Ray v. United States

• Decision Date: 06 November 1974
• Docket Number: Civ. A. No. 72-H-1475.
• Citation: 385 F. Supp. 372
• Parties: Colletta Lake RAY et al., Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Southern District of Texas

385 F. Supp. 372

Colletta Lake RAY et al., Plaintiffs, v. UNITED STATES of America, Defendant.

Civ. A. No. 72-H-1475.

United States District Court, S. D. Texas, Houston Division.

November 6, 1974.

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Marvin K. Collie, Carl Estes, II, & Donald F. Wood, Vinson, Elkins, Searls, Connally & Smith, Houston, Tex., for plaintiffs.

Anthony J. P. Farris, U. S. Atty., Houston, Tex., Larry Jones, Tax Div., Dept. of Justice, Dallas, Tex., for defendant.

MEMORANDUM AND OPINION

CARL O. BUE, Jr., District Judge.

In this action for refund of estate taxes paid by the Estate of Robert H. Ray, the defendant has counterclaimed, alleging that the estate was erroneously permitted to redeem certain Treasury Bonds at face value in payment of the estate taxes. The action is brought by Jack C. Pollard, Collette Lake Ray and Taylor Ray, the duly qualified and acting Independent Executors of the estate, and was heard by the Court without a jury. Jurisdiction vests in this Court by virtue of 28 U.S.C. § 1346(a)(1).

The facts relevant to this controversy indicate that on September 26, 1967, the decedent was found to be terminally ill, a victim of multiple myeloma or bone cancer. On the advice of decedent's attorney and with the consent of decedent's wife, Pollard, decedent's business partner, borrowed, as agent for decedent, $1,000,000 from the First City National Bank and signed a promissory note for that amount on December 26, 1967. The note, which was due in six months and bore interest at the rate of 6½ percent, contained the following language:

Bank acknowledges that the proceeds of the loan evidenced by this note are and shall be the separate property of Robert H. Ray and hereby agrees that this indebtedness shall be paid out of his separate funds and that only his separate property (including the Government bonds purchased with proceeds of this loan) shall be liable for the payment of this indebtedness.

Payment of this note is secured by a security agreement dtd 12-26-67 covering $1,270,000.00 U. S. Treas, 3½% Bds due 2-15-90.

Using the proceeds of this loan, Pollard purchased on the same date $1,270,000 par value 3½ percent United States Treasury Bonds due February 15, 1990, and signed a security agreement pledging the Treasury Bonds as security for the loan. This agreement contained the following stipulation:

The term "Liabilities" shall mean the indebtedness evidenced by note of even date herewith in the principal amount of $1,000,000.00 executed by Jack C. Pollard as Agent and Attorney in Fact for Robert H. Ray, payable to the order of Bank on or before six months.

Notwithstanding anything herein to the contrary, Bank agrees that the Liabilities shall be paid out of the separate funds of Robert H. Ray and that only his separate property (including the Collateral) shall be liable for payment of the Liabilities.

At the time of the loan and subsequent purchase of the bonds, the decedent owned only a negligible amount of separate property, the vast majority of his assets consisting of community property. Decedent died on January 5, 1968, a resident of the State of Texas.

Plaintiffs timely filed Form 706, United States Estate Tax Return, on behalf of the estate with the District Director of Internal Revenue. The return reported the United States Treasury Bonds as the separate property of decedent and the note executed for the loan to purchase the bonds as a separate debt of the decedent. Accordingly, a marital deduction based upon the bonds being the decedent's separate property was claimed. By virtue of 26 U.S.C. § 6312(a) (since repealed, with respect to bonds issued after March 3, 1971, by Pub.L. No. 92-5 § 4(a), 85 Stat. 5),¹ a substantial portion of these bonds were then accepted by the Internal Revenue Service at their face value in payment of the estate taxes due as shown on the estate's tax return.

Subsequently, the Commissioner determined the bonds to be community rather than separate property and included only one-half of the bonds in the estate, thereby reducing the separate debt by one-half and disallowing the marital deduction. Additional taxes were assessed against the estate as the result of this determination. These were paid in part by the redemption of the remaining Treasury Bonds, which were redeemed by the Service at their face value.

Plaintiffs timely filed a claim for refund premised principally upon the Commissioner's characterization of the bonds as community property. Upon the disallowance of this claim, plaintiffs subsequently instituted this action. The complaint, supplemental complaint and counterclaim thus present for determination several issues:

(1) whether the bonds purchased on December 26, 1967, constitute the separate property of the decedent;

(2) whether the characterization of the bonds by the estate as separate property lacks economic substance and must be therefore disregarded;

(3) whether the estate is entitled to a marital deduction;

(4) whether the estate is entitled to deduct certain administrative expenses in full or whether these may be attributed in part to the community and deducted only in part.

The Government's counterclaim is premised upon the fact that the Internal Revenue Service redeemed at their face value in payment of the estate tax the totality of the bonds purchased on December 26, 1967. By virtue of the Commissioner's determination that only 50 percent of these bonds were includable in the decedent's estate, the Government argues that the other one-half of these bonds were erroneously redeemed at face value and should be reissued to the decedent's spouse. Additional payment would then be due to replace the reissued bonds.

THE U. S. TREASURY BONDS AS THE SEPARATE OR COMMUNITY PROPERTY OF THE DECEDENT

The separate property of a spouse is characterized in Texas by Article 5.01 of the Texas Family Code, V. T.C.A., as:

(1) the property owned or claimed by the spouse before marriage;

(2) the property acquired by the spouse during marriage by gift, devise or descent; and

(3) the recovery for personal injuries sustained by the spouse during marriage, except any recovery for loss of earning capacity during marriage.

Community property is thus defined as all "property, other than separate property, acquired by either spouse during marriage". Under Texas law, the separate or community nature of property has been determined by courts at the time of acquisition under the inception of title rule. See, e. g., Lindsay v. Clayman, 151 Tex. 593, 254 S.W.2d 777, 780 (1952). In transactions not involving credit or the indicia of a gift, courts have applied a tracing principle and characterized the subject property as separate or community or a combination thereof depending upon the nature of the funds or property actually used at the time of purchase to acquire it. See, e. g., Freedman v. United States, 382 F. 2d 742 (5th Cir. 1967); Duncan v. United States, 247 F.2d 845 (5th Cir. 1957); Gleich v. Bongio, 128 Tex. 606, 99 S.W.2d 881, 883 (1937); Baize v. Baize, 460 S.W.2d 255 (Tex.Civ.App. — Eastland 1970, no writ). However, Texas courts have not uniformly traced the source of funds used in acquiring property during a marriage. Where the deed or purchase agreement contains a recitation that the property acquired is the separate property of one spouse and the other spouse has acquiesced in the transaction, the nature of the funds actually used to acquire the property has been viewed as irrelevant; the property is considered to be a gift. See, e. g., Paudler v. Paudler, 210 F.2d 765 (5th Cir. 1954); Messer v. Johnson, 422 S. W.2d 908 (Tex.1968); Lindsay v. Clayman, supra; McKivett v. McKivett, 123 Tex. 298, 70 S.W.2d 694 (Tex.1934). Likewise, Texas courts have recognized that when one spouse acquires property on credit with the creditor agreeing to look solely to the separate property of that spouse for compensation in the event of default, the spouse serving as the source of credit is considered the owner.² See Broussard v. Tian, 156 Tex. 371, 295 S.W.2d 405 (1956); Gleich v. Bongio, supra; Dorfman v. Dorfman, 457 S.W.2d 91, 95 (Tex.Civ.App. — Waco 1970, no writ); Harrington v. Harrington, 451 S.W.2d 797, 799 (Tex.Civ.App. — Houston 1st Div. 1967, writ dism'd); Dillard v. Dillard, 341 S.W.2d 668, 671 (Tex. Civ.App. — Ft. Worth 1960, writ ref. n. r. e.); Carter v. Grabeel, 341 S.W.2d 458, 460 (Tex.Civ.App. — Amarillo 1960, no writ); Goodloe v. Williams, 302 S.W.2d 235, 237 (Tex.Civ.App. — Texarkana 1957, writ ref.). See generally Huie, W., Commentary — Community Property Law, 13 Vernon's Annotated Revised Civil Statutes § 6 (1960).

Thus, by virtue of the inception of title rule in instances where property is purchased on credit, Texas courts have indicated that it is irrelevant if community funds were actually used to repay the separate debt.³See Broussard v. Tian, supra; Lindsay v. Clayman, supra; Smith v. Buss, 135 Tex. 566, 144 S.W. 529 (1940); Orr v. Pope, 400 S.W.2d 614 (Tex.Civ.App. — Amarillo 1960, writ. ref. n. r. e.). Although the other spouse or the community may be entitled to reimbursement for the funds expended in repayment of the separate debt, title to the property still vests in the purchasing spouse. See Broussard v. Tian, supra; Beeler v. Beeler, 363 S.W.2d 305 (Tex.Civ.App. — Beaumont 1962, writ dism'd). Furthermore, courts have indicated that it is irrelevant under Texas law if the community or separate estate incurring the obligation has sufficient funds to repay its debt. See Gleich v. Bongio, supra.

Under a strict application of the above principles, the bonds in this instance should be treated as separate property. Decisions of the Texas courts have emphasized that the agreement between the creditor and the borrower is the primary indication of whether a debt is separate or community. It is evident from the loan agreement that the First City National Bank intended to look only to the decedent's...