, under the

cases, if there is an ascertainable standard the settlor-

trustee's estate is not taxed, United States v. Powell,

supra; Jennings v. Smith, supra; Estate of Budd, 1968, 49

T.C. 468; Estate of Pardee, 1967, 49 T.C. 140, but if there

is not, it is taxed. Henslee v. Union Planters Nat'l Bank &

Trust Co., 1949, 335 U.S. 595, 69 S.Ct. 290, 93 L.Ed.

259; Hurd v. Com'r. 1 Cir., 1947, 160 F.2d 610; Michigan

Trust Co. v. Kavanagh, 6 Cir., 1960, 284 F.2d 502.

The trust provision which is uniformly dominion

and control' so as to be equated is one which, though

variously expressed, authorizes such distributions as may

be needed to continue the beneficiary's accustomed way

of life. Ithaca Trust Co. v. United States, 1929, 279 U.S.

151, 49 S.Ct. 291, 73 L.Ed. 647; cf. United States v.

Commercial Nat'l Bank, 10 Cir., 1968, 404 F.2d 927, cert.

denied 393 U.S. 1000, 89 S.Ct. 487, 21 L.Ed.2d 465;

Blodget v. Delaney, 1 Cir., 1953, supra. On the other

hand, if the trustee may go further, and has power to

provide for the beneficiary's 'happiness,' Merchants Nat'l

Bank v. Com'r of Internal Revenue, 1943, 320 U.S. 256,

64 S.Ct. 108, 88 L.Ed. 35, or 'pleasure,' Industrial Trust

Co. v. Com'r of Internal Revenue, 1 Cir., 1945, 151 F.2d

592, cert. denied 327 U.S. 788, 66 S.Ct. 807, 90 L.Ed.

1014, or 'use and benefit,' Newton Trust Co. v. Com'r of

Internal Revenue, 1 Cir., 1947, 160 F.2d 175, or

'reasonable requirement(s),' State Street Bank & Trust Co.

v. United States, 1 Cir., 1963, 313 F.2d 29, the standard

is so loose that the trustee is in effect uncontrolled.

In the case at bar the trustees could increase the

life tenant's income 'in case of sickness, or (if) desirable

in view of changed circumstances.' Alternatively, they

could reduce it 'for his best interests.' 'Sickness' presents

no problem. Conceivably, providing for 'changed

circumstances' is roughly equivalent to maintaining the

son's present standard of living. But see Hurd v. Com'r,

of Internal Revenue, supra. The unavoidable stumbling

block is the trustees' right to accumulate income and add

it to capital (which the son would never receive) when it

is to the 'best interests' of the son to do so. Additional

payments to a beneficiary whenever in his 'best interests'

might seem to be too broad a standard in any event. In

addition to the previous cases see Estate of Yawkey,

1949, 12 T.C. 1164, where the court said, at p. 1170,

34

'We can not regard the language involved ('best

interest') as limiting the usual scope of a trustee's

discretion. It must always be anticipated that

trustees will act for the best interests of a trust

beneficiary, and an exhortation to act 'in the

interests and for the welfare' of the beneficiary

does not establish an external standard.'

Power, however, to decrease or cut off a

beneficiary's income when in his 'best interests,' is even

more troublesome. When the beneficiary is the son, and

the trustee the father, a particular purpose comes to mind,

parental control through holding the purse strings. The

father decides what conduct is to the 'best interests' of the

son, and if the son does not agree, he loses his allowance.

Such a power has the plain indicia of ownership control.

The alternative, that the son, because of other means,

might not need this income, and would prefer to have it

accumulate for his widow and children after his death, is

no better. If the trustee has power to confer 'happiness' on

the son by generosity to someone else, this seems clearly

an unascertainable standard. Cf. Merchants Nat'l Bank v.

Com'r of Internal Revenue, supra, 320 U.S. at 261-263,

64 S.Ct. 108.

The case of Hays' Estate v. Com'r of Internal

Revenue, 5 Cir., 1950, 181 F.2d 169, is contrary to our

decision. The opinion is unsupported by either reasoning

or authority, and we will not follow it. With the present

settlor-trustee free to determine the standard himself, a

finding of ownership control was warranted. To put it

another way, the cost of holding onto the strings may

prove to be a rope burn. State Street Bank & Trust Co. v.

United States, supra.

Affirmed.

35

ASSIGNMENT 7

Code: §2039(a) and (b)

Regulations: §§20.2039-1(b)(1) and (c)

S, M, L, & C: ¶ 4.11[1] through [5]

Readings: Bahen v. U.S.

Questions:

1. In year one, D entered into a contract with an insurance company under which he paid thecompany $150,000, and it agreed that, beginning in ten years, it would pay D $2,000 per month for hislife and, after his death, it would pay the same amount to his wife for as long as she should live.Assuming that it is not life insurance, what is included under §2039 in each of the following situations:

a. D dies in year eight, survived by W.

b. What result in (a) if W had paid $75,000 of her funds toward the $150,000 cost of thecontract?

c. What result in (a) if D's employer had paid $50,000 of the cost of the contract.

2. Acme (D's employer) provides certain "retirement" benefits to D and his wife. What is includedunder §2039 in each of the following situations.

a. D retires from full time employment after 35 years with Acme. Acme agreed to pay$20,000 per year to D for 10 years. The right to these payments would cease on D'sdeath within the 10 year period. During that time, D agreed to provide consultingservices to Acme. Acme also agreed to pay D's wife $200 per month after D's death forher life. D dies after 8 years of retirement, predeceasing his wife.

b. Acme agreed to pay D's wife $300 per month after D's death. If D became permanently

36

disabled prior to retirement, he would also receive that payment during the remainder ofhis life. D died before retirement and without becoming disabled. (Bahen v. U.S.)

c. Acme agreed to pay D $10,000 on his retirement. Acme also agreed to pay D's wife orher estate $10,000 on D's death. If D died before retirement, D's wife or her estate wouldreceive $20,000. D dies before retirement.

d. Same as (c), but D retired, received the $10,000 lump sum payment, and died 3 monthslater.

e. In 1995, as the result of labor negotiations, Acme agreed to pay D $300 per month afterhe retires for as long as he shall live. In 1997, under a separate bargaining agreement,Acme agreed to pay D's wife the sum of $200 per month on D's death or the wifeattaining age 70, whichever shall occur first. D dies when his wife is 68.

f. Same as (e), but D dies when his wife is 72 and already has begun to receive her benefits.

37

ESTATE of J. William BAHEN, Deceased, Kathleen

Privett Bahen, Sole Executrix

v.

The UNITED STATES.

(Ct.Cl. 1962)

DAVIS, Judge.

The estate of a former high-ranking officer of The

Chesapeake and Ohio Railway Company claims that sums paid

by the C. & O. to his widow on his death in 1955, under benefit

plans unilaterally adopted by the railroad in 1952 and 1953,

were improperly included in his gross estate for tax purposes.

The issue is one of law under the Internal Revenue Code of

1954; the parties have agreed upon a stipulation of facts which

we have accepted.

The decedent, J. William Bahen, was born in 1905 and

died in 1955. He married the plaintiff, executrix of the estate,

in 1930; they had no children. For almost 37 1/2 years Mr.

Bahen worked continuously for the C. & O.; at his death he was

the fulltime Assistant to the President. He had not retired nor

was he eligible for retirement. He worked regularly and hard

and was repeatedly urged by the Medical Director of the

Greenbrier Clinic (at White Sulphur Springs, West Virginia),

which examined him periodically, to get more rest because of the

tension under which he was working. He suffered some

abdominal disturbances and electrocardiograms showed some

evidence of partial blockage (without appreciable change over

the years), but he had no illness that indicated a heart attack and

there was also nothing to indicate that he could not perform his

duties. While at the Greenbrier Hotel, to attend a meeting on

November 11, 1955, Mr. Bahen suffered a heart attack and died

within six hours after first reporting his symptoms to the

Greenbrier Clinic. The death certificate showed that he died as

the result of arteriosclerotic heart disease and coronary

thrombosis.

After Mr. Bahen's death, the C. & O. made payments to his

widow under two plans which it had earlier established for its

employees. The first was the Death Benefit Plan, adopted in

January 1952, which provided (see finding 9) that, if a covered

employee with more than 10 years' service died while in the

company's employ and before becoming eligible for retirement,

the C. & O. would pay, 'in recognition of the services rendered

by him', a sum equal to three months' salary to his widow or (if

she died prior to payment) to the guardian of any of his minor

children.

The more significant arrangement was the Deferred

Compensation Plan adopted by the company in February 1953

for forty of its officers and executives. See finding 6. For a

designated officer who was under 60 at that time, like Mr.

Bahen, the C. & O. would pay a stated maximum sum

($100,000 in Mr. Bahen's case), at his death either before or

after retirement, to his widow and to those of his surviving

children under 21 the officer might specify (and in the

proportions he designated), in 60 equal monthly installments.

These payments were to be made only if a wife or minor child

survived the officer and would continue only so long as there

was a surviving wife or child under 21. However, if prior to

retirement the officer became totally incapacitated, mentally or

physically, for further performance of duty, the payments would

be made to him in 60 equal monthly installments so long as he

survived, any unpaid installment going to his widow or minor

children. The president of the company was to notify each

officer covered by the Plan of the benefits payable to him and

was also 'to represent that the Plan is irrevocable, not subject to

later withdrawal by this Board (of Directors), and represents a

firm commitment on the part of the Company to extend

benefits in accordance with the terms and conditions herein set

forth' (finding 6). Mr. Bahen was immediately notified of this

Deferred Compensation Plan and its irrevocability.

Both of these plans were established by the voluntary

unilateral action of the C. & O. The costs were not deducted

from other compensation received by Mr. Bahen. Both plans

were unfunded and the company did not purchase insurance

policies or annuity contracts in connection with them. Neither

of the plans was, at the time of the decedent's death, qualified

under Section 401 of the Internal Revenue Code of 1954, 26

U.S.C.A. § 401.

Mrs. Bahen received.$7,437.50 (three months' salary)

under the Death Benefit Plan and 60 monthly payments totalize

$100,000 under the Deferred Compensation Plan. These

amounts were not included in the estate tax return on Mr.

Bahen's estate. On audit, the Commissioner of Internal Revenue

made an additional assessment on the basis of his determination

that the value at the decedent's death of the benefits payable

under the two plans was includable in the gross estate. This

additional assessment was paid, and a claim for refund was filed

on July 28, 1959, and rejected on November 10, 1959.

The Government invokes each of four sections of the

Internal Revenue Code of 1954 (Sections 2036(a)(2), 2037,

2038(a)(1), and 2039), 26 U.S.C.A. §§ 2036(a) (2), 2037,

2038(a)(1), 2039 as authority for the inclusion in Mr. Bahen's

taxable estate of the value of his employer's payments to Mrs.

Bahen under the two plans. We need consider only Section

2039, a new provision added to the estate tax in 1954 which for

the first time established specific rules for the coverage of

annuities and other survivor benefits. See S.Rept. No. 1622,

83d Cong., 2d Sess., pp. 123, 469; H.Rept. No. 1337, 83d

Cong., 2d Sess., p. 90, A314 U.S.C.ode Cong. and Adm.News

1954, pp. 4457, 5113, 5335.

The text of Section 2039(a) states:

'The gross estate shall include the value of an annuity or

other payment receivable by any beneficiary by reason of

38

surviving the decedent under any form of contract or

agreement entered into after March 3, 1931 (other

than as insurance under policies on the life of the

decedent), if, under such contract or agreement, an

annuity or other payment was payable to the

decedent, or the decedent possessed the right to

receive such annuity or other payment, either alone or

in conjunction with another for his life or for any

period not ascertainable without reference to his death

or for any period which does not in fact end before

his death.”

The Treasury has issued Regulations under this provision

which plaintiff does not challenge and which we are to take fully

into account. Unless they violate the statute they seek to

implement, such Treasury Regulations must be accepted in the

areas they occupy. Fawcus Machine Co. v. United States, 282

U.S. 375, 378, 51 S.Ct. 144, 75 L.Ed. 397; Commissioner of

Internal Revenue v. Wheeler, 324 U.S. 542, 546--547, 65 S.Ct.

799, 89 L.Ed. 1166; Commissioner of Internal Revenue v.

South Texas Lumber Co., 333 U.S. 496, 501, 503, 68 S.Ct.

695, 92 L.Ed. 831.

Section 2039 was a development of the earlier provisions

of the estate tax which spoke of the decedent's 'property' and of

'transfers' by the decedent in contemplation of or taking effect

at death. See Section 811 of the Internal Revenue Code of

1939, 26 U.S.C.A. § 811. The new section does not use that

phraseology but frames its operative requirements more directly

in terms of particular types of transactions or arrangements

involving the decedent. This change is significant. We must

pay heed to the precise new form in which Congress cast its net

and not become entangled in the older meshes.

A. The Deferred Compensation Plan: We first consider

the application of Section 2039 (and the Regulations) to the C.

& O.'s major plan, the Deferred Compensation Plan (of 1953)

under which $100,000 was paid to Mrs. Bahen in a five-year

span. As we read the section and the Regulations, they demand

inclusion in the estate of the proceeds of this Plan. Every

requirement is squarely met, not only in literal terms but in

harmony with the legislative aim.

1. There is, initially, no doubt that the Plan, though

adopted by the company unilaterally and without negotiation

with the officers and employees, was a 'form of contract or

agreement' under the statute. This phrase is defined by Section

20.2039--1(b)(1)(ii) of the Treasury Regulations on Estate

Tax to include 'any arrangement, understanding or plan, or any

combination of arrangements, understandings, or plans arising

by reason of the decedent's employment.' A compensation plan

unilaterally adopted by the employer, but made irrevocable and

communicated to the employee, falls directly within this

definition, at least where the employee continues in the

company's service after the adoption of the plan.

2. There is likewise no doubt that Mrs. Bahen, the

beneficiary, received 'an annuity or other payment' under the

statute when she was paid the $100,000 in sixty equal

installments. The Regulations (Sec. 20.2039--1(b)(1)(ii))

appropriately say that this double term in Section 2039, as used

with respect to both the beneficiary and the decedent, 'has

reference to one or more payments extending over any period of

time', and that the payments may 'be equal or unequal,

conditional or unconditional, periodic or sporadic.' See also

S.Rept. No. 1622, 83d Cong., 2d Sess., at p. 470; H.Rept. No.

1337, 83d Cong., 2d Sess., at p. A315.

3. The next problem is whether at Mr. Bahen's death there

was payable to him or he possessed the right to receive 'an

annuity or other payment.' The Deferred Compensation Plan

provided that, if Mr. Bahen became totally incapacitated for

further performance of duty before retirement, the C. & O.

would pay him the $100,000 in 60 equal monthly installments.

Under both the normal understanding of the statutory words

'annuity or other payment' and the broad definition given them

by the Regulations (referred to above), these sums must be

characterized as at least an 'other payment.' Stressing Congress's

use of the singular ('payment') and a reference in the Senate

Committee report to a lump-sum payment in lieu of an annuity,

plaintiff appears to urge that the only 'payment' to a decedent

covered by Section 2039 is a lump sum paid or payable in the

place of a strict lifetime annuity (i.e., an annuity paid in the form

of a lump sum). But we cannot confine the general language of

Section 2039, as interpreted by the Regulations, within the

limits of one illustration given by the Committee as a reason for

adding the all-inclusive words 'other payment' to 'annuity'. As

we point out more in detail below, the history and pattern of

Section 2039 fail to indicate that it deals only with true lifetime

annuities (in installment form or in a commuted lump sum).

The statute covers--as an 'other payment', at least--disability

compensation benefits of the type involved here.

4. Were these benefit payments--assuming, as we have just

decided, that they constituted an 'annuity or other payment'

within Section 2039-- 'payable to' Mr. Bahen at his death or did

he 'possess the right to receive such annuity or payment'? The

Regulations (Sec. 20.2039--1(1)(ii)) establish that amounts are

'payable' to a decedent 'if, at the time of his death, the decedent

was in fact receiving an annuity or other payments, whether or

not he had an enforceable right to have payments continue.'

Since Mr. Bahen was not receiving disability benefits when he

died, this term of the statute is not satisfied.

We hold, however, that at his death Mr. Bahen did 'possess

the right' to receive the disability payments in the future if

certain conditions were fulfilled, and therefore that the

alternative requirement of Section 2039 is met. The intentional

juxtaposition in the statute of amounts 'payable' and those the

decedent 'possessed the right to receive' indicates that the former

relates to the present (i.e. at time of death) and the latter to the

39

future. The Regulations make clear that, in circumstances like

these, the decedent's interest in future benefits, even if

contingent, is sufficient. [FN8] Where the employer has

offered a plan of this kind, the employee's compliance with his

obligations to the company gives him 'an enforceable right to

receive payments in the future, whether or not, at the time of his

death, he had a present right to receive payments.' This

provision of the Regulations both governs the Deferred

Compensation Plan and faithfully reflects its essential

characteristics. The arrangement may have been unilateral in

inception but it was also irrevocable, and its irrevocability was

deliberately communicated to the individuals covered. It thus

became an integral article of Mr. Bahen's terms of employment

by the C. & O. See S. Rept. No. 1622, 83d Cong., 2d Sess., at

p. 471, quoted in paragraph 6, infra. There can be no doubt

that he and the others relied upon the Plan, as they were

expected to do. See Worthen v. United States, 192 F.Supp.

727, 734 (D.Mass.). The right they possessed may have been

contingent but it was not at the whim of the employer. Neuffer

v. Bakery and Confectionery Workers, D.C.Cir., 1962, 307

F.2d 671.

FN8. Section 20.2039--1(1)(ii) of the Regulations states:

The decedent 'possessed the right to receive' an annuity or

other payment if, immediately before his death, the

decedent had an enforceable right to receive payments at

some time in the future, whether or not, at the time of his

death, he had a present right to receive payments. In

connection with the preceding sentence the decedent will

be regarded as having had 'an enforceable right to receive

payments at some time in the future' so long as he had

complied with his obligations under the contract or

agreement up to the time of his death. * * *

See also Example (3).

The same section of the Regulations declares that the

payments going to make up an 'annuity or other payment'

under the statute--both with respect to the decedent and

the beneficiary--'may be equal or unequal, conditional or

unconditional, periodic or sporadic.' (Emphasis added).

In answer, the plaintiff insists that the decedent cannot be

considered to have 'possessed the right to receive' these disability

payments because they were contingent on his becoming totally

disabled before retirement, and would never have been received

had he lived healthily to retirement age. Only future payments

which are sure to be paid if the decedent lives to a designated

time are covered by Section 2039, plaintiff says. However, as

we have pointed out, in specifically covering amounts not

payable to the decedent at the time of his death but which he

then had merely the 'right to receive', the statute and the

Regulations obviously cover sums becoming due in the future;

and there is no support in the statute's language for the

distinction plaintiff makes between the different types of such

future payments (at least if they are not forfeitable at the will of

another). Both classes of payment are contingent and neither is

sure. A benefit payable only if a man lives to a certain age is

conditioned upon his living that long, just as a benefit payable

only if he becomes disabled is conditional on his future

disability. Any distinction between the types seems rejected by

the Regulations which include 'conditional' payments without

qualification (see footnote 8, supra). Moreover, the comparable

term 'right to income' in related earlier provisions of the estate

tax (such as present Section 2036, former Section 811(c)(1)(B)

has been in effect read as including a contingent right to receive

income. See, e.g., Marks v. Higgins, 213 F.2d 884 (C.A.2);

Commissioner of Internal Revenue v. Estate of Nathan, 159

F.2d 546, 548--9 (C.A.7), cert. denied, 334 U.S. 843, 68 S.Ct.

1510, 92 L.Ed. 1767; Commissioner of Internal Revenue v.

Arents' Estate, 297 F.2d 894, 896 (C.A.2), cert. denied, 1962,

369 U.S. 848, 82 S.Ct. 932, 8 L.Ed.2d 9; but cf. Hubbard's

Estate v. Commissioner, 250 F.2d 492 (C.A.5). The legislative

history of Section 2039 suggests that the rules applicable under

Section 2036, in this connection, should likewise control under

the new provision. S.Rept. No. 1622, 83d Cong., 2d Sess., at p.

472; H.Rept. No. 1337, 83d Cong., 2d Sess., at p. A316; see

Stephens and Marr, Federal Estate and Gift Taxes (1959), pp.

108--109.

5. Another requirement of Section 2039 is that the

decedent's right to receive payments must be possessed 'for his

life or for any period not ascertainable without reference to his

death or for any period which does not in fact end before his

death.' For the period from February 1953, when the Deferred

Compensation Plan was adopted, to his death in November

1955, Mr. Bahen had the right to receive, under this Plan,

$100,000 in 60 installments upon his total disability prior to

retirement. He thus possessed the right to receive this 'annuity

or other payment' for a period which did not in fact end before

his death--and, accordingly, this element of Section 2039 is also

present. The correctness of this conclusion is shown by the

Regulations (Sec. 20.2039--1(b)(2)). Example (5) of which

concerns a plan under which an employer-contributed fund is to

be divided, on retirement at age 60, one-half in a lump sum to

the employee and one-half to his beneficiary, the entire amount

going to the beneficiary if the employee died before retiring.

The Regulations state that if the employee dies before

retirement the payment to the beneficiary is includable in gross

estate under Section 2039 because 'the decedent possessed the

right to receive a lump sum payment (at retirement) for a period

which did not in fact end before his death (before retirement).'

This regulation is consistent with the holdings, under older

provisions of the estate tax, relating to the meaning of the phrase

'for any period which does not in fact end before his death'

(Commissioner v. Estate of Nathan, supra, 159 F.2d 546, 548

(C.A.7), cert. denied, 334 U.S. 843, 68 S.Ct. 1510, 92 L.Ed.

1767; Marks v. Higgins, supra, 213 F.2d 884, (C.A.2);

Commissioner of Internal Revenue v. Arents' Estate, 297 F.2d

894, 896 (C.A.2), cert. denied, 1962, 369 U.S. 848, 82 S.Ct.

932, 8 L.Ed.2d 9 )--rulings which Congress has indicated

should be applied under Section 2039. S.Rept. No. 1622,

40

83dCong., 2d Sess., at p. 472; H.Rept. No. 1337, 83d Cong.,

2d Sess., at p. A316.

6. The last element necessary for coverage by Section 2039

is that Mr. Bahen must have 'contributed' the 'purchase price' of

the 'annuity or other payment' received by Mrs. Bahen which is

to be included in the taxable estate. Subsection (b), which adds

this requirement, provides:

'(b) Amount includible.--Subsection (a) shall apply to only

such part of the value of the annuity or other payment

receivable under such contract or agreement as is

proportionate to that part of the purchase price therefor

contributed by the decedent. For purposes of this section,

any contribution by the decedent's employer or former

employer to the purchase price of such contract or

agreement (whether or not to an employee's trust or fund

forming part of a pension, annuity, retirement, bonus or

profit sharing plan) shall be considered to be contributed

by the decedent if made by reason of his employment.'

The second sentence of this subsection automatically

attributes the employer's contribution to the employee 'if made

by reason of his employment.' This phrase is given broad scope

by the Senate Committee Report (S.Rept. No. 1622, 83d

Cong., 2d Sess., at p. 471, U.S.Code Cong. and Adm.News

1954, p. 5115) which holds that it applies 'if, for example, the

annuity or other payment is offered by the employer as an

inducement to employment, or a continuance thereof, or if the

contributions are made by the employer in lieu of additional

compensation or other rights, if so understood by employer and

employee whether or not expressly stated in the contract of

employment or otherwise.' The Deferred Compensation Plan,

we have already noted, plainly meets this standard; it was an

inducement to continued service with the C. & O. It is

immaterial, we think, that the company did not formally make

'contributions' to a separate fund, or actually purchase annuity

or like contracts. Section 2039 (b) does not use the words

'contribution', 'contributed', or 'purchase price' in a narrow

literal sense, any more than subsection (a) uses 'contract or

agreement' in that rigid fashion. The section deals, for the area

it covers, with the substance of transactions, not with the

mechanical way they happen to be formulated. The C. & O.'s

undertaking to make payment under the Plan was its

'contribution,' made by reason of the decedent's employment.

Congress did not demand that the company create a tangible

fund as a condition to coverage of its employees under this new

estate tax provision, and so far as we can see there would be no

reason to impose that requirement in a taxing statute such as

this.

7. To all of this the plaintiff--in addition to challenging

the existence in this case of some individual elements of

coverage--protests that despite its literal language Section 2039

is applicable only where there is a true lifetime annuity payable

to the decedent for life. Plaintiff correctly points out that the

main impetus for the new section was the doubt in 1954 that

the former estate tax provisions covered conventional joint and

survivor annuities purchased wholly or partly by the decedent's

employer (as distinguished from those purchased by the

decedent himself). S.Rept. No. 1622, 83d Cong., 2d Sess., at

p. 123; H.Rept. No. 1337, 83d Cong., 2d Sess., at p. 90. But

the committee reports do not indicate that Congress, although

using language in Section 2039 which goes well beyond the

precise situation which initially impelled the change, restricted

the scope of the new provision to those very circumstances

alone. We find nothing to show that Congress desired the

broader words it carefully used in Section 2039 not to have

their normal significance and application; indeed some of the

examples and words Congress used in the Committee Reports

(see the references, supra) show that wider coverage was plainly

intended. And the Treasury Regulations, as our prior discussion

explains, cover annuities and payments to a decedent other than

a full lifetime annuity.

8. Finally, we note briefly that Section 2039, as we

construe it, is harmonious with the general objective of the

federal estate tax to include in the decedent's estate (with

designated exceptions) the valuable interests belonging to,

accumulated by, or created by or for him, which pass to others

at his death. Many such benefits promised, given, and paid for

by an employer were specifically brought within this framework

by the new section in 1954. In subsection (b), quoted above,

Congress provides that contributions by the employer 'shall be

considered to be contributed by the decedent if made by reason

of his employment.' Phrased in terms of the earlier concepts of

a decedent's 'property' 'transferred' at his death, Section 2039

declares that annuities or other payments payable by an

employer to his employee, and on his death to a beneficiary,

constitute his property--created by him through his employer as

part of the employment arrangement and in consideration of his

continued services--which is transferred to another at his death.

See the discussion in Lehman v. Commissioner, 109 F.2d 99,

100 (C.A.2); and Worthen v. United States, 192 F.Supp. 727,

733--4 (D.Mass.). A new provision of the estate tax which

attempts to apply these fundamental concepts to a fairly well

understood set of concrete situations should not be grudgingly

read so as to chip away at the specific rule and to continue (as

in the past) to leave as much as possible to the ambiguities of

the general sections.

Plaintiff does not attack the validity of Section 2039,

interpreted as we read it, and any challenge would be baseless

under the accepted principles marking the outer boundaries of

the constitutional power of Congress to levy the estate tax. See,

e.g., United States v. Manufacturers National Bank, 363 U.S.

194, 80 S.Ct. 1103, 4 L.Ed.2d 1158; Fernandez v. Wiener, 326

U.S. 340, 351, ff. 66 S.Ct. 178, 90 L.Ed. 116; United States

Trust Co. v. Helvering, 307 U.S. 57, 60, 59 S.Ct. 692, 83 L.Ed.

1104; United States v. Jacobs, 306 U.S. 363, 59 S.Ct. 551, 83

41

L.Ed. 763; Lehman v. Commissioner, supra, 109 F.2d 99, 100

(C.A.2).

B. The Death Benefit Plan: It is a more difficult question

whether the Death Benefit Plan--under which the C. & O. paid

Mrs. Bahen a sum equal to Mr. Bahen's salary for three months--

is covered by Section 2039. Under that arrangement no

benefits were payable to the decedent during his life, and if the

Plan were to be judged by itself it would fall outside the ambit

of the section for lack of 'an annuity or other payment' to the

decedent. The defendant contends that this factor is present

because the words 'or other payment' can include the decedent-

employee's regular salary; the Death Benefit Plan must be taken,

defendant says, together with Mr. Bahen's entire employment

arrangement including his ordinary compensation. We cannot

agree. Since employees normally receive salary or wages,

defendant's interpretation would effectively obliterate, for

almost all employees, the express requirement in Section 2039

of 'an annuity or other payment' to the decedent. If Congress

had intended that strange result, it would certainly have

mentioned or referred to it. The Government's argument also

runs counter to the theory and examples of the Regulations (Sec.

*835 20.2039--1) which impliedly exclude ordinary salary from

consideration.

But the Government makes another point which we do

accept as bringing the Death Benefit Plan under Section 2039.

The suggestion is that this Plan should not be viewed in

isolation but must be considered together with the Deferred

Compensation Plan--as if both arrangements were combined

into one plan, providing two types of benefits for beneficiaries

after the employee's death but only one type of benefit

(disability compensation) to the employee himself. There is

some factual support, if that be necessary, for looking at the two

plans together, since the Death Benefit Plan was adopted in

January 1952 and the Deferred Compensation Plan only a year

later in February 1953. There appears to be a common genesis

and a unifying thread.

The firmer legal basis is provided by the Regulations (Sec.

20.2039--1(b)(2), Example (6)) which provide: 'All rights and

benefits accruing to an employee and to others by reason of the

employment (except rights and benefits accruing under certain

plans meeting the requirements of section 401(a) (see §

20.2039--2)) are considered together in determining whether or

not section 2039 (a) and (b) applies. The scope of Section

2039(a) and (b) cannot be limited by indirection.' Effect must

be given to this declaration, adopted pursuant to the Treasury's

recognized power to issue regulations and not challenged by

plaintiff, since it does not violate the terms or the spirit of

Section 2039. In view of the general purpose of the statute to

cover a large share of employer-contributed payments to an

employee's survivors, it is not unreasonable to lump together all

of the employer's various benefit plans taking account of the

employee's death (except those qualified under Section 401(a),

which are excepted by the statute, see footnotes 2 and 3, supra)

in order to decide whether and to what extent Section 2039

applies to his estate. There is no immutable requirement in the

legislation that each plan separately adopted by a company must

be considered alone. One good ground for rejecting that

position is to prevent attempts to avoid the reach of the statute

by a series of contrived plans none of which, in itself, would fall

under the section.

This directive in the Regulations that all rights and benefits

'are to be considered together'--read with another part of the

same Regulation which defines 'contract or agreement' under

Section 2039 to cover 'any combination of arrangements,

understandings, or plans arising by reason of the decedent's

employment'--requires the two plans of the C. & O. to be

deemed a coordinated whole for the purposes of Section 2039.

On that view the payments under the Death Benefit Plan were

includable in the decedent's gross estate for the reasons given

above with respect to the Deferred Compensation Plan. If the

two Plans are integrated into one, each element required for

coverage of all payments is present.

We conclude that the plaintiff is not entitled to a refund of

the estate taxes assessed because of the inclusion by the

Commissioner of Internal Revenue in the decedent's estate of

the value of the benefits paid by the C. & O. to his widow under

the two plans. Judgment will be entered for the defendant and

the petition will be dismissed.

It is so ordered.

42

ASSIGNMENT 8

Code: §2040

Regulations: §20.2040-1

S, M, L, & C: ¶ 4.12[1] though [10]

Readings: Estate of Goldsborough v. Comm'r Endicott Trust Company v. U.S.

Questions:

1. Son contributed $1,000 of his funds to a joint savings account between D and Son. On D's deathseveral years later, there was $10,000 in the account. The origin of $9,000 of the $10,000 is obscure,but there have been no withdrawals. What, if anything is included in D's gross estate if he predeceasesSon?

2. What result under §2040 in the following situations in which a parcel of joint tenancy realproperty owned by D and Son was worth $30,000 at its acquisition and $60,000 at D's death?

a. D paid the full $30,000 purchase price, and D predeceased.

b. D paid the full $30,000 purchase price, and Son predeceased.

c. D and Son each contributed $15,000 of the purchase price, and D predeceased.

d. X devised the property to D and Son as joint tenants, and D predeceased Son.

43

e. What results in (a), (b), and (c) if the only joint tenants were D and his wife W?

3. Discuss the estate tax consequences under §2040 in the following situations:

a. D transfers stock worth $5,000 outright to Daughter, who subsequently transfers thesame stock (which had appreciated in value to $10,000) to D and herself as joint tenants.At the time of D's death, the stock is worth $20,000.

b. Same as (a), except that in the current year, Daughter predeceases D within three yearsof her transfer. The stock is worth $20,000 at her death.

c. D transfers stock outright to Daughter. Daughter subsequently uses $10,000 of ordinarycash dividends paid on the stock to purchase stock as joint tenants with D. D made nocontribution to the purchase of this stock. D predeceased Daughter when the jointlyowned stock was worth $20,000.

d. D transferred stock worth $5,000 outright to Daughter. When the stock had appreciatedin value to $10,000, Daughter sold it and used the proceeds to purchase other stock worth$10,000 as joint tenants with D. D made no contribution to the purchase of this stock.D predeceased Daughter when the jointly owned stock was worth $20,000.(Goldsborough v. Comm'r)

e. D transferred stock worth $5,000 to himself and Daughter as joint tenants. They sell thestock when it is worth $10,000 and reinvest the proceeds in real property which is worth$20,000 on D's death. (Endicott Trust Company v. U.S)

4. D purchased land in 1997 for $20,000 and took title as joint tenants with Son. Five years later,D became terminally ill and several weeks before his death, D and Son severed the joint tenancy, owning

44

the land as tenants in common at the time of D’s death.

a. What are the gift tax consequences at the time the joint tenancy is severed?

b. What, if anything, is included in D’s gross estate at his death?

5. In 1970, H purchased land for $100,000, and title was taken in H and W as joint tenants. Hprovided all the consideration. In 2004, H died when the property was worth $1,000,000. In 2007, Wsold the property for $1,100,000.

a. How much gain should W recognize on the sale?

b. Would there be a difference if the land were purchased in 1977?

45

ESTATE of MARCIA P. GOLDSBOROUGH

v.

COMMISSIONER

70 T.C. 1077 (1978)

OPINION

Section 2040 provides in general that the decedent's

gross estate includes the entire value of jointly held

property but that section "except(s) such part thereof as

may be shown to have originally belonged to * * * (the

surviving joint tenant(s)) and never to have been received

or acquired by the latter from the decedent for less than an

adequate and full consideration in money or money's

worth." Section 2040 further provides that if the decedent

owned property jointly with another, the amount to be

excluded from the decedent's gross estate is "only such

part of the value of such property as is proportionate to

the consideration furnished by * * * (the surviving joint

tenant(s))." Mathematically this "consideration furnished"

exclusion can be expressed as follows:

Entire value of propertyAmount (on the date of Survivor's considerationexcluded = death or alternate X ------------------------------ valuation date) Entire consideration paid

In the instant case, the decedent (Goldsborough)

acquired on May 12, 1937, real property (St. Dunstans) in

her individual name. On April 4, 1946, decedent

transferred St. Dunstans, valued at $25,000 on that date,

to her two daughters (Eppler and O'Donoghue) as a gift.

On July 17, 1949, the daughters sold St. Dunstans to H.

W. Ford and his wife for $32,500. Sometime in that same

year, each daughter invested her share of the proceeds

from the sale of St. Dunstans in various stocks and

securities; each daughter took title to her respective stocks

and securities in joint tenancy with decedent. These stocks

and securities remained in joint tenancy until December

21, 1972, the date of decedent's death, and during the

period of joint tenancy the stocks and securities

appreciated in value to $160,383.19, the value on the

alternate valuation date.

Thus, the section 2040 exclusion depends on the

amount, if any, of the consideration Eppler and

O'Donoghue, the surviving joint tenants, furnished toward

the $32,500 purchase price of the jointly held stocks and

securities.

Respondent contends that all the funds used to

purchase the stocks and securities in question were

derived from decedent and thus the entire value of the

jointly held property ($160,383.19) is includable in her

gross estate.

Petitioners Buppert and Eppler argue that only the

value of St. Dunstans at the time the gift was made to

decedent's two daughters (i. e., $25,000) is includable in

decedent's gross estate. In the alternative, petitioner

Eppler contends that the gain of $7,500, measured by the

appreciation in value from the time St. Dunstans was

given to the two daughters in 1946 until that property was

sold by them in 1949, constitutes consideration furnished

by the daughters toward the $32,500 purchase price of the

jointly held stocks and securities. Thus Eppler argues that

$37,011.50 ($7,500/$32,500 of $160,383.19), the value

of the jointly held property on the alternate valuation date,

should be excluded from decedent's gross estate. We

agree with this alternative argument.

To be sure, section 2040 is not a paragon of clarity,

and the courts and Internal Revenue Service have wrestled

with the question of whether a contribution made out of

gain representing appreciation in value of property

received gratuitously from decedent is attributable to the

decedent or, instead, is to be treated as income from the

property and thus separate funds of the surviving tenant.

[FN5] the law, as we perceive it, recognizes two distinct

situations and treats the two differently. In one situation,

the surviving joint tenant receives property gratuitously

from the decedent; the property thereafter appreciates, and

the property itself is contributed in an exchange for jointly

held property. In this circumstance section 20.2040- 1(c)

(4), Estate Tax Regs., treats all the property as having

been paid for by the decedent, and the entire value of the

property is included in the decedent's gross estate. See

Estate of Kelley v. Commissioner, 22 B.T.A. 421, 425

(1931).

FN5. It is clear that income from property acquired

gratuitously from the decedent constitutes a

contribution from a surviving joint tenant's separate

funds. Sec. 20.2040-1(c)(5), Estate Tax Regs

In the second situation, the surviving joint tenant

receives property gratuitously from the decedent; the

property thereafter appreciates or produces income and is

sold, and the income or the sales proceeds are used as

consideration for the acquisition of the jointly held

property. In this situation, the income or the gain,

measured by the appreciation from the time of receipt of

the gift to the time of sale, has been held to be the

46

surviving joint tenant's income and a part of that joint

tenant's contribution to the purchase price. Harvey v.

United States, 185 F.2d 463, 467 (7th Cir. 1950); First

National Bank of Kansas City v. United States, 223

F.Supp. 963, 967 (W.D. Mo. 1963); Swartz v. United

States, 182 F.Supp. 540, 542 (D. Mass. 1960). Thus, in

the words of the statute, "such part of the value of such

property as is proportionate to the consideration furnished

by (the surviving joint tenant)" is excluded. See also

Estate of Kelley v. Commissioner, supra; cf. Dimock v.

Corwin, 99 F.2d 799 (2d Cir. 1938), affd. sub nom United

States v. Jacobs, 306 U.S. 363 (1939); Stuart v. Hassett,

41 F.Supp. 905 (D. Mass. 1941).

The facts of the instant case fall precisely within this

second situation. In Harvey v. United States, supra at 465,

the court characterized the facts and framed the issue as

follows:

The jointly held property is not the gift property

itself, in either its original or transmuted form,

but property traceable to (1) the profits made

through sales of the original gift property and

successive reinvestments of the proceeds of such

sales or (2) the rents, interest and dividends

produced by such property in its original or

converted form, while title thereto was in the

wife. The question presented by this appeal,

then, is whether such profits and income,

realized from property originally received by the

wife as a gift from her husband and traceable

into property which was held by them as joint

tenants at the time of the husband's death, came

within the exception to the requirement of

Section 811(e) (predecessor to sec. 2040) that

the entire value of property held in joint tenancy

shall be included in the decedent's gross estate.

The Government in Harvey argued that the full value

of the jointly held property should be included in the

decedent's gross estate, and the court dealt with that

argument in the following manner (185 F.2d at 467):

It seems clear that none of the cases cited

contains any support for the novel proposition

that income produced by gift property, after the

gift has been completed, belongs to the donor

and is property received or acquired from him by

the donee; nor is there, in these cases, anything

to impeach the conclusion of the trial court, or

that of the Tax Court in the Howard case, that

the income produced by property of any kind

belongs to the person who owns the property at

the time it produces such income and does not

originate with a donor who has made a

completed gift of that property prior to its

production of the income. * * *

* * * Moreover, no reason is suggested for

holding that one form of income, i. e., "profit

gained through a sale or conversion of capital

assets," * * * is outside the exception, whereas

other forms of income, such as dividends, rentals

and interest, fall within its terms. It follows that

the government's contention that the full value of

the property held in joint tenancy by decedent

and his wife at the time of his death should have

been included in decedent's gross estate must be

rejected. (Citations omitted.)

Thus we conclude that Eppler and O'Donoghue

furnished $7,500 toward the $32,500 purchase price paid

for the stocks and securities they held in joint tenancy

with decedent until her death on December 21, 1972.

Under the terms of the statute, such part of the value of

the property, i. e., $160,383.19 on the alternate valuation

date, as is proportionate to the $7,500 of consideration

Eppler and O'Donoghue furnished is excluded from

decedent's gross estate. [FN8] Under the mathematical

formula, set out above, the amount of the exclusion is

$37,011.50.

FN8. Petitioners Buppert's and Eppler's original

contention that only $25,000 (the value of St.

Dunstans at the time of the gift) is includable is

without merit, and their reliance on Swartz v.

United States, 182 F.Supp. 540 (D. Mass. 1960),

and First National Bank of Kansas City v.

United States, 223 F.Supp. 963 (W.D. Mo.

1963), is, in this respect, misplaced. In Swartz,

there was no appreciation in value after transfer

to joint ownership, i. e., the initial cost of the

jointly held property was $60,000 and remained

so until the death of one of the joint tenants.

Further, although certain language in First

National Bank of Kansas City may indeed be

read to support these petitioners' initial claim, we

think that a closer reading of the case indicates

that the court focused only on the preliminary

legal question there involved (i. e., whether the

proceeds received by Mrs. Cline in 1947 from

the sale of stock given her by the decedent in

1936, which proceeds were used to acquire

jointly held assets, should be considered as Mrs.

Cline's own separate funds) and, due to the lack

47

of certain relevant facts, did not precisely apply

the consideration-furnished test of sec. 2040.

See First National Bank of Kansas City, supra at

964, 967.

Decisions will be entered under Rule 155.

ENDICOTT TRUST COM PANY

v.

UNITED STATES

305 F.Supp. 943 (N.D.N.Y. 1969)

PORT, Judge.

Merlin J. Barret, at the time of his death, held 500

shares of Fruehauf Trailer and 1100 shares of I.B.M.

common stock jointly with his surviving wife Estella,

valued at $13,268.75 and $220,886.25 respectively. It is

the inclusion of the total value of these securities in the

gross estate of the decedent, that gives rise to the narrow

and, apparently, first impression question presented by the

plaintiff's motion for summary judgment.

The parties upon the oral argument of the motion

agreed, and the defendant in its brief concedes, that there

are no factual issues.

The facts in this proceeding are not complicated.

Between September 21, 1946 and January 28, 1954,

Merlin J. Barret, with his own funds, accumulated 256

shares of I.B.M. common stock in his and his wife's

(Estella Barret) names as joint owners, at a total cost of

$32,252.25.

During February 1954, the deceased sold the above

256 shares for $68,516.78, leaving a net gain of

$36,246.53 over cost. The proceeds were deposited in the

joint checking account of Merlin and Estella Barret.

On April 20, 1956, $18,544.40 was withdrawn from

the joint checking account and used to purchase 500

shares of the common stock of Fruehauf Trailer, which

were again held in joint tenancy. On May 1, 1956,

$49,252.15 was similarly withdrawn from the joint

checking account and used to purchase 100 shares of

I.B.M. common stock in joint tenancy.

On the date of Merlin Barret's death, the Fruehauf

stock was worth $13,268.75 and the I.B.M. worth

$220,886.25. Merlin Barret's estate tax return reported a

total of $458,715.86, upon which an estate tax of

$36,750.71 was assessed.

Claiming that $62,051.00 [FN2] should have been

excluded from the gross estate of the decedent, the

plaintiff, after having made a claim for a refund of

$8263.10, the amount of tax attributable to said sum,

which was denied, brought this suit for the tax allegedly

illegally and erroneously assessed and collected. The

defendant's position is simply that the full value of the

Fruehauf and I.B.M. stock was properly included in the

gross estate as jointly held property under the provision of

§ 2040 of the Internal Revenue Code of 1954 (26 U.S.C.

§ 2040).

FN2. Plaintiff contends that the original

purchase of the I.B.M. stock in joint tenancy

equaled a gift of one-half to Estella Barret.

When these stocks were sold for for a net gain of

$36,246.53, one-half of this gain belonged to

Estella Barret, i.e., $18,123.27. Plaintiff further

claims that when the reinvestments in Fruehauf

and I.B.M. were made in 1956, that $17,966.09

of her $18,123.27 was used as her contribution

towards the $67,796.55 total purchase price; this

works out to 26.5%. Therefore, 26.5% Of the

value of these shares on the date of decedent's

death equaled her contribution, and should be

excludible in the eyes of the plaintiff. 26.5% Of

the value at the date of death was $62,051.00.

The plaintiff contends that the $62,051.00 represents

'such part of the value of such property (Fruehauf and

I.B.M. shares) as is proportionate to the consideration

furnished by such other person' (the surviving wife), and

accordingly is excepted from decedent's gross estate by

virtue of the first proviso of § 2040.

To reach the above result, the plaintiff argues that the

purchase between 1946 and 1950 of the initial I.B.M.

stock with funds in deposit in the joint checking account

gave rise to a gift by the decedent of 50% Of the stock to

his surviving wife. Upon the sale of this stock in 1954, a

capital gain of $36,246.53 having been realized, one-half

($18,123.27) became the property of the surviving wife.

The plaintiff claims that this $18,123.27 of the capital

gain was reinvested in the stock held jointly at the

decedent's death, and that the value of the shares so

purchased with the $18,123.27 amounted to $62,051.00

of the total value of all the stocks held at the date of death.

48

The property in question was held in joint tenancy at

time of death, hence it is all includible in the gross estate

unless an applicable exception can be found to § 2040.

The plaintiff cites Regulation 20.2040-1(c)(5), [FN4]

Harvey v. United States, 185 F.2d 463 (7th Cir.1950);

Swartz v. United States, 182 F.Supp. 540(D.Mass.1960);

and First National Bank of Kansas City v. United States,

223 F.Supp. 963 (W.D.Mo.1963) in support of its

position.

FN4. § 20.2040-1 Joint interests (5) If the decedent,

before the acquisition of the property by himself and

the other joint owner, transferred to the latter for less

than an adequate and full consideration in money or

money's worth other income-producing property, the

income from which belonged to and became the other

joint owners entire contribution to the purchase price,

then the value of the jointly held property less that

portion attributable to the income which the other

joint owner did furnish is included in the decedent's

gross estate.

However, neither the Regulation nor the cases cited

support the position of the plaintiff. In the cases above-

cited, the income, profits, appreciation or gain that was

treated as the contribution of the survivor, resulted from

the ownership by the survivor of property which the

decedent had given to the survivor as an outright, 'no-

strings attached' gift; consequently, the 'income belonged

to (the survivor).' The interest of the survivor herein in

the capital gain resulting from the sale of the initial I.B.M.

stock, never 'belonged to' her in that sense. It was always

joint property, subject to a right of survivorship in the

other joint tenant (the decedent).

The plaintiff's claim is founded on the concept of a

gift of one-half of the jointly held original I.B.M. shares

under local New York property law. This does not afford

a firm foundation:

The obvious scheme of § 2040 is to recapture the

entire value of jointly- held property into a decedent's

gross estate, notwithstanding the fact that the decedent

may have made a gift under local law of one-half of the

property. Section 2040 looks to the source of the

consideration represented by the property and disregards

legal title. Estate of Peters v. Commissioner of Internal

Revenue, 386 F.2d 404, 407 (4th Cir.1967).

The surviving widow and the decedent at all times

held their property as joint tenants with a right of

survivorship. Changing the character of the property but

not the character of the ownership, will not or should not

permit an escape from taxation as joint property, unless so

excepted by statute.

In this case, the decedent chose to consistently keep

practically his entire estate in the form of joint ownership

with a right of survivorship in his wife. Having done so,

his property must be taxed as such upon his death. To

have avoided taxation as joint property, decedent was

obliged to avoid this form of ownership. See, e.g., 34

Am.Jur.2d Federal Taxation (1969) para. 8610.

49

ASSIGNMENT 9

Code: §§2041(a)(2) and 2041(b).

Regulations: §§20.2041-1(a) through 20.2041-1(c)(2) and 20.2041-3(a) through 20.2041-3(c).

S, M, L & C: ¶ 4.13[1] through [5], [7], and [9].

Readings: Rev. Rul. 77-60

Questions:

1. X created a trust in 1990 with income payable to A for A's life, remainder to B. D predeceasesA and B. Indicate whether D has a general power of appointment in these circumstances:

a. D has the right to appoint during his lifetime any or all of the corpus to anyone other thanS, his creditors, or the creditors of his estate.

b. Same as (a), except that D can exercise his power only with S's consent.

c. Same as (a), except that D can exercise his power only with A's consent.

d. Same as (a), except that D can exercise his power only with X's consent.

e. Same as (a), except that D can exercise his power only with Y's consent, and Y will havethe sole power to appoint the trust corpus to anyone after D's death.

f. Same as (a), except that D can exercise his power only with the consent of Z to whom

50

the property may be appointed, but who will have no power over the trust after D's death.D dies before Z.

g. Same as (a), except that D was the grantor of the trust, rather than X.

h. D has the power to invade the corpus for his maintenance in health and reasonablecomfort, regardless of whether D exhausts his other sources of income. (Rev. Rul. 77-60)

i. D has the power to invade the corpus for the health and maintenance in reasonablecomfort of his minor children.

2. Indicate what, if anything, is included under §2041 in D's estate, assuming that any powers inD were created under the will of X who died in 1988.

a. D is the income beneficiary (for D's life) of a trust created by X, had a power to appointthe trust corpus to anyone, but died in the current year without ever exercising his power.On default of D's appointment, the property passed to Y or Y's estate.

b. Same as (a), except that D could not exercise his power until six months after writtennotice to the remainderman Y that he intended to do so, and D died in the current yearwithout having given such notice.

c. Same as (a), except that D's power was not exercisable until after the death of R, and Ddied in the current year survived by R.

51

d. How might D have avoided any estate or gift tax consequences in (a)?

4. D was the income beneficiary of a trust created by X with a remainder to Z or Z's estate. D alsohad a noncumulative annual power to withdraw $15,000 per year from the corpus of the trust, which atall times had a value of $200,000. The trust was created over four years ago, and D never exercised hispower to withdraw. What estate tax consequences to D's estate upon his death in the fifth year aftercreation of the trust?

5. X creates a trust in 1985 with income payable to D for D's life, remainder to A. D has the powerto appoint under his will all the trust corpus to any person, including his estate. What result under §2041in the following circumstances.

a. D releases the testamentary power of appointment 5 years before he dies.

b. D also has a lifetime power to appoint the trust corpus to any person and he exercises thatpower by appointing the remainder interest to his son, effective only after the expirationof his income interest.

c. At all times after the creation of the trust, D is under a conservatorship, having beendetermined to be unable to handle his affairs by the local court.

52

Rev. Rul. 77-60

Advice has been requested whether the decedent

possessed at death a general power of appointment within

the meaning of section 2041 of the Internal Revenue Code

of 1954, under the circumstances described below.

Under the will of decedent's spouse, who died in

1970, the decedent was granted a life estate in certain

properties, with the power to invade corpus as desired 'to

continue the donee's accustomed standard of living.'

Upon the death of the decedent, the corpus was to be

distributed to other named beneficiaries. The decedent

died in 1975. Under the state law applicable to the

administration of the estate of decedent's spouse, the

quoted language is not construed to impose an objective

limitation on the exercise of the power of invasion granted

by the donor, other than one of good faith.

Section 2041(a)(2) of the Code provides that the

value of the gross estate of the decedent shall be

determined by including the value at the time of death of

all property 'to the extent of any property with respect to

which the decedent has at the time of his death a general

power of appointment created after October 21, 1942 * *

*.'

Section 2041(b)(1) of the Code defines the term

'general power of appointment' as a power which is

exercisable in favor of the decedent, his estate, his

creditors, or the creditors of his estate. However, section

2041(b)(1)(A) provides as follows:

A power to consume, invade, or appropriate property

for the benefit of the decedent which is limited by an

ascertainable standard relating to the health, education,

support or maintenance of the decedent shall not be

deemed a general power of appointment.

Section 20.2041-1(c)(2) of the Estate T ax

Regulations provides:

A power to consume, invade, or appropriate

income or corpus, or both, for the benefit of the

decedent which is limited by an ascertainable

standard relating to the health, education,

support or maintenance of the decedent is, by

reason of section 204(b)(1)(A), not a general

power of appointment. A power is limited by

such a standard if the extent of the holder's duty

to exercise and not to exercise the power is

reasonably measurable in terms of his needs for

health, education, or support (or any

combination of them). As used in this

subparagraph, the words 'support' and

'maintenance' are synonymous and their meaning

is not limited to the bare necessities of life. A

power to use property for the comfort, welfare or

happiness of the holder of the power is not

limited by the requisite standard. Examples of

powers which are limited by the requisite

standard are powers exercisable for the holder's

'support,' 'support in reasonable comfort,'

'maintenance in health and reasonable comfort,'

'support in his accustomed manner of living,'

'education, including college and professional

education,' 'health,' and 'medical, dental, hospital

and nursing expenses and expenses of

invalidism.'

The ascertainable standard set forth in section

204(b)(1)(A) of the Code spells out the limited degree of

economic control over property that Congress chose to

exempt from the estate tax. The language of the Code is

detailed, i.e., if the exercise of the power is restricted by

definite bounds relating to the health, education, support,

or maintenance of the donee, it is not a general power of

appointment with the resulting tax consequence. Further,

section 20.2041-1(c)(2) of the regulations provides that

the power must be limited to the donee's 'needs for health,

education, or support (or any combination of them).'

While this ascertainable standard is not restricted to the

bare necessities of life, the power must be exercisable

only for the designated statutory purposes.

In determining whether property subject to a power

is limited by an ascertainable standard within the meaning

of section 2041 of the Code, the test is the 'measure of

control' over the property by virtue of the grant of the

power, i.e., whether the exercise of the power is restricted

by definite bounds. That the amount of property that

could be consumed for the benefit of the donee is not

measurable or predictable is of no consequence. The test

under section 2041 differs from the test applicable before

the Tax Reform Act of 1969 under section 2055 (relating

to deductions for charitable transfers). The query under

section 2041 is the breadth of the power granted; the

query under section 2055 was the measurability of

property subject to both private and charitable uses. Strite

v. McGinnes, 330 F.2d 234 (3rd Cir. 1964), cert. denied,

379 U.S. 836 (1964); see Estate of Josephine R. Lanigan,

45 T.C. 247 (1965).

A power to use property to enable the donee to

continue an accustomed mode of living, without further

limitation, although predictable and measurable on the

basis of past expenditures, does not come within the

ascerta inab le standard presc ribed in section

2041(b)(1)(A) of the Code since the standard of living

may include customary travel, entertainment, luxury

items, or other expenditures not required for meeting the

53

donee's 'needs for health, education or support.' Nor does

the requirement of a good faith exercise of a power create

an ascertainable standard. Good faith exercise of a power

is not determinative of its breadth. Strite and Lanigan,

above.

Accordingly, the power possessed by the decedent to

invade trust principal as desired to continue an

accustomed standard of living was not limited by an

ascertainable standard relating to health, education,

support or maintenance. Therefore, the decedent

possessed at death a general power of appointment

requiring inclusion of the value of the trust property in the

decedent's gross estate under section 2041 of the Code.

ASSIGNMENT 10

54

Code: §2042

Regulations: §20.2042-1(a) through (c)

S,M,C, & L: ¶ 4.14 (Omit 4.14[3][a] - [c], [4][d], [5][b], [6], [8], and [10])

Readings: Estate of Skifter v. Comm'r Estate of Leder v. Comm'r

Questions:

1. X took out a $10,000 single-premium policy of insurance on his life, and immediately, assignedall right, title and interest in the policy to D, who died one year later, survived by X. What, if anything,is included in D's estate?

2. D took out a policy of insurance on his life, primarily to assure the availability of cash forpayment of claims and taxes when he died. What result in the following circumstances on D's death?

a. The policy was payable to his estate.

b. W was beneficiary, but the policy permits D to change the beneficiary.

c. How can D exclude the policy from his gross estate?

3. Wife purchases a life insurance policy on D's life and transfers it to a trust, with income to theirchildren and remainder to their grandchildren or grandchildren's estates. Wife names D as trustee. Whatresult in the following circumstances on D's death? (Estate of Skifter v. Comm'r)

a. D, as trustee, can surrender the policy and receive the cash surrender value of the policyas a trust asset.

b. D can select the remaindermen among the grandchildren by way of a limited power to

55

amend the trust.

c. D has the power to pay trust income and corpus to himself.

d. Is there any difference in the result under (a) through (c) if D had purchased the policyand transferred it outright to Wife several years prior to her creation of trust?

4. D owned 60 percent of the voting stock of Acme which owned a policy on D's life. X ownedthe remaining stock. The corporation owned all incidents of ownership in the policy. What result in thefollowing circumstances:

a. The proceeds were payable to Acme.

b. The proceeds were payable to X.

5. D had a life insurance policy on his life that had a face value of $20,000. He had paid premiumson it for ten years. In the tenth year, he conveyed it to his brother. D did not retain any incidents ofownership. Unless stated to the contrary, a gift tax return was required to be filed at the time of thetransfer. What result in the following circumstances on D's death?

a. D dies two years after conveyance, and D continued to pay the premiums.

b. D dies two years after conveyance, but his brother paid the post-transfer premiums.

56

c. D dies four years after conveyance, and D continued to pay the premiums.

d. D dies four years after conveyance, but his brother paid the post-transfer premiums.

6. In 2005, D's wife applied for and received insurance on the decedent's life. The applicationindicated that W was the sole owner and beneficiary. All premiums were paid by ABC Corp. which waswholly owned by the decedent. These payments were treated on the books of ABC as loans to D. In2007, soon before D's death, W transferred the policy to a trust for the benefit of their children. Soonthereafter, D dies unexpectedly. What, if anything, is included in D's estate? (Estate of Leder v.Comm'r)

57

ESTATE of Hector R. SKIFTER,

Appellees,

v.

COMMISSIONER OF INTERNAL REVENUE,

Appellant.

468 F.2d 699 (2nd Cir. 1972)

LUMBARD, Circuit Judge:

The Commissioner of Internal Revenue appeals from a

decision of the Tax Court holding that proceeds of nine

insurance policies on decedent's life were not includible in

decedent's estate. The Tax Court, 56 T.C. 1190, held incorrect

the Commissioner's inclusion of these *701 proceeds in

decedent's gross estate and his assessment of a deficiency

thereon.

In 1961 Hector Skifter, the decedent, assigned all his

interest in nine insurance policies on his life to his wife Naomi,

effectively making her the owner of those policies. Skifter

retained no interest in the policies and retained no power over

them. Several months later, Naomi died and left a will directing

that her residuary estate, which included the nine insurance

policies, be placed in trust. She directed that the income was to

be paid to their daughter, Janet, for life and, upon Janet's death,

there were provisions for the distribution of corpus and income

to other persons.

Naomi appointed Skifter as trustee and authorized him, in

his absolute discretion, at any time and from time to time, to

pay over the whole or any part of the principal of the trust to

the current income beneficiary whether or not this would result

in the termination of the trust. It was explicitly provided that, in

making these payments, the trustee could disregard any rules of

trust law that may require impartiality between income

beneficiaries and remaindermen. In addition, Skifter, as trustee,

was given broad powers of management and control over the

trust, including the powers to sell and mortgage the property

and invest and reinvest the proceeds.

In 1964 Skifter died and a successor trustee was named.

Contending that, under the terms of the trust established under

Naomi's will, Skifter possessed at his death "incidents of

ownership" so as to require that the proceeds of the insurance be

included in his estate under § 2042(2) of the Internal Revenue

Code, the Commissioner assessed a deficiency against the estate.

From the Tax Court's holding in favor of the estate, the

Commissioner appeals.

Section 2042(2) of the Internal Revenue Code provides, in

pertinent part, as follows:

The value of the gross estate shall include the value of

all property to the extent of the amount receivable by

all . . . beneficiaries as insurance under policies on the

life of the decedent with respect to which the

decedent possessed at his death any of the incidents of

ownership, exercisable either alone or in conjunction

with any other person.

The essential issue before this Court is whether the broad

fiduciary powers that were granted to Skifter under Naomi's will

constitute "incidents of ownership" within the meaning of §

2042(2). We hold that they do not, and thus affirm the

decision of the Tax Court.

In enacting the predecessor of § 2042(2), the Senate and

House Committee Reports of the Seventy-seventh Congress

acknowledged that, while the new provision introduced the term

"incidents of ownership," it failed to suggest a definition of it.

The Reports then went on to list the sort of powers and interest

that the Congress was concerned with:

Examples of such incidents are the right of the

insured or his estate to the economic benefits of the

insurance, the power to change the beneficiary, the

power to surrender or cancel the policy, the power to

assign it, the power to revoke an assignment, the

power to pledge the policy for a loan, or the power to

obtain from the insurer a loan against the surrender

value of the policy.

See 1942-2 Cum.Bull., pp. 491, 677. The Treasury relied on

this legislative history in promulgating its regulations on §

2042(2). Reg. § 20.2042-1(c)(2) states:

For purposes of this paragraph, the term "incidents of

ownership" is not limited in its meaning to ownership

of the policy in the technical legal sense. Generally

speaking, the term has reference to the right of the

insured or his estate to the economic benefits of the

policy. Thus, it includes the power to change the

beneficiary to surrender or cancel the policy, to assign

the policy, to revoke an assignment, to pledge the

policy for a loan, or to obtain from the insurer a loan

against the surrender value of the policy, etc. . . .

It seems significant to us that the reference point in the

regulation for "incidents of ownership" is "the right . . . to the

economic benefits of the policy," since there was no way in

which Skifter could have exercised his powers to derive for

himself any economic benefits from these insurance policies.

The predecessor of § 2042 provided that, if the decedent

continued to pay the premiums on the policy, even if he had

divested himself of all interest therein, the proceeds therefrom

would be included in his estate at death. In reenacting this

predecessor provision as § 2042 of the Internal Revenue Code

of 1954, Congress eliminated this premium test. In explaining

58

this change, the Senate Finance Committee stated:

No other property is subject to estate tax where the

decedent initially purchased it and then long before

his death gave away all rights to the property and to

discriminate against life insurance in this regard is not

justified.

S.Rep.No. 1622, 83rd Cong.2d Sess., p. 124, U.S.Code Cong.

& Admin.News 1954, p. 4757. The inference from this

statement is very strong that it was the intent of Congress that

§ 2042 should operate to give insurance policies estate tax

treatment that roughly parallels the treatment that is given to

other types of property by § 2036 (transfers with retained life

estate), § 2037 (transfers taking effect at death), § 2038

(revocable transfers), and § 2041 (powers of appointment).

This inference is supported by the fact that § 2042(2)

explicitly provides that "incident of ownership" includes a

reversionary interest, and then proceeds to treat such

reversionary interests in a manner closely paralleling the

treatment that § 2037 gives to reversionary interests in other

property. This provision was added when Congress enacted §

2042 into the 1954 Code. The Senate Finance Committee

explained this addition as follows:

The House and your committee's bill retains the

present rule including life- insurance proceeds in the

decedent's estate if the policy is owned by him or

payable to his executor, but the premium test has been

removed. To place life- insurance policies in an

analogous position to other property, however, it is

necessary to make the 5-percent reversionary interest

rule, applicable to other property, also applicable to

life insurance.

S.Rep. No. 1622, 83d Cong., 2d Sess., p. 124, U.S.Code Cong.

& Admin. News 1954, p. 4757.

Although this legislative history is hardly conclusive on the

matter, we feel that there is sufficient support to justify our

conclusion that Congress intended § 2042 to parallel the

statutory scheme governing the interests and powers that will

cause other types of property to be included in a decedent's

estate. This conclusion is reinforced by the types of interests and

powers that Congress indicated were exemplary of what it meant

to be included within the scope of "incidents of ownership."

The interests there listed are interests that would cause other

types of property to be included in a decedent's estate under §

2036 or § 2037; and the powers that Congress discussed are

also powers that would result in the property being included in

the decedent's estate under § 2038 or § 2041. Therefore, in

ruling on the Commissioner's contention that the fiduciary

power here involved is an "incident of ownership," a question

that has not been considered under § 2042, we feel that we

should look to the experience under the statutory scheme

governing the application of the estate tax to other types of

property. Indeed, the Commissioner, in making his contentions

before us, relies on numerous analogies to decisions under these

other statutory provisions.

The core of the controversy here centers on the decedent's

power, as trustee, to prefer the current income beneficiary over

the remainderman and all later income beneficiaries through

payment of the entire trust corpus. He did not have the power

to alter or revoke the trust for his own benefit and he could not

name new, additional, or alternative beneficiaries. In this regard,

Reg. § 20.2042-1(c)(4) provides:

A decedent is considered to have an "incident of

ownership" in an insurance policy on his life held in

trust if, under the terms of the policy, the decedent

(either alone or in conjunction with another person or

persons) has the power (as trustee or otherwise) to

change the beneficial ownership in the policy or its

proceeds, or the time or manner of enjoyment thereof,

even though the decedent has no beneficial interest in

the trust.

The Commissioner contends that this regulation requires

that the proceeds of the policies here be included in decedent's

estate.

The Tax Court declined to interpret that regulation so as

to make it applicable here, but concluded that, since the power

could not be exercised to benefit the decedent or his estate, it

would not cause the proceeds to be included in his estate. If the

power had been exercisable for the benefit of decedent, or for

the benefit of whomever the decedent selected, it would have

been necessary to include the proceeds in the estate; for there

would be a powerful argument that this was an incident of

ownership since he would have had the equivalent of a power of

appointment, which under § 2041 would cause other types of

property to be included in the estate of the holder of such a

power. This distinction causes us to concur in the Tax Court's

conclusion that the Commissioner's reliance on our decision in

Commissioner v. Karagheusian's Estate, 233 F.2d 197 (2d Cir.

1956), is misplaced.

The power that the decedent possessed was over the entire

trust corpus, which included property other than the insurance

policies. But there is no serious doubt that this power did not

result in this other property being in decedent's estate for tax

purposes. This type of power would fall under both § 2036 and

§ 2038. The former provision is clearly not triggered in this case

because it only applies to a power retained by the grantor over

the income from property when he transferred it to another.

Thus, for purposes of § 2036, it would not matter that the

decedent effectively had the power to deprive later income

beneficiaries of the income from the corpus in favor of an earlier

59

income beneficiary. However, the latter provision, § 2038,

would apply because decedent had the power "to alter, amend

. . ., or terminate" the trust. The Commissioner has pointed to

many cases holding that such a power would result in the

property interest over which the power could be exercised being

included in the estate of the holder of the power. See e. g. Lober

v. United States, 346 U.S. 335, 74 S.Ct. 98, 98 L.Ed. 15

(1953); United States v. O'Malley, 383 U.S. 627, 86 S. Ct.

1123, 16 L.Ed.2d 145 (1966) (decided under § 2036);

Commissioner of Internal Revenue v. Newbold's Estate, 158

F.2d 694 (2d Cir. 1946). Therefore, he argues, this power must

be an incident of ownership for § 2042 purposes also.

But the Commissioner's reliance on § 2038 cases exposes

the fatal flaw in his position. The cases he cites dealt with

powers that were retained by the transferor or settlor of a trust.

That is not what we have here; the power the decedent had was

given to him long after he had divested himself of all interest in

the policies-it was not reserved by him at the time of the

transfer. This difference between powers retained by a decedent

and powers that devolved upon him at a time subsequent to the

assignment is not merely formal, but has considerable substance.

A taxpayer planning the disposition of his estate can select the

powers that he reserves and those that he transfers in order to

implement an overall scheme of testamentary disposition;

however, a trustee, unless there is agreement by the settlor

and/or beneficiaries, can only act within the powers he is

granted. When the decedent is the transferee of such a power

and holds it in a fiduciary capacity, with no beneficial interest

therein, it is difficult to construe this arrangement as a substitute

for a testamentary disposition by the decedent. Cf. Porter v.

Commissioner of Internal Revenue, 288 U.S. 436, 444, 53 S.Ct.

451, 77 L.Ed. 880 (1933); Commissioner of Internal Revenue

v. Chase National Bank, 82 F.2d 157, 158 (2d Cir. 1936).

Accordingly, we conclude that, although such a power

might well constitute an incident of ownership if retained by the

assignor of the policies, it is not an incident of ownership within

the intended scope of § 2042 when it has been conveyed to the

decedent long after he had divested himself of all interest in the

policies and when he cannot exercise the power for his own

benefit. We justify this interpretation of "incidents of

ownership" on the apparent intent of Congress that § 2042 was

not to operate in such a manner as to discriminate against life

insurance, with regard to estate tax treatment, as compared with

other types of property. We also note that our conclusion

comports with the views expressed by the Sixth Circuit in Estate

of Fruehauf v. Commissioner of Internal Revenue, 427 F.2d 80,

84-85 (6th Cir. 1970). Therefore, we must reject the contention

of the Commissioner that the language of § 2042 requires that

it be given a broader scope of operation than the statutes

covering other types of property.

Until now, the discussion has assumed that § 2038 only

applies when the power possessed by the decedent was reserved

by him at the time he divested himself of all interest in the

property (other than life insurance) subject to the power. This

necessitates a brief discussion of the language of § 2038, which

provides in pertinent part:

The value of the gross estate shall include the value of

all property to the extent of any interest therein of

which the decedent has at any time made a transfer .

. ., by trust or otherwise, where the enjoyment thereof

was subject at the date of his death to any change

through the exercise of a power (in whatever capacity

exercisable) . . . . (without regard to when or from

what source the decedent acquired such power), to

alter, amend, revoke, or terminate . . . (emphasis

added).

The emphasized language would appear to indicate that §

2038 would apply even when the power was acquired under

circumstances such as are present here. However, there is no

indication that the Commissioner has ever made such an

argument and we have been able to find no case applying § 2038

in this manner.

The noted language was added to the predecessor of §

2038 in 1936 in response to the decision in White v. Poor, 296

U.S. 98, 56 S.Ct. 66, 80 L.Ed. 80 (1935). In that case, the

decedent had created an inter vivos trust and conferred on the

trustee the power jointly to terminate the trust. Subsequently,

the decedent was appointed a successor trustee. Therefore, at

death decedent possessed this power to terminate and

theCommissioner attempted to apply the predecessor to § 2038;

but the Supreme Court held this was impermissible because

decedent had not retained the power at the time of transfer but

had received it later. It was for the purpose of changing this

result that Congress added the emphasized language. However,

this language appears never to have been applied to a power

other than one that the decedent created at the time of transfer

in someone else and that later devolved upon him before his

death. In essence, the language has been applied strictly to

change the result in White v. Poor.

We need not here consider the reasons for applying § 2038

to powers such as that involved in White v. Poor. Nor need we

speculate whether or not such a power would trigger § 2042, for

that question is not before us. What is significant for our

purposes is that § 2038 has not been applied when the power

possessed by decedent was created and conferred on him by

someone else long after he had divested himself of all interest in

the property subject to the power. Therefore, because of our

view that Congress did not intend § 2042 to produce divergent

estate tax treatment between life insurance and other types of

property, we conclude that the fiduciary power that Skifter

possessed at his death did not constitute an "incident of

ownership" under § 2042; hence, that provision does not

require that the life insurance proceeds at issue be included in

60

Skifter's estate.

The Tax Court was thus correct in holding that Reg. §

20.2042-1(c)(4) must be read to apply to "reservations of

powers by the transferor as trustee" and not to powers such as

that in issue. Accordingly, the decision of the Tax Court is

affirmed.

ESTATE OF JOSEPH LEDER, Petitioner

v.

COMMISSIONER OF INTERNAL

REVENUE, Respondent

89 T.C. 235 (1987)

WELLS, JUDGE:

Respondent determined a deficiency in petitioner's

Federal estate tax in the amount of $253,547.77. After

concessions, the sole issue for decision is whether proceeds

from a life insurance policy, purchased by the insured's spouse

within three years of the insured's death, are includable in the

insured's gross estate where the policy premiums were paid by

pre-authorized withdrawals from the account of a corporation

wholly owned by the insured.

Petitioner is the Estate of Joseph Leder, represented by

Jeanne Leder, executrix of the estate and widow of Joseph

Leder. (Joseph Leder is hereinafter referred to as the

'decedent.') At the time she filed the petition, Jeanne Leder

resided in Oklahoma City, Oklahoma.

The decedent died on May 31, 1983. At the time of

decedent's death, he was insured under life insurance policy

number 6438531, issued by the TransAmerica Occidental

Life Insurance Company on January 28, 1981 (the 'policy').

The application for the policy was signed by Jeanne Leder, as

owner, and the decedent, as the insured. The policy initially

reflected Jeanne Leder as sole owner and beneficiary. The face

amount of the policy was $1,000,000.

The premiums for the policy were $3,879.08 per month

which were paid by pre- authorized withdrawals from the

account of Leder Enterprises, a corporation wholly owned by

the decedent. All of the premiums were paid less than three

years before the decedent's death. The premium payments

were treated as loans made by Leder Enterprises to the

decedent. Neither Leder Enterprises nor the decedent received

any consideration from Jeanne Leder in return for the

premium payments on the policy.

On February 15, 1983, Jeanne Leder, as owner of the

policy, transferred the policy to herself as trustee of an inter

vivos trust dated February 15, 1983. The trust agreement,

titled 'Irrevocable Trust Agreement of the Jeanne Leder Life

Insurance Trust', provides, inter alia, that upon receipt of the

trust corpus, the Trustee shall divide the assets of the trust

into four equal shares, each as an equal trust, these equal

shares to be for the benefit of Jeanne Leder, Jil Ida Leder

Larwig, Joseph Jak Leder, and Ethel Anna Leder. The three

latter beneficiaries are the children of the decedent and Jeanne

Leder. No further assignments of the policy were made.

Upon the death of the decedent, the proceeds of the

policy, totaling $971,526.49, were distributed outright, one-

fourth to each of the beneficiaries. No part of the

$971,526.49 was included in thedecedent's gross estate on

the Federal estate tax return filed for the estate of the

decedent. In the notice of deficiency, respondent determined

that the proceeds of the policy were properly includable in the

gross estate.

Respondent argues that the proceeds from the policy are

includable in the decedent's gross estate pursuant to section

2035. Petitioner asserts that (1) section 2035 applies only if

the insurance proceeds are includable in the gross estate

pursuant to section 2042; (2) the decedent never possessed

any of the incidents of ownership in the policy, thus rendering

section 2042 inapplicable to the proceeds; and consequently,

(3) the proceeds are not includable in the value of the gross

estate pursuant to section 2035 because there was not a

transfer of incidents of ownership includable in the estate

under section 2042. In the alternative, petitioner argues that

even if a determination that the proceeds are not includable

pursuant to section 2042 is not dispositive of the issue for

purposes of section 2035, the policy proceeds are not

includable under section 2035 because the decedent

controlled no aspect of the transaction and did not transfer

the policy within the meaning of section 2035(a).

We hold that the proceeds from the policy are not

includable in the gross estate where the decedent did not

possess at the time of his death, or at any time in the three

years preceding his death, any of the incidents of ownership in

the policy because (1) section 2042 is not applicable; (2) the

section 2035(d)(2) exception to section 2035(d)(1) is not

applicable because the conditions of section 2042 (or any of

the other sections cited in section 2035(d)(2)) are never met;

and (3) section 2035(d)(1) overrides section 2035(a). In so

holding, we do not reach the issue of whether there was a

transfer within the meaning of section 2035(a).

SECTION 2035

Section 2035(a) generally requires inclusion in a decedent's

gross estate of the value of property, any interest in which was

transferred by him within three years of death for less than

adequate and full consideration. The Economic Recovery Tax

61

Act of 1981 ('ERTA'), Pub. L. 97-34, sec. 424, 95 Stat. 172,

317, added Code section 2035(d), which applies to estates of

decedents dying after 1981. Section 2035(d) nullifies section

2035(a) (hereinafter sometimes referred to as the '3-year rule'),

except in the case of certain transfers described in section

2035(d)(2) still subject to inclusion under the 3-year rule.

Section 2035(a) itself is unchanged since 1976. Section

2035(d) is simply an added sieve through which transactions

must pass before the transfer may even be tested under the 3-

year rule. Although section 2035(d)(1) generally repeals the 3-

year rule, perforations in the sieve are found in section

2035(d)(2) which allow the 3-year rule to be applied to a

transfer of an interest in property which either (1) is included in

the value of the gross estate under section 2042, or (2) would

have been included under section 2042 had such an interest

been retained by the decedent.

The decedent died after 1981, so section 2035(d) applies

to his estate. This is a case of first impression insofar that no

other reported decision has considered the impact of section

2035(d) on the 3-year rule; all other cases that discuss section

2035 concern decedents dying before section 2035(d) went into

effect.

In order to apply section 2035 to the facts of the instant

case, we first must interpret section 2035(d)(2). Unless the

proceeds from the life insurance policy come under the

provisions of section 2035(d)(2), section 2035(d)(1) will apply

to the proceeds. If section 235(d)(1) does apply, it mandates

that the 3- year rule shall not apply to the decedent's estate,

since he died after December 31, 1981. If, on the other hand,

the policy proceeds do come under the provisions of section

2035(d)(2), that paragraph overrides section 2035(d)(1) and

allows the proceeds to be tested for includability under the 3-

year rule.

Petitioner asserts that unless the decedent possessed some

incident of ownership of the policy at some time during the

three years before his death, there was nothing for the decedent

to transfer, section 2035(d)(2) is inapplicable, and section

2035(d)(1) precludes application of the 3-year rule to any

proceeds from the policy. Respondent counters that petitioner's

reading of the term 'transfer' is highly technical and that the

term 'transfer' as used in section 2035 refers to any transfer

whether direct or indirect. Respondent's argument may be

appropriate in interpreting the meaning of section 2035(a);

however, respondent overlooks the language of section 2035(d),

which must be satisfied BEFORE any consideration may be

given to section 2035(a).

There is no more persuasive evidence of the purpose of a

statute than the words by which the legislature undertook to give

expression to its wishes; where these words are sufficient in and

of themselves to determine the purpose of the legislation, we

should follow their plain meaning. United States v. American

Trucking Associations, 310 U.S. 534, 543 (1940). The plain

language of section 2035(d)(2) requires as a threshold issue that

there be an interest in property under the terms of the sections

it lists (e.g., sec. 2042). It requires that the decedent transfer an

interest in property included in the gross estate or an interest

that would have been included if the decedent had retained such

an interest. The decedent must have had at some time such an

interest in property, or else there is nothing for him to retain or

transfer and section 2035(d)(2) cannot apply. If section

2035(d)(2) does not apply and no other exception to section

2035(d)(1) applies, section 2035(d)(1) acts to foreclose any

consideration of includability in the gross estate under section

2035(a).

Respondent, however, cites language from the legislative

history accompanying the enactment of section 2035(d) as

evidence that Congress 'clearly' intended in 1981 that the 3-year

rule would continue to apply to gifts of life insurance regardless

of section 2035(d)(1). This Court requires unequivocal

evidence of legislative purpose before we construe a statute so as

to override the plain meaning of the words used therein.

Huntsberry v. Commissioner, 83 T.C. 742, 747-748 (1984).

Respondent first cites the Senate Finance Committee

Report, S. Rept. No. 97- 144 (1981), 1981-2 C.B. 412, 466,

to support his argument. We attach no significance to the Senate

explanation because the Conference Report underlying section

2035(d) as finally enacted states, 'the conference agreement

follows the House bill.' H. Rept. No. 97-215 (Conf.) (1981),

1981- 2 C.B. 481, 511. The Conference Report does not say

that it only follows the House bill 'in general.' If the Conference

Report had been phrased thusly, we MIGHT be able to infer

that the conferees intended to incorporate some portion of the

Senate version. Rather, the Conference Report gives a brief

explanation of the House bill; notes that the Senate amendment

proposed to continue the 3- year rule, only changing the date at

which the value is determined for estate tax purposes; and then

proceeds to follow the House bill without alluding to any

provision in the Senate version. H. Rept. 97-215 (Conf.),

supra, 1981-2 C.B. at 511.

Respondent also cites the House Report, the pertinent part

of which states that:

In general, the bill provides that section 2035(a) will

not be applicable to the estates of decedents dying

after December 31, 1981. Thus, gifts made within

three years of death will not be included in the

decedent's gross estate, and the post-gift appreciation

will not be subject to transfer taxes. * * *

The committee bill contains exceptions which continue the

application of section 2035(a) to (1) GIFTS OF LIFE

INSURANCE and (2) interests in property otherwise included

62

in the value of the gross estate pursuant to section 2036, 2037,

2038, 2041, or 2042 (or those which would have been included

under any of such sections if the interest had been retained by

the decedent).

The House Report specifies two instances which would

continue to be subject to the 3-year rule. One instance is the

exception which is now section 2035(d)(2); the other exception

is for life insurance. The exception for life insurance, however,

was never enacted by Congress. In fact, the life insurance

exception was not even included in the earlier Senate or House

versions of the Code provision. In addition, the specific

reference to life insurance in the House Report was not repeated

in the Conference Report. In discussing the 3- year rule and its

general negation by the new provision, the Conference Report

only states that, 'the House bill continues to apply present law

to gifts of certain types of property covered by sections 2036,

2037, 2038, 2041, and 2042. ' 1981-2 C.B. at 511.

Congress could have placed in the Code a provision

whereby life insurance was excluded specifically from the general

rule of section 2035(d)(1). It did not. Although we may resort

in some circumstances to the legislative history to find Congress'

intent, we are hesitant to rely on inconclusive legislative history

to supply a provision NOT ENACTED by Congress. United

States v. American College of Physicians, 475 U.S. 834, 846,

106 S. Ct. 1591, 1598 (1986). There is no language in the

Code regarding the specific applicability of section 2035(d) to

life insurance except, as discussed above, for the general

incorporation of section 2042 by reference. Therefore, we

follow the plain meaning of the statute and find that there is no

basis for treating life insurance policies differently per se from

other property for purposes of section 2035(d)

Thus, in order to determine whether section 2035(d)(2)

applies, we must determine whether the decedent ever possessed

any interest under the terms of section 2042, which, as noted

earlier, is the only cited section in section 2035(d)(2) that

potentially applies to this case.

SECTION 2042

Respondent has argued his case based solely upon the

applicability of section 2035, not upon section 2042.

Nevertheless, we must consider how section 2042 applies to the

instant case because of the incorporation by reference of that

provision into section 2035(d)(2).

Includability of life insurance proceeds under section 2042

depends upon the decedent's retention of incidents of ownership

of the policy. Estate of Coleman v. Commissioner, 52 T.C. 921,

922 (1969). The case closest to the instant case on the facts is

Estate of Carlstrom v. Commissioner, 76 T.C. 142 (1981). In

Carlstrom the decedent owned by attribution 71 percent of the

stock of a corporation that paid all the premiums on a life

insurance policy on the decedent's life. Under state law the

decedent's wife was the owner of the policy at all times from the

time of the original application for the policy. Even though she

never exercised any rights under the policy, only she had the

power to exercise such rights, the corporation did not. On that

basis, this Court held that the corporation, and consequently the

decedent, held no incident of ownership over the portion of the

policy proceeds paid to the wife as beneficiary. 76 T.C. at 149.

Similarly, in the instant case we also must look to the relevant

state law to determine whether the decedent had any rights that

might be incidents of ownership taxable under section 2042. See

Burnet v. Harmel, 287 U.S. 103, 110 (1932) (state law creates

legal interests and Federal law determines how they should be

taxed).

The face of the policy declares that 'this policy isissued as

an Oklahoma contract and its terms shall be construed in

accordance with the laws of Oklahoma.' In Oklahoma it is well

settled that where no express right to change the beneficiary

exists in a policy, the insured is without power by deed of

assignment or will or any other act of his to transfer to any

person the beneficial interest in the policy. Brown v. Home Life

Insurance Co. of New York, 3 F.2d 661, 662 (E.D. Okla.

1925). A valid assignment of the policy cannot be made, except

as provided in the policy itself. City National Bank of Lawton

v. Lewis, 73 Okla. 329, 176 P. 237, 239 (1918). The policy on

the decedent's life specifically states that 'only the owner will be

entitled to the rights granted under this policy.' The parties have

stipulated that Jeanne Leder was the owner of the policy from

the time of application for the policy until the policy was

transferred to the trust; at no time did the decedent have any

contractual rights in the policy or any express powers exercisable

under the policy.

In addition, insureds such as the decedent have no implicit

power of disposition over a life insurance policy that, like the

policy on the decedent here, is for the benefit of the insured's

spouse or children. See Okla. Stat. Ann. tit. 36, sec. 3631 (West

1976). The Oklahoma Supreme Court has interpreted the

predecessor to this statutory provision and held that the insured

does not have 'any interest in such a policy of which he can avail

himself; nor upon his death have his personal representatives or

his creditors any interest in the proceeds of such insurance

contracts.' Johnson v. Roberts, 124 Okla. 68, 254 P. 88, 90

(1926), citing Central National Bank of Washington City v.

Hume, 128 U.S. 195 (1888).

Finally, the payment of premiums by an insured does not

give him any interest in the insurance policy under Oklahoma

law. Clark v. Clark, 460 P.2d 936, 941 (Okla, 1969); Johnson

v. Roberts, supra.

Thus, under Oklahoma law the decedent never possessed

any contractual rights under the policy, any power to assign the

policy, any express or implied power to change the beneficiary

63

of the policy, or any power to make an effective pledge of the

policy to any creditors. In short, he never possessed any of the

incidents of ownership in the policy, regardless of his payment

of premiums on the policy.

Because the decedent never possessed any of the incidents

of ownership in the policy under state law, the proceeds from

the policy are not, and never could have been included in the

gross estate pursuant to section 2042. Thus, we hold that the

exception in section 2035(d)(2) is inapplicable to the proceeds

from the policy and that under section 2035(d)(1) the proceeds

from the insurance policy are not includable in the gross estate.

Accordingly, and to reflect concessions by the parties,

Decision will be entered under Rule 155.

64

ASSIGNMENT 11

Code: §§2031 and 2032

Regulations: §20.2032-1

S,M,L & C: ¶ 4.03 (Omit [4])

Readings: Estate of Hance v. Comm'r

Questions:

1. D received an annuity during his lifetime. On his death, his widow was entitled to receive $1,000per month for the remainder of her life. She was 84 years old at the time of his death. The cost ofpurchasing a policy to provide her those benefits as of D's date of death was $55,000. The widow dieswithin 6 months of the decedent's death, after only receiving five payments.

a. What is included in the gross estate if the estate does not elect the alternate valuationdate?

b. What is included in the gross estate if the estate elects the alternate valuation date?(Estate of Hance v. Comm'r)

2. In year one, X gave certain securities to a trust, the income to be paid to B for life and, upon B'sdeath, the remainder to go to D or D's estate. At the time of D's death in year ten, the securities wereworth $10,000. B was seventy years old at D's death. Six months later, the securities had doubled invalue to $20,000 and B was then 71. (Although B would be only six months older, assume that he wasa full year older for purposes of simplicity.) Using the valuation tables, what should be included in D'sgross estate in the following situations:

a. D's executor values the estate as of D's death.

b. D's executor values the estate as of the alternate valuation date.

65

c. Assume B dies within the six months following D's death and D's executor elects thealternate valuation date.

d. Assume three months after D's death, the trustee sells the securities for $12,000, theproceeds are reinvested in Acme stock, six months after the decedent's death, the Acmestock is worth $15,000, and the executor elects the alternate valuation date.

66

ESTATE OF JOHN A. HANCE,

PETITIONER,

v.

COMMISSIONER OF INTERNAL REVENUE,

RESPONDENT.

18 T.C. 499 (1952)

OPINION.

OPPER, Judge:

Respondent determined a deficiency in estate tax of

$125,580.69, based on a number of adjustments of which

only one now remains in controversy. An overpayment

of $14,791.55 is claimed. The single issued relates to the

valuation of seven survivorship annuities taken out by

decedent during his life. All of the facts have been

stipulated and are hereby so found. The estate tax return

was filed with the collector for the third district of New

York.

The factual background and the question presented

are well summarized in petitioner's brief from which we

quote verbatim (pp. 2-3):

* * * Decedent John A. Hance died February 22,

1947, survived by his widow. The estate tax

return was duly filed and the executor elected to

have the gross estate valued as of the optional

date in accordance with Section 811 (j) of the

Internal Revenue Code. Among the assets

reported in the return were seven single premium

annuity contracts issued by five life insurance

companies. Each of these contracts provided for

the payment of a specified annuity to decedent

during his lifetime and thereafter to his widow

for her life. The widow died May 15, 1947, at

the age of 83 years and 9 months. In the estate

tax return these contracts were valued at an

aggregate amount of $44,632.92. This valuation

was arrived at by discounting at the rate of 4%

the total payments which would have been

received by the widow on the basis of her life

expectancy at the time of decedent's death,

without regard for the fact that she died on May

15, 1947. For present purposes it is conceded

that this method of valuation was incorrect.

The Commissioner has determined that these

contracts should be valued on the basis of the cost of

similar policies issued on the date of decedent's death to

a female applicant of the same age as the surviving

widow. It has been stipulated that the total cost of such

policies would be $121,905.27 * * * . This increase in the

valuation of the annuities, coupled with several minor

changes not in issue, results in the assessed deficiency of

$125,580.69.

Petitioner concedes that the Commissioner has

correctly valued the annuity policies as of the date of

decedent's death but contends that, because of the election

to have the estate valued as of the date one year after

death, the Commissioner erred in failing to allow an

adjustment for the difference in value as of the later date

not due to mere lapse of time.

The point where the parties are really at odds is the

correct interpretations of section 811(j), Internal Revenue

Code, reading as follows:

(j) OPTIONAL VALUATION.-- If the executor

so elects upon his return (if filed within the time

prescribed by law or prescribed by the

Commissioner in pursuance of law), the value of

the gross estate shall be determined by valuing

all the property included therein on the date of

the decedent's death as of the date one year after

the decedent's death, except that (1) property

included in the gross estate on the date of death

and, within one year after the decedent's death,

distributed by the executor (or, in the case of

property included in the gross estate under

subsection (c), (d), or (f) of this section,

distributed by the trustee under the instrument or

transfer), or sold, exchanged, or otherwise

disposed of shall be included at its value as of

the time of such distribution, sale, exchange, or

other disposition, whichever first occurs, instead

of its value as of the date one year after the

decedent's death, and (2) any interest or estate

which is affected by mere lapse of time shall be

included at its value as of the time of death

(instead of the later date) with adjustment for

any difference in its value as of the later date not

due to mere lapse of time. No deduction under

this subchapter of any item shall be allowed if

allowance for such item is in effect given by the

valuation under this subsection. Wherever in

any other subsection or section of this chapter,

reference is made to the value of property at the

time of the decedent's death, such reference shall

be deemed to refer to the value of such property

used in determining the value of the gross estate.

67

In case of an election made by the executor

under this subsection, then for the purposes of

the deduction under section 812(d) or section

861(a)(3), any bequest, legacy, devise, or

transfer enumerated therein shall be valued as of

the date of decedent's death with adjustment for

any difference in value (not due to mere laps of

time or the occurrence or nonoccurrence of a

contingency) of the property as of the date one

year after the decedent's death (substituting the

date of sale or exchange in the case of property

sold or exchanged during such one-year period).

Petitioner insists, and we agree, that the present

situation falls squarely within the language of (2) and that

the property must accordingly 'be included at its value as

of the time of death * * * with adjustment for any

difference in its value as of the later date not due to mere

lapse of time.'

The error of respondent's position may be described

as his insistence that the widow's actual intervening death

did not affect the value of the annuities on the optional

date because the possibility of her death within that period

was one of the factors taken into account in appraising the

property as of the date of decedent's death.

But possibility is all that an actuarial computation can

deal with. Actuality is an opposite concept. If we were

confined to an appraisal of the facts as they existed at

decedent's death, the possibility would be the limit of our

concern, as it was in Ithaca Trust Co. v. United States,

279 U.S. 151. And if, as in Estate of Judson C. Welliver,

8 T.C. 165, the widow had not yet died on the optional

date, the limitation to actuarial estimates would be as

necessary under section 811(j)(2) as it was under the

earlier provision construed in the Ithaca Trust case.

The present situation was, however, envisioned, and

we think correctly dealt with, in the Welliver case, where

we said, referring to the actual intervening death of an

annuitant: ' * * * by such event the interest or estate would

not be affected merely by the lapse of time and express

provision is made for adjustment on the later date because

of a contingency other than the lapse of time.'

Respondent in fact expressly a disavows any

contention 'that death is an event due to mere lapse of

time.' But it was precisely the widow's death which made

the annuities totally worthless by the time the optional

date arrived. The statute requires 'adjustment for (such)

difference in its value as of the later date * * * ,' and there

is of course nothing in respondent's regulations to the

contrary.

Petitioner proposes to make the requisite adjustment

by comparing the cost of annuities of the character

involved on the date of decedent's death and of that of the

widow. The difference, slightly over $5,000, which is in

effect the value of the payments during the interval, is

treated as the amount due to mere lapse of time. This

appears reasonable considering that an annuitant situated

as was decedent's widow would collect the differential by

merely remaining alive.

Since it is this figure which represents the value 'due

to mere lapse of time,' the balance of the amounts

attributable to the annuities as of decedent's death was lost

by the optional date due to causes other than mere lapse

of time-- in this instance by the widow's prior death. The

upshot is to make an adjustment for the latter event

amounting to the difference between the values at

decedent's death and the $5,000-odd representing the

differential in values which seems to meet precisely the

statutory direction to value the property as of decedent's

death, 'with adjustment for any difference in its value as of

the later (optional) date not due to mere lapse of time.'

The ultimate effect of this process is to include in the

estate the figure representing in substance the payments

actually received by the widow, notwithstanding that as of

the optional date the annuities were entirely worthless. It

is a reasonable result, since that is what turned out to be

the dimensions of the property which decedent actually

left, and it neither excludes the entire amount nor includes

all of an item which by the optional date had ceased to

exist. That is exactly what Congress said and we see no

reason why they should not also have meant it.

To permit computation of the overpayment, decision

will be entered under Rule 50.

68

ASSIGNMENT 12

Code: §§2053(a)-(c), 2054, and 2043.

Regulations: §§20.2032-1(g) and 20.2053-1

S,M,L & C: ¶ 5.03 (Omit [3][c] - [d], [4], [5][c] - [d], [8], and [9])

Readings: Russell v. United StatesEstate of Van Horne v. Comm'r

Questions:

1. D died in 1995 having a gross estate of approximately $5,000,000. Her will directed that (1) theexecutor pay X's debt to Security Bank, and (2) the residue of her estate be distributed to fourtestamentary trusts. One of the assets in the residue was a house worth approximately $2,000,000. By1996, virtually all administration of the estate had been completed. However, the executor elected tosell the house rather than to distribute it in kind to the testamentary trusts. It took 5 years to accomplishthe sale. During this period of time, the executor was required to borrow $775,000 to maintain thehouse, and paid $196,000 in interest. In addition, the executor incurred an additional $20,000 in attorneyfees. The probate court determined that under state law, D obligated his estate to pay X's debt and thatthe debt was deductible as a claim against the estate. In addition, the interest and additional attorney feeswere proper administration expenses.

a. Is the interest deductible under §2053?

b. Are the attorney fees deductible under §2053?

c. Is X's debt to Security Bank deductible under §2053?

2. At the time of D's death, D was acting as trustee of a trust which X established for the benefitof D's son S. D had converted trust assets for his own benefit. Under state law, S had the right torecover from the estate the sum of $150,000 which represents amounts which D converted as of D'sdeath. Since S was the residual beneficiary, S decided not to file his claim.

a. Can the estate elect to deduct $150,000 under §2053? (W.E. Russell)

69

b. What result if S's attorney failed to file S's claim in probate and S subsequently lost hiscause of action?

3. D seriously injured X in an accident that caused D's death. Is X's claim against D's estatedeductible? If so, how is the value of the claim measured?

4. At the time of D's death, D was obligated to pay $5,000 per month for spousal support to herhusband for the remainder of his life. If the event D should die before her ex-spouse, her estate wouldbe responsible for the payments. The decedent died in September 2007 and the ex-spouse died beforethe federal estate tax return was filed. How should this liability be reported? (Estate of Van Horne v.Comm'r)

5. Ten years ago, D transferred securities to a corporate trustee under an instrument which providedthat the trustee was to pay the income to D for his life and, at D's death, to pay the corpus to S or S'sestate. D had been receiving $60,000 annually, and the corpus had a value of $800,000 at his death.

a. When D died the trust corpus had substantial value, and, in accordance with its regularfee schedule, the trustee charged a termination commission of $10,000 in connectionwith the distribution of the assets to S. Does the $10,000 payment qualify as an estatetax deduction?

b. When D died, he had only $50,000 in an account at a stock broker and no other assets.He was personally liable for debts to a bank in the amount of $100,000. How much, ifany, of the debt is deductible is his estate?

70

William E. RUSSELL, Executor of the Estate of Lillian L.

Russell, Plaintiff,

v.

UNITED STATES of America, Defendant.

260 F.Supp. 493 (N.D. Ill. 1966)

JULIUS J. HOFFMAN, District Judge.

This action is brought by the plaintiff, William E. Russell,

in his capacity as the executor of the estate of Lillian L. Russell,

his mother. Jurisdiction over the subject matter of the suit is

created by 28 U.S.C. § 1346(a)(1), the complaint being one

against the United States for the recovery of a tax erroneously

collected under the internal revenue laws, in that it was allegedly

in excess of the amount properly due.

The cause was tried to the court without a jury, and

pursuant to Rule 52(a) of the Federal Rules of Civil Procedure,

this memorandum of decision will constitute the court's findings

of fact and conclusions of law.

It appears from the evidence that the decedent, Lillian L.

Russell, died on January 9, 1960. The plaintiff, who is the duly

qualified executor of her estate, filed an estate tax return for the

decedent's estate on April 10, 1961, reporting the taxable estate

as $236,545.43, and asserting the federal estate tax due as

$58,146.54 which amount was paid on the date the return was

filed.

On March 14, 1963, the plaintiff filed an amended estate

tax return, reporting the taxable estate as $76,084.33 and

computing the estate tax due as $14,003.61. If that figure is

determined to be correct, the conclusion would be that there had

been an overpayment of $44,142.93. A claim was filed with the

District Director of Internal Revenue at Chicago for a refund of

this amount on April 23, 1966. This claim was disallowed, and

after an audit of the estate, the District Director increased the

value of the taxable estate above that reported on the original

return and assessed additional taxes in the sum of $48,778.61.

This amount was paid by the plaintiff on December 31, 1963.

On December 30, 1963, the plaintiff filed an amended claim for

a refund, seeking the sum of $92,802.21, which is the amount

sought to be recovered in this suit. This sum is the aggregate of

the original refund claimed plus the amount paid pursuant to

the deficiency assessment. On April 27, 1964, the plaintiff paid

an additional assessment of $8,044.00 representing the interest

due on the deficiency assessment paid on December 31, 1963.

On April 27, 1964, the plaintiff filed a further amended claim

for refund to include this interest payment, increasing the claim

to $100,542.99. This claim was disallowed on July 1, 1964.

The rejection by the District Director of the plaintiff's

claimed deductions or exclusions from the gross estate and the

concomitant disallowance of the claims for refund constitute the

basis of this action.

A. CLAIMS AGAINST THE ESTATE BY PATRICK AND

MARY RUSSELL

The first issue to be dealt with is the allegation that Patrick

Russell and Mary St. Marie, children of the decedent and

brother and sister of the plaintiff, had valid claims against the

decedent's estate which should have been allowed as deductions

from the gross estate, and which were improperly denied as such

by the District Director of Internal Revenue.

William E. Russell Senior, the father of the plaintiff died

on March 3, 1948. Under the terms of his will, he bequeathed

to his wife Lillian (the decedent whose estate is here involved)

certain assets to be held by her, not as an individual, but as

trustee for the benefit of Patrick and Mary, until they attained

their majority. The particular trust assets here relevant consisted

of 2,569.8 shares of the capital stock of the Peerless Packing

Co., bequeathed by the elder Russell to be held in trust for the

benefit of Patrick, and a like number to be so held for Mary.

These shares were distributed to Lillian Russell, along with

Peerless shares distributed to her as an individual and along with

certain other trust assets which need not be detailed here.

Following the death of the senior Russell, and up to December

28, 1950, dividends were paid on the Peerless shares held in

trust by Lillian in the following sums: $1,890.00 in dividends

on those shares of Peerless held in trust for Patrick, and

$4,770.00 on those held for Mary. On December 28, 1950, the

Peerless shares held by Lillian for Patrick were sold for

$64,250.00 as were those held for Mary, for a total of

$128,500.00.

Patrick reached the age of 21 on July 13, 1954 and Mary

attained the same age on November 30, 1957. Lillian Russell

did not at either time inform them of the trusts created by their

father's will, and neither was aware of the existence of those

trusts until after the death of their mother. Prior to her death,

Lillian made no distribution to either beneficiary of any part of

the sums held in trust for Patrick and Mary.

Letters testamentary were issued in connection with the will

of the decedent, Lillian Russell, on January 19, 1960,

appointing the plaintiff and the American National Bank &

Trust Co. as co-executors. The bank subsequently resigned as

an executor. Twenty-three months after the issuance of these

letters, Patrick and Mary initiated proceedings in the Probate

Court of Cook County, Illinois, seeking the removal from the

inventory of the decedent's estate the sums held in trust for them

by their mother, at her death. As a result of these proceedings,

the Probate Court, on December 7, 1962, awarded to Patrick

and Mary the sum of $207,961.00. This figure included the

principal plus interest. The parties have stipulated that this

figure included $14,778.56 of interest accruing after the death

71

of Lillian Russell, and that this amount is neither excludable nor

deductible from the gross estate.

The plaintiff claims that this sum, with the adjustment for

the post-death interest, should have been allowed as a deduction

under the terms of 26 U.S.C. § 2053(a)(3), which provides:

'* * * the value of the taxable estate shall be

determined by deducting from the value of the gross

estate such amounts * * * (3) for claims against the

estate * * * as are allowable by the laws of the

jurisdiction * * * under which the estate is being

administered.'

The controversy on this issue concerns the question of

whether or not the claims of Patrick and Mary are deductible

under this statute. The executor argues that this point has been

concluded against the defendant by the decree of the probate

court removing $207,961.00 from the decedent's estate as an

award to the children. The plaintiff is unquestionably correct in

his position that a valid order of a state court conclusively

determines property interests as a matter of state law, and that

such an order is binding on a federal court for estate tax

purposes. I cannot agree, however, that the probate court order

under present examination is binding upon this court. The

Government has made a successful collateral attack upon that

order; it is void and of no effect.

The order in question was entered on the joint petition of

Patrick and Mary brought under 3 Ill.Ann.Stat. § 187a and, in

the alternative, on their separate claims brought under 3

Ill.Ann.Stat. § 202(5th). The probate court had no jurisdiction

to enter the order under § 202. (The parties have proceeded on

the assumption that claims against a decedent's estate are

brought 'under' § 202, and the court employs that terminology

for that reason. However, § 202, while it does designate the

classes of claims which may be brought, is not the statute which

provides for the filing of claims in the probate court. See 3

Ill.Ann.Stat. § 192.) 3 Ill.Ann.Stat. § 204 creates a nine month's

period of limitation on claims against an estate which may be

paid from estate assets inventoried within that period.

Moreover, § 204 is not of the nature of an ordinary statute of

limitations, creating a defense to be raised or lost by the party in

whose favor it operates. It is a nonclaim statute, and it operates

as a limitation upon the jurisdiction of the probate court. Of

course, subject-matter jurisdiction cannot be conferred upon a

court by the agreement or defaults of litigants. The section 202

claims made by Patrick and Mary were presented well beyond

the nine month period following the issuance of letters to the

co- executors, and there were no new after-inventoried assets

from which their claims could be satisfied. The probate court,

then, was without jurisdiction. It had no power and was not

competent to allow the § 202 claims of Patrick and Mary.

Austin v. City Bank of Milwaukee, 288 Ill.App. 36, 44-45, 47,

5 N.E.2d 585 (1936); Pratt v. Baker,48 Ill.App.2d 442, 446,

199 N.E.2d 307 (1964). Therefore, the relevant order of that

court, insofar as it dealt with the § 202 claims, is void.

As has been observed, Patrick and Mary also requested the

same relief of the probate court in a joint petition under § 187a,

and the court's order was alternatively based on that statute.

The probate court, however, was also without jurisdiction to

grant the requested relief under that statute. As the defendant

points out, § 187a was passed to vest jurisdiction in the probate

court over the claims of third persons to ownership of property

which has been included in the inventory of an estate. Its

enactment was prompted by the cases of In re Estate of Quick,

333 Ill.App. 573, 78 N.E.2d 26 (1948) and In re Estate of

George, 335 Ill.App. 509, 82 N.E.2d 365 (1948). See 4 James,

Ill.Probate Law & Practice § 187a. In Quick and George it was

ruled that the probate courts had no jurisdiction to determine

the ownership of personal property in the hands of a personal

representative and which was claimed by a third party as his

own. The property involved in both Quick (50 shares of Blair-

Tirrel stock) and George (rugs, pictures, jewelry, and the like)

was specific and identifiable. That is the sort of property which

the Illinois legislature intended the probate courts to deal with

under the jurisdiction with which they were invested under §

187a. Here, by contrast, there was no specific, identifiable,

earmarked trust res. The claims of Patrick and Mary, as allowed

by the probate court, would have to be satisfied out of the

general assets of the estate.

Under § 202, the probate courts of Illinois had jurisdiction

over claims similar to those of Patrick and Mary prior to the

passage of § 187a. Under Illinois law, if a trustee contravenes

the terms of the trust by failing to pay over the trust corpus to

the beneficiaries when they reach their majority the trust does

not terminate. Crimp v. First Union Trust and Savings Bank,

352 Ill. 93, 185 N.E. 179 (1933) (cited by plaintiff.)

Therefore, the decedent, at the time of her death, was the trustee

of technical trusts for Patrick and Mary, the funds of the trusts

having been commingled with her personal assets. Claims for

the recovery of such funds were within the jurisdiction of the

probate courts prior to the enactment of § 187a as claims of the

fifth class in the statute which was the predecessor of § 202.

And the claims of these children constituted claims of the fifth

class under § 202, and as such were barred by the nonclaim

provisions of § 204. It cannot be said that the legislature

intended to allow claimants to escape the nonclaim statute by

bringing § 202 claims as § 187a claims. The statutes do not

overlap. The claims which had been included within the

predecessor to § 202 do not also come within § 187a. § 187a

was designed to add to the scope of probate court jurisdiction,

not to duplicate that which it had. The Probate Court of Cook

County had no jurisdiction, under either § 202 or § 187a, to

allow the claims of Patrick and Mary, and the order therefore is

void and is not binding on this court.

The question remains whether the claims of Patrick and

72

Mary are deductible under the terms of 26 U.S.C. § 2053. My

decision, thus far, states only that the issue has not been

conclusively determined as a matter of state law by the action of

the Probate Court of Cook County. That does not resolve the

ultimate issue. The claims of Patrick and Mary were not

enforceable under state law at the time they were filed with the

probate court. This fact makes necessary an interpretation of

the language of § 2053 providing for deductions from the gross

estate of such claims against the estate 'as are allowable by the

laws of the jurisdiction * * * under which the estate is being

administered.' The persuasive weight of the case law is to the

effect that this language must be read to refer to such claims 'as

are allowable (at the time of the decedent's death) under the laws

of the jurisdiction where the estate is being administered.'

Commissioner of Int. Rev. v. Strauss, 77 F.2d 401 (7th Cir.

1935); Smyth v. Erickson, 221 F.2d 1, (9th Cir. 1955); Winer

v. United States, 153 F.Supp. 941 (S.D.N.Y.1957). See also

Ithaca Trust Co. v. United States, 279 U.S. 151, 49 S.Ct. 291,

73 L.Ed. 647 (1929). In that case, involving another statute, the

Supreme Court, in an opinion by Justice Holmes, held that an

estate tax is a tax on the act of the decedent and not on the

receipt of property by legatees, and that the estate transferred

must be valued at the date of death. Justice Holmes wrote:

'The question is whether the amount of the

diminution, that is, the length of the postponement,

is to be determined by the event as it turned out, * * *

or * * * as they stood on the day when the testator

died. * * * The estate so far as may be is settled as of

the day of the testator's death.'

The Court there made a pronouncement about the nature

of an estate tax, and it held that the estate must be considered as

settled as of the date of the decedent's death, and not as effected

by subsequent events; that is, the taxpayer cannot be compelled

to pay taxes on amounts which fall into an estate by reason of

events subsequent to the date of death.

The relevant inquiry, therefore, is whether the claims of

Patrick and Mary were allowable in the State of Illinois on

January 9, 1960, the date of the death of Lillian Russell. That

the claims were subsequently lost by lapse of time is irrelevant.

It is significant to note that Strauss, Winer, and Erickson

dealt with statutes which were the predecessors of § 2053. The

latter two cases indicate that the earlier statute used the words

'claims as are allowed by the jurisdiction.' This language was

changed in the 1954 revision to 'claims as are allowable,' which

brings the language of the statute into line with the case law as

it had developed in the cases to which I have referred.

Consideration has also been given to Revenue Ruling 60-

247, relied on by the Government. If controlling, it might

compel a different decision on this point. The word 'might' is

used because that ruling bars deductions for claims against an

estate which have not been paid or will not be paid because the

creditor (1) waives payment, (2) fails to file his claim within the

time limit and under the conditions prescribed by applicable

local law, or (3) otherwise fails to enforce payment. Its

applicability here is questionable because we assume that the

probate court's order was obeyed and that the claims of these

children were paid.

In any event, this revenue ruling is not controlling because

of applicable case law. A revenue ruling which runs counter to

the provisions of a statute is a legal nullity. United States v.

Eddy Brothers, Inc., 291 F.2d 529, 531 (8th Cir. 1961); Tandy

Leather Co. v. United States, 232 F.Supp. 641, 649 and 347

F.2d 693 (5th Cir. 1965), citing United States v. Bennett, 186

F.2d 407 (5th Cir. 1951). The statute says only what the cases

interpret it to say, and the statute, through the cases, is directly

opposed to Revenue Ruling 60-247.

It must now be determined whether the children, Patrick

and Mary, had claims against the estate, allowable at the time of

the decedent's death, for trust funds held for their benefit by

Lillian Russell. In Illinois, the law is that the cestuis que

trustent do have a claim against an estate for trust funds held

and commingled by the decedent. Crimp, supra; Velde v.

Reardon, 322 Ill.App. 177, 54 N.E.2d 91 (1944) (abstract of

case); Edgerton v. Johnson, 178 F.2d 106 (7th Cir. 1949). If

this were not true, there would be no need for the provision in

§ 202, as a claim of the 5th class, for claims for 'money and

property received or held in trust by decedent which cannot be

identified or traced.' See Adams Exp. Co. v. Oglesby, 215

Ill.App. 94 (1919), which apparently was codified by § 202.

It is clear from the evidence that the decedent, at her death,

held as trustee for Patrick under the will of the senior William

Russell, the sum of $66,245.00, plus interest due to that date;

and that she similarly held for the benefit of Mary, the sum of

$69,015.00, plus interest due at that date. The Government

contends that the evidence proved that a partial accounting of

trust assets was had by both Mary and Patrick. These sums,

being one of $7,956.54 had by Mary and one of $10,317.70

had by Patrick, the Government urges should not be deducted

from the gross estate. The court does not agree with this

position.

With respect to the sum received by Mary and allegedly

chargeable to her as a partial trust accounting, Government

group exhibit B contains a copy of savings account no. 4336 of

the Evergreen Plaza Bank. It is identified as 'Lillian L. Russell,

trustee for Mary Russell.' The account was opened on

September 19, 1959 with a deposit of $8,500.00 from the

decedent's personal funds. On September 22, 1959, the

decedent made a deposit of $8,341.03. This was the closing

balance from an account in another bank which was also

identified as a trust account for Mary. Because it came from

that account, the Government argues that this sum is traceable

73

to earmarked trust assets. It should be noted that when the

Government was arguing the invalidity of the probate court

order under § 187a, it urged that the other account held

commingled funds, that is, non-specific non-identifiable funds.

Nevertheless, the traceability of this sum is not material. It is

clear that as of the moment of deposit into the Evergreen

account, this sum was commingled with the personal assets of

Lillian Russell. The course of her treatment of this account, as

reflected by Government exhibit B, demonstrated that she

regarded this as a fund constituted out of her personal assets and

subject to her control unfettered by the fiduciary obligations she

bore as a result of her husband's will. Moreover, she eventually

reduced the balance from a high of $16,800.00 to a figure less

than the amount which was traceable to the earlier trust account.

After the death of Lillian Russell, this account was closed by

Mary. She withdrew the balance, which consisted of a deposit

of $57,600.00 which was not a trust asset, and of the sum

allegedly received by Mary as a partial trust accounting.

The evidence regarding this account demonstrates that the

deposits made into it by Lillian Russell were not made as

deposits of earmarked funds pursuant to the trust created by the

will of her late husband. The sum in question was received from

this account by Mary as a gift from her mother, see e.g., In re

Estate of Petralia, 32 Ill.2d 134, 204 N.E.2d 1 (1965), and of

her mother's personal assets, and it may not be charged to her as

an accounting of sums due under the testamentary trust created

by her father.

The court's finding on this issue is, of course, bolstered by

the law of Illinois as set forth in Crimp v. First Union Trust and

Savings Bank, 352 Ill. 93, 185 N.E. 179 (1933). See 2 Scott,

Trusts § 172 (2d ed. 1956). The rule under that case is that

when a trustee has mingled trust assets with his own, as occurred

in the account under examination, and if there is a question

whether distributions from the trustee to the beneficiary

represented a trust accounting or some other form of

distribution, any doubts are to be resolved against the trustee

and in favor of the beneficiary.

The same reasoning applies with regard to the sums

allegedly received as a partial accounting by Patrick. On April

25, 1958, the decedent opened joint account no. 2263 at the

Evergreen Bank, in her name and in the name of Patrick. This

was not designated as a trust account, and although the initial

deposit may have been traceable to trust assets, it was not a

deposit of trust assets. It became a personal asset of Lillian

Russell, subject to the claims of her creditors. Moreover, the

evidence clearly shows that the decedent intended that Patrick

have the funds in that account as a gift from her. (Tr. pp. 540-

541.) That Lillian was also a trustee of funds for Patrick does

not mean that every transfer of money from her to him must

necessarily have been a trust accounting, or that Patrick may be

so charged. This is also true of Mary's situation. Merely

because sums received by beneficiaries emanate from persons

who are trustees for their benefit, the cestuis are not disqualified

from receiving them as anything but trust accountings. See

Crimp, supra. The funds had by Patrick from the Evergreen

Bank were taken by him as gifts from his mother and out of her

personal assets, and these sums are not chargeable to him as

partial accountings of amounts due under the testamentary trust

created by his father.

ESTATE OF Ada E. VAN HORNE, Deceased,

v.

COMMISSIONER OF INTERNAL REVENUE

(9th Cir. 1983)

REINHARDT, Circuit Judge:

This case concerns the proper method of valuing certain

assets and liabilities for estate tax purposes. The tax court, 78

Tax Court 728, determined that under I.R.C. § 2053(a)(3)

(1976) the estate is entitled to a deduction for the full date of

death actuarial value of a life time spousal support obligation

even when the spouse of the decedent dies prior to the filing of

the estate tax return. The government appeals. The tax court

also determined that the relevant block of shares to be

considered for a blockage discount was that held by the estate at

the alternate valuation date, rather than at the date of decedent's

death, and that a blockage discount on those shares was not

warranted. The plaintiff cross appeals from these

determinations. We affirm the tax court in all respects.

I. Background

The facts are uncontroverted. Ada E. Van Horne

(decedent) died September 4, 1976. The federal estate tax

return was timely filed on June 1, 1977. The executors elected

to value the gross estate as of the alternate valuation date, March

4, 1977, rather than as of the date of death.

At the time of her death, the decedent was obligated,

pursuant to an interlocutory judgment of dissolution of

marriage, to pay $5,000 per month for spousal support to her

surviving ex-husband, James Van Horne, for the remainder of

his life. The judgment provided that the award could not be

modified, notwithstanding either his remarriage or her death.

In the event of the latter, the judgment provided that all

payments thereafter falling due would become payable by the

estate. The ex-husband filed a creditor's claim against the estate

on October 29, 1976. The executors filed a petition for court

approval of this claim on November 29, 1976, and it was

approved on December 27, 1976.

The ex-husband died on April 20, 1977, having received

74

only $35,000 from the estate in support payments. At the time

of decedent's death, the ex-husband was aware that he had a liver

ailment but had no reason to suspect that he was terminally ill

with cancer. His fatal condition was not diagnosed until March

of 1977.

The estate claims a deduction of $596,386.58 for the value

of the ex-husband's claim. This amount was calculated by

reference to the actuarial tables included in Treas.Reg. §

20.2031-10 (1983). The parties have stipulated that the

amount computed is correct, if actuarial valuation is proper.

The government contends that actuarial valuation is not proper

here because the claim was actually extinguished after payment

of only $35,000.

At the time of decedent's death she owned 56,454 shares

of Wm. Wrigley Jr. Co. common stock (Wrigley stock). The

executors decided to liquidate 42,416 shares to pay various

expenses and taxes owed by the estate. In February 1977, these

shares were sold in three blocks. Thus, on March 4, 1977, the

alternate valuation date, the estate held only 14,038 shares of

Wrigley stock. The estate contends on appeal that the entire

block of Wrigley stock should be valued on the basis of a

blockage discount.

II. Valuation of Spousal Support Obligation

The general principle that a claim against a decedent's

estate is to be valued at the time of the decedent's death, and

that events subsequent to death do not alter this valuation, was

first announced by the Supreme Court in Ithaca Trust Co. v.

United States, 279 U.S. 151, 49 S.Ct. 291, 73 L.Ed. 647

(1929). We recently reaffirmed this principle in Propstra v.

United States, 680 F.2d 1248 (9th Cir.1982). In Propstra, the

petitioner's estate included two parcels of real estate which were

encumbered by liens for past dues and penalties owing to a local

water users' association. The Government contested petitioner's

claim that the liens were to be valued at the time of decedent's

death. Because the amount of the liens was reduced by the

association prior to the time the tax return was filed, the

Government argued that their actual value rather than their value

as of the date of death, should be deducted for estate tax

purposes. We held that because the claims were certain and

enforceable, we would not consider post-death events. Rather,

"as a matter of law, when claims are for sums certain, and are

legally enforceable as of the date of death, post-death events are

not relevant in computing the permissible deduction." Id. at

1254.

The government argues both that Propstra was wrongly

decided and that it is distinguishable on the ground that

petitioner's spousal support obligation was not a "sum certain"

and is therefore outside the rationale of Propstra. It contends

that "[h]ere the spousal support obligation amounted in effect

to a series of monthly claims each of which was contingent upon

James' survival to a particular date."

In deciding Propstra, we carefully considered and rejected

many of the arguments which the Government sets forth here.

We said that Congress clearly intended that post-death events

be disregarded when valuing legally recognized and enforceable

claims against an estate. We see no reason to reconsider Propstra

or to distinguish spousal support obligations from other

allowable claims.

The fact that it is necessary to refer to an actuarial table in

order to value a support obligation does not justify our reaching

a different result here than we did in Propstra. A claim that is

actuarialy valued is not uncertain for estate tax purposes. We

have recently approved the use of actuarial tables to value assets

for purposes of estate tax deduction in Bank of California v.

U.S., 672 F.2d 758 (9th Cir.1982). After reexamining this

method of valuation we concluded that "actuarial tables provide

a needed degree of certainty and administrative convenience in

ascertaining property values." Id. at 760.

Moreover, the charitable trust at issue in Ithaca Trust Co.

also required actuarial valuation. Justice Holmes, writing for

the Court, specifically considered whether post-death events are

relevant when lifetime interests are at issue, and concluded that

they are not:

"The first impression is that it is absurd to resort to

statistical probabilities when you know the fact. But

this is due to inaccurate thinking. The estate so far as

may be is settled as of the date of the testator's

death.... Tempting as it is to correct uncertain

probabilities by the now certain fact, we are of

opinion that it cannot be done, but that the value of

the [wife's] life interest must be estimated by the

mortality tables."

Id. at 155, 49 S.Ct. at 291.

We hold that legally enforceable claims valued by reference

to an actuarial table meet the test of certainty for estate tax

purposes. Because decedent's spousal support obligation meets

that test, it is subject to the Propstra rule. We affirm the tax

court's determination that the date of decedent's death was the

proper time for valuation of the claim.

AFFIRMED.

75

ASSIGNMENT 13

Code: §§2055(a)-(d), 2055(e)(1)-(2), and 2032(b)

Regulations: §20.2055-2(e)(2)(i), (ii) and (iii)

S,M,L & C: ¶ 5.05[1], [2], [3], [6], [7], and 8[a]

Readings: Estate of Pickard

Questions:

1. After making specific bequests in his will, D gave the residue of his estate to his executor,directing him to distribute the funds to those charities which the executor could select in his owndiscretion. D then appointed as executor his long time friend, Rush Limbaugh, who he knew would dothe right thing.

a. Does the residue of the estate qualify for the charitable deduction?

b. What result if the D's will required the executor to select organizations which arequalified recipients pursuant to §2055?

2. Under the terms of his will, D gave a life insurance policy on X's life and his residence inNorman to the University of Oklahoma School of Law. As of the date of death, the policy had a fairmarket value (determined in accordance with the regulations) of $5,000, and the house had a fair marketvalue of $85,000. As of the alternate valuation date, the policy was worth $5,200, and the house wasworth $80,000. The difference in the value of the policy was entirely attributable to interest earned afterdeath on the cash surrender value.

a. What deduction under §2055 will the estate receive if it does not elect the alternatevaluation date?

b. What deduction under §2055 will the estate receive if it elects the alternate valuationdate?

76

c. What result under (b) if X dies 4 months after the decedent's death, and the Universityreceives $50,000 as the policy proceeds?

3. Under the terms of his will, D gave a life estate in both his residence and rental property to hiswife, with the remainder passing to the University of Oklahoma School of Law. At the time of death,the house was worth $60,000, the rental property was worth $65,000, and the surviving spouse was 70years old. What deduction under §2055 will the estate receive?

4. D's will established a trust (D's Trust) from which $3,000 per year was to be payable to D'smother (M), and upon M's death, the residue was to go to D's father (F). D dies on December 3, 1967.D was predeceased by F. In F's will, he established a trust (F's Trust) from which $10,000 per year waspayable to M, and upon M's death, the residue was to pass to a qualified charity within the meaning of§2055. The probate court ordered that the principal of D's Trust be payable to F's Trust (and thus tocharity) on M's death. Assume that a charitable deduction is allowable for gifts of remainder interestsin property. (Estate of Pickard)

a. Is the estate entitled to a deduction under §2055?

b. What result if the probate court determined that the property escheats to the state?

77

ESTATE OF CLAIRE FERN PICKARD

v.

COMMISSIONER OF INTERNAL REVENUE

60 T.C. 618 (1973)

TANNENWALD, Judge:

Respondent determined a deficiency of $45,895.36 in the

estate tax of the Estate of Claire Fern Pickard. The only

question raised is whether the estate is entitled to a charitable

deduction under section 2055.

All of the facts have been stipulated and are so found.

The Ohio National Bank of Columbus is the executor of

the Estate of Claire Fern Pickard. Its principal office was

located in Columbus, Ohio, at the time of the filing of the

petition herein. A Federal estate tax return was timely filed with

the district director of internal revenue, Cincinnati, Ohio.

On June 24, 1954, decedent, Claire Fern Pickard,

established a revocable trust (hereinafter referred to as the

Pickard Trust) with the Ohio National Bank of Columbus and

Herbert S. Peterson (decedent's stepfather) as trustees. The trust

instrument provided for payment of income and principal to

decedent upon request during her life. After decedent's death,

an annuity of $3,000 was to be paid to decedent's mother, Etta

Mae Peterson, during her life and, upon the mother's death (or

upon decedent's death, if her mother predeceased her), 'the

Trustees shall transfer, assign and convey the entire Trust Estate

then remaining in its hands absolutely and in fee simple to

Herbert S. Peterson to be his absolute property.'

The decedent died testate on December 3, 1967, a resident

of Columbus, Ohio. On December 13, 1967, her will was

admitted to probate. Under the will, the residue of the

decedent's estate was bequeathed and devised to the Pickard

Trust.

The decedent was survived by her mother, Etta Mae

Peterson. The parties have agreed on the value of the annuity

payable to her.

Decedent's stepfather, Herbert S. Peterson (hereinafter

referred to as Peterson), died testate on October 14, 1967, 7

weeks prior to the date of decedent's death. His will, duly

admitted to probate, bequeathed and devised the residue of his

estate to a revocable trust (sometimes hereinafter referred to as

the Peterson Trust), of which the Ohio National Bank of

Columbus was trustee, created by him just prior to the execution

of his will on June 1, 1964.

The Peterson Trust named Peterson's wife (decedent's

mother) as life beneficiary after Peterson's death and provided

that, upon the death of Peterson, his said wife, and decedent,

$10,000 of the trust assets should be distributed to two named

individuals if living, and the balance as follows:

One-half of the remaining assets to the First English

Lutheran Church of Columbus, Ohio, or its successors.

One-half of the remaining assets to the Columbus

Foundation, Columbus, Ohio.

On June 26, 1968, the Ohio National Bank of Columbus,

as executor of the Estate of Claire Fern Pickard, deceased,

commenced an action in the Probate Court of Franklin County,

Ohio, naming as defendants the First English Lutheran Church

of Columbus, Ohio, the Pickard Trust, the Estate of Herbert S.

Peterson, the Peterson Trust, the Columbus Foundation, and

Etta Mae Peterson. The action had as its purpose the obtaining

of a court determination as to how the probate assets of

decedent's estate and the assets of the Pickard Trust should be

distributed.

All of the defendants filed answers which, with the

exception of the answer of Etta Mae Peterson, were identical,

admitting the allegations of fact and joining in the request for a

court determination. Etta Mae Peterson's answer also admitted

the facts in the petition but claimed that she was entitled to a

termination of the Pickard Trust and to a distribution of all of

its assets as sole surviving beneficiary named therein and as sole

surviving heir at law of decedent and to a distribution of the

residue of the decedent's probate assets as sole heir at law of the

decedent.

The case was submitted to a referee. Oral argument was

heard and the case was submitted on briefs. The referee

submitted his report, which formed the basis of an order by the

Probate Court on July 16, 1969, providing in pertinent part as

follows:

IT IS THEREFORE ORDERED, ADJUDGED AND

DECREED, that:

1. The Pickard Trust is the residuary beneficiary of all the

assets of the Estate of Claire Fern Pickard, deceased.

2. The property contained within the Pickard Trust passes

to the beneficiaries named in that Trust in accordance with the

provisions contained solely within that Trust.

3. Herbert S. Peterson obtained a vested interest subject to

divestment in the Pickard Trust assets at the time of the creation

of that Trust.

4. The interest of Herbert S. Peterson in the assets of the

Pickard Trust, never having been divested, became absolute at

the time of Claire Fern Pickard's death.

78

5. Since Herbert S. Peterson predeceased Claire Fern

Pickard, the Herbert S. Peterson Estate and/or the Peterson

Trust must be the residuary beneficiary of both the Probate and

Non-Probate assets of the Pickard Trust.

6. The Peterson Estate and/or Peterson Trust being the

residuary beneficiary of both the Probate and Non-Probate

assets of the Pickard Trust, the following distribution should be

made:

(a) The Executor of the Estate of Claire Fern Pickard,

deceased, should distribute the Probate assets of said Estate to

the Trustee of the Claire Fern Pickard Trust.

(b) The Trustee of the Pickard Trust should pay Three

Thousand Dollars ($3,000.00) annually to Etta Mae Peterson

during her lifetime; at her death the Trustee of the Pickard

Trust should pay the balance to either Herbert S. Peterson

Estate or the Peterson Trust:

(1) Of those assets received from the Pickard Estate;

(2) Of those assets preferably held by the Trustee of the

Pickard Trust.

(c) The Pickard Trust should not be terminated until the

death of Etta Mae Peterson, distribution to then be made to

either the Herbert S. Peterson Estate or the Peterson Trust:

(1) If at the time the Pickard Trust is terminated, the

Herbert S. Peterson Estate is active, distribution of the Trust

assets should be made to the Herbert S. Peterson Estate.

(2) If at the time the Pickard Trust is terminated, the

Herbert S. Peterson Estate is closed, distribution of the Trust

assets should be made to the Herbert S. Peterson Trust.

Section 2055 provides, among other things, that 'the value

of the taxable estate shall be determined by deducting from the

value of the gross estate the amount of all bequests, legacies,

devises, or transfers * * * to or for the use of any corporation

organized and operated exclusively for religious, charitable,

scientific, literary, or educational purposes.'

The parties herein are in agreement as to the exempt

character of the two organizations involved and as to the

amount of the deduction, if found to be allowable.

Additionally, no question has been raised whether the provisions

of any of the instruments involved or the possibility of claims

against either the Pickard or Peterson estates or trusts might

operate in such a way as to make the interests of those

organizations unascertainable or subject to the so- remote-as-to-

be-negligible possibility that the transfers would not become

effective. See sec. 20.2055-2, Estate Tax Regs.

The sole question to be decided herein is whether the

provisions of decedent's will and the Pickard Trust are operative

within the framework of the above-quoted statutory language.

Petitioner asserts that there are three elements contained in

section 2055, all of which are satisfied in this case, namely, (1)

decedent made a transfer, (2) of property includable in her gross

estate, and (3), by virtue of her stepfather's death and the

provisions of his will and the Peterson Trust, to or for the use

of a qualified entity. Such assertion is premised upon the

assumption that each of three elements is independent of each

other and that section 2055 can therefore be fragmented in

order to determine whether a deduction is allowable. Under

petitioner's reasoning, the route of devolution is immaterial; it

is enough if there is a transfer of includable property which

must, because of the surrounding circumstances, inevitably find

its way into the coffers of an exempt organization.

In our opinion, such separation of the three elements is

improper. We believe that the first and third elements are

mutually interdependent and that the 'transfer * * * to or for the

use of' such organization must be manifest from the provisions

of the decedent's testamentary instrument.

The impact of the route of devolution has been considered

in a variety of contexts. Thus, in Senft v. United States, 319

F.2d 642 (C.A. 3, 1963), property of the decedent, who died

intestate, escheated to the Commonwealth of Pennsylvania. In

denying the decedent a deduction under section 2055, the Court

of Appeals emphasized decedent's failure to make the transfer,

as opposed to the property passing to the qualified recipient by

another force, i.e., by operation of law.

In Cox v. Commissioner, 297 F.2d 36 (C.A. 2, 1961),

affirming a Memorandum Opinion of this Court, a deduction

under the predecessor of section 2055 was denied where the

testatrix, with full knowledge of all relevant facts and her express

approval of the ultimate recipient of the bequest, bequeathed

part of her estate to her son, a priest, who had, prior to her death

but subsequent to the making of the testatrix's will, taken

solemn vows of poverty and renounced all his interests in

property (including donations and legacies) in favor of the

Society of Jesus, a qualified entity under the statute.

Similar reasoning formed the underpinning of the Supreme

Court's decision in Taft v. Commissioner, 304 U.S. 351

(1938), where the decedent died with an outstanding but

unfulfilled pledge of a charitable contribution which constituted

a binding contractual obligation under local law. The Supreme

Court denied a deduction for estate tax purposes on the grounds

that the claim was not supported by adequate and full

consideration as required by then existing law and that there was

no bequest, legacy, devise, or transfer within the meaning of the

predecessor of section 2055.

In each of the foregoing cases, the fact that the designated

79

portion of the decedent's estate inevitably inured to the benefit

of the charity did not save the day. To be sure, they can be

distinguished on their facts, but the common element which

forms the foundation for decision is that the transfer to or for

the use of the charity was not effectuated by a testamentary

transfer on decedent's part but rather by the operation of an

external force. The same is true herein, where it was the

testamentary disposition of decedent's stepfather via the

Peterson Trust which accomplished the transfer.

Concededly, the charities herein would not have received

decedent's property if the decedent had not made the

testamentary disposition to her stepfather. The lesson from the

decided cases, however, is that a simple 'but for' test is not, as

petitioner would have us hold, sufficient. There must be

something more, namely, the testamentary facts as gleaned from

the decedent's own disposition must manifest the transfer to the

charity. Commissioner v. Noel Estate, 380 U.S. 679 (1965). In

so stating, we do not imply that the decedent must specify the

charitable recipient in so many words. But, at the very least, the

instrument of testamentary disposition must sufficiently

articulate, either directly or through appropriate incorporation

by reference of another instrument, the manifestation of

decedent's charitable bounty. See Y.M.C.A. v. Davis, 264 U.S.

47, 50 (1924). Such a situation simply does not obtain herein

and, accordingly, the claimed deduction is not allowable.

In order to reflect other concessions by the parties and to

permit a deduction for expenses in this proceeding (see Rule 51,

Tax Court Rules of Practice),

Decision will be entered under Rule 50.

ASSIGNMENT 14

Code: §2056(a)-(c)Skim §2032

Regulations: §§20.2056(a)-1(b), 20.2056(a)-2, 20.2056(b)-1, 20.2056(b)-3, and 20.2056(b)-4

S,M,L & C: ¶ 5.06[1]-[5] and [7]

Readings: Rev. Rul. 85-100

Questions:

In answering the following questions, ignore the exceptions to the terminable interest rule

80

provided for in §§2056(b)(3)-(9).

1. In each of the following situations, indicate whether and to what extent a deduction is allowableunder §2056:

a. H and W own their residence as joint tenants. At the time of H's death, it is worth$200,000.

b. Same as (a), except that the residence is subject to a mortgage on which they were bothliable and which had a balance at the time of D's death of $80,000. The property passedto W subject to the mortgage.

c. Same as (b), except that in his will, H directed that his estate pay the entire mortgage.

d. Same as (a), except that H and W were legally separated at the time of H's death.

e. Assume that H owned real estate individually. H and W were involved in a car accident,and it could not be determined who survived. Under the terms of H's will, H gave thereal estate to W and W was presumed to have survived if the order of deaths could notbe determined.

f. Assume that H made a specific bequest to W in the amount of $200,000 and gave theresidue of his estate to X. W commenced a will contest proceeding, claiming that Xexercised undue influence over H. Before going to trial, X agreed to settle the disputeby giving W an additional $250,000.

g. H was trustee of a trust established by X. H had a limited testamentary power to appointamong a group of beneficiaries, including W. H had no power to appoint to himself anddid not have any other beneficial interest in the trust. At the time of H's death, the trustprincipal was worth $300,000. H exercises his power by appointing the property to W.

81

h. Same as (g), except that H had the testamentary power to appoint to his estate which heexercised in favor of his estate. Under the terms of his will, the residue of the estatepassed to W.

2. In each of the following situations, indicate whether and to what extent a deduction is allowableunder §2056:

a. H gives W a life estate in real property, with the remainder passing to their children. Thereal estate had a fair market value at the date of the decedent's death of $100,000. W was55 at the time of H's death.

b. H gives W his interest in a patent which will expire in 7 years. The patent has a fairmarket value of $10,000.

c. H sold interests in certain real estate to his daughter for $20,000. H was to retainpossession for 20 years, at which time his daughter would receive possession. At thetime of the sale, the fair market value of the interest transferred to the daughter was$20,000. D died after 10 years, at which time the full fair market value of the entireproperty was $100,000. H gave the right to possess the property for the remaining tenyears to W.

d. Same as (c), except that H initially gave the remainder interest in the property to hisdaughter.

e. Same as (d), except that under the terms of H's will, W received one-half of the residueof the estate, and the right to possess the real estate was included in the residue. The totalvalue of the residue, including the 10 year interest in the real estate, was $1,000,000.

f. H, by a provision in his will, ordered his executor to purchase a $100,000 annuity for W.The executor purchased the annuity which provided for the payment of $1,500 per monthto W for the remainder of her life. W was 60 years old at the time of H's death.

82

g. H was survived by W and a minor daughter. H had purchased an annuity contract duringhis life. At his death, the payments would continue to W for her life, and, at her death,any remaining excess of the cost of the contract over the annuity payments would bepayable to W. However, if W died before receiving all of the payments leaving minorchildren, the payments would continue for the minor children until they reach age 18, atwhich time the excess would be payable to the child's estate. At the time of death, theiryoungest child is 17 years and 10 months. The estate elects the alternate valuation date.(Rev. Rul. 85-100)

h. H gives $25,000 to W, with a direction that she pay his sister $5,000.

i. H leaves a parcel of real property to his mother for life, remainder to W. At the time ofhis death, H is survived by his mother (age 85) and W. The value of real property is$100,000.

j. Same as (i), except that H's mother dies 3 months after H's date of death, at the alternatevaluation date, the real property is worth $90,000, and the estate elects the alternatevaluation date.

83

Rev. Rul. 85-100

ISSUE

Does an employee death benefit annuity qualify for

the marital deduction under section 2056(a) of the

Internal Revenue Code, if another person's contingent

interest therein will be extinguished before the alternate

valuation date of section 2032 of the Code?

FACTS

Decedent, D died on February 1, 1983, survived by

a spouse, S, and a minor child. Prior to D's death, D had

the right to receive annuity payments for life. Under the

terms of the annuity contract, at D's death the payments

would continue to S for life. If S died leaving minor

children, the payments would continue to the minor

children until the last surviving child of D and S

reached 18, at which time any remaining excess of the

cost of the contract over the annuity payments already

made would be refunded to the surviving children. If S

died leaving no surviving minor children, the excess, if

any, was to be refunded to S's estate. C reached age 18

on June 5, 1983. Thus, had S died prior to June 5, 1983,

C would have been entitled to payments on the annuity

(and refund of the excess of the contract cost over the

annuity payments). Because S survived until June 5,

1983, S became entitled to receive all of the payments

of the annuity until S's death and to have the excess of

the cost of the contract over the sum of the annuity

payments distributed to S's estate.

The executor timely filed the estate tax return on

November 1, 1983, and elected to value all the property

included in D's gross estate as of August 1, 1983, the

alternate valuation date. No election was made to treat

any property in D's estate as qualified terminable

interest property.

LAW AND ANALYSIS

Section 2032(a) of the Code states that the value of

a decedent's gross estate may be determined, if the

executor so elects, by valuing all the property included

in the gross estate as of the date six months after the

decedent's death for property which has not been

distributed, sold, exchanged, or otherwise disposed of

proper to that date (commonly referred to as the

'alternate valuation date'). Under section 2032(a)(3), if

such an election is made, any interest affected by a mere

lapse of time will be included at its date of death value

(instead of the alternate valuation date) with adjustment

for any difference in its value as of the alternate

valuation date not due to mere lapse in time.

Section 2056(a) of the Code allows a deduction

from the value of the gross estate of the value of certain

property interests that are included in the decedent's

gross estate and that pass from the decedent to the

surviving spouse.

Under section 2056(a)(1), however, no deduction is

allowed for any property interest that passes to the

surviving spouse and that may terminate or fail on the

lapse of time or the occurrence or the failure to occur of

some contingency, if (1) another interest in the same

property has also passed from the decedent to some

other person for less than an adequate and full

consideration in money or money's worth, and (ii) by

reason of the passing of such interest, such other person

may possess or enjoy any part of the property after the

termination of the spouse's interest.

Whether a property interest meets the requirements

of section 2056(b) of the Code must be determined in

light of events at the time of the decedent's death. Allen

v. United States, 359 F.2d 151, 154 (2d Cir. 1966), cert.

denied, 385 U.S. 832 (1966). See Shedd's Estate v.

Commissioner, 237 F.2d. 345, 350-351 (9th Cir. 1956),

cert. denied. 352 U.S. 1024 (1957). An election to value

all property included in the gross estate as of the

alternate valuation date under section 2032 does not

affect the determination of whether a property interest

meets the requirements of section 2056(b). Section

2032(b) provides that no deduction from the gross

estate shall be allowed for any item if allowance of that

item is in effect given by selection of the alternate

valuation date under section 2032. With respect to the

marital deduction, Senate Report No. 1013 (Part 2),

80th Cong., 2d Sess. 10 (1948), 1948-1 C.B.338, states:

The election of the executor to determine the

value of the gross estate of a date subsequent

to the decedent's death, as provided in section

811(j) of the Code (the Internal Revenue Code

of 1939, the predecessor to section 2032 of the

Internal Revenue Code of 1954), does not

extend to such later date the time for

determining the character of the interest

passing to the surviving spouse and its

deductibility under (section 812(e)(1)(B) of

the 1939 Code, the predecessor to section

2056(b) of the 1954 Code). Section 811(j)

relates only to valuation and applies only with

respect to interest at the date of the decedent's

death....

84

In this case, the annuity received by S at D's death

constituted a terminable interest. Moreover, at the date

of D's death, C had a contingent right to the annuity

payments if S, the surviving spouse, should die before C

reached 18 years of age. Because C received an interest

in the annuity at D's death and could enjoy the interest

after the termination of S's interest, at D's death S's

interest is a nondeductible terminable interest as

described in section 2056(b) of the Code.

Therefore, as of the date of D's death, the value of

the annuity passing to S (to the extent includible in D's

gross estate) does not qualify for the marital deduction

under section 2056(a) of the Code.

If D had died after C had reached age 18, the value

of the annuity which passed to S would have been a

deductible terminable interest under section 2056(a) of

the Code because no other person would have had a

right to possess or enjoy the property after the

termination of S's interest.

HOLDING

The value of the annuity does not qualify for the

marital deduction under section 2056 of the Code, even

though another person's contingent interest will be

extinguished before the alternate valuation date under

section 2032, as elected by the decedent's estate.

ASSIGNMENT 15

85

Code: §§2056(b)(3), (5), and (7)Skim §§2044, 2056(b)(4), (6), and (8), and 2207A

Regulations: §§20.2056(b)-7(a)-(d)

S,M,L & C: ¶ 5.06[8] (Omit [c], [d][iv], and [e])

Readings: 58 Okla. Stat. Section 314Rev. Rul. 72-283

Questions:

1. H dies in 2007, survived by W. After H's death, W files for a support allowance pursuant toOklahoma law. The court awards her the sum of $10,000 for her support during the administrationof the estate. This money is payable from the residue of H's estate which passes to his child. Is thisamount deductible under §2056?

2. H dies leaving his IBM stock to W, with the residue of his estate passing to his children. On theadvice of his attorney, H included the following provisions in his will:

a. The will provides that W must survive H by six months in order to take. Will thestock qualify for the marital deduction?

b. W's interest in the stock will lapse and it will pass to others if she "should not livelong enough to probate" his will. W lives until D's will is probated, which occurswithin six months of D's death. Will the stock qualify for the marital deduction?

3. H dies leaving $1,000,000 in trust. Unless otherwise indicated, the terms of the trust providethat the income from the trust is to be paid monthly. Assuming that an election under §2056(b)(7) isNOT made, determine whether and to what extent a marital deduction is allowable in the followingcircumstances:

a. The third party trustee can pay any amount of income that she deems desirable to Wand must pay any accumulated income and corpus to W's estate at her death.

86

b. W receives an income interest for life, with a testamentary power to appoint theproperty to her estate. In default of her appointment, the corpus will pass to herchildren.

c. Same as (b), except that W has to exercise her power to appoint to her estate duringher life.

d. Same as (c), except that W can only exercise the power together with X.

e. Same as (b), but soon after H's death, W becomes incompetent and was placed undera conservatorship. Under state law, the conservator could not exercise the power forher.

f. Same as (b), except that the trustee has the power to distribute corpus to W's childrenfor their health and education during their minority, and, at the time of H's death, theyare all under 18 years of age.

g. W receives one-half of the income for her life, with a testamentary power to appointall the property to her estate. In default of her appointment, the corpus will pass toher children.

h. W receives $1,000 per month for her life, with a testamentary power to appoint theproperty to her estate. In default of her appointment, the corpus will pass to herchildren.

4. In each of the following situations, indicate whether and to what extent the estate can make aQTIP election under §2056(b)(7):

87

a. Under the terms of his will, H gives W a life estate in real property, remainder to theirchildren.

b. H establishes a trust from which W receives an income interest for life, with theremainder going to the children of H's first marriage.

c. Same as (b), except that the trustee is directed to compute the income after the end ofeach year, and, in the subsequent year, distribute the previous year's income inmonthly installments. (Rev. Rul. 72-283)

d. Same as (b), except that W is given a testamentary power to appoint among thechildren of H's first marriage.

e. Same as (b), except that W is given an inter vivos power to distribute principalamong the children of H's first marriage.

f. Same as (b), except that a third party trustee has a power to distribute principal to W.

g. If the facts are the same as (b) and a §2056(b)(7) election was made, what furtherestate or gift consequences will occur? Consider as well the liability for any taxconsequences.

88

Rev. Rul. 72-283

Advice has been requested whether a marital

deductions is allowable under section 2056 of the

Internal Revenue Code of 1954 with respect to the

testamentary trust created by the decedent under the

circumstances described below.

The decedent bequeathed in trust one-half of his

adjusted gross estate. He provided in his will:

One year after the trust has been created and the net

income from the trust for the past year has been

determined, that is, the income from the trust less all

charges and reasonable reserves, such income shall be

quarterly paid to my wife as long as she may live, and

this shall continue by paying in each year the net

income of the past year.

Decedent also gave his wife the exclusive power to

appoint the trust corpus by will. In the absence of her

exercise of such right, upon her death the trust is to end

and the corpus is to be paid to her heirs under the laws

of descent and distribution of the state.

Section 20.2056(b)-5 of the Estate Tax Regulations

provides that if an interest in property passes from the

decedent to his surviving spouse and the spouse is

entitled for life to the income from the entire interest or

all the income from a specific portion of the entire

interest, with a power in her to appoint the entire

interest or the specific portion, the interest which passes

to her is a deductible interest to the extent that it

satisfies all five of the following conditions:

(1) The surviving spouse must be entitled for life

to all the income from the entire interest or to a specific

portion of the entire interest, or to a specific portion of

all the income from the entire interest.

(2) The income payable to the surviving spouse

must be payable annually or at more frequent intervals.

(3) The surviving spouse must have the power to

appoint the entire interest or the specific portion to

either herself or her estate.

(4) The power in the surviving spouse must be

exercisable by her alone and (whether exercisable by

will or during life) must be exercisable in all events.

(5) The entire interest or the specific portion must

not be subject to a power in any other person to appoint

any part to any person other than the surviving spouse.

Section 20.2056(b)-5(f)(8) of the regulations

provides that in the case of an interest passing in trust,

the terms 'entitled for life' and 'payable annually or at

more frequent intervals,' as used in the conditions set

forth in paragraphs (1) and (2), above, require that

under the terms of the trust the income must be

currently distributable to the spouse or that she must

have such command over the income that it is virtually

hers.

The one-year delay in the payment of trust income

conflicts with the second condition of the regulations,

i.e., the requirements that the income be payable

annually or at more frequent intervals. In order that this

condition be satisfied, it is required that the income be

currently distributable to the surviving spouse. Where

there is a mandatory delay of at least a year before

income may be paid out, such payment of income is not

considered current. Consequently, the trust does not

comply with the second condition of the regulations.

Accordingly, it is held that the estate tax marital

deduction is not allowable with respect to the

testamentary trust established by the decedent in this

case.

Okla. Stat. tit. 58, §314

If the amount set apart as aforesaid be less than that

allowed, and insufficient for the support of the surviving

spouse and children, or either, or, if there be no such

personal property to be set apart, and if there be other

estate of the decedent, the court may in its discretion

make such reasonable allowance out of the estate as

shall be necessary for the maintenance of the family,

according to their circumstances during the progress of

the settlement of the estate, which, in case of an

insolvent estate, must not be longer than one (1) year

after granting letters testamentary, or of

administration.

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ASSIGNMENT 16

Code: §§2501(a)(1) and 2511(a)

Regulations: §§25.2511-1(e)-(h) and 25.2511-2

S,M,L & C: ¶ 10.01 (Omit [3], [5][d] and [e], [10], and [11])

Questions:

1. Here are some transactions that have been considered from the standpoint of their estate taxsignificance upon the death of the transferor. To what extent do they constitute transfers subject togift tax at the time of the transfer?

a. D gave an insurance policy on his life to S and died within one month after thetransfer.

b. D transferred securities to a trust, retaining the right to the income for his life, andproviding for payment of the corpus at his death to S or S's estate.

c. D transferred securities to a trust, under the terms of which the income was to be paidto S for S's life. Upon S's death, the corpus was to be returned to D if living. Otherwise, it was to be paid to X or X's estate.

d. D transferred securities to a trust, under the terms of which the income was to be paidto S for S's life. Upon S's death, the remainder was to go to X or X's estate, but Dretained an unlimited right to alter the terms of the trust in any manner.

2. D owns 60% and X owns 40% of the stock of Acme. To what extent are there taxable gifts in thefollowing situations:

a. Because of Acme's cash flow problems, D contributes $100,000 to the capital ofAcme Co. X does not make or obligate himself to make any contribution since healso is financially strapped.

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b. X had borrowed $50,000 from a loan shark. In a separate transaction, Acme paid X'sdebt so that X would not get his legs broken.

3. In 2005, D gives S a check in the amount of $10,000 at Christmas. S does not cash the checkuntil January 3, 2007. When is this treated as a completed gift?

4. What are the gift tax consequences of the following transfers:

a. D establishes a savings account, depositing $50,000 of his own funds into an account"D and S, as joint tenants."

b. Same as (a), except that the account is "D and/or S."

c. D purchases real estate for $100,000 with his own funds, taking title as "D and S, asjoint tenants".

5. D owned a contingent remainder in a trust, which he transferred to Son. Under the trustterms, income was payable to A for life. X was to receive the remainder if he survived A. Otherwise, the remainder would pass to D or his estate. D paid a gift tax on the transfer to S. Oneyear later, A (the income beneficiary) died survived by X. D sued for a refund of the gift tax. Whatresult?

6. Prior to rendering services as executor of an estate, E renounces any right to compensation. As a result, the $10,000 fees he would have earned passes to the residuary beneficiaries. Has E madea taxable gift?

7. D creates a trust with income payable for his life either to A or to B, as D directs, remainder

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to C or C's estate. D retains a power to revoke. What are the gift tax consequences in the followingsituations:

a. Has D made a completed gift at the time of trust's creation?

b. At D's direction, the first year's income is paid equally to A and B.

c. Same as (b), except that at the end of year one, D relinquishes his power to revoke,but not his right to direct income payment.

d. Same as (c), except that at the end of year two, D directs that year's income to be paidto A and that all remaining income during D's life be paid to A or A's estate.

8. D creates a trust with income to A for life, remainder to A's estate. D reserves the right toaccumulate income, adding it to corpus. Has D made a taxable gift?

9. D creates a trust with income to A for A's life, remainder to B or B's estate. What are the gifttax consequences in the following situations:

a. D retains a power to give income to C, but only with A's approval.

b. D retains a power to revoke the entire trust, but only with A's approval.

c. D retains no power over trust income, but a power to make C or his estate theremainderman if he secures A's approval.

d. D retains a power to give either the income or the remainder or both to C, but onlywith A's approval.

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10. D creates a trust with an independent trustee. Has a completed gift been made in thefollowing situations:

a. The trustee has the power to give income to A or B for D's life. On D's death, theremainder shall pass to C or C's estate.

b. Same as (a), except that D reserved the right to remove the trustee and appointhimself?

11. D creates a trust with an independent trustee. Trustee is directed to pay income to D for D'slife, remainder to B or B's estate. To what extent has a completed gift been made in the followingsituations:

a. In addition, the trustee has the power to distribute to D amounts from principal for hismaintenance and support.

b. In addition, the trustee has the power in its absolute discretion to make distributionsfrom principal to D.

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ASSIGNMENT 17

Code: §2512Skim §2503(e)

Regulations: §§25.2512-1 and 25.2512-8.

S,M,L & C: ¶ 10.02 (Omit [1][b], 2[b]-[g], 5[d], and 7)

Readings: Sachs v. Comm'r

Questions:

1. D and S, who are father and son, own adjoining lots in a residential area, each worth $40,000. D needs $20,000 for use in his business and offers his lot to S for $20,000. S agrees to buy it for thatprice. Are there any gift tax consequences?

2. D was considering getting married for a second time. He was currently receiving about$5,000 per year in income from a trust established by his first wife. However, his income rights wereto cease on his remarriage. Motivated by true love, D's fiance agreed to transfer stock worth$150,000 to D so that he would not suffer financial loss. Are there any gift tax consequences?

3. For several months Fred negotiated with his uncle Ned for the purchase of 100 acres of Ned'sranch. Ned finally sells the land to Fred for $80,000. The Commissioner asserts (and it cannot bedisproved), that the property was worth $100,000.

a. Has Ned made a gift to Fred?

b. Is Ned's intent, donative or otherwise, at all relevant?

4. D transfers $50,000 cash to his brother on the condition that he transfer Blackacre, worth$20,000, to their sister. What are the gift tax consequences?

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5. In the current year, the following events occur. What are the gift tax consequences?

a. D gives his nineteen-year old daughter $15,000 cash as he agreed to do if she wouldpractice safe sex, which she agreed to do.

b. D gives his sixteen-year old son a $15,000 automobile so the he can get himself toand from high school.

c. D transfers the sum of $50,000 to a trust. The trustee is authorized to spend as muchof the income and principal as necessary to support D's 12 year old daughter. Whenthe daughter attains age 18, the trustee is directed to return the balance of the trust toD.

6. D owned real property with a value of $200,000 in which he had a basis of $50,000. D wantsto give the property to B.

a. What if the property is subject to a $75,000 mortgage which B agrees to assume?

b. What if D's cash position was so poor that he asked B to pay the resulting gift tax. Bagreed and the transfer was completed.

c. Would the result be different if there were no agreement B would pay but the tax wascollected from him? See §6324(b).

7. X (age 60) and Y (age 55) own Blackacre as tenants in common. In order to protect thesurvivor from the sale of the property after the first owner dies, they transfer the property to airrevocable trust, with income payable equally to them during their joint lives. After the death of thefirst to die, the survivor receives all the income during the remainder of her life, and on her death, itpasses to their nephew Bob or his estate. To what extent has a taxable gift been made. If a gift hasbeen made, do not make an effort to value that gift.

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ASSIGNMENT 18

Code: §2514 (omit (a), (d), and (f))

Regulations: §§25.2514-1(b) and 25.2514-3(c) and (e)

S,M,L & C: ¶ 10.04 (Omit [3] and [5])

Questions:

1. D is the income beneficiary of a trust. Under the terms of the trust, there are no restrictionson D's right to transfer his life interest.

a. Does §2514 have any bearing on the tax consequences of D's exercise of this right.

b. Are there any other gift tax provision applicable to the D's transfer of his incomeinterest?

2. What are the transfer tax consequences of the following transactions:

a. D exercises a general power of appointment over the corpus of a trust by appointingone half of that corpus to himself.

b. D exercises a general power of appointment over the corpus of a trust by appointingthe corpus to a second trust, the income to be paid to D for his life, with the remainderpassing to R or R's estate.

c. D has an unrestricted right to alter the terms of a trust created by S. D substitutes Afor B as remainderman of the trust, without relinquishing his right to make furtheralterations.

3. In the current year, D drafts a will which leaves W a life interest in a trust with a power toappoint corpus to their children during her life and a power to appoint to anyone by her will. In the

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event she fails to appoint the property, it passes at her death to their children equally.

a. After D's death, W exercises the power to appoint during her lifetime by appointingthe entire corpus to Daughter. Are there any tax consequences to W?

b. W dies two years after making the appointment in (a). Are there any estate taxconsequences to W on her death?

c. What estate tax consequences to D on his death?

4. D was the income beneficiary of a trust created by X with a remainder to R or R's estate. Dalso had a noncumulative annual power to withdraw $30,000 per year from the corpus of the trust,which at all times had a value of $60,000.

a. What transfer tax consequences if D does not exercise the power in the first year?

b. What transfer tax consequences in year 4 if D did not exercise his power in that year,assuming D never exercised his power in any year?

c. What transfer tax consequences if D dies in year 5 with D never exercising his powerto withdraw?

5. D creates a trust with income to A for life, remainder to C. D retained a right to revoke theremainder interest. D also retained the right to accumulate income, but only with A's consent. Whatare the gift tax consequences in the following situations:

a. At the time of the creation of the trust.

b. In year 1, A relinquishes his right to prevent the accumulation of income.

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c. After A's relinquishment of his rights as provided in (b), D permits $15,000 of incometo be distributed to A in year 1.

d. D releases his power to revoke the remainder interest in year 2.

e. What result in (c) if D did not have the power to revoke the remainder interest?

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ASSIGNMENT 19

Code: §§2503, 6019(a), and 6075(b)

Regulations: §§25.2503-1

S,M,L & C: ¶ 9.04

Questions:

1. D pays his twenty-two year old son's law school expenses at New York University in theamount of $25,000. What are the gift tax consequences.

2. D creates a trust with income to A for A's life and a remainder to B or B's estate. Does Dmake a gift of a "present interest" to either A or B in the following circumstances:

a. D retains no powers.

b. D make A's interest subject to a spendthrift clause. (A spendthrift clause generallyprovides that A cannot alienate his interest and that creditors cannot attach hisinterest)

c. D names a third-party trustee who holds a power to accumulate income.

d. D names a third-party trustee who is required to distribute all income to A or C forA's life, with the remainder passing to B or B's estate.

e. Same as (c), except that the trustee can accumulate income only with A's approval.

f. D names a third-party trustee who holds a power to invade corpus for A.

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3. D, a single taxpayer, transferred securities worth $20,000 to an irrevocable trust providing forpayment of the income to A for four years and then a distribution of the remainder to A or his estate. Assume that at the time of the transfer A's income interest was properly valued at $5,000, theremainder was properly valued at $15,000, and that this was the first gift that D has ever made.

a. To what extent, if at all, can D claim an annual exclusion?

b. What is the "total amount of gifts" made by him in the year?

c. Might D's taxable gifts be less if the income interest given to A was for a longer termof years?

d. If the transfer in (a), was D's only transfer for the year, would he be required to file agift tax return for the year?

e. If a return is required, when would it be due?

4. D, a single taxpayer, was the owner of a policy of insurance on his own life. The policy wasa "whole life" policy requiring annual $1,000 premium payments until his death.

a. When the policy was properly valued at $15,000, D assigned all his right, title, andinterest in the policy to son S. If this was D's only gift in the year, what was the "totalamount of gifts" by D for the year?

b. If, a year later, D paid the $1,000 premium on the policy, would D have to file a gifttax return?

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c. How do you differentiate your answers to (a) and (b), from Example (2) in Reg.§25.2503-3(c).

d. What result under Example (2) in Reg. § 25.2503-3(c), if S has an unrestricted right todemand any amount of transfers to the trust up to a maximum of $10,000 at any timeduring the year of the transfer?

5. Brother who is hurting both financially and physically, is given $15,000 by Sister in thecurrent year to reimburse him for $8,000 of medical costs he incurred and to provide for hissupport. What is the "total amount" of Sister's gift to Brother in the year.

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ASSIGNMENT 20

Code: §2518

Regulations: §§25.2518-2 and 3 (Omit examples)

S,M,L & C:

Questions:

1. D created an irrevocable trust with income for life to A, age 50, to be paid monthly, andprovided A with a general testamentary power of appointment over the corpus of the trust. In defaultof appointment, the property passes to B, age 30, or B's estate. Donor created the trust on January 1of year one and A dies on January 1 year five. Assuming all disclaimers below are in writing and aretransmitted to the proper person, determine if each is a "qualified disclaimer" as described in §2518.

a. A receives the first six months of income and, on July 1 of year one, disclaims hisincome interest.

b. A receives the first six months of income and, on July 1 of year one, disclaims hisgeneral power of appointment.

c. Same as question (b), except that A disclaims his general power to appoint over onlyone half of the corpus.

d. On August 1 of year one, A disclaims any right to exercise the general power in his orhis estate's favor, thereby converting his general power of appointment to a specialpower.

e. In view of A's disclaimer on July 1 of year one in (c), B disclaims his interest onDecember 1 of year one.

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f. Same as (e), except that A held a special power to appoint to someone other thanhimself, his estate, his creditors, or the creditors of his estate.

g. Assume A has a general power of appointment. A dies on January 1 of year five,exercising his general power of appointment upon his death in favor of C. Cdisclaims on June 1 of year five with regard to the receipt of the property.

h. In view of C's action in (g), B disclaims his interest on December 1 of year five.

i. Same as (g), except that C disclaims a remainder interest in the property but retainsthe right to income for his life.

2. D writes a will leaving the residue of his estate to X. In the event that X disclaims all or anyportion of the residue, the disclaimed portion passes into a trust from which X receives the incomefor his life, and the remainder passes to Y. D dies on January 1 in the current year. Are thedisclaimers qualified in the following situations:

a. If X is the surviving spouse, can X file a qualified disclaimer on June 1?

b. Assume that X is a child, can X file a qualified disclaimer on June 1?

c. Same as (a), except that X also had a special power to appoint the corpus of the trust,on her death, to any of her children. In default of appointment, it goes to Y.

d. Same as (a), except that X has a power to withdraw $5,000 or 5% of the trust corpus,whichever is greater, each year.

e. Same as (a), except that X files a qualified disclaimer with respect to $100,000.

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3. On January 1, 2007, D creates a joint account at Sooner State Bank, depositing $50,000 in hisname and in the name of X. There were no other transactions. On June 1, 2007, D dies. When mustX file a qualified disclaimer?

4. In 1973, H acquired a farm with funds that he inherited from his parents. He took title to thefarm in the name of himself and W, as joint tenants. On January 1, 2007, H died, and, under statelaw, the title to the farm passed automatically to W. What, if anything, can W disclaim within 9months of H's death?

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ASSIGNMENT 21

Code: §§2519, 2522(a), 2522(c), 2523, 2524, and 6019(a). See §§2044 and 2207A.

S,M,L & C: ¶ 11.01, 11.02, 11.03, and 11.04 (omit 11.03[5]).

Questions:

1. In the current year, Fred gives $20,000 cash to charity and $20,000 cash to his son. Fredclaims that he had made no taxable gifts based on the following calculations:

Gross Gifts $40,000 Exclusions (2) $20,000 Charitable deduction 20,000

40,000

Taxable gifts -0-

a. Is the above computation correct?

b. Will Fred make a taxable gift if he puts $20,000 cash in a trust with income to A for aperiod of years (assume that A's interest is worth $10,000) and a remainder to charity?

2. Assume that H has made no other post-1976 transfers to W. H transfers property worth$20,000 to a trust. In each instance, assume the income interest is worth $10,000 at the timeof the gift. What, if any, marital deduction is H entitled to in the following situations?

a. The income to be paid to his mother M for her life, remainder to wife W or W'sestate.

b. The income to be paid to wife W for her life, remainder to son S or S's estate.

c. The income to paid to wife W for ten years, remainder to wife W or W's estate.

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3. Determine the extent to which the gift tax marital deduction is available in the followingtransactions.

a. Husband purchases for $200,000 a parcel of real property for himself and his wife asjoint tenants with right of survivorship.

b. Husband places $100,000 in trust with income to Wife for life and a remainder totheir children. In addition, Wife is given a power to appoint the corpus to anyone bywill.

c. Husband places $100,000 in trust with income to Wife for life and a remainder to thechildren of his first marriage.

4. Consider the following:

a. Is a gift return required to be filed in questions 3(a), 3,(b), or 3(c), above?

b. What are the gift tax consequences to Wife in question (3)(c) if Husband makes a§2523(f) election and Wife gives her life estate or some portion of it to a third personprior to her death?

c. What estate tax consequences to Wife in 3(c) if Husband makes a §2523(f) electionand Wife dies without any inter vivos disposition of her life estate?