Estate of Heim v. C.I.R.

• Decision Date: 18 September 1990
• Docket Number: No. 89-70169,89-70169
• Parties: -6009, 90-2 USTC P 60,040 ESTATE OF Carl I. HEIM, Deceased, Isabelle J. Heim, Executrix, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1322

914 F.2d 1322

66 A.F.T.R.2d 90-6009, 90-2 USTC P 60,040

ESTATE OF Carl I. HEIM, Deceased, Isabelle J. Heim Executrix, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 89-70169.

United States Court of Appeals Ninth Circuit.

Argued and Submitted May 11, 1990.

Decided Sept. 18, 1990.

John M. Kent, Anaheim, Cal., James Toledano, Toledano & Wald, Irvine, Cal., for petitioner-appellant.

Shirley D. Peterson, Asst. Atty. Gen., Gary R. Allen, Charles E. Brookhart, and Curtis C. Pett, Tax Div., Dept. of Justice, Washington, D.C., for respondent-appellee.

Appeal from a Decision of the United States Tax Court.

Before HUG and TROTT, Circuit Judges, and REED, District Judge. ^*

EDWARD C. REED, Jr., Chief District Judge:

The estate appeals the Tax Court's ¹ determination that a bequest to Isabelle J. Heim, surviving spouse of the deceased, was a nondeductible terminable interest under section 2056 of the Internal Revenue Code (26 U.S.C.); that section 1036 of the California Probate Code did not apply to save the bequest from the terminable interest rules; and that the estate therefore was not entitled to a marital deduction. We affirm the decision of the Tax Court.

I. FACTS

On November 12, 1981, Carl I. Heim (hereinafter "Mr. Heim" or "decedent" ) died testate, a resident of California, leaving a will wherein he bequeathed all of his estate "of whatsoever kind and nature and wheresoever situated to my wife, ISABELLE J. HEIM." The decedent's will provided that, in the alternative, the gift would pass to the children of his wife if she "should predecease me or fail to survive distribution." ² His wife, Isabelle J. Heim (hereinafter "Mrs. Heim" or "surviving spouse" ), survived the decedent.

On January 3, 1984, the Superior Court for the State of California for the County of Orange entered its final order distributing the estate as provided in decedent's will. The superior court found that "[a]ll of the estate is bequeathed to the decedent's wife, ISABELLE J. HEIM, if she survived distribution; she is now surviving; and distribution of the estate should be made to her."

On its estate tax return, the estate claimed a marital deduction of $344,754, one-half of the reported adjusted gross estate. Upon auditing the return, the Internal Revenue Service (IRS) determined that $207,497 transferred to the surviving spouse under decedent's will was a nondeductible terminable interest, and therefore reduced the marital deduction to $137,257. ³ Based on the reduced marital deduction, the IRS assessed a deficiency in estate tax of $62,513. ⁴

The estate petitioned the United States Tax Court for a redetermination of the deficiency ⁵ pursuant to 26 U.S.C. Sec. 6213 (1989). The tax court denied the estate's request for a redetermination, holding that the estate was not entitled to a marital deduction for the value of the interest which passed to the surviving spouse. Because vesting of the gift to Mrs. Heim was conditioned upon her survival until distribution, the court found that this condition rendered the interest terminable, and therefore nondeductible, under Internal Revenue Code ⁶ section 2056. The court further held that California Probate Code section 1036 did not operate to reform the survivorship provision by limiting it to six months, since there was no evidence that the testator intended the gift to his wife to qualify for a marital deduction.

The tax court had jurisdiction to consider redetermination of the deficiency under I.R.C. sections 6214 and 7442. This appeal is timely filed, and jurisdiction lies under I.R.C. section 7482.

II. DISCUSSION

A. Standard of Review

We review Tax Court decisions "in the same manner and to the same extent as decisions of the district courts in civil actions tried without a jury." 26 U.S.C. Sec. 7482(a)(1) (1989). See Guth v. Commissioner, 897 F.2d 441, 443 (9th Cir.1990). Federal Rule of Civil Procedure 52(a) mandates use of a clearly erroneous standard in review of district court fact-finding. Therefore, the Tax Court's factual determination regarding intent of the testator will be reviewed for clear error. See id.

Because Mr. Heim lived in California, California law governs construction of his will. De Oliveira v. United States, 767 F.2d 1344, 1347 (9th Cir.1985). Under California law, construction of the testator's will is a question of law, subject to de novo review, unless that construction turns on the credibility of extrinsic evidence. Id. If extrinsic evidence renders the language of the will susceptible to two or more meanings, the will is said to be ambiguous and the construction of the will then turns on the credibility of the extrinsic evidence. Extrinsic evidence is admissible to make this determination, and it is reviewed for clear error. On the other hand, if extrinsic evidence does not render the will susceptible to two or more meanings, then the will is deemed not ambiguous, such extrinsic evidence thereafter is disregarded, and the plain language of the will is relied upon to determine the intent of the testator.

In this case, the tax court found that the will was unambiguous, and that the intent of the testator could be determined from the face of the will. This conclusion is not clearly erroneous, and we affirm this finding. Therefore, we proceed with a de novo review of the will to determine the intent of the testator.

Further, questions of state law are reviewed under the same independent de novo standard as are questions of federal law. Matter of McLinn, 739 F.2d 1395, 1397 (9th Cir.1984) (en banc). Neither former Probate Code section 1036, nor current Probate Code section 21525 have been construed by any California court; therefore, this Court must place itself in the position of the California Supreme Court in ruling on the applicability of Probate Code section 1036. Prestin v. Mobil Oil Corp., 741 F.2d 268, 270 (9th Cir.1984).

B. The I.R.C.

1. Does the bequest contained in the will constitute a nondeductible terminable interest under section 2056 of the Internal Revenue Code?

Section 2056(a) ⁷ of the I.R.C. provides that in determining the value of the taxable estate, an estate may, subject to certain limitations, deduct from the gross estate a marital deduction, in an amount equal to the value of any interest in property which passes or has passed from the decedent to his surviving spouse. ⁸ The marital deduction was enacted to equalize the effects of federal estate taxes in common law and community property states. See S.Rep. No. 1013, 80th Cong., 2nd Sess. (1948) (1948-1 C.B. 285, 303-306), reprinted in 1948 U.S.Code Cong. & Admin.News 1163, 1222, 1224; Jackson v. United States, 376 U.S. 503, 510, 84 S.Ct. 869, 873, 11 L.Ed.2d 871 (1964). In theory, property owned by the marital unit should be subject to a single estate tax. In community property states, each spouse is deemed to own one-half of the community property. Therefore, one-half of the community property generally is taxed in the estate of the first to die (the decedent); the remaining one-half is taxed when transferred (either inter vivos or testamentary) by the surviving spouse. The marital deduction permits transfer of property within the marital unit, and thus avoidance of taxation of that property in the estate of the decedent, only if the property passes outright to the surviving or donee spouse. S.Rep. No. 1013, Part 2 at 28 (1948-1 C.B. at 305), reprinted in 1948 U.S.Code Cong. & Admin.News at 1228-31. This defers taxation of that property until it is transferred by the surviving spouse.

However, subsection (b)(1) disallows any marital deduction for terminable interests, that is, interests passing to the surviving spouse which will fail or lapse under certain conditions. In relevant part, section 2056(b)(1) provides:

(b) Limitation in the case of life estate or other terminable interest.

(1) General rule. Where, on the lapse of time, on the occurrence of an event or contingency, or on the failure of an event or contingency to occur, an interest passing to the surviving spouse will terminate or fail, no deduction shall be allowed under this section with respect to such interest--

(A) if an interest in such property passes or has passed (for less than an adequate and full consideration in money or money's worth) from the decedent to any person other than such surviving spouse (or the estate of such spouse); and

(B) if by reason of such passing such person (or his heirs or assigns) may possess or enjoy any part of such property after such termination or failure of the interest so passing to the surviving spouse....

Given the structure of the marital deduction, the purpose of the nondeductible terminable interest rule is apparent. For example, if an estate in a common law jurisdiction was permitted to deduct a life estate which passed from the decedent to the surviving spouse, the decedent's estate could avoid taxation at the first level. The surviving spouse would have full use and enjoyment of the property during life. However, upon death of the surviving spouse, that property would pass to a third person, as directed by the decedent. Because the property would not be included in the estate of the surviving spouse, it would avoid taxation at the second level, thereby escaping taxation entirely. See Allen v. United States, 359 F.2d 151, 154 (2nd Cir.1966), cert. denied, 385 U.S. 832, 87 S.Ct. 71, 17 L.Ed.2d 67 (1966).

This is precisely the type of "abuse and tax avoidance" that the nondeductible terminable interest rule was designed to prevent. Estate of Reilly v. Commissioner, 239 F.2d 797, 799 (3rd Cir.1957). See also Allen, 359 F.2d at 153-54. The nondeductible terminable interest rule seeks to ensure that property is taxed either in the estate of the decedent, or in the estate of the surviving spouse. If the interest passing to the surviving spouse "may by any event ultimately pass from the decedent to any other person for...