Heffley v. C.I.R.

• Decision Date: 17 August 1989
• Docket Number: No. 88-1929,88-1929
• Citation: 884 F.2d 279
• Parties: -5909, 89-2 USTC P 13,812 Timothy S. HEFFLEY, as Executor of the Estate of Opal P. Heffley, deceased, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 279

884 F.2d 279

64 A.F.T.R.2d 89-5909, 89-2 USTC P 13,812

Timothy S. HEFFLEY, as Executor of the Estate of Opal P Heffley, deceased, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent.

No. 88-1929.

United States Court of Appeals Seventh Circuit.

Argued Jan. 10, 1989.

Decided Aug. 17, 1989.

Stephen J. Williams, Shambaugh, Kast, Beck & Williams, Fort Wayne, Ind., for petitioner.

Gary R. Allen, William S. Rose, Jr., Asst. Atty. Gen., Dept. of Justice, Tax Div., Appellate Section, William F. Nelson, I.R.S., David E. Carmack, David M. Moore, Dept. of Justice, Tax Div., Washington, D.C., Ross E. Springer, Indianapolis, Ind., for respondent.

Before POSNER, COFFEY and MANION, Circuit Judges.

MANION, Circuit Judge.

Opal P. Heffley died in 1981. Her estate claimed the right to value under the special use valuation provisions of 26 U.S.C. Sec. 2032A a farm in which Opal had held an interest. The Commissioner of Internal Revenue disagreed, and assessed a federal estate tax deficiency. The Tax Court determined that the property had not been put to a statutorily qualified use. We affirm.

I. FACTS

History of the farm

Opal P. Heffley died on September 23, 1981 at age 67. Her son Timothy Heffley is the duly appointed, qualified and acting executor of her estate.

Opal Heffley's estate included a farm containing 280 acres of tillable land which Opal and her husband Max Heffley owned as tenants by the entirety. Max died on May 26, 1972. During spring 1972 Opal assumed management and arranged for Max's brother Wayne Heffley to farm the land. On October 24, 1976, Opal and Wayne entered a farm rental contract under which Wayne, as tenant, agreed to pay Opal an annual cash rent of $10,011.80. They continued to operate under the lease for the years 1977-1980 inclusive.

By warranty deed recorded on September 26, 1978, Opal conveyed title to the farm to Timothy as trustee. Timothy continued to hold title to the farm as trustee from that date until Opal's death on September 23, 1981. Under the terms of Opal's April 23, 1981, revocable trust agreement, the title to the farm would be transferred to Timothy upon her death.

Participation by Timothy Heffley

Timothy worked on the farm from the mid-1970's until 1981. Timothy testified that his farm work prior to 1981 was not labor required by the land rental contract between his mother and Wayne Heffley, but that Wayne paid him for his services. During each of the four academic years beginning in September 1976, Timothy was a full-time student at Indiana University in Bloomington, Indiana, where he lived. During academic year 1980-81, Timothy attended and graduated from Indiana University at its Fort Wayne, Indiana, regional campus, and lived on Opal's farm.

On February 11, 1981, Timothy, as trustee of Opal's trust, rented 186 tillable acres to his cousin, Jerry Heffley. Jerry's rent included a combination of cash and grain. The trust had no obligations under this arrangement other than providing the land and applying limestone to the soil if necessary. During 1981, prior to his mother's death, Timothy raised approximately 15 acres of beans and planted about three acres of trees on the farm (on acreage not leased to Jerry), but he paid no rent to the trust for the use of this real estate.

Tax filings and treatment by Opal and Timothy

In her 1973 federal income tax return Opal used Form 4835 to report farm rental income based on crops or livestock produced by a tenant, where a landowner does not materially participate in operating or managing the farm. For 1974-1980 inclusive, Opal reported the farm income as rent. Opal paid no self-employment tax upon her farm income for the years 1973-1980 inclusive.

In the estate tax return, Timothy, as executor, elected to value the real estate pursuant to the provisions of Sec. 2032A. ¹ The estate and the IRS agree that the fair market value of the farm on the date of Opal's death was $463,000. They also agree that the special valuation of this real estate is the special use value of $90,339.50. ²

Timothy reported that the special use value based upon the average gross cash rental for comparable farmland was $90,339.50, and he reported a total gross estate of $110,450.92 with no federal estate tax liability. He made no election under Sec. 6166A, ³ nor protective election under Treasury Regulation, 26 C.F.R. Sec. 20.6166-1(d), ⁴ to pay in installments any of the federal estate tax due upon the return. Through a notice of November 13, 1984, the Commissioner determined that the estate did not qualify for special use valuation under Sec. 2032A. Because the Commissioner determined that the farm had not qualified, he included the farm in the gross estate at its fair market value and identified a deficiency of $84,373.47 in estate tax.

II.

A. Tax Court Proceedings

In the Tax Court, the issues were (1) whether Timothy S. Heffley as executor of Opal's estate is entitled to value the farm by the special use valuation provisions of Sec. 2032A; and (2) pursuant to petitioner's amended petition with the Tax Court of September 30, 1985, whether the petitioner is entitled to pay interest upon any deficiency in the estate tax at the reduced rate provided in Sec. 6601(j).

The specific dispute in the Tax Court centered on whether the farm, when owned by Opal and operated by Timothy as Trustee, met the "qualified use" requirement of Sec. 2032A(b)(1)(C)(i) and the "material participation" requirement of Sec. 2032A(b)(1)(C)(ii). The Tax Court concluded that the farm real estate had not been put to such a qualified use. It also determined that neither Opal nor a member of her family had materially participated in operating the farm. The Tax Court also held that Opal's estate was not entitled at this time to make an election under Sec. 6166(a), which would have permitted the estate to pay the estate tax by installments. An estate's eligibility to pay at the reduced rate provided in Sec. 6601(j) depends on whether it is entitled to pay a portion of the deficiency in installments under Sec. 6166, which in turn depends upon its executor making a valid election or protective timely election for installment payments. No such timely election having been made here, the Tax Court found itself without jurisdiction to compute the interest payable on the deficiency.

B. Standard of Review

Tax Court legal conclusions receive plenary review upon appeal. We reverse the Tax Court's factual findings only when they are clearly erroneous. Estate of Arthur S. Kraus v. Commissioner, 875 F.2d 597, 599 (7th Cir.1989); Eli Lilly & Co. v. Commissioner, 856 F.2d 855, 861 (7th Cir.1988). We review mixed questions of fact and law, applying a legal principle to a specific factual pattern as here, under the clearly erroneous standard of review. Eli Lilly & Co., 856 F.2d at 861; Schuneman v. U.S., 783 F.2d 694, 699 (7th Cir.1986).

III. ANALYSIS

A. Background and Purpose of the Statute

Section 2032A of the Internal Revenue Code originally was enacted as part of the Tax Reform Act of 1976, Pub.L. No. 94-455, 90 Stat. 1520, 1856. Schuneman, 783 F.2d at 697. As initially enacted, Sec. 2032A(b)(1)(A)(i) required that the property on the date of the decedent's death be used for a qualified use. But Sec. 421(B)(1) of the Economic Recovery Tax Act of 1981, Pub.L. No. 97-34, 95 Stat. 172, 306, amended Sec. 2032A(b)(1) to require that the property on the date of decedent's death be used for qualified use "by the decedent or a member of the decedent's family." The 1981 legislation made this amendment retroactively effective to the estates of decedents dying after December 31, 1976. Id. at 698.

The purpose of Sec. 2032A was to encourage the continuation of family farms after the death of a farm's owner. While the statute applies to other small businesses, the benefit it confers (allowing real estate to be valued below its market value) is chiefly important to farms. Martin v. Commissioner, 783 F.2d 81, 82 (7th Cir.1986). The congressional purpose underlying today's statutory language is to make clear that the decedent himself did not have to be working the property at the date of his death. If, as typically is so, the decedent died following an illness, he would be quite likely to have quit working the property a substantial time before he died. As long as a member of the family had continued the farming operation when the decedent became ill, he would be considered to have been operating the farm when the decedent died. Id. at 83.

The federal estate tax on real property normally is determined through valuing the property at its highest and best use at or near the date of death. To pay estate taxes, those who inherited family farms frequently had to sell their newly-inherited property. Estate of Cowser v. Commissioner, 736 F.2d 1168, 1170 (7th Cir.1984). This occurred because the real property, in effect, was valued separately and apart from the ongoing farm enterprise. Estate of Coon v. Commissioner, 81 T.C. 602, 607 (1983), citing D. Kelly & D. Ludtke, Estate Planning for Farmers and Ranchers, 642-43 (1980).

Consequently, under Sec. 2032A certain real property used in family farming is valued on the basis of the property's actual use at the time of the decedent's death, rather than on the basis of the highest and best use--that which a willing buyer, perhaps a developer, would pay. Cowser, 736 F.2d at 1170. Thus, the congressional purpose of Sec. 2032A is to avoid forced liquidation of working family farms in order to pay a substantial estate tax. Estate of Sherrod v. Commissioner, 774 F.2d 1057, 1061-62 (11th Cir.1985). When Sec. 2032A permits qualifying real estate to be valued for estate tax purposes on the basis of its actual use, it reduces these typical estate tax bills considerably because working family farms ordinarily do not yield high annual profits. Id. at 1062.

To determine whether Opal's farm met the "qualified use" requirement of Sec. 2032A(b)(1)(C)(i) and...