Estate of Fruehauf v. Commissioner of Internal Revenue

• Decision Date: 03 June 1970
• Docket Number: No. 19535.,19535.
• Citation: 427 F.2d 80
• Parties: ESTATE of Harry R. FRUEHAUF, Deceased, National Bank of Detroit, Harry R. Fruehauf, Jr., and Thomas L. Munson, Co-Executors, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Sixth Circuit

427 F.2d 80 (1970) ESTATE of Harry R. FRUEHAUF, Deceased, National Bank of Detroit, Harry R. Fruehauf, Jr., and Thomas L. Munson, Co-Executors, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 19535.

United States Court of Appeals, Sixth Circuit.

June 3, 1970.

E. James Gamble, Detroit, Mich., for appellants; Dykema, Wheat, Spencer, Goodnow & Trigg, Detroit, Mich., of counsel.

Janet R. Spragens, Dept. of Justice, Washington, D. C. (Johnnie M. Walters, Asst. Atty. Gen., Lee A. Jackson, Crombie J. D. Garrett, Benjamin M. Parker, Attys., Dept. of Justice, Washington, D. C., on the brief), for appellees.

Before PECK, McCREE and COMBS, Circuit Judges.

PECK, Circuit Judge.

Harry R. Fruehauf (hereinafter "the decedent") died on April 29, 1962, in Detroit, Michigan. An estate tax return filed with the district director of internal revenue for Detroit, Michigan, was subsequently determined by the Commissioner of Internal Revenue (hereinafter "the Commissioner") to disclose a deficiency in the tax upon the estate. The basis of the Commissioner's deficiency determination was the failure by the executors to include in decedent's gross estate the value of the proceeds of six insurance policies on decedent's life in which the Commissioner determined that decedent possessed "incidents of ownership" at the time of his death. This appeal is from the Tax Court's affirmance¹ of the Commissioner's deficiency determination.

All six of the policies on decedent's life were applied for, paid for, and owned by decedent's wife, Vera Berns Fruehauf, who was also the primary beneficiary of each policy. She died testate approximately fourteen months prior to the date of decedent's death. Among other things, her will bequeathed her residuary estate to a trust, the net income of which was to be paid to her husband, the decedent, for life with a remainder over to her issue per stirpes. The will also assigned to the trust created from the residuary estate the life insurance policies owned by the wife at the date of her death and gave to the executors and trustees certain powers over those insurance policies. Finally, the will named decedent as a co-executor of his wife's estate and as a co-trustee of the trust created by her will. The pertinent provisions of the will are as follows:

"Eighth: All the rest, residue and remainder of my estate of whatever kind and wherever situate, I give, devise and bequeath to the trustees hereinafter named to be held in trust for the following uses and purposes:

(1) To pay the entire net income from the corpus of the trust quarterly, or at such other intervals as he requests, to my husband, Harry R. Fruehauf, so long as he lives.

(2) If at any time or from time to time during the life of my husband the trustees other than my said husband shall, in their sole and uncontrolled discretion, determine that the resources of my husband are insufficient to enable him to maintain the standard of living to which he was accustomed during the year preceding my death and such deficiency cannot be met out of the assets of any other trust of which my husband is a beneficiary, the trustees shall distribute to my husband such portion of the principal of the trust as shall, in the sole and uncontrolled discretion of the trustees other than my husband, be deemed sufficient to enable him to maintain such standard of living.

(3) Upon the death of my said husband, the entire remaining corpus of the trust shall forthwith be assigned, paid over, conveyed and distributed, free of trust, to my then surviving issue per stirpes."

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"Tenth: My Executors and my trustees may retain for such periods as they determine advisable any insurance policies owned by me at my death on the life of any other person, and pay the premiums on such policies whenever they become due out of income and/or principal as they shall see fit, and cause themselves to be designated as the beneficiaries thereof, or they may, at any time, sell and assign any of such policies to the person whose life is insured for the cash surrender value thereof, or they may surrender any of such policies for their cash surrender value, or they may, at any time, convert any of such policies into paid up policies in whatever amounts may be provided by the terms of such policies. With respect to any policies retained by them, they may arrange for the automatic application of dividends in reduction of premium payments and they may borrow on any of such policies, make premium payments from the funds so derived, and repay such loans."

At the date of decedent's death the administration of his wife's estate had not been completed. There had been no distribution to the trust established under paragraph Eighth of his wife's will, and neither decedent nor the other trustees named in the will had been appointed by the probate court. All of the assets of the wife's estate which would have been distributed to the testamentary trust were distributed directly to the Fruehauf's son, Harry R. Fruehauf, Jr.

The Commissioner determined that the proceeds of the six insurance policies on decedent's life were includible in his gross estate under § 2042(2) of the Internal Revenue Code of 1954 (hereinafter "the Code"), which provides in part as follows:

"Sec. 2042. Proceeds of Life Insurance.

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

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"(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."

The immediate question raised by the above quoted language is whether the decedent possessed "any of the incidents of ownership" in the policies on his life at the time of his death, and this raises the additional question of the meaning of the term "incidents of ownership." Fortunately, the treasury regulations promulgated under the statute provide a definition of the term sufficient for the purposes of this case. The regulations provide in pertinent part as follows:

"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." Treas.Regs. § 20.2042-1 (c) (2).

Comparison of the above-quoted regulation with the pertinent provisions of the wife's will, supra, readily discloses that decedent did possess a number of powers over the policies in the nature of "incidents of ownership" in his fiduciary capacity as executor of his wife's will and trustee-designate of the testamentary trust. The issue was thus narrowed, both in this Court and in the Court below, to the question of whether the powers over the policies which decedent here held constitute "incidents of ownership" in view of the fact that he held these powers in a fiduciary capacity only. The Tax Court answered this in the affirmative and held that therefore the proceeds of the policies were includible in his gross estate.

While the opinion of the Tax Court clearly related the holding to the facts of this case, certain language in that opinion is susceptible to interpretation as a broad per se rule that possession by a decedent of powers constituting incidents of ownership in insurance policies on his life, regardless of the capacity in which they are held, always requires inclusion of the proceeds of the policies in the decedent's gross estate. In reasoning to this conclusion the Tax Court placed heavy reliance on a number of cases² which arose under § 2038 (and its predecessor sections) of the Code. Section 2038 charges a decedent's gross estate with any property of which he made an inter vivos transfer if, at the date of his death, he possessed the power to "alter, amend, revoke, or terminate" the transfer. The statute also provides that the existence of the power is to be determined "without regard to when or from what source the decedent acquired the power." Thus, the Tax Court reasoned:

"There is no doubt at all but that sections 2038 and 2042 are parts of a tax pattern to make includable in the gross estate property over which the decedent held various powers affecting beneficial enjoyment. Since case law makes immaterial for purposes of section 2038 the capacity in which the powers are held, it is not logical to make capacity a significant factor as far as section 2042 is concerned."

and held that:

"The fact the powers over the policies were held by decedent in a fiduciary capacity is no bar to their constituting incidents of ownership under section 2042." 50 T.C. at 926.

We must disagree with the Tax Court's broad per se rule. We believe that there is a distinction between the issues arising under § 2038 where the decedent, as transferor of certain property, possesses at his death the power, even though in a fiduciary capacity, to revoke or change the transfer, and the issues in a case arising under § 2042 where the decedent is the transferee, in a fiduciary capacity, of powers constituting incidents of ownership in the insurance policies on his life. Where a decedent holds the requisite powers over policies on his life solely because he is a transferee, in a fiduciary capacity, of those powers, with no beneficial interest therein, such arrangement can hardly be construed as a substitute for testamentary disposition on decedent's part. Cf. Porter v. Commissioner of Internal Revenue, 288 U.S. 436, 444, 53 S.Ct. 451, 77 L.Ed. 880 (1933); Commissioner of...