Connelly's Estate v. U.S.

• Decision Date: 17 February 1977
• Docket Number: No. 76-1149,76-1149
• Parties: 77-1 USTC P 13,179, 1 Employee Benefits Ca 1209 ESTATE of John J. CONNELLY, Sr. (Deceased) and Ellen C. King, Executrix v. UNITED STATES of America, Appellant.
• Court: U.S. Court of Appeals — Third Circuit

Page 545

551 F.2d 545

77-1 USTC P 13,179, 1 Employee Benefits Ca 1209 ESTATE of John J. CONNELLY, Sr. (Deceased) and Ellen C. King, Executrix v. UNITED STATES of America, Appellant.

No. 76-1149.

United States Court of Appeals Third Circuit.

Argued Dec. 2, 1976.

Decided Feb. 17, 1977.

Adams, Adubato, Tafro & Connelly, Maurice H. Connelly, South Orange, N. J., for appellee.

Scott P. Crampton, Asst. Atty. Gen., Gilbert E. Andrews, Jonathan S. Cohen, Ann Belanger Durney, Tax Div., Dept. of Justice, Washington, D. C., for appellant.

Before ROSENN, FORMAN and GARTH, Circuit Judges.

OPINION OF THE COURT

FORMAN, Circuit Judge.

This is an appeal by the United States from a judgment of the United States District Court for the District of New Jersey granting the plaintiff, the Estate of John J. Connelly, Sr., a refund of $3,200.00, plus statutory interest, for federal estate tax paid under protest. The matter was submitted as though on cross-motions for summary judgment, on stipulated facts. The District Court concluded that the Commissioner erroneously included in decedent's gross estate the proceeds of a policy of group term life insurance. We affirm. The decedent did not possess any of the incidents of ownership of this insurance policy at the time of his death so as to require inclusion of the proceeds in the decedent's gross estate pursuant to Section 2042 of the Internal Revenue Code of 1954.

I.

At the time of his death, on November 16, 1964, John J. Connelly, Sr. was covered by a non-contributory group term life insurance policy for which his employer paid. ¹ The terms of the policy provided for the payment of a lump sum of $375.00 immediately upon the employee's death plus a monthly annuity of $248.44 for a period of 50 months. ² The beneficiaries of the policy were irrevocably fixed and were of three classes. Benefit payments went to the surviving spouse of the employee, if living at the time of his death, until they were exhausted or until her death. If there were no surviving spouse, or if a surviving spouse died before receiving all the payments, the payments were made to the next of the classes, ³ who, like the spouse, would receive them until their exhaustion or the death of the beneficiary. Because payments terminated if no eligible beneficiaries lived to receive them, there was no assurance that the insurer would make any or all of the payments, and in no event would the payments ever be made to the estate of the insured.

At the time of his death, Connelly was a widower. The only member of the class of beneficiaries next entitled to the proceeds in the absence of a surviving spouse was his son, Robert. Thus, the lump sum payment and monthly annuities accrued to Robert.

The only substantive power Connelly possessed over the proceeds of the policy, at the time of his death, was to elect an optional mode of payment to the beneficiary. ⁴ However, such an election would have required the mutual agreement of Connelly, his employer and the insurance company. ⁵ This option would reduce the monthly payments by a selected percentage and increase the period of time over which the payments would be made. For example, he could arrange to have the monthly payments reduced by one-half and paid for twice as long. Regardless of which settlement option was utilized, the total amount paid to the beneficiary would remain the same. In the event that Connelly elected a settlement option as described and the beneficiary died before the payments were exhausted, the estate of the beneficiary would receive the difference between the amount actually received and the amount which would have been paid during the same period at the higher rate of payment had the option not been elected. Therefore, Connelly could not alter the amount that any beneficiary would receive; he possessed only the power to change the time at which the proceeds would be received. This constituted Connelly's entire power over the proceeds of the policy, which in no way could be exercised for his own economic benefit.

II.

Section 2042(2) of the Internal Revenue Code of 1954 provides that the proceeds from life insurance receivable by any beneficiary other than his executor are includable in the decedent's gross estate, if immediately prior to his death he possessed any incident of ownership, exercisable either alone or in conjunction with any other person. ⁶ Incidents of ownership are not defined by the Code, but Treasury Regulation section 2042-1(c)(2) repeats almost verbatim ⁷ the legislative history of section 2042 ⁸, and provides "For purposes of this paragraph, the term 'incidents of ownership' is not limited in its meaning to ownership of the policy in the technical legal sense. Generally speaking, the term has reference to the right of the insured or his estate to the economic benefits of the policy. Thus, it includes the power to change the beneficiary, to surrender or cancel the policy, to assign the policy, to revoke an assignment, to pledge the policy for a loan, or to obtain from the insurer a loan against the surrender value of the policy, etc. . . ."

Appellant contends that decedent's power to elect optional modes of settlement exercisable in conjunction with his employer and the insurer, and the right to assign this power, constituted incidents of ownership. We do not agree.

III.

In 1937 the Board of Tax Appeals was confronted with this precise argument in Billings v. Commissioner, 35 B.T.A. 1147 (1937), acq. 1937-2 Cum.Bull. 3. Billings involved a large number of life insurance policies, three of which gave the decedent much wider options as to the modes of settlement than those involved here. The Board of Tax Appeals held that "(t)he mere right to say when the proceeds of the insurance policies should be paid to the beneficiary does not amount to a control of the proceeds. They irrevocably belonged to the beneficiary from the date the policies were taken out." (35 B.T.A. at 1152). ⁹

The Commissioner acquiesced in the Billings decision ¹⁰ and that acquiescence remained in effect until 1972 when it was "withdrawn and nonacquiescence (was) substituted therefor." ¹¹

In 1970, the Sixth Circuit focused on the meaning of "incidents of ownership," in Estate of Fruehauf v. Commissioner, 427 F.2d 80 (6th Cir. 1970). There, decedent's wife paid all the premiums on several insurance policies written on the life of decedent. Mrs. Fruehauf predeceased her husband by fourteen months, leaving a will naming decedent co-executor of her estate, and co-trustee and life beneficiary of a trust to which the life insurance policies passed. Mr. Fruehauf was given broad powers in a fiduciary capacity over the insurance policies. The Tax Court held that Fruehauf possessed incidents of ownership in the policies, regardless of the capacity in which such incidents of ownership could be exercised, and included the proceeds in his gross estate. ¹²

Although the Sixth Circuit affirmed, it rejected the "Tax Court's broad per se rule" that the capacity in which powers are held should not be considered in determining whether such powers constitute incidents of ownership. The court stated that where the requisite powers over policies on his life have been transferred to a decedent, with no beneficial interest therein, "such arrangement can hardly be construed as a substitute for testamentary disposition on decedent's part." ¹³ 427 F.2d at 84. ¹⁴ The court held that decedent's powers were sufficient to constitute incidents of ownership only because as lifetime beneficiary of the trust, he could exercise his powers in such a way as to receive economic benefit from the insurance.

In Estate of Skifter v. Commissioner, 468 F.2d 699 (2d Cir. 1972), decedent made an irrevocable assignment of nine insurance policies on his life to his wife, more than three years before his death. His wife predeceased him and under her will the policies became part of a testamentary trust with the insured as trustee. Although Skifter's powers to effect changes in the beneficial ownership of the policies or their proceeds were broad, he could not exercise any power for his own economic benefit.

The Second Circuit, affirming the Tax Court, held that where powers which may not be exercised so as to benefit the decedent are conferred upon him in his capacity as trustee, the "incidents of ownership" test of section 2042(2) is not met. The court concluded that while non-beneficial powers retained in connection with a transfer of the beneficial interest in the policies might constitute incidents of ownership, it distinguished that situation from Skifter, where decedent received a grant of non-beneficial powers.

The only case since Billings in 1937 to directly consider the issue whether the right to select a settlement option is an "incident of ownership" is Estate of Lumpkin v. Commissioner, 474 F.2d 1092 (5th Cir. 1973). The Lumpkin court considered the same insurance policy involved here. However, the decedent in Lumpkin possessed certain powers which Mr. Connelly did not: in Lumpkin, the decedent was still employed when he died and thus could quit his job thereby cancelling the policy; Mr. Connelly was retired. The decedent in Lumpkin was survived by a widow and under the terms of the policy had the power to unilaterally exercise a settlement option; Mr. Connelly had no unilateral powers. In Lumpkin, the decedent was found to have the right to assign the power to exercise the settlement option; under the law of New Jersey, Mr. Connelly did not have that right. ¹⁵

Relying on Billings and the language of Treasury Regulation 20.2042-1(c)(2), the Tax Court held that the non-beneficial power possessed by decedent was not an appropriate predicate for the estate tax. ¹⁶ The Court of Appeals reversed, holding that Lumpkin possessed an incident of ownership in the insurance policy.

The Fifth Circuit inferred from the legislative history of section 2042 that Congress was attempting to tax...