E. Norman Peterson Marital Trust v. C.I.R.

Decision Date04 March 1996
Docket NumberNo. 30,D,30
Parties-1184, 64 USLW 2578, 96-1 USTC P 60,225 E. NORMAN PETERSON MARITAL TRUST, Chemical Bank, Trustee, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee. ocket 95-4001.
CourtU.S. Court of Appeals — Second Circuit

Michael I. Frankel, Carter, Ledyard & Milburn, New York City, (Richard B. Covey, New York City, of counsel), for Petitioner-Appellant.

Loretta C. Argrett, Assistant Attorney General, Bridget M. Rowan, Tax Division, U.S. Department of Justice, Washington, D.C. (Gary R. Allen, Kenneth L. Greene, of counsel), for Respondent-Appellee.

Before: KEARSE, LEVAL, and CALABRESI, Circuit Judges.

CALABRESI, Circuit Judge:

Language does not have a "plain meaning" outside of its particular context. "You should have passed, dummy," means something entirely different at a bridge table from what it means on Superbowl Sunday. The same words signify very different things because the linguistic context has changed. In this case, the taxpayer has asked us to invalidate a Treasury regulation that defines the word "added" in a way that is consistent with half a century of tax law. The taxpayer

                asserts that the plain meaning of the word cannot support the definition given to it in the Treasury's regulation.   But in estate and gift tax law, "added" has a significance that, though different from its meaning in other contexts, is nonetheless readily comprehended.   And in the language of transfer taxes, the Treasury's regulation is not only a reasonable reading of "added" as it is used in the statute that the regulation purports to interpret, it is one that fully accords both with what the legislature intended and with what all the parties can properly be held to have understood the word to mean
                
BACKGROUND

When E. Norman Peterson died in 1974, his will included a marital trust for the benefit of his second wife, Eleanor Peterson. According to the terms of the trust, Mrs. Peterson was to receive all of the income of the trust, and was given a general testamentary power of appointment over the corpus of the trust. 1 In addition, Mrs. Peterson had the right to withdraw one half of the principal during her lifetime. In the event that Mrs. Peterson did not exercise her testamentary power of appointment, Mr. Peterson's will provided that the principal was to be set aside in equal shares for Mr. Peterson's grandchildren. Mr. and Mrs. Peterson allegedly had a private understanding that she would not exercise her power of appointment, except to pay the estate tax attributable to the trust.

Mrs. Peterson died in 1987. Because she held a general testamentary power of appointment over the marital trust, the entire value of the trust was included in her gross estate pursuant to 26 U.S.C. § 2041. In her will, Mrs. Peterson exercised the power to direct that the estate tax attributable to the inclusion of the trust property in her estate should be paid from the trust. She specifically stated that she was not otherwise exercising the power. The property remaining in the trust after payment of the estate taxes was therefore transferred to Mr. Peterson's grandchildren, as he had specified in his will.

In 1988, Mrs. Peterson's estate filed a Federal Estate Tax Return, and included a form stating that the transfers from the marital trust to the grandchildren's trusts were subject to the Generation-Skipping Transfer Tax (GST), 26 U.S.C. §§ 2601-2663 (presumably because they came about as a result of her failure to exercise her general power of appointment), and that the GST due was $827,404. The trustees of the E. Norman Peterson Trust subsequently filed a statement with the Commissioner, challenging the above-mentioned GST liability and arguing that the Trust's GST liability should be reduced to $18,910. 2 The Internal Revenue Service disagreed, and notified the taxpayer that it had a tax deficiency of $810,925.

The Peterson Trust petitioned the Tax Court, under 26 U.S.C. § 6213, for a redetermination of the deficiency. The Tax Court accepted some of the taxpayer's arguments, but rejected petitioner's contention that Mrs. Peterson had not added to the marital trust the funds transferred to the grandchildren and that, therefore, the trust was not subject to the GST on the transfer of those funds. It did so by affirming, over the taxpayer's objection, the validity of the Treasury regulation defining the lapse of Mrs. Peterson's power of appointment as a constructive addition to the trust of the sum she had controlled. It is that issue that is appealed here.

DISCUSSION

We review the Tax Court's legal conclusions de novo. See Samuels, Kramer & Co. v. Commissioner, 930 F.2d 975, 979 (2d Prior to the enactment of the GST, 26 U.S.C. §§ 2601-2663, 3 it was common for individuals seeking to reduce tax liability to bequeath their property in trust, with a life estate in one or more generations, and the remainder over to succeeding generations. See 5 Boris I. Bittker & Lawrence Lokken, Federal Taxation of Income, Estates and Gifts p 133.1 (2d ed. 1993). Congress passed the GST to ensure that transfers of this sort, in which the transferee is two or more generations below the transferor, would be subject to a tax liability at least as great as that which would ordinarily have been imposed had the transfers been taxed at each generation level. See Staff of Joint Comm. on Taxation, 99th Cong., 2d Sess., General Explanation of the Tax Reform Act of 1986 at 1263 (1987).

                Cir.1991), cert. denied, 502 U.S. 957, 112 S.Ct. 416, 116 L.Ed.2d 436 (1991).   In reviewing the validity of a Treasury Regulation, we accord the Commissioner's interpretation of the statute substantial deference, applying a strong presumption in favor of validity.   See Goodson-Todman Ents., Ltd. v. Commissioner, 784 F.2d 66, 73-74 (2d Cir.1986).   A regulation should "be declared invalid only if it is unreasonable or clearly contrary to the language or spirit of the statute it purports to implement."  Id. at 74.   However, "the deference paid to Treasury regulations is not boundless."  Id.  Particularly where--as here--a regulation is promulgated pursuant to the Commissioner's general authority to "prescribe all needful rules and regulations," 26 U.S.C. § 7805(a), rather than pursuant to a specific grant of authority, a court owes it less deference.   See United States v. Vogel Fertilizer Co., 455 U.S. 16, 24, 102 S.Ct. 821, 827, 70 L.Ed.2d 792 (1982).   The fact that the regulation at issue is a temporary regulation does not change our analysis.   Until the passage of final regulations, temporary regulations are entitled to the same weight we accord to final regulations.  Truck & Equipment Corp. of Harrisonburg v. Commissioner, 98 T.C. 141, 149, 1992 WL 18381 (1992).   Cf. LeCroy Research Sys. Corp. v. Commissioner, 751 F.2d 123, 127 (2d Cir.1984) (noting that temporary regulations, unlike proposed regulations, are binding)
                

The effect of the GST, as enacted, can be draconian, 4 and because of it previously beneficial estate and trust arrangements became exceedingly undesirable. To protect taxpayers who had legitimately made trust and estate dispositions which, although sensible when made, had become very disadvantageous, and from which they could no longer escape, Congress created a limited "grandfathering" exception to the GST. It established an effective-date rule which provides, in relevant part, that the GST will not apply to "any generation-skipping transfer under a trust which was irrevocable on September 25, 1985, but only to the extent that such transfer is not made out of corpus added to the trust after September 25, 1985." Pub.L. 99-514, § 1433(b)(2)(A), 100 Stat. 2731.

The parties do not dispute that the transfer from the marital trust to Mr. Peterson's grandchildren was a generation-skipping transfer that would be subject to the GST unless excepted from its reach by the effective-date rule. The taxpayer argues, however, that since the marital trust became irrevocable when Mr. Peterson died, eleven years before September 25, 1985, the transfer before us is exempt from the GST. The Commissioner counters that the lapse of Mrs. Peterson's general power of appointment over the trust constituted a "constructive addition" to the trust, and that, because this addition took place on September 5, 1987--well after the effective date of the GST--the effective-date rule does not insulate the trust from GST liability.

The Commissioner bases her argument on an interpretive regulation, Temp.Treas.Reg. § 26.2601-1(b)(1)(v)(A), 53 Fed.Reg. 8445 On June 19, 1980, H established an irrevocable trust with a corpus of $500,000. The trust instrument provides that the trustee shall distribute the entire income from the trust annually to H's wife, W, during her life. At W's death the remainder is to be distributed to H and W's grandson, GS. H also gave W a general power of appointment over one-half of the trust assets. On December 21, 1989, when the value of the trust corpus is $1,500,000, W dies without having exercised her general power of appointment. The value of one-half of the trust corpus, $750,000 ... is included in W's gross estate under section 2041(a) and is subject to tax under Chapter 11. Because the value of one-half of the trust corpus is subject to tax under Chapter 11 with respect to W's estate, W is treated as the transferor of that property for purposes of Chapter 13.... For purposes of the generation-skipping transfer tax, the lapse of W's power of appointment is treated as if $750,000 ... had been distributed to W and then transferred back to the trust. Thus, W is considered to have added $750,000 ... to the trust at the date of her death.

                (1988), corrected by 53 Fed.Reg. 18,839 (1988), promulgated pursuant to her general authority to make regulations defining and interpreting provisions of the tax code.   See 26 U.S.C. § 7805.
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