United States v. Estate Grace

• Decision Date: 02 June 1969
• Docket Number: No. 574,574
• Citation: 395 U.S. 316,89 S.Ct. 1730,23 L.Ed.2d 332
• Parties: UNITED STATES, Petitioner, v. ESTATE of Joseph P. GRACE, Deceased, et al
• Court: U.S. Supreme Court

395 U.S. 316

89 S.Ct. 1730

23 L.Ed.2d 332

UNITED STATES, Petitioner,

v ESTATE of Joseph P. GRACE, Deceased, et al.

No. 574.

Argued April 22, 1969.

Decided June 2, 1969.

Rehearing Denied Oct. 20, 1969.

See 90 S.Ct. 147.

Sol. Gen. Erwin N. Griswold, for petitioner.

William S. Downard, Dallas, Tex., for respondents.

Mr. Justice MARSHALL delivered the opinion of the Court.

This case involves the application of § 811(c)(1)(B) of the Internal Revenue Code of 1939 to a so-called 'reciprocal trust' situation.¹ After Joseph P. Grace's death in 1950, the Commissioner of Internal Revenue determined that the value of a trust created by his wife was includible in his gross estate. A deficiency was assessed and paid, and, after denial of a claim for a refund, this refund suit was brought. The Court of Claims, with two judges dissenting, ruled that the value of the trust was not includible in decedent's estate under § 811(c)(1)(B) and entered judgment for respondent. Estate of Grace v. United States, 393 F.2d 939, 183 Ct.Cl. 745 (1968). We granted certiorari because of an alleged conflict between the decision below and certain decisions in the courts of appeals and because of the importance of the issue presented to the administration of the federal estate tax laws. 393 U.S. 975, 89 S.Ct. 452, 21 L.Ed.2d 437 (1968). We reverse.

I.

Decedent was a very wealthy man at the time of his marriage to the late Janet Grace in 1908. Janet Grace had no wealth or property of her own, but, between 1908 and 1931, decedent transferred to her a large amount of personal and real property, including the family's Long Island estate. Decedent retained effective control over the family's business affairs, including the property transferred to his wife. She took no interest and no part in business affairs and relied upon her husband's judgment. Whenever some formal action was required regarding property in her name, decedent would have the appropriate instrument prepared and she would execute it.

On December 15, 1931, decedent executed a trust instrument, hereinafter called the Joseph Grace trust. Named as trustees were decedent, his nephew, and a third party. The trustees were directed to pay the income of the trust to Janet Grace during her lifetime, and to pay to her any part of the principal which a majority of the trustees might deem advisable. Janet was given the power to designate, by will or de d, the manner in which the trust estate remaining at her death was to be distributed among decedent and their children. The trust properties included securities and real estate interests.

On December 30, 1931, Janet Grace executed a trust instrument, hereinafter called the Janet Grace trust, which was virtually identical to the Joseph Grace trust. The trust properties included the family estate and corporate securities, all of which had been transferred to her by decedent in preceding years.

The trust instruments were prepared by one of decedent's employees in accordance with a plan devised by decedent to create additional trusts before the advent of a new gift tax expected to be enacted the next year. Decedent selected the properties to be included in each trust. Janet Grace, acting in accordance with this plan, executed her trust instrument at decedent's request.

Janet Grace died in 1937. The Joseph Grace trust terminated at her death. Her estate's federal estate tax return disclosed the Janet Grace trust and reported it as a nontaxable transfer by Janet Grace. The Commissioner asserted that the Janet and Joseph Grace trusts were 'reciprocal' and asserted a deficiency to the extent of mutual value. Compromises on unrelated issues resulted in 55% of the smaller of the two trusts, the Janet Grace trust, being included in her gross estate.

Joseph Grace died in 1950. The federal estate tax return disclosed both trusts. The Joseph Grace trust was reported as a nontaxable transfer and the Janet Grace trust was reported as a trust under which decedent held a limited power of appointment. Neither trust was included in decedent's gross estate.

The Commissioner determined that the Joseph and Janet Grace trusts were 'reciprocal' and included the amount of the Janet Grace trust in decedent's gross estate. A deficiency in the amount of $363,500.97, plus interest, was assessed and paid.

II.

Section 811(c)(1)(B) of the Internal Revenue Code of 1939 provided that certain transferred property in which a decedent retained a life interest was to be included in his gross estate. The general purpose of the statute was to include in a decedent's gross estate transfers that are essentially testamentary—i.e., transfers which leave the transferor a significant interest in or control over the property transferred during his lifetime. See Commissioner of Internal Revenue v. Estate of Church, 335 U.S. 632, 643—644, 69 S.Ct. 322, 328, 93 L.Ed. 288 (1949).

The doctrine of reciprocal trusts was formulated in response to attempts to draft instruments which seemingly avoid the literal terms of § 811(c)(1)(B), while still leaving the decedent the lifetime enjoyment of his property.² The doctrine dates from Lehman v. Commissioner of Internal Revenue, 109 F.2d 99 (C.A.2d Cir.), cert. denied, 310 U.S. 637, 60 S.Ct. 1080, 84 L.Ed. 1406 (1940). In Lehman, decedent and his brother owned equal shares in certain stocks and bonds. Each brother placed his interest in trust for the other's benefit for life, with remainder to the life tenant's issue. Each brother also gave the other the right to withdraw $150,000 of the principal. If the brothers had each reserved the right to withdraw $150,000 from the trust that each had created, the trusts would have been includible in their gross estates as interests of which each had made a transfer with a power to revoke. When one of the brothers died, his estate argued that neither trust was includible because the decedent did not have a power over a trust which he had created.

The Second Circuit disagreed. That court ruled that the effect of the transfers was the same as if the decedent had transferred his stock in trust for himself, remainder to his issue, and had reserved the right to withdraw $150,000. The court reasoned:

'The fact that the trusts were reciprocated or 'crossed' is a trifle, quite lacking in practical or legal signifia nce. * * * The law searches out the reality and is not concerned with the form.' 109 F.2d, at 100.

The court ruled that the decisive point was that each brother caused the other to make a transfer by establishing his own trust.

The doctrine of reciprocal trusts has been applied numerous times since the Lehman decision.³ It received congressional approval in § 6 of the Technical Changes Act of 1949, 63 Stat. 893.⁴ The present case is, however, this Court's first examination of the doctrine.

The Court of Claims was divided over the requirements for application of the doctrine to the situation of this case. Relying on some language in Lehman and certain other courts of appeals' decisions,⁵ the majority held that the crucial factor was whether the decedent had established his trust as consideration for the establishment of the trust of which he was a beneficiary. The court ruled that decedent had not established his trust as a quid pro quo for the Janet Grace trust, and that Janet Grace had not established her trust in exchange for the Joseph Grace trust. Rather, the trusts were found to be part of an established pattern of family giving, with neither party desiring to obtain property from the other. Indeed, the court found that Janet Grace had created her trust because decedent requested that she do so. It therefore found the reciprocal trust doctrine inapplicable.

The court recognized that certain cases had established a slightly different test for reciprocity.⁶ Those cases inferred consideration from the establishment of two similar trusts at about the same time. The court held that any inference of consideration was rebutted by the evidence in the case, particularly the lack of any evidence of an estate tax avoidance motive on the part of the Graces. In contrast, the dissent felt that the majority's approach placed entirely too much weight on subjective intent. Once it was established that the trusts were interrelated, the dissent felt that the subjective intent of the parties in establishing the trust should become irrelevant. The relevant factor was whether the trusts created by the settlors placed each other in approximately the same objective economic position as they would have been in if each had created his own trust with himself, rather than the other, as life beneficiary.

We agree with the dissent that the approach of the Court of Claims majority places too much emphasis on the subjective intent of the parties in creating the trusts and for that reason hinders proper application of the federal estate tax laws. It is true that there is language in Lehman and other cases that would seem to support the majority's approach. It is also true that the results in some of those cases arguably support the decision below.⁷ Nevertheless, we think that these cases are not in accord with this Court's prior decisions interpreting related provisions of the federal estate tax laws.

Emphasis on the subjective intent of the parties in creating the trusts, particularly when those parties are members of the same family unit, creates substantial obstacles to the proper application of thef ederal estate tax laws. As this Court said in Estate of Spiegel v. Commissioner of Internal Revenue, 335 U.S. 701, 705—706, 69 S.Ct. 301, 303, 93 L.Ed. 330 (1949):

'Any requirement * * * (of) a post-death attempt to probe the settlor's thoughts in regard to the transfer, would partially impair the effectiveness of * * * (section 811(c)) as an instrument to frustrate estate tax evasions.'

We agree that 'the taxability of a trust corpus * * * does not hinge on a settlor's motives, but depends on the nature and...