Estate of Spencer v. C.I.R., 93-1997

• Decision Date: 05 January 1995
• Docket Number: No. 93-1997,93-1997
• Citation: 43 F.3d 226
• Parties: -563, 63 USLW 2442, 95-1 USTC P 60,188, 1995 Fed.App. 4P ESTATE OF John D. SPENCER, Deceased; Ernestine W. Spencer, Executor; John D. Spencer, Trust A; Ernestine W. Spencer, Trust B; Ernestine W. Spencer, Trustee; Ernestine W. Spencer, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 226

43 F.3d 226

75 A.F.T.R.2d 95-563, 63 USLW 2442,

95-1 USTC P 60,188,

1995 Fed.App. 4P

ESTATE OF John D. SPENCER, Deceased; Ernestine W. Spencer,

Executor; John D. Spencer, Trust A; Ernestine W. Spencer,

Trust B; Ernestine W. Spencer, Trustee; Ernestine W.

Spencer, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 93-1997.

United States Court of Appeals, Sixth Circuit.

Argued June 16, 1994.

Decided Jan. 5, 1995.

Robert T. Pappas (argued and briefed), Jones, Troyan, Coco, Pappas & Perkins, Columbus, OH, for petitioners-appellants.

Ernest J. Brown (argued) and Gary R. Allen, Acting Chief (briefed), U.S. Dept. of Justice, Appellate Section Tax Div., Washington, DC, for respondent-appellee.

Before: MERRITT, Chief Judge; and GUY and NORRIS, Circuit Judges.

MERRITT, Chief Judge.

SUMMARY

In this estate tax case, Mrs. Ernestine W. Spencer, a surviving spouse who is also the executrix of her husband's estate, disagrees with the Internal Revenue Service and the Tax Court because they have disallowed $1.2 million in assets as a marital deduction from her husband's taxable estate. Internal Revenue Code Sec. 2056(b)(7) provides for the deductibility of "qualified terminable interest property," or so-called "QTIP". The QTIP provision, Sec. 2056(b)(7)(B), Title 26, allows a life estate in property to qualify for deductibility if (1) the surviving spouse receives all income from the property, (2) no one can appoint the property away from the surviving spouse during her lifetime, and (3) the proper statutory election is made by the executor of decedent's estate on decedent's estate tax form.

Congress created QTIP in 1981 to permit decedents to control the ultimate disposition of their estates while providing for the support and maintenance of their surviving spouses. H. R. Rep. 201, 97th Cong., 1st Sess. (1981). The basic idea under a QTIP arrangement is that the elected QTIP property will avoid taxation in the husband's estate, become subject to estate taxation in the wife's estate, and allow the husband to insure that his designated beneficiaries will receive the remainder upon the wife's death. When used in conjunction with the allowable "unified estate tax credit" of $600,000, taxation can be deferred for a time long after the decedent's death.

Estimating in advance of death how much property to commit to QTIP in order to minimize estate taxes is a problem for the estate planner. This problem led the decedent in this case not to designate specific QTIP property in his will but rather to grant his wife as executor the authority to decide what amount of property would be subject to the Sec. 2056(b)(7) QTIP election when the time came to make it.

The IRS challenges this "wait-and-see" arrangement. It argues that the testator must specify or designate in advance in the will the property to be included in a QTIP trust. It contends that because Mrs. Spencer as executrix had the power to decide how much property would go to the QTIP trust, she possessed an impermissible power to appoint property away from the surviving spouse for the interim period from decedent's death until the date of the QTIP election. She responds that once the election had been made, no one had the power to appoint any of the QTIP trust corpus away from the surviving spouse, and, the other requirements having been met, the trust should qualify under Sec. 2056(b)(7). The IRS argues alternatively that the property in the QTIP trust did not "pass" to Mrs. Spencer within the meaning of Sec. 2056.

We come to the same conclusion as both the Fifth and Eighth Circuits ¹ and agree with Mrs. Spencer. Wills are often drafted a decade or more before death. Property is sold and acquired and goes up or down in value during this period. Family situations change. It is often impossible to prudently designate what should be committed as QTIP far in advance of death. By statute the election can only be made after the death of a decedent. Therefore, no property anywhere can meet the definition of "qualified terminable interest property" until after the decedent's death. Since it would be contrary to the policy and meaning of the statute, as well as counter-intuitive and against common sense, to apply the definition before the election can be satisfied, we hold that the date of election is the proper date for deciding if property meets the requirements set out under Sec. 2056(b)(7).

We also reject the Commissioner's argument that the trust fails under Sec. 2056(c) because Sec. 2056(b)(7) contains self-excepting language which, when read in light of the legislative history of the marital deduction, makes it an exception to the general rule stated in Sec. 2056(c).

Therefore, for the reasons set forth below, the decision of the Tax Court will be REVERSED.

I. Facts of the Case

On September 24, 1984, the decedent, Mr. John D. Spencer of Licking County, Ohio, executed the John D. Spencer Trust Agreement. It provided that upon decedent's death two trusts would be established, Trust A, the QTIP Trust, for his surviving spouse, and Trust B for his children. Trust A is the subject of the current dispute.

Trust A was to be funded by the amount elected under Sec. 2056(b)(7) by the executor after decedent's death. The Trust Agreement further provided that all income from trust principal would be distributed to the surviving spouse on at least a quarterly basis and that no one could grant income or principal to anyone other than the spouse during her lifetime. The Trust Agreement named decedent's spouse, Mrs. Ernestine W. Spencer, as the trustee.

On the same day, the decedent executed his Will naming Mrs. Spencer executor of his estate. The will gave her almost complete discretion to determine the amount of the QTIP election. The will had a nonbinding provision elsewhere in its text indicating that the decedent anticipated "that my Executor will elect to minimize the estate tax payable [by] my estate."

Mr. Spencer died in March 1987. Mrs. Spencer survived him, and began her multiple roles of trustee, executrix and surviving spouse. As executrix, she determined the gross estate to have a value of approximately $1.9 million. On December 3, 1987, she appointed approximately $1.2 million of the estate to Trust A, the QTIP Trust, and used the unified tax credit of $600,000 plus certain administrative costs to reduce the taxable estate to zero. She filed Form 706, the estate tax form, with the IRS on December 5, 1987, claiming the entire value of Trust A to be exempt from taxation under Sec. 2056(b)(7). On this form, she made the QTIP election required by law. On November 8, 1990, the IRS disallowed this deduction form decedent's estate and sent Mrs. Spencer a tax bill for $416,477.62. On behalf of decedent's estate, she appealed this finding to the Tax Court. See T. C. M.1992-579. It ruled in favor of the IRS, and Mrs. Spencer appealed once more.

II. Sec. 2056(b)(7)

Code Sec. 2001 imposes a tax on all transfers of estates by deceased United States citizens. Section 2056(a) then provides for a "marital deduction", which generally excludes from present taxation all property passing from a decedent to a surviving spouse that will later be taxed in the estate of the surviving spouse. Currently there is no limit to the amount that may be claimed as a marital deduction. But Sec. 2056(b)(1) makes an exception to this deduction for transfers of "terminable interests," defined as any interest that will terminate or fail upon the lapse of time or occurrence of a stated condition. ² An example of a terminable interest would be a life estate in the surviving spouse with the remainder in the decedent's children. Thus, the general rule is that terminable interests are included in the taxable estate. Confusion arises because this exception is itself subject to a number of counter-exceptions which permit certain kinds of terminable interests to be excluded from the taxable estate. The subject of this litigation is the counter-exception created by Sec. 2056(b)(7), which deals with "qualified terminable interest property."

The Economic Recovery Tax Act of 1981 made a number of revisions to the estate tax code. Among others it raised the total amount of the unified credit, abolished the fifty-percent (50%) cap on the marital deduction, and added Sec. 2056(b)(7) to the tax code. By abolishing the cap on the marital deduction, Congress intended to address the problem of taxing a single estate "one and one-half times, i.e., one-half on the death of the first spouse and again fully upon the death of the second spouse." H.R.Rep. 201 at 159.

Congress added Sec. 2056(b)(7) primarily to allow a decedent to provide for a surviving spouse while controlling the ultimate disposition of the property after the surviving spouse's death. See H.R.Rep. 201 at 159-60. Before the addition of Sec. 2056(b)(7), a person planning an estate was forced to choose between either leaving property outright to the surviving spouse or leaving it to the surviving children because under prior law simply granting a life estate to the surviving spouse with remainder in the decedent's children resulted in the property's inclusion in the taxable estate. Section 2056(b)(5) had already provided an exception to the terminal interest exception to the marital deduction by allowing deductions of a life estate with a general power of appointment in the surviving spouse. But this one exception was not considered sufficient because there are situations when a decedent would want to remove discretion from the surviving spouse so as to ensure the ultimate disposition of the estate after the death of the spouse. This concern led Congress to revise the estate tax code, including the addition of Sec. 2056(b)(7).

Section 2056(b)(7) states in relevant part (with the language to be interpreted in italics):

(A) In general. In the case of qualified terminable interest property--

(i) for the...