C&S/Sovran Trust Co.(Georgia), N.A. v. Comm'r of Internal Revenue (In re Estate of Hubert)

• Decision Date: 19 October 1993
• Docket Number: No. 22333–90.,22333–90.
• Citation: 101 T.C. No. 22,101 T.C. 314
• Parties: ESTATE OF Otis C. HUBERT, Deceased, C & S/Sovran Trust Company (Georgia), N.A., A National Banking Association, Co–Executor, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Tax Court

101 T.C. 314

101 T.C. No. 22

ESTATE OF Otis C. HUBERT, Deceased, C & S/Sovran Trust Company (Georgia), N.A., A National Banking Association, Co–Executor, Petitioner,

v.COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 22333–90.

United States Tax Court

Oct. 19, 1993.

David W. Aughtry, and James M. McCarten, for petitioner.

Willard N. Timm, Jr., for respondent.

OPINION

CLAPP, Judge:

Respondent determined a deficiency in petitioner's estate tax in the amount of $14,052,146. After concession by the parties, the remaining issues for decision are: (1) Whether the amounts of petitioner's marital and charitable deductions are limited to the amounts passing to the marital and charitable shares under the 1982 will and three codicils, or are the amounts actually passing under a settlement agreement to the marital and charitable shares as reduced by obligations charged to the respective shares; (2) whether the amounts of the marital and charitable deductions must be reduced by administration expenses paid from the marital and charitable portions ¹ under the settlement agreement, without regard to whether the estate allocated those expenses to income; and (3) whether the marital and charitable portions must be discounted by 7 percent per annum to take into account income deemed to be earned by the residue.²

This case was submitted fully stipulated under Rule 122. We incorporate by reference the stipulation of facts and attached exhibits. All section references are to the Internal Revenue Code as in effect at the date of decedent's death, and all Rule references are to the Tax Court Rules of Practice and Procedure.

Petitioner is the Estate of Otis C. Hubert (decedent). Decedent was a resident of Marietta, Georgia, when he died on June 2, 1986. C & S/Sovran Trust Company (C & S) is the coexecutor of decedent's estate. On the date the petition was filed, C & S had its principal place of business in Atlanta, Georgia.

At the time of his death, decedent was married to Ruth S. Hubert (Mrs. Hubert). The Huberts had four children: Richard N. Hubert, Marilyn Hubert Kemper, Judith Hubert Manning, and Deborah Hubert Jones.

In January 1982, decedent executed the last will to be signed prior to his death (the 1982 will). That will superseded his previous will, which had been executed in 1977. The 1982 will was modified three times by codicils executed between February 4, 1982, and June 8, 1983. Decedent's nephew, Robert H. Owen (Owen), drafted the will and the three codicils.

In addition to certain specific bequests, the 1977 will left, in trust, an amount equal to the maximum marital deduction; however, if the estate tax due from the estate (before application of any credits) were less than any credits available to the estate, the marital bequest was to be reduced to that amount which would cause the estate tax owed by decedent's estate (before application of any credits) to equal the total of all credits finally allowed. Decedent's intent was to fully utilize all credits and deductions. The income from the trust was payable to Mrs. Hubert for her life, with the remainder to charity. Mrs. Hubert had a general power of appointment over the trust. The 1977 will also established a charitable remainder unitrust from the residue of the estate. The trustee had the discretion to distribute 5 percent of the net assets of the charitable trust annually to Mrs. Hubert or any of the Hubert children. Upon the death of Mrs. Hubert, the charitable trust terminated, and the remainder was to be distributed outright to charity.

The 1982 will left the residue of decedent's estate in trust, the income of which was to be paid to Mrs. Hubert, with the remainder to charity. Mrs. Hubert had a general power of appointment. The second codicil to the 1982 will eliminated Mrs. Hubert's general power of appointment.

Upon decedent's death, will contests were filed by various members of the Hubert family, including Mrs. Hubert. The will contest instituted by Mrs. Hubert requested the Probate Court to strike the second codicil to the 1982 will or, in the alternative, to strike the 1982 will and all the codicils, because of alleged undue influence by Owen in favor of the charitable remainder beneficiaries. In June 1987, the Hubert family, Owen, and the district attorney for Cobb County, Georgia, where the will was being probated, entered into an “Agreement of Interested Parties” (the first agreement), which purported to resolve all of the differences among the competing interests under the will.

The Georgia revenue commissioner challenged the first agreement alleging that he was a necessary party to ensure that the charitable beneficiaries were treated fairly. As a result of negotiations, which included the Georgia revenue commissioner and the Georgia attorney general as representatives for the charities, the first agreement was supplanted by the “Second and Final Settlement Agreement” (settlement agreement) on October 10, 1990, which was approved by the Superior Court of Cobb County in an Order, Judgment, and Decree. The Cobb County Probate Court entered a final order adopting the Order, Judgment, and Decree as binding in its proceedings on November 28, 1990.

The settlement agreement amended the 1982 will and codicils by deleting item VIII, which disposed of the residuary estate, and all codicil provisions related to that item. In lieu thereof, the settlement agreement added various provisions, including provisions for the division of the residuary estate between the marital and charitable portions and for the allocation of expenses between the marital and charitable portions. Under the settlement agreement, Mrs. Hubert was named beneficiary of a part of the residue in two trusts: The marital trust, over which she had a general power of appointment, and the QTIP trust. The charity received the rest of the residue outright.

Based on the first agreement, an estate tax return, Form 706, was filed on September 2, 1987. Respondent issued a notice of deficiency on August 31, 1990, disallowing $12,650,592 of the marital deduction and $12,502,655 of the charitable deduction, as well as making adjustments to the deduction for debts of the decedent and to the amount of adjusted taxable bequests.

Limitations on Deductions Based on the 1982 Will and Codicils

The first issue for decision is whether the marital and charitable deductions are limited by the amounts Mrs. Hubert and the charity would have taken under the 1982 will and codicils.

Marital Deduction

Section 2056(a) provides in pertinent part:

For purposes of the tax imposed by section 2001, the value of the taxable estate shall * * * be determined by deducting from the value of the gross estate an amount equal to the value of any interest in property which passes or has passed from the decedent to his surviving spouse, but only to the extent that such interest is included in determining the value of the gross estate.

In defining whether an interest in property has “passed from the decedent to his surviving spouse” in the context of a will contest, section 20.2056(e)–2(d)(2), Estate Tax Regs., states:

If as a result of the controversy involving the decedent's will, or involving any bequest or devise thereunder, a property interest is assigned or surrendered to the surviving spouse, the interest so acquired will be regarded as having “passed from the decedent to his surviving spouse” only if the assignment or surrender was a bona fide recognition of enforceable rights of the surviving spouse in the decedent's estate. Such a bona fide recognition will be presumed where the assignment or surrender was pursuant to a decision of a local court upon the merits in an adversary proceeding following a genuine and active contest. However, such a decree will be accepted only to the extent that the court passed upon the facts upon which deductibility of the property interests depends. If the assignment or surrender was pursuant to a decree rendered by consent, or pursuant to an agreement not to contest the will or not to probate the will, it will not necessarily be accepted as a bona fide evaluation of the rights of the spouse.

Respondent argues that petitioner's marital deduction is limited to the lesser of the amount distributed to Mrs. Hubert under the settlement agreement or the amount that would have been so distributed under the 1982 will and codicils. Presumably, respondent's contention is that Mrs. Hubert did not have an enforceable right in decedent's estate to any amount in excess of what she would have received under the 1982 will and codicils.

Petitioner argues that “(i) a good faith compromise of (ii) a bona fide will dispute, (iii) involving uncontested provisions of state law, is absolutely dispositive of the question of enforceable rights.” Petitioner contends that, although a settlement agreement cannot definitively determine questions of law, it can conclusively resolve questions of fact. Petitioner concludes that, since the State law in this case is clear and the dispute is inherently factual, the settlement agreement should control.

In deciding whether a settlement agreement is a “bona fide recognition of enforceable rights of the surviving spouse in decedent's estate”, this Court has looked to whether the agreement was made in good faith as the result of arm's-length negotiations. Estate of Barrett v. Commissioner, 22 T.C. 606, 611 (1954).

However, in Commissioner v. Estate of Bosch, 387 U.S. 456 (1967), the Supreme Court held that a Federal court deciding the estate tax consequences of an attempted disclaimer was not bound by the State trial court's adjudication of the property rights involved. Citing Erie R. Co. v. Tompkins, 304 U.S. 64 (1938), the Court noted that “state law as announced by the highest court of the State is to be followed.” Commissioner v. Estate of Bosch, supra at 465. Moreover, the Court explained that the State's intermediate appellate court decisions should be...