Kisling v. C.I.R.

• Decision Date: 10 August 1994
• Docket Number: No. 93-3528,93-3528
• Citation: 32 F.3d 1222
• Parties: -5672 Erma M. KISLING, Deceased; William L. Kisling, Jr., Personal Representative; John W. Kisling, Personal Representative; and Rosemary Kisling Doerr, Personal Representative, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.
• Court: U.S. Court of Appeals — Eighth Circuit

Page 1222

32 F.3d 1222

74 A.F.T.R.2d 94-5672

Erma M. KISLING, Deceased; William L. Kisling, Jr. Personal Representative; John W. Kisling Personal Representative; and Rosemary Kisling Doerr, Personal Representative, Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Appellee.

No. 93-3528.

United States Court of Appeals Eighth Circuit.

Submitted April 11, 1994.

Filed Aug. 10, 1994.

John L. Sullivan, St. Louis, MO, argued, for appellants.

Curtis C. Pett, Dept. of Justice, Washington, DC, argued, for appellee.

Before RICHARD S. ARNOLD, Chief Judge, HENLEY, Senior Circuit Judge, and BEAM, Circuit Judge.

RICHARD S. ARNOLD, Chief Judge.

The taxpayer in this case, the estate of Erma M. Kisling, appeals a decision of the United States Tax Court granting summary judgment to the Commissioner of Internal Revenue. On two separate occasions, both of which occurred within three years of her death in 1987, Mrs. Kisling executed three identical irrevocable assignments of fractional interests in the corpus of her trust, one to each of her children. The three children, serving as the personal representatives of the estate, omitted the assigned interests from the gross estate for the computation of estate taxes, but the Internal Revenue Service determined otherwise. The IRS sent a deficiency notice to one child, William L. Kisling, Jr., with a copy to the estate's lawyer. The personal representatives contested the IRS's ruling and argued that sending the notice of deficiency to only one of them was insufficient. The Tax Court held that notice to one of the personal representatives served as notice to all. In addition, it held that the interests transferred were includable in the gross estate under Sections 2035 and 2038 of the Internal Revenue Code, because the assets were never actually severed from Mrs. Kisling's trust. We reverse.

I.

In February of 1986, Mrs. Kisling amended and restated a revocable trust she had created in 1981. The trust instrument included several provisions which provided Mrs. Kisling, as the Settlor, with the power to create irrevocable, fractional shares in the trust for her lineal descendants and their spouses and also provided her with the power to alter, amend, or modify the trust at will. ¹ The trust instrument also provided that the beneficiaries of the fractional interests would receive any income attributable to those interests. ²

Mrs. Kisling exercised her power of assignment in December of 1986 when she executed three Assignments of Interest, one for each of her three children. Each child received an irrevocable fractional interest in the corpus of the trust worth approximately $10,000. Mrs. Kisling repeated this process in January of 1987. Each assignment stated that:

The undersigned Settlor, exercising her reserved power to designate beneficiaries and to set over to them irrevocably fractional interests in the trust estate, hereby assigns, conveys and sets over irrevocably to [name of child] an undivided .0055 fractional interest in and to the corpus of the trust estate ... existing as of the date of this assignment, thereby irrevocably entitling the assignee to the income derived by such fractional interest and the vested interest in the principal pertaining thereto.

Mrs. Kisling died testate in September of 1987. Her estate filed an estate tax return which included the value of the interest in the revocable trust remaining in Mrs. Kisling's name at the time of her death as part of her gross estate. The return did not include the value of the irrevocable interests, totalling $60,000, transferred by Mrs. Kisling to her children in 1986 and 1987.

The Internal Revenue Service sent a tax-deficiency notice to William L. Kisling, Jr., one of the beneficiaries of the fractional interests, and one of the three personal representatives of the estate. The notice stated that the fractional interests Mrs. Kisling had assigned before her death were taxable as part of her gross estate under Sections 2035 and 2038 of the Internal Revenue Code. Thus, according to the IRS, the value of Mrs. Kisling's estate was $60,000 more than that included in decedent's estate tax return.

II.

Under Section 2001 of the Internal Revenue Code, the taxable estate of every decedent who is a resident of the United States is subject to the federal estate tax. The Code defines the taxable estate as the gross estate less deductions. I.R.C. Sec. 2051. The gross estate includes the value of all interests in property which belong to the decedent at the time of death. I.R.C. Secs. 2031, 2033. In addition, under Section 2035(a), all transfers made within three years of the decedent's death are includable in the gross estate, unless they are excluded under another provision of the Code. Section 2035(b)(2) exempts from the estate tax gifts for which the decedent was not required to file a gift tax return. For transfers made after December 31, 1981, Section 2035(b) excludes the first $10,000 per year, per donee. Section 2035(d)(1) further limits 2035(a) by providing that, generally, gift transfers made after December 31, 1981, are not taxable, unless they fall into the provisions enumerated in Section 2035(d)(2). Thus, such gifts are generally not includable in the gross estate of a decedent, unless they are recaptured under another provision of the Code. Jalkut v. Commissioner, 96 T.C. 675, 679, 1991 WL 64935 (1991).

Sections 2035 and 2038 of the Code apply to the transfers in this case. Even though Mrs. Kisling made the transfers at issue within three years of her death, they are not taxable, under Section 2035(d)(1), unless they are recaptured pursuant to the sections enumerated in 2035(d)(2). I.R.C. Sec. 2038 is one of those sections. Section 2035(d) states:

SEC. 2035(d). DECEDENTS DYING AFTER 1981.--

(1) IN GENERAL.--Except as otherwise provided in this subsection, subsection (a) shall not apply to the estate of a decedent dying after December 31, 1981.

(2) EXCEPTIONS FOR CERTAIN TRANSFERS.--Paragraph (1) of this subsection and paragraph (2) of subsection (b) shall not apply to a transfer of an interest in property which is included in the value of the gross estate under section 2036, 2037, 2038, or 2042 or would have been included under any of such sections if such interest had been retained by the decedent.

Section 2038(a)(1) states in part:

The value of the gross estate shall include the value of all property--

... [t]o the extent of any interest therein of which the decedent has at any time made a transfer ... where the enjoyment thereof was subject at the date of his death to any change through the exercise of a power ... to alter, amend, revoke, or terminate, or where any such power is relinquished during the 3-year period ending on the date of the decedent's death.

Under Section 2038, transfers made during the life of the decedent are includable in the gross estate if enjoyment of the transferred property is limited or subject to change, because the decedent retained power to alter, amend, revoke, or terminate the transfer or relinquished that power within three years of her death--even if the decedent does not exercise those powers. Jalkut, 96 T.C. at 682, 1991 WL 64935, at *----. Whether or not the decedent's actions qualify as a transfer turns on the actual terms of the trust. Id. at 684, 1991 WL 64935, at *----.

In Jalkut, the Tax Court applied Sections 2035 and 2038 to two sets of gift transfers from a trust made within three years of the decedent's death. It looked at the first set of transfers made by the decedent and, after concluding that the decedent was the sole permissible distributee of the income and principal of the revocable trust, it determined that the transfers could only have been made pursuant to the decedent's power to withdraw both income and principal from the trust. On the basis of this conclusion, the Tax Court held that the decedent had exercised his power to withdraw assets and had then made transfers to the donees. The Tax Court characterized these gifts as "withdrawals preceding direct gift transfers by the decedent," and reasoned that it "necessarily follow[ed] that the transfers [did] not constitute a relinquishment of the decedent's power to alter, amend, revoke, or terminate the trust ... as contemplated under section 2038." Id. at 685, 1991 WL 64935, at *----.

The Tax Court distinguished those transfers from a second set of transfers made by substitute trustees after the decedent was pronounced unfit to manage his own affairs. The substitute trustees had the power to distribute income and principal to both the decedent and his descendants. According to the Tax Court, transfers by the trustees to persons other than the decedent could not properly be categorized as withdrawals by the decedent. Instead, those transfers were actually a relinquishment by the decedent, through the trustees, of his power to alter, amend, revoke, or terminate the trust with respect to those assets. As a result, those assets, if retained by the decedent, would have been taxable as part of his gross estate, and should continue to be taxable as such. Id. at 685-86, 1991 WL 64935, at *----.

Since the Jalkut case, two other decisions have been rendered which are relevant to our determination of whether Mrs. Kisling's transfers are exempt under Sections 2035 and 2038. In Estate of Barton v. Commissioner, T.C.Memo. 1993-583, 1993 WL 503909, the Tax Court considered whether gifts of stock transferred from a decedent's revocable trust within three years of her death were includable in her gross estate. The government argued that Barton had relinquished her powers with respect to the stocks, and therefore, the stocks were includable in the gross estate. The Tax Court looked at the terms of Barton's trust and determined that she had retained, for herself, the power to terminate the trust and to invade the corpus. Then it distinguished a relinquishment of power from an exercise of power, and...