Estate of Bowgren v. C.I.R.

• Decision Date: 24 January 1997
• Docket Number: No. 96-1366,96-1366
• Parties: -660, 97-1 USTC P 60,257 ESTATE OF Helen E. BOWGREN, Deceased, Warren D. Bowgren, Executor, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 1156

105 F.3d 1156

79 A.F.T.R.2d 97-660, 97-1 USTC P 60,257

ESTATE OF Helen E. BOWGREN, Deceased, Warren D. Bowgren,

Executor, Petitioner-Appellee, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellant.

No. 96-1366.

United States Court of Appeals, Seventh Circuit.

Argued Sept. 17, 1996.

Decided Jan. 24, 1997.

Thomas F. Joyce, Robert L. Wiesenthal (argued), Bell, Boyd & Lloyd, Chicago, IL, for Petitioner-Appellee.

Stuart L. Brown, Curtis G. Wilson, Internal Revenue Service, Gary R. Allen, Jonathan S. Cohen, Curtis C. Pett (argued), Department of Justice, Tax Division, Appellate Section, Loretta C. Argrett, Department of Justice, Tax Division, Washington, DC, for Respondent-Appellant.

Before EASTERBROOK, RIPPLE and ROVNER, Circuit Judges.

RIPPLE, Circuit Judge.

Helen E. Bowgren, deceased, created an Illinois land trust in 1975 and divided the trust's beneficial interest into ninety-eight units. Between 1975 and 1979, she transferred some of those units to her three children. She died testate on April 8, 1990. Mrs. Bowgren's estate disclosed the transfer of those units but excluded their value from the gross estate. The Commissioner of Internal Revenue ("CIR") issued a notice of deficiency to the estate, and the estate petitioned the Tax Court for a redetermination of the deficiency. The Tax Court granted the estate the relief it requested. For the reasons that follow, we reverse the judgment of the Tax Court and remand the case for further proceedings consistent with this opinion.

I BACKGROUND

A. Facts

In 1975, Mrs. Bowgren inherited property in Kane County, Illinois. On December 30, 1975, she entered into an agreement with the State Bank of St. Charles to create an Illinois land trust and deeded the real estate to the bank as trustee. The trust agreement provided:

[T]he interest of any beneficiary hereunder shall consist solely of a power of direction to deal with the title to said real estate and to manage and control said real estate as hereinafter provided, and the right to receive the proceeds from rentals and from mortgages, sales or other disposition of said real estate, and that such right in the avails of said real estate shall be deemed to be personal property, and may be assigned and transferred as such; ... and that no beneficiary hereunder at any time shall have any right, title or interest in or to any portion of said real estate....

....

While the State Bank of St. Charles is the sole owner of record of the real estate ..., it is understood and agreed by the parties ... that said Bank of St. Charles will ... convey title to said real estate, execute and deliver deeds for or otherwise deal with said real estate only when authorized to do so in writing and that it will (notwithstanding any change in the beneficiary or beneficiaries hereunder, unless otherwise directed by the beneficiaries) on the written direction of

Helen E. Bowgren

or on the written direction of such person or persons as may be beneficiary or beneficiaries at the time, make deeds for, or otherwise deal with said real estate....

Trust Agreement, Joint Ex. 1-A at 1-2. The trust agreement also divided the beneficial interest in the trust into ninety-eight units.

Between December 30, 1975 and January 4, 1979, Mrs. Bowgren assigned twenty-seven units of the beneficial interest to her three children--nine units each. ¹ On its federal estate tax return, her estate disclosed the transfer of these units to her children and attached copies of the Quarterly Gift Tax Returns to the federal estate tax return. The estate did not, however, include the value of these gifts in Mrs. Bowgren's gross estate. By notice dated July 28, 1993, the CIR informed the estate of a $152,080 tax deficiency. According to the Internal Revenue Service ("IRS"), under §§ 2036 and 2038 of the Internal Revenue Code ("I.R.C."), ² the value of the transfers should have been included

in Mrs. Bowgren's gross estate. The estate filed a petition with the United States Tax Court seeking a redetermination of the deficiency.

B. Tax Court Proceedings

The Tax Court recognized that whether the value of the twenty-seven units of beneficial interest should have been included in Mrs. Bowgren's gross estate turns on the relationship between any power of direction retained by Mrs. Bowgren and the beneficial interests assigned to her children. In the Tax Court, the CIR insisted that the decedent's power of direction continued in full force, notwithstanding the assignments. Because she retained the power to modify or to defeat the transferred beneficial interests at any time, the value of the assignments, the CIR maintained, should have been included in the gross estate. Mrs. Bowgren's estate, on the other hand, contended that, when Mrs. Bowgren transferred the entire beneficial interest without specifically reserving the power to direct the trustee with respect to these twenty-seven units, she retained no individual power to modify her children's enjoyment of their units. Consequently, the estate submitted, it properly excluded the value of the transferred units from the gross estate, and there is no tax deficiency.

The Tax Court disagreed with both parties' positions. The court determined that, under Illinois law, the land trust agreement, when executed, vested two separate powers of direction in Mrs. Bowgren, one exercisable in conjunction with all the beneficiaries and one exercisable by herself alone. The Tax Court held that the power of direction retained by Mrs. Bowgren alone did not include the right to terminate or to modify the beneficial interests held by her three children because this power was analogous to a power to direct the activities of the trustee with respect to the investment of the trust property. The Tax Court also determined that any exclusive power Mrs. Bowgren retained to direct the trustee to dispose of the trust property was limited by a fiduciary duty she owed to the beneficiaries. With regard to the joint power of direction Mrs. Bowgren retained (the power of direction exercisable concurrently with the other beneficiaries), the Tax Court held that such a power did not make the value of the units taxable under § 2036(a)(2). From the resulting decision disallowing the deficiency, the CIR took this appeal.

II DISCUSSION

A. Taxation of Estates

Under § 2001 of the I.R.C., the taxable estate, which § 2051 defines as the value of the gross estate less applicable deductions, of every decedent who is a citizen or resident of the United States is subject to a federal estate tax. The value of the gross estate includes the value of all the decedent's property--real or personal, tangible or intangible, wherever situated--at the time of death. I.R.C. §§ 2031, 2033. Sections 2036 and 2038 further delineate the type of property interest properly included in a decedent's gross estate. Under these provisions, the gross estate includes the value of transferred property if the decedent retains any power or control over the transferred property. ³ Section 2036(a) requires that the value of property transferred in trust be included in the settlor's gross estate if, at the time of his death, the settlor retains a discretionary right, either alone or in conjunction with another, to designate the person who will possess or enjoy the property. Estate of Sulovich v. Commissioner, 587 F.2d 845, 847-48 (6th Cir.1978). Section 2038(a)(1) requires inclusion of the value of the property transferred in trust in the settlor's gross estate if, at the time of his death, the settlor retains the discretionary power to terminate the trust. Id. at 848. The settlor's power to terminate the beneficiaries' rights to enjoyment of the trust is a power to "alter, amend, revoke or terminate" for purposes of I.R.C. § 2038(a)(1). ⁴

B. Illinois Land Trusts

The Illinois land trust ⁵ has been described variously as "an imaginative creation of nineteenth and twentieth century Illinois practitioners, abetted by the Illinois courts," Old Orchard Bank & Trust Co. v. Rodriguez, 654 F.Supp. 108, 110 (N.D.Ill.1987), as a "fiction[ ]," Anthony Haswell & Barbara B. Levine, The Illinois Land Trust: A Fictional Best Seller, 33 DePaul L.Rev. 277, 277 (1984), and as a "unique creation." People v. Chicago Title & Trust Co., 75 Ill.2d 479, 27 Ill.Dec. 476, 479, 389 N.E.2d 540, 543 (1979). ⁶ One Illinois court has described land trusts in this manner:

The land trust is a device by which the real estate is conveyed to a trustee under an arrangement reserving to the beneficiaries the full management and control of the property. The trustee executes deeds, mortgages or otherwise deals with the property at the written direction of the beneficiaries. The beneficiaries collect rents, improve and operate the property and exercise all the rights of ownership other than holding or dealing with the legal title. Th[is] arrangement is created by two instruments. The deed in trust conveys the realty to the trustee. Contemporaneously with the deed in trust a trust agreement is executed.

Robinson v. Chicago Nat'l Bank, 32 Ill.App.2d 55, 176 N.E.2d 659, 661 (1961).

Thus, land trusts are characterized by four distinctive features. First, both the legal and equitable title to the res are vested in the trustee, not the beneficiary. ⁷ Land trusts vest the usual attributes of ownership--the rights of possession and management of the property, as well as the rights to rents and proceeds from the property--in the beneficiary or beneficiaries. ⁸ Second, this beneficial interest, the bundle of beneficiaries' rights and privileges, is not characterized as a real estate interest, but as a personal property interest. ⁹ Third, the trustee has no duties or powers other than to execute deeds and mortgages or otherwise to deal with the property as directed by the holder of the power of direction. Robinson, 176 N.E.2d at 661. Fourth, in land trusts the power of direction, which is a property interest separable from...