Estate of Reno v. C.I.R.

• Citation: 916 F.2d 955
• Decision Date: 04 January 1991
• Docket Number: No. 89-2078,89-2078
• Parties: -6018, 90-2 USTC P 60,046 ESTATE OF William L. RENO, Jr.; Barbara G. Reno, Executrix, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (4th Circuit)

Page 955

916 F.2d 955

66 A.F.T.R.2d 90-6018, 90-2 USTC P 60,046

ESTATE OF William L. RENO, Jr.; Barbara G. Reno, Executrix Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 89-2078.

United States Court of Appeals Fourth Circuit.

Argued Oct. 30, 1989.

Decided Oct. 19, 1990.

Order on Grant of Rehearing

In Banc Jan. 4, 1991.

K.K. Hall, Circuit Judge, filed dissenting opinion.

James Laurence Malone, III, McDermott, Will & Emery, Chicago, Ill. (Richard L. Dees, on brief), for petitioners-appellants.

Teresa Ellen McLaughlin, Tax Div., U.S. Dept. of Justice, Washington, D.C. (Shirley D. Peterson, Asst. Atty. Gen., Gary R. Allen, Jonathan S. Cohen, Tax Div., U.S. Dept. of Justice, Washington, D.C.), for respondent-appellee.

Before HALL, MURNAGHAN and CHAPMAN, Circuit Judges.

MURNAGHAN, Circuit Judge:

We are called on in the case before us to direct our attention to the interplay between (1) the federal tax code as specifically outlined in the allowance for a marital deduction, (2) the allotment of federal estate tax as directed by Virginia law, (3) the testator's intent as expressed by will, and (4) Virginia common law property principles concerning property held by husband and wife as a tenancy by the entireties. The question presented is whether a testator, under Virginia law, can direct that part of the federal estate tax due on his gross estate be paid out of property held as a tenancy by the entirety with his surviving wife, which would otherwise qualify for a marital deduction and be exempt from tax. We hold that he can and affirm the judgment of the Commissioner of Internal Revenue.

I.

Dr. William L. Reno, the testator, died on October 8, 1978. At the time of his death, Reno owed both "probate" property, i.e., property passing under his will, and non-probate property passing by operation of law. The property passing under his will consisted of certain real estate in Kentucky valued at approximately $545,200, as well as corporate bonds and other property valued at approximately $103,200. His non-probate holdings consisted of his residence in Falls Church, Virginia, and a checking account, both of which he held with his wife, Barbara Reno, as tenants by the entireties with the right of survivorship. The non-probate property was valued at $527,400. The percentages of contribution for the Falls Church, Virginia, property were approximately 88% for Reno and the remaining 12% presumably for his wife. ¹

In his will, Reno devised the Kentucky real estate to his wife for her life with the remainder in fee simple to the couple's daughter. That disposition of the Kentucky property rendered it ineligible for the marital deduction under I.R.C. Sec. 2056(b)(1). ² In the same paragraph of the will, Reno directed that "all death duties on this Kentucky real estate ascertainable at my death be paid by my Executrix [his wife, Barbara Reno] out of the assets of my estate other than Kentucky real estate." Reno's will made no mention of the federal estate tax marital deduction.

At the time Reno executed his will, the residue of the probate estate--that not represented by the Kentucky real estate--was sufficient to pay the state and federal estate taxes as well as the estate's expenses. At the time of Reno's death, however, the value of the residue had decreased and was no longer enough to pay those expenses. The residue, left to Barbara Reno, would have been eligible for the marital deduction, I.R.C. Sec. 2056(a), except that it was exhausted in the payment of taxes and the estate's expenses.

On April 7, 1982, the Commissioner issued a statutory notice of deficiency of $253,656. In finding a portion of that deficiency, the Commissioner determined that the estate had improperly increased the marital deduction by failing to charge the entireties property in Falls Church with the estate taxes attributable to the Kentucky real estate. ³ In order to correct the error and honor the intent as expressed in the will, the Commissioner reallocated the federal estate taxes attributable to the Kentucky real estate to the Virginia entireties property. That reallocation resulted in a reduction of the estate's marital deduction of approximately $25,981.

The estate filed a petition in the Tax Court seeking a redetermination of the assessed deficiency. The Tax Court ruled for the Commissioner, holding that Reno's will expressed his desire that his estate taxes not be apportioned among the assets of his estate. Without that expressed intent, Va.Code Ann. Sec. 64.1-161 would have directed that estate taxes be apportioned against the asset that produced the tax. Such an apportionment is limited to the extent that "each such person shall have the benefit of any exemptions, deductions and exclusions allowed by such law." Id. Thus, but for the will, the Virginia property would be exempt from tax by virtue of the marital deduction and the tax due on the Kentucky property would be apportioned against that property.

The Tax Court found that Reno had taken advantage of the Virginia statute which allowed him to disturb that allocation scheme. Va.Code Ann. Sec. 64.1-165 provides that

none of such provisions shall in any way impair the right or power of any person by will or by written instrument executed inter vivos to make direction from [sic] the payment of such estate or inheritance taxes and to designate the fund or funds or property out of which such payment shall be made; and in every such case the provisions of the will or of such written instrument executed inter vivos shall be given effect to the same extent as if this article had not been enacted.

The Tax Court found that by the express language of his will, Reno expressed his desire that the estate taxes not be apportioned among the assets of his estate. Estate of Reno v. Commissioner, 51 T.C.M. (CCH) 909 (1986). Since the entireties property fell within the gross estate for federal tax purposes, I.R.C. Sec. 2040(a), Reno's direction that his estate taxes be paid out of the "assets of my estate other than Kentucky real estate" was sufficient to shift the taxes due on the Kentucky property to the entireties property, consequently reducing the marital deduction claimed. The estate has appealed that determination.

II.

The estate contends that Barbara Reno's tenancy by the entireties property cannot properly be required to pay more than its proportionate share of the federal estate tax. Because the Virginia property might qualify for the marital deduction, its share of the estate tax, had Reno's will been silent on the matter, would be zero. Hence, according to the estate, the tenancy by the entireties property, in being assessed any tax, is being assessed more than its share of tax, an action the taxpayer concludes is illegal under Virginia property law. We find the proffered conclusion a doubtful reflection of Virginia law as far as collection of estate tax is concerned given Va.Code Ann. Sec. 58.1-901 which, while concerned with Virginia estate tax, nevertheless, like the federal tax code, includes the entireties property in the decedent's gross taxable estate. We do not need to reach that question, however, since the entireties property is not subject to any disproportionate calculation of the tax due.

There is a distinction of controlling significance here between (1) something included in the gross estate and hence exempt from tax only to the extent it earns the benefit of an exemption, and (2) something not even included in the gross estate and hence immune from tax. Such an immunity from tax extends, for example, to property which had been owned by the decedent but sold by him or her more than three years prior to his or her death for an adequate and full consideration. I.R.C. Sec. 2035. In contrast, the property held as tenants by the entireties had the distinct possibility of ripening in fee in Reno up until he died survived by Barbara Reno. It was clearly part of the gross estate for federal estate tax purposes. I.R.C. Sec. 2040(a).

William Reno explicitly stated that the Kentucky real estate should pay no estate tax. To give that language effect, the tax must come out of other property in his estate. First, the residual property in the probate estate was exhausted in meeting only a portion of that tax, even though that residual also might (though in fact it did not) qualify for the marital deduction and pay no tax. Because the residual was probate property, the estate does not quarrel with it being assessed its "disproportionate" share of tax at the expense of Barbara Reno's marital deduction. See Baylor v. National Bank of Commerce of Norfolk, 194 Va. 1, 72 S.E.2d 282 (1985). The rest of the marital property which might qualify for the marital deduction was the tenancy by the entireties property, which passed outside of the will and hence can be termed non-probate property. By both federal and state law, however, it is still part of Reno's gross taxable estate and still responsible for estate tax unless relieved by a federal tax deduction. Because of the language of Reno's will, he voided the tenancy by the entireties property's qualification as marital deduction property to the extent that the taxes generated by the Kentucky property must come out of it.

The estate asserts that Reno could not do so, relying on Virginia property law principles governing tenancy by the entireties property. It argues that inclusion of the entireties property in the gross estate does not permit Reno's will to charge it with taxes inconsistent with his wife's survivorship interest in the property. In support, the estate points to cases interpreting Virginia tenancy by the entireties property law. A husband may not obligate the property or subject it to his debts without the consent of his wife. Vasilion v. Vasilion, 192 Va. 735, 740, 66 S.E.2d 599, 602 (1951); In re Bishop, 482 F.2d 381, 393 (4th Cir.1973); In re Saunders, 365 F.Supp. 1351, 1352-53 ...