Estate of D'Ambrosio v. C.I.R.

• Decision Date: 26 November 1996
• Docket Number: No. 95-7643,95-7643
• Citation: 101 F.3d 309
• Parties: -7347, 65 USLW 2380, 96-2 USTC P 60,252 ESTATE OF Rose D'AMBROSIO, Deceased, Vita D'Ambrosio, Executrix, Appellant, v. COMMISSIONER OF INTERNAL REVENUE SERVICE.
• Court: U.S. Court of Appeals — Third Circuit

Page 309

101 F.3d 309

78 A.F.T.R.2d 96-7347, 65 USLW 2380,

96-2 USTC P 60,252

ESTATE OF Rose D'AMBROSIO, Deceased, Vita D'Ambrosio,

Executrix, Appellant, v. COMMISSIONER OF INTERNAL REVENUE SERVICE.

No. 95-7643.

United States Court of Appeals, Third Circuit.

Argued June 4, 1996.

Decided Nov. 26, 1996.

Harvey R. Poe (argued), Poe & Rotunda, Florham Park, NJ, for Appellant.

Charles Bricken (argued), Gary R. Allen, Gilbert S. Rothenberg, United States Department of Justice, Tax Division, Washington, DC, for Appellee.

Before: COWEN, NYGAARD and LEWIS, Circuit Judges.

OPINION OF THE COURT

NYGAARD, Circuit Judge.

Vita D'Ambrosio, executrix of the estate of Rose D'Ambrosio, appeals from a judgment of the United States Tax Court upholding a statutory notice of deficiency filed against the estate by the Commissioner of Internal Revenue. The tax court held that, even though the decedent had sold her remainder interest in closely held stock for its fair market value, 26 U.S.C. § 2036(a)(1) brought its entire fee simple value back into her gross estate. We will reverse and remand with the direction that the tax court enter judgment in favor of appellant.

I.

The facts in this case have been stipulated by the parties. Decedent owned, inter alia, one half of the preferred stock of Vaparo, Inc.; these 470 shares had a fair market value of $2,350,000. In 1987, at the age of 80, decedent transferred her remainder interest in her shares to Vaparo in exchange for an annuity which was to pay her $296,039 per year and retained her income interest in the shares. There is no evidence in the record to indicate that she made this transfer in contemplation of death or with testamentary motivation. According to the actuarial tables set forth in the Treasury Regulations, the annuity had a fair market value of $1,324,014. The parties stipulate that this was also the fair market value of the remainder interest.

Decedent died in 1990, after receiving only $592,078 in annuity payments and $23,500 in dividends. Her executrix did not include any interest in the Vaparo stock when she computed decedent's gross estate. The Commissioner disagreed, issuing a notice of deficiency in which she asserted that the gross estate included the full, fee simple value of the Vaparo shares at the date of death, still worth an estimated $2,350,000, less the amount of annuity payments decedent received during life. ¹ The estate then petitioned the tax court for redetermination of the alleged tax deficiency.

The tax court, relying largely on Gradow v. United States, 11 Cl.Ct. 808 (1987), aff'd, 897 F.2d 516 (Fed.Cir.1990), and Estate of Gregory v. Commissioner, 39 T.C. 1012, 1963 WL 1488 (1963), ruled in favor of the Commissioner. Eschewing any attempt to construe the language of either the Code or the applicable Treasury Regulations, the tax court reasoned that the transfer of the remainder interest in the Vaparo stock was an abusive tax avoidance scheme that should not be permitted:

In the instant case, we conclude that Decedent's transfer of the remainder interest in her preferred stock does not fall within the bona fide sale exception of section 2036(a). Decedent's gross estate would be depleted if the value of the preferred stock, in which she had retained a life interest, was excluded therefrom. Decedent's transfer of the remainder interest was of a testamentary nature, made when she was 80 years old to a family-owned corporation in return for an annuity worth more than $1 million less than the stock itself. Given our conclusion that Decedent did not receive adequate and full consideration under section 2036(a) for her 470 shares of Vaparo preferred stock, we hold that her gross estate includes the date of death value of that stock, less the value of the annuity.

Estate of D'Ambrosio v. Commissioner, 105 T.C. 252, 260, 1995 WL 564078 (1995). The executrix now appeals; we have jurisdiction under 26 U.S.C. § 7482. Both parties agree that our standard of review for this issue of law is plenary.

II.

Our nation's tax laws have, for several generations, imposed a tax upon decedents' estates. Under 26 U.S.C. § 2033, a decedent's gross estate includes "[t]he value of all property to the extent of any interest therein of the decedent at the time of his death." In addition the Code contains, among other provisions, § 2036(a), 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 (except in case of a bona fide sale for 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[.]

Section 2036(a) effectively discourages manipulative transfers of remainder interests which are really testamentary in character by "pulling back" the full, fee simple value of the transferred property into the gross estate, except when the transfer was "a bona fide sale for adequate and full consideration."

There is no dispute that Rose D'Ambrosio retained a life interest in the Vaparo stock and sold the remainder back to the company. The issue is whether the sale of a remainder interest for its fair market value constitutes "adequate and full consideration" within the meaning of § 2036(a). Appellant argues that it does. The Commissioner takes the position that only consideration equal to the fee simple value of the property is sufficient. Appellant has the better argument.

A.

The tax court and the Commissioner rely principally on four cases, Gradow v. United States, 11 Cl.Ct. 808 (1987), aff'd for the reasons set forth by the claims court, 897 F.2d 516 (Fed.Cir.1990); United States v. Past, 347 F.2d 7 (9th Cir.1965); Estate of Gregory v. Commissioner, 39 T.C. 1012, 1963 WL 1488 (1963); United States v. Allen, 293 F.2d 916 (10th Cir.1961). We find these cases either inapposite or unpersuasive; we will discuss them in chronological order.

In Allen, the decedent set up an irrevocable inter vivos trust in which she retained a partial life estate and gave the remainder (as well as the remaining portion of the income) to her children. Apparently realizing the tax liability she had created for her estate under the predecessor of § 2036, she later attempted to sell her retained life interest to her son for an amount slightly in excess of its fair market value. After she died, the estate took the position that, because decedent had divested herself of her retained life interest for fair market value, none of the trust property was includable in her gross estate. The Court of Appeals disagreed, holding that consideration is only "adequate" if it equals or exceeds the value of the interest that would otherwise be included in the gross estate absent the transfer. See 293 F.2d at 917. Although acknowledging that the decedent owned only a life estate, which she could not realistically hope to sell for its fee simple value, the court nevertheless rejected the estate's argument, opining:

It does not seem plausible, however, that Congress intended to allow such an easy avoidance of the taxable incidence befalling reserved life estates. This result would allow a taxpayer to reap the benefits of property for his lifetime and, in contemplation of death, sell only the interest entitling him to the income, thereby removing all of the property which he has enjoyed from his gross estate. Giving the statute a reasonable interpretation, we cannot believe this to be its intendment. It seems certain that in a situation like this, Congress meant the estate to include the corpus of the trust or, in its stead, an amount equal in value.

Id. at 918 (citations omitted).

Allen, however, is inapposite, as the Commissioner now concedes, because it involved the sale of a life estate after the remainder had already been disposed of by gift, a testamentary transaction with a palpable tax evasion motive. This case, in contrast, involves the sale of a remainder for its stipulated fair market value. Nevertheless, we agree with its rationale that consideration should be measured against the value that would have been drawn into the gross estate absent the transfer. As the tax court persuasively reasoned in a later case:

[W]here the transferred property is replaced by other property of equal value received in exchange, there is no reason to impose an estate tax in respect of the transferred property, for it is reasonable to assume that the property acquired in exchange will find its way into the decedent's gross estate at his death unless consumed or otherwise disposed of in a nontestamentary transaction in much the same manner as would the transferred property itself had the transfer not taken place....

In short, unless replaced by property of equal value that could be exposed to inclusion in the decedent's gross estate, the property transferred in a testamentary transaction of the type described in the statute must be included in his gross estate.

Estate of Frothingham v. Commissioner, 60 T.C. 211, 215-16, 1973 WL 2531 (1973) (emphasis added).

Gregory presents a closer factual analogy to D'Ambrosio's situation. Gregory was a "widow's election" case involving the testamentary disposition of community property. Typically in such cases, the husband wishes to pass the remainder interest in all of the marital property to his children, while providing for the lifetime needs of his surviving spouse. In a community property state, however, half of the marital property belongs to the wife as a matter of law, so he cannot pass it by his own will. To circumvent this problem, the will is drafted to give the widow a choice: take her one-half share in fee simple, according to law, or trust over her half...