White v. U.S.

• Decision Date: 14 June 1982
• Docket Number: No. 81-2043,81-2043
• Parties: 82-2 USTC P 13,472 John F. WHITE, Administrator D.B.N., C.T.A., of the Estate of Theodore N. Townsend, Deceased, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 1156

680 F.2d 1156

82-2 USTC P 13,472

John F. WHITE, Administrator D.B.N., C.T.A., of the Estate

of Theodore N. Townsend, Deceased, Plaintiff-Appellee, v. UNITED STATES of America, Defendant-Appellant.

No. 81-2043.

United States Court of Appeals, Seventh Circuit.

Argued Jan. 18, 1982.

Decided June 14, 1982.

Frank P. Cihlar, Tax Div., Dept. of Justice, Washington, D. C., for defendant-appellant.

Douglass R. Shortridge, Indianapolis, Ind., for plaintiff-appellee.

Before CUMMINGS, Chief Judge, BAUER, Circuit Judge, and DOYLE, Senior District Judge. ^*

BAUER, Circuit Judge.

This tax refund suit concerns the federal estate tax consequences of decedent Theodore N. Townsend's failure to mention his general power of appointment over certain trust assets in his will. The district court granted summary judgment in favor of decedent's estate, concluding that the Internal Revenue Service (IRS) erroneously included the trust-assets' value in Townsend's estate. White v. United States, 511 F.Supp. 570 (S.D.Ind.1981). The United States now appeals. We affirm.

I

Settlor-donor Charlotte K. Townsend, a resident of Le Roy, New York, established several testamentary trusts upon her death in 1931. Item Seventh ¹ of her will gave her son, decedent-donee Theodore N. Townsend, a life income interest in one of the trusts and a general power of appointment ² over any interest remaining in that trust upon his death. In the event decedent failed to exercise his unrestricted appointment power, Item Seventh provided that the trust property would pass to decedent's issue. Item Seventh was silent, however, as to whether the law of the donor's or that of the donee's domicile would govern if a dispute arose over whether the donee had exercised his appointment power.

On November 9, 1973, decedent died testate in Indianapolis, Indiana, his residence and domicile since 1946. Decedent's will, which was admitted to probate in Marion County, Indiana, specifically bequeathed $45,000 to several educational institutions. A general residuary clause then divided the remainder of decedent's estate equally among his three children. The will mentioned neither decedent's life income interest in the 1931 trust fund nor his appointment power.

As part of his duties as executor of decedent's estate, George S. Olive, Jr., filed a federal estate tax return reflecting decedent's interests in the other testamentary trusts created by Charlotte K. Townsend in 1931. As to the trust over which decedent held the appointment power, Olive included the following notation in Schedule H of Form 706:

Powers Created Prior to October 21, 1942, but Not Included in Gross Estate: Securities held by the Marine Midland Bank-Western, Buffalo, New York, in a trust created by Charlotte K. Townsend, under Item 7th of her Will, subject to general power of appointment, are not included in decedent's gross estate under the provisions of Sec. 2041, I.R.C., because decedent never exercised power. (Copy of C.K. Townsend Will follows Sch. F)

At the time decedent died the trust assets subject to his appointment power were valued at $352,760.64.

An IRS agent auditing the estate's tax return considered decedent's power exercised and therefore included the trust-assets' value in decedent's estate. The agent relied on New York law, under which a testate decedent is presumed to have exercised his general power absent clear proof to the contrary. Olive objected to this decision, but the IRS rejected his timely protest. As a result, Olive paid the asserted $99,727.39 estate tax deficiency and $12,489.13 additional interest with funds advanced by Midland Marine Bank-Western of Buffalo, New York (Midland). Midland, the original and continuous trustee of the 1931 trust fund subject to decedent's power, deducted the sum advanced for the estate tax and then paid the balance of the trust proceeds to decedent's three children. Thereafter the Marion County probate proceedings were closed, with the exception of John F. White's appointment as successor administrator for the purpose of filing a tax refund claim. The claim was disallowed and White filed this suit.

After considering the parties' cross-motions for summary judgment, the district court decided that the $352,760.64 should not have been included in decedent's gross estate and that a refund was therefore due. This appeal followed.

II

Under section 2041(a)(1) of the Internal Revenue Code of 1954, ³ appointive trust ⁴ assets are included in a decedent's estate only if the decedent exercised his general appointment power over them. In cases such as this one, where a decedent disposes of all his property through a residuary clause but fails to mention his general power, a question arises as to whether the residuary clause operates as an exercise of the power. New York law presumes that a testate decedent has exercised his power unless a different testamentary intent appears expressly or by necessary implication. N.Y.Est., Powers & Trusts Law (McKinney) § 10-6.1(a)(4). ⁵ Indiana law creates the opposite presumption by deeming a power unexercised absent some specific testamentary indication that the decedent intended to exercise his power. Ind.Code.Ann. § 29-1-6-1(f) (Burns). ⁶

The parties agree that decedent's silence as to his intent raises a question of law, but divide over which state's law should govern. The government contends that New York law controls because the trust was created, located, and administered in New York. Proper application of New York's presumption, the government asserts, requires judgment in favor of the United States. Decedent's estate representative, however, argues that Indiana law governs and dictates a refund to the estate or, in the alternative, that correct analysis under New York law mandates recovery for the estate.

The district court, sitting in Indiana, looked to Indiana choice-of-law rules to resolve this conflict. See Klaxon Co. v. Stentor Electric Mfg. Co., Inc., 313 U.S. 487, 496, 61 S.Ct. 1020, 1021, 85 L.Ed. 1477 (1941); First National Bank of Chicago v. Ettlinger, 465 F.2d 343, 346 (7th Cir. 1972). Although Indiana decisions address certain areas involving conflicts of laws, see, e.g., W. H. Barber Co. v. Hughes, 223 Ind. 570, 63 N.E.2d 417 (1945) (contract action); Suyemasa v. Myers, 420 N.E.2d 1334 (Ind.Ct.App.1981) (same); Clow Corp. v. Ross Township School Corp., 384 N.E.2d 1077 (Ind.Ct.App.1979) (same), ⁷ no Indiana choice-of-law rule covers power-of-appointment questions. The district court therefore properly recognized its duty to decide what position the Indiana Supreme Court would take if confronted with this problem. See Commissioner v. Estate of Bosch, 387 U.S. 456, 465, 87 S.Ct. 1776, 1782, 18 L.Ed.2d 886 (1967). We agree with the district court that Indiana's highest court would adopt the more sensible rule that the law of the donee's domicile governs issues concerning the donee's intention to exercise a power of appointment by will.

The donee's unrestricted appointment power gives him complete control over the trust-assets' disposition. As a practical matter, then, property subject to the donee's general power belongs not to the donor, as the traditional rule suggests, but to the donee, at least for appointment purposes. The donee, as the only person able to alter the designation of beneficiaries, thus becomes the key figure and his intent the central issue. Consequently, a court called upon to decide whether a donee effectively exercised a power by will, when his will's residuary clause disposed of all his property without mentioning the power, must attempt to discern the donee's intent. See, e.g., Radford v. Fidelity & Columbia Trust Co., 185 Ky. 453, 458-59, 215 S.W. 285, 288 (1919); Restatement (Second) of Conflict of Laws § 275, Comment c (1971); H. Goodrich, Handbook of the Conflict of Laws § 177 (4th ed. E. Scoles 1964); R. Leflar, American Conflicts Law § 200 (3d ed. 1977); 5 A. Scott, The Law of Trusts § 642 (3d ed. 1967).

Given the realities of this situation, it seems logical to focus on the donee's express, implied, or constructive intent to exercise his power as determined by the rules of his state. The language of the donee's will is his own and should be construed according to the laws under which his will was drafted and with which he was presumably most familiar, those of his own domicile. See R. Leflar, American Conflicts Law § 200 (3d ed. 1977). Furthermore, the decision to exercise a general power lies solely within the donee's unfettered discretion, which probably is influenced by local rules, customs, and decisions. Accordingly, the law of the donee's domicile should control; it is his will that is being construed. See 5 A. Scott, The Law of Trusts § 642 (3d ed. 1967).

Although our assessment of the donor-donee relationship differs from the traditional view, the nature of this case justifies our departure. In all tax controversies courts consider substance over form. Thus, from a taxation standpoint the power to dispose of property at death has long been considered the equivalent of ownership, see Graves v. Schmidlapp, 315 U.S. 657, 660, 62 S.Ct. 870, 873, 86 L.Ed. 1097 (1942), overruling Wachovia Bank & Trust Co. v. Doughton, 272 U.S. 567, 47 S.Ct. 202, 71 L.Ed. 413 (1926); Whitney v. State Tax Commission of New York, 309 U.S. 530, 538, 60 S.Ct. 635, 638, 84 L.Ed. 909 (1940); Wachovia Bank & Trust Co. v. Doughton, 272 U.S. 567, 576, 47 S.Ct. 202, 204, 71 L.Ed. 413 (1926) (Holmes, J joined by Brandeis and Stone, JJ., dissenting); Bullen v. Wisconsin, 240 U.S. 625, 631, 36 S.Ct. 473, 474, 60 L.Ed. 830 (1916), irrespective of technical legal ownership. Because a donee upon exercising his general power becomes the appointive property's de facto owner for tax purposes, his constructive testamentary intent to exercise his appointment power should arise from the laws of his domicile rather than those of the donor's.

Our holding that the donee's will...