Badgley v. United States

• Citation: 957 F.3d 969
• Decision Date: 28 April 2020
• Docket Number: No. 18-16053,18-16053
• Parties: Judith BADGLEY, Plaintiff-Appellant, v. UNITED STATES of America, Defendant-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (9th Circuit)

957 F.3d 969

Judith BADGLEY, Plaintiff-Appellant,

v.UNITED STATES of America, Defendant-Appellee.

No. 18-16053

United States Court of Appeals, Ninth Circuit.

Argued and Submitted December 2, 2019 San Francisco, California

Filed April 28, 2020

Paul Frederic Marx (argued), Rutan & Tucker LLP, Costa Mesa, California, for Plaintiff-Appellant.

Nathaniel S. Pollock (argued) and Teresa E. McLaughlin, Attorneys; Richard E. Zuckerman, Principal Deputy Assistant General; Tax Division, United States Department of Justice, Washington, D.C.; for Defendant-Appellee.

Before: Carlos F. Lucero,^* Consuelo M. Callahan, and Bridget S. Bade, Circuit Judges.

LUCERO, Circuit Judge:

Thanks to Benjamin Franklin, death and taxes are inextricably linked in most Americans’ minds as the only two things in this world that are certain. Thanks to the estate tax, certainty is not the only tie. For the duration of its existence, taxpayers have attempted to avoid the estate tax by utilizing a variety of legal mechanisms to transfer property during their lifetimes while holding onto the fruits of that property. In response to taxpayers’ impulse to retain a legal interest in the property despite the transfer, Congress enacted what is now 26 U.S.C. § 2036(a).

At the most colloquial level, § 2036(a) stands for the proposition that if the taxpayer does not let property go, neither will the taxman. It delineates three criteria—possession, enjoyment, and a right to income—for determining when the connection between a grantor and property is sufficient to require the property’s inclusion in the grantor’s estate for purposes of the federal estate tax. § 2036(a)(1). Unless a taxpayer "absolutely, unequivocally, irrevocably, and without possible reservations, parts with" her possession of, enjoyment of, or a right to income from the property—leaving no "string" tying her to the property—property transferred inter vivos is included in a decedent’s gross estate. Comm’r v. Church’s Estate , 335 U.S. 632, 645, 69 S.Ct. 322, 93 L.Ed. 288 (1949) ; see also Estate of McNichol v. Comm’r , 265 F.2d 667, 670–73 (3d Cir. 1959).

Judith Badgley challenges the application of § 2036(a) by the Internal Revenue Service ("IRS") to her mother’s grantor-retained annuity trust ("GRAT"). The district court granted summary judgment in favor of the IRS. To resolve this appeal, we must determine whether under § 2036(a)(1), a grantor’s interest in a GRAT is a sufficient "string" that requires the property interest to be included in a gross estate. Exercising jurisdiction under 28 U.S.C. § 1291, we affirm, holding that because the grantor retains enjoyment of a GRAT, it is properly included in the gross estate.

I

A GRAT allows a grantor to transfer property to a beneficiary while retaining the right to an annuity from the transferred property. John F. Bergner, 44 U. Miami L. Ctr. on Est. Plan. ¶ 401.1 (2019). The grantor creates an irrevocable grantor trust for a fixed term of years, transfers assets into it, and designates trustees and beneficiaries. She receives an annuity for a specified term of years. Id. At the end of the term, the GRAT dissolves and the property is transferred to the beneficiaries. Howard Zaritsky, Tax Planning for Family Wealth Transfers During Life: Analysis with Forms , ¶ 12.06(1) (5th ed. 2013 & Supp. 2020).

At the time of transfer into a GRAT, property is subject to a gift tax on the present value of the GRAT’s remainder interest, valued according to the methodology in 26 U.S.C. § 7520. Id. A reduction in the transferred property’s gift value for tax purposes is permitted if the recipient is a family member and the transferor or a family member retains a "qualified interest" in the property, which includes "any interest which consists of the right to receive fixed amounts payable not less frequently than annually." 26 U.S.C. § 2702. For a GRAT, this means that the value of the transferred property subject to the gift tax is lessened by the amount of the retained annuity. Depending on the structure of the GRAT, it is possible to eliminate the applicable gift tax entirely by modifying the trust term and annuity amount to zero out any remainder. Zaritsky, supra , ¶ 12.06(3)(c)(i). This permits assets to be transferred to beneficiaries at the termination of a GRAT’s term without the imposition of a gift tax. Id. Moreover, if the term of a GRAT ends before the grantor dies, the property is not included in the grantor’s gross estate for purposes of the estate tax. See § 2036(a).

In this case, Patricia Yoder ("Decedent") was married to Donald Yoder, a fifty-percent partner in Y & Y Company, a family-run general partnership and property development company in southern California. After Mr. Yoder’s death in 1990, Decedent succeeded to his fifty-percent partnership interest. In February 1998, Decedent created a GRAT to transfer the partnership interest in Y & Y, valued at $2,418,075, to her daughters, Judith Badgley and Pamela Yoder. The interest was the only property placed in the GRAT. Decedent retained a right to an annuity of $302,259 paid from the GRAT for fifteen years, equivalent to 12.5 percent of the date-of-gift value of the partnership interest. In April 1999, Decedent filed a gift tax return reporting the gift to her daughters of the GRAT’s remainder interest and paid a gift tax of $180,606.

Decedent was both the grantor and trustee of the GRAT, with her daughters serving as special trustees. The GRAT instrument provided that the special trustees could make additional distributions to Decedent if requested. At the end of the fifteen-year annuity term or upon her death, whichever occurred earlier, the GRAT’s corpus would pass to her daughters. Decedent explained to them that if she did not outlive the fifteen-year annuity term, the partnership interest "would probably go back into her estate" for tax purposes.

From 2002 to 2012, Y & Y reported income ranging from $994,642 to $1,325,478.¹ Half of Y & Y’s income was distributed to the GRAT. Y & Y made cash distributions to the GRAT ranging from $435,400 to $730,000. Although neither party identified the source of the annuity payments in a given year, these cash distributions were sufficient to pay the annuity without decreasing the value of the partnership interest or requiring the sale of any of Y & Y’s holdings.

Decedent died on November 2, 2012, shortly before the fifteen-year annuity period expired. The estate tax return reported a total gross estate of $36,829,057. This included the GRAT’s assets, which consisted of the Y & Y partnership interest (valued at $6,409,000); $1,384,558 held in a bank account; and $3,193,471 held in an investment account. The estate paid $11,187,475 in taxes.

In 2016, Badgley, in her capacity as statutory executor of Decedent’s estate, sought a refund of an overpayment of Decedent’s estate tax in the amount of $3,810,004. She asserted that the overpayment resulted from the inclusion of the entire date-of-death value of the GRAT in Decedent’s gross estate and argued that only the net present value of the unpaid annuity payments should have been included.

The IRS did not act on Badgley’s refund claim within six months, and Badgley filed a refund action in district court, as authorized by 26 U.S.C. § 6532(a)(1). Both parties filed motions for summary judgment. The district court denied Badgley’s motion and granted the government’s cross-motion. It held that Decedent’s retained annuity interest was both a retained right to income from and continued enjoyment of the property. Both "strings" tied the GRAT to Decedent, requiring inclusion of the entire date-of-death value of the GRAT in her gross estate.² The court also concluded that 26 C.F.R. § 20.2036-1(c)(2), the Treasury regulation construing § 2036(a)(1) to apply to GRATs, was valid. Badgley timely appealed.

II

We review a district court’s order granting or denying summary judgment de novo, examining all evidence in the light most favorable to the non-moving party. Oswalt v. Resolute Indus., Inc. , 642 F.3d 856, 859 (9th Cir. 2011). The court "does not weigh the evidence or determine the truth of the matter, but only determines whether there is a genuine issue for trial," Balint v. Carson City , 180 F.3d 1047, 1054 (9th Cir. 1999) (en banc), and whether the district court "applied the relevant substantive law," Tzung v. State Farm Fire & Cas. Co. , 873 F.2d 1338, 1339–40 (9th Cir. 1989).

Section 2036(a) provides:

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 an 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 ....

Id. "The general purpose of the statute [i]s to include in a decedent’s gross estate transfers that are essentially testamentary—i.e. , transfers which leave the transferor a significant interest in or control over the property transferred during his lifetime." United States v. Estate of Grace , 395 U.S. 316, 320, 89 S.Ct. 1730, 23 L.Ed.2d 332 (1969).³ To this end, a decedent’s gross estate includes the value of property transferred while the decedent was alive if the decedent retained possession of, enjoyment of, or the right to income from the property. These three factors—possession, enjoyment, and income—are referred to as "strings" tying the transferor to the property despite the transfer. See, e.g. , United States v. Brown , 134 F.2d 372, 373 (9th Cir. 1943).

A

At the outset, we address Badgley’s argument that because § 2036(a) does not include the term "annuity," it unambiguously does not apply to annuities. In § 2036(a)(1), Congress set forth the three "strings" tying a grantor to...