American Nat. Bank & Trust Co. v. U.S., 78-1136

• Decision Date: 28 February 1979
• Docket Number: No. 78-1136,78-1136
• Citation: 594 F.2d 1141
• Parties: 79-1 USTC P 13,284 AMERICAN NATIONAL BANK & TRUST COMPANY, not personally, but as Executor of the Estate of Robert C. Usher, Deceased, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 1141

594 F.2d 1141

79-1 USTC P 13,284

AMERICAN NATIONAL BANK & TRUST COMPANY, not personally, but as Executor of the Estate of Robert C. Usher Deceased, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.

No. 78-1136.

United States Court of Appeals Seventh Circuit.

Argued Nov. 29, 1978.

Decided Feb. 28, 1979.

Roger B. Harris, Altheimer & Gray, Chicago, Ill., for plaintiff-appellant.

Ronald A. Dweck, Tax Div., Dept. of Justice, Washington, D. C., for defendant-appellee.

Before SWYGERT and SPRECHER, Circuit Judges, and GRANT, Senior District Judge. ^*

SPRECHER, Circuit Judge.

The issue raised by this appeal is whether the penalty for the late-filing of an estate tax return after a substantial recovery on a contested insurance claim should be based on the value of the claim at death or on the amount of the claim ultimately recovered. We hold that the value at the date of death controls and remand to the district court for a determination of that value necessary to establish the refund due to the taxpayer.

I

On January 23, 1967, Robert C. Usher was killed when the automobile he was driving was struck by a train. An eyewitness to the accident reported that Mr. Usher had driven onto the train tracks, at which the warning bells were ringing, passing a car which was awaiting the approaching train. Mr. Usher then backed off the tracks, drove on the tracks, backed off again, and finally drove on once more, whereupon he was struck by the train. Beyond the circumstances of the collision itself, there were other factors suggesting that Mr. Usher had committed suicide. Several months before his death, it had been revealed that Mr. Usher had embezzled a substantial amount of money from a corporation and that he was unable to meet corporate demands to repay the money. Further, within one month of his death, Mr. Usher applied for and obtained binders for $450,000 of accidental death insurance. One month before that he had obtained a binder for $500,000 of accidental death insurance. Combining these amounts with other amounts obtained the year prior to his death, Mr. Usher was covered with $200,000 in life insurance and $1,150,000 in accidental death insurance.

All the insurers refused payment on these policies on the basis of suicide exclusions, material misrepresentations by the insured, and technical insufficiencies of the binders. As a result, the executor brought suit against the insurance carriers in district court on July 24, 1967. This suit had not been resolved by April 23, 1968, the date on which the return was required to have been filed. The executor requested and received an extension to October 23, 1968. However, no return was filed by that time, and a return was ultimately filed on April 3, 1970, after a notice from the IRS. In that return the executor listed the value of the accidental death insurance claims as zero.

In 1972 the accidental death insurance claims were tried, and a verdict was obtained on behalf of the estate for $1,000,000. This recovery was thereupon reported to the IRS which then assessed an additional tax of $100,693.29 and a late filing penalty of 25 percent of that amount, or $25,173.32.

The executor paid the tax and penalty and filed a claim for a refund of the penalty with the IRS. When the IRS denied this refund, the instant action was filed. At trial the executor contended that the pendency of the insurance claims constituted reasonable cause for the failure to file a timely return, thereby exempting the estate from the 25 percent penalty. A jury returned a verdict in favor of the United States.

The executor did not contest or appeal the jury finding that no reasonable cause existed to exempt him completely from the penalty. Instead, the executor appealed from the trial court's disposition of the executor's post-trial motion dealing with the computation of the 25 percent penalty. The executor claimed that the 25 percent penalty should be computed on the basis of the value of the claims at the date of death, which might have been either minimal or non-existent, and should not be computed on the basis of the amount ultimately recovered. The IRS replied by contending that this argument was foreclosed by the executor's failure to give reasonable notice of this argument in its refund claim and that the amount upon which the penalty was to be computed was the amount of insurance proceeds "receivable" by the estate. The district court found that adequate notice had been given to preserve the executor's argument as to the amount of the penalty, ¹ but that the amount was correctly computed on the basis of the amount receivable. The plaintiff now appeals this latter finding.

II

The penalty provision involved here is section 6651(a)(1) of the Internal Revenue Code which provides that

In case of failure . . . to file any return . . . on the date prescribed therefor . . . there shall be added to the amount required to be shown as tax on such return 5 percent of the amount of such tax if the failure is for not more than one month, with an additional 5 percent for each additional month or fraction thereof during which such failure continues, not exceeding 25 percent in the aggregate.

The controlling phrase here is "the amount required to be shown as tax on such return." That amount is computed on the basis of the "value of the gross estate" reduced by certain deductions provided in I.R.C. §§ 2051-56 and by certain credits permitted by I.R.C. §§ 2010-16. See I.R.C. § 2051. The "value of the gross estate" is defined generally by § 2031(a) as "the value At the time of . . . (the decedent's) Death of all property, real or personal, tangible or intangible, wherever situated" (emphasis supplied). Although section 2031(a) only clarifies the time scheme of the valuation, the regulations to that section detail the concept of valuation. Section 20.2031-1(b) of the regulations provide that value is the "fair market value at the time of the decedent's death" and that the fair market value is the "price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of relevant facts."

Applying these provisions alone to the instant case, it is clear that the assessed penalty will depend on the value of the insurance claims at the time of death and that any subsequent recovery is irrelevant. The courts which have considered the valuation of contingent claims have been uniform in this result. In Duffield v. United States, 136 F.Supp. 944 (E.D.Pa.1955), one of the assets in the deceased attorney's estate was a contingent fee contract relating to his representation of certain heirs in a will contest unresolved at the time of the attorney's death. Subsequent to the attorney's death, but before the estate tax return was filed, the client-heirs received the bulk of the multi-million dollar contested estate and as a result the attorney's estate received almost one million dollars in fees. When the estate tax return was filed, the executor listed the value of the contingent fee contracts as zero. The IRS audited the return, valued the contracts as equal to the amounts ultimately received and assessed the additional taxes. In the executor's refund suit, Circuit (then District) Judge Van Dusen rejected the executor's argument that the contingent character of the contracts precluded them from having any value whatsoever. However, the court also rejected the IRS's contention that the full amount of the ultimate proceeds would be taxable:

The court agrees with counsel for plaintiff's contention that the value of any rights attached to these contingent fee contracts must be determined as of the time of decedent's death and defendant's contention in the answer that these contracts were worth the full amount ultimately received would seem most unlikely.

136 F.Supp. at 947-48 n.11. ²

The IRS seeks to avoid this result by relying on Section 2042 of the Code and its regulations thereunder. Section 2042 provides:

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

(1) RECEIVABLE BY THE EXECUTOR. To the extent of the amount receivable by the executor as insurance under policies on the life of the decedent.

(2) RECEIVABLE BY OTHER BENEFICIARIES. To the extent of the amount receivable by all other 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. For purposes of the preceding sentence, the term "incident of ownership" includes a reversionary interest (whether arising by the express terms of the policy or other instrument or by operation of law) only if the value of such reversionary interest exceeded 5 percent of the value of the policy immediately before the death of the decedent. As used in this paragraph, the term "reversionary interest" includes a possibility that the policy, or the proceeds of the policy, may return to the decedent or his estate, or may be subject to power of disposition by him. The value of a reversionary interest at any time shall be determined (without regard to the fact of the decedent's death) by usual methods of valuation, including the use of tables of mortality and actuarial principles, pursuant to regulations prescribed by the Secretary (or his delegate). In determining the value of a possibility that the policy or proceeds thereof may be subject to a power of disposition by the decedent, such possibility shall be valued as if it were a possibility that such policy or proceeds may return to the decedent or his estate.

The Regulations under this section provide that "the amount to be included in the gross estate under section 2042 is the full amount receivable under the policy." Treas.Reg. § 20.2042-1(a)(3). Based on these provisions the government argues...