T.C. Memo. 1996-10
UNITED STATES TAX COURT
ESTATE OF BERT B. RAPP, DECEASED,
RICHARD L. RAPP, EXECUTOR, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 19107-92. Filed January 18, 1996.
Dennis N. Brager and Gerald E. Lunn, Jr., for
petitioner.
Clifton B. Cates III and Nancy C. McCurley, for
respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
WHALEN, Judge: Respondent determined the following
deficiency in, and additions to, petitioner's Federal
estate tax:
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Additions to Tax
Deficiency Sec. 6653(a)(1)(A) Sec. 6653(a)(1)(B)
50% interest on:
$1,685,271 $84,264 $1,685,271
Unless stated otherwise, all section references are to the
Internal Revenue Code in effect for the date of the
decedent's death.
After concessions, the sole issue for decision is
whether petitioner is eligible to deduct, as an allowance
of marital deduction under section 2056(a), the value of
certain property distributed to a testamentary trust for
the benefit of the decedent's surviving spouse. This
issue turns on whether the subject property is "qualified
terminable interest property" within the meaning of section
2056(b)(7).
FINDINGS OF FACT
The parties have stipulated some of the facts that
are pertinent to this case. The stipulation of facts filed
by the parties and the exhibits attached thereto are
incorporated herein by this reference.
The decedent, Mr. Bert B. Rapp, died on February 23,
1988. He was a California resident at that time. The
executor of the decedent's estate, Mr. Richard Rapp, the
decedent's son, was also a California resident when the
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instant petition was filed. Originally, the decedent's
other son, Mr. David Rapp, served as coexecutor, but he
relinquished that position before this action was
commenced.
In addition to his two sons, the decedent was survived
by his wife of approximately 35 years, Mrs. Laura Rapp.
The decedent first met his wife in 1946, approximately 7
years before they were married. At that time, the decedent
owned an automobile service station and garage. Mrs. Rapp
was employed, but she also worked for the decedent in the
evenings and sometimes on weekends. The decedent did not
pay Mrs. Rapp for her services. After the Rapps were
married, Mrs. Rapp continued to work for the decedent until
the birth of their sons. After that time, Mrs. Rapp was
not employed outside the home.
Over the years, the decedent's business enterprises
prospered. His principal business was Motor Transportation
Service Systems (MTSS), a corporation engaged in vehicle
leasing. He was president of MTSS and owned one-third of
its outstanding stock worth $938,194 at the time of his
death. In addition to MTSS, the decedent was a partner in
several partnerships, and he owned shares in mutual funds,
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several parcels of real property, promissory notes, and
shares of stock in other corporations.
Mrs. Rapp managed the household budget and paid
household expenses. She did not take an active role in
either her husband's business or his investment activities.
The decedent put several investments and at least one
venture in his wife's name, but Mrs. Rapp played no active
role in their management. The decedent was satisfied with
Mrs. Rapp's management of their household expenses.
In 1972, Mrs. Rapp was involved in an automobile
accident. As a result of the accident, she was in a coma
for 8 days, and she spent a total of 5 months in the
hospital. The accident left her with poor vision and other
medical problems. After the accident, Mrs. Rapp often
complained about her physical limitations. She believed
that she would never again be able to work. The decedent
believed that the accident greatly affected his wife's
personality and was partially to blame for some of the
marital discord that the Rapps later suffered.
The decedent was not an attorney or an accountant.
In conducting his business affairs, he relied on the
advice of professionals. However, he attempted to become
knowledgeable about the legal and tax consequences of
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his business transactions. The decedent consulted
frequently with Mr. Laurence Clark, an attorney, and with
Mr. George Lippert, a certified public accountant. Neither
Mr. Clark nor Mr. Lippert is an expert in estate planning.
Most of the decedent's legal affairs were handled by
Mr. Clark, who is licensed to practice law in the State of
California. Mr. Clark engaged in a general practice of
law. He maintained a professional and personal
relationship with the decedent until the decedent's death.
Mr. Clark had minimal experience in estate planning
and in handling estates with assets of more than $1.2
million. Nevertheless, in 1978, he prepared wills for both
the decedent and Mrs. Rapp (the 1978 wills). These wills
were essentially identical. Each of the 1978 wills
provided that all household furniture and furnishings,
clothing, personal effects, and automobiles of the testator
were to be given to the surviving spouse. All other
property of the testator was given to the testator's two
sons to be held in trust during the life of the surviving
spouse. As cotrustees, Messrs. David and Richard Rapp were
given the power to disburse such amounts from the principal
and income of the trust estate as they would decide is
necessary "in their absolute discretion" for the "health,
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education and support" of the surviving spouse. Upon the
death of the surviving spouse, the trust was to cease and
the cotrustees were directed to distribute the balance of
the trust estate to the testator's two sons or their living
issue. In 1982, the decedent executed a codicil that
amended his 1978 will by changing the last successor
trustee and the last successor executor but made no change
in the substantive provisions of the will.
Mr. Clark also prepared the wills that the decedent
and Mrs. Rapp executed on July 9, 1986 (the 1986 wills).
These wills revoked the 1978 wills but were substantively
the same, with only minor changes in language and form, and
with changes in the identity of successor executors and
alternate trustees. The decedent's and Mrs. Rapp's 1986
wills were identical to one another in all material
aspects.
Like the 1978 wills, the 1986 wills provide that all
of the household furniture and furnishings, clothing,
personal effects, and automobiles of the testator are given
to the surviving spouse. All other property of the
testator is given to the testator's two sons, Richard Rapp
and David Rapp, to be held in trust during the life of the
surviving spouse. The trustee of the trust is given the
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power to disburse such amounts from the principal and
income of the trust as the trustee decides is necessary "in
his absolute discretion" for the "proper health, education
and support" of the surviving spouse. Article Fifth (b) of
the decedent's will states as follows:
If at any time, in the absolute discretion
of the Trustee or co-Trustees, my wife, LAURA B.
RAPP, should for any reason be in need of funds
for her proper health, education and support, the
Trustee may in his absolute discretion pay to or
apply for the benefit of my wife, such amounts
from the principal and income of the trust
estate, up to the whole thereof, as the Trustee
may from time to time deem necessary or advisable
for her use and benefit.
The 1986 wills provide that on the death of the surviving
spouse, the trust shall cease and the trustee shall
distribute the residue of the trust to the decedent's sons
or their children.
Before he prepared the 1986 wills, Mr. Clark had
become acquainted with the size and complexity of the
decedent's business and financial holdings due to the fact
that he had handled legal matters for the decedent and his
businesses beginning in the mid-1970's. The decedent had
also given Mr. Clark a personal financial statement dated
April 30, 1986, listing assets of $13,530,671, liabilities
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of $3,357,915, and a net worth of $10,172,756. The
financial statement detailed the investments that the Rapps
owned in 1986.
The decedent and Mrs. Rapp executed their 1986 wills
during a meeting in Mr. Clark's office. Prior to that
time, Mr. Clark had not consulted with Mrs. Rapp about the
provisions of her 1986 will. During the meeting, Mr. Clark
read parts of the decedent's 1986 will to the decedent and
Mrs. Rapp. Mr. Clark told Mrs. Rapp that her 1986 will
was essentially the same as the decedent's, and that she
would not understand it because it was technical. At the
time the wills were signed, Mr. Clark did not discuss the
estate tax consequences of the 1986 wills with either the
decedent or Mrs. Rapp.
The 1986 wills were executed during a difficult
time in the decedent's marriage to Mrs. Rapp. During the
mid-1980's, the decedent had considered divorcing his wife.
Mr. Clark advised the decedent that a divorce would be
disruptive to the decedent's business ventures. Mr. Clark
put the decedent in contact with a marriage counselor in
1984. The Rapps remained married until Mr. Rapp's death in
1988.
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From time to time, the decedent discussed estate tax
matters with his friends and acquaintances. On those
occasions, he urged them to plan to avoid estate taxes.
He did not disclose any specific provisions of his will or
his wife's will, except to say that his sons would be co-
trustees and that his wife, children, and grandchildren
would not have to worry about the estate. The decedent
stated that he trusted Mr. Richard Rapp to handle financial
matters and to look after Mrs. Rapp in the event of his
death. The decedent also told his friends that he caused
his will to be updated to account for changes in the law,
and he advised them to do the same. The decedent told
Mr. Bruce Bell, an employee of Wells Fargo Bank who
supervised the decedent's and MTSS's loan accounts with the
bank, that there would be minimal estate taxes and minimal
liquidity problems at the time of his death.
The decedent also discussed the estate tax marital
deduction with his accountant, Mr. Lippert. Sometime
between 1984 and 1986, the decedent showed Mr. Lippert an
article about the marital deduction permitted for Federal
estate tax purposes. The decedent told Mr. Lippert that he
was "moving forward in that area." On other occasions, the
decedent told Mr. Lippert that his estate tax matters were
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"moving forward and * * * under control". Mr. Lippert also
discussed with the decedent how to provide liquidity to pay
estate taxes on death. After the decedent's death,
Mr. Lippert was surprised to learn that the testamentary
trust created under the decedent's 1986 will was not
eligible for the marital deduction.
The decedent's 1986 will was admitted to probate on
May 5, 1988, before the Superior Court of California,
County of Los Angeles (referred to herein as the probate
court). Initially, the coexecutors, Messrs. David and
Richard Rapp, retained Mr. Clark to handle the probate of
the decedent's estate. As the proceedings went on,
however, they became displeased with Mr. Clark's handling
of the estate. They grew dissatisfied with the time it
took Mr. Clark to file required papers, and they felt
uncomfortable with some of the advice that he gave to them.
They also became aware that the decedent's 1986 will would
require the payment of substantial Federal estate taxes.
Mr. Richard Rapp felt that Mr. Clark was uncooperative and
was more concerned with avoiding a malpractice suit than
with settling the estate's problems. Further, Mr. Richard
Rapp was unhappy because Mr. Clark threatened to withdraw
as counsel for MTSS in a litigation matter if he were
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removed as counsel for the decedent's estate. After the
other matter was resolved, Mr. Richard Rapp caused the
decedent's estate to retain different counsel.
On August 19, 1988, Mrs. Rapp filed with the probate
court a document entitled Petition For Modification of
Trust Created Under Article Fifth of Decedent's Will
Admitted to Probate In Order to Carry Out Decedent's
Intent. Mrs. Rapp's petition alleges:
it was decedent's intention that the Trust
created under Article Fifth of his Will for the
benefit of Petitioner [i.e., Mrs. Rapp] during
her lifetime was intended to qualify for the QTIP
election and that decedent believed that the
Trustees would pay all of the income from the
Trust, at least annually, to or for the benefit
of Petitioner during her lifetime.
Based upon the decedent's intentions as alleged,
Mrs. Rapp's petition asks the probate court to reform the
decedent's will "to make it clear that the income from
the Trust will be payable annually to Petitioner [i.e.,
Mrs. Rapp]" in order that the trust corpus will qualify as
qualified terminable interest property as defined by
section 2056(b)(7)(B). The petition claims that the
subject trust is a "marital deduction gift", as defined by
section 21520(b) of the California Probate Code to be "a
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transfer of property that is intended to qualify for the
marital deduction." Mrs. Rapp's petition relies upon
section 15403 of the California Probate Code, which permits
modification or termination of a trust upon consent of
all beneficiaries, and section 15409(a) of the California
Probate Code (West 1991), which permits modification or
termination of a trust to account for changed
circumstances.
A hearing on Mrs. Rapp's petition was set for
September 29, 1988, and Mrs. Rapp served a copy of her
petition and a copy of the notice of hearing on the
decedent's sons, both in their capacity as cotrustees and
as beneficiaries, on Mr. David Rapp's two minor children,
and on Mr. Clark. On or about September 28, 1988, the
probate court appointed Matthew S. Rae, Esquire, as
guardian ad litem for the minor children of Mr. David Rapp,
who were contingent remaindermen under the will, and for
the unborn, unknown, and/or unascertained lawful issue of
the decedent's two sons.
In advance of the hearing on Mrs. Rapp's petition,
Mr. Richard Rapp made a survey of his father's friends and
associates to determine the decedent's intent at the time
his 1986 will was executed. He also caused a search to be
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made of the decedent's financial records and files.
Mr. Richard Rapp believed that Mr. Clark would not make a
credible witness, and Mr. Rapp concluded that he could not
defeat his mother's petition for reformation of the
decedent's will.
The hearing on Mrs. Rapp's petition took place on
September 29, 1988. The Commissioner of Internal Revenue
was not notified of the proceeding and did not enter an
appearance. Mr. Clark was notified of the hearing, but he
did not voluntarily appear at the hearing. The probate
court granted Mrs. Rapp's petition on October 31, 1988,
and the Court's order became final on April 30, 1989.
The order of the probate court dated October 31, 1988,
reads as follows:
The Petition for Modification of Trust
Created Under Article Fifth of Decedent's Will
Admitted to Probate in Order to Carry Out
Decedent's Intent, came on the 29th day of
September, 1988 in Department 11 at 9:15 a.m.
for hearing and settlement by the above-entitled
Court, the Honorable Richard C. Hubbell, Judge
presiding, with Clark R. Byam of HAHN & HAHN,
appearing on behalf of Laura B. Rapp; Gerald E.
Lunn, Jr., appearing on behalf of Richard L. Rapp
and David L. Rapp, Co-Executors of the Will of
Bert Rapp, deceased and Matthew S. Rae, Jr.,
Guardian ad Litem appearing on behalf of any
and all minor and unborn, unknown, and/or
unascertained grandchildren of decedent.
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Oral argument was presented by all parties
present and all parties then submitted the matter
for the Court's determination.
Based upon the written pleadings and oral
argument, the Court finds as follows:
(1) All notices of the hearing
have been given as required by law.
The Court Orders:
(1) That Article FIFTH (b) of decedent's
Will is modified as follows:
"(b) During the lifetime of
my wife, LAURA B. RAPP, the
Trustee or co-Trustees shall
pay the net income from the
corpus of the trust annually
or at more frequent intervals
to or for the benefit of
LAURA B. RAPP, during her
lifetime. In addition to the
net income, the Trustee or
co-Trustees shall pay as much
of the principal from the
Trust to or for the benefit
of my wife as shall be needed
to provide for the reasonable
health, education and support
of my wife during her life-
time. Any income accrued or
held undistributed at the
time of my wife's death shall
be distributed to her
estate."
(2) that the following is added
as Subsection (i) to Article FIFTH:
"(i) I authorize my executor
to elect to treat the trust
created under this Article
FIFTH, or any portion there-
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of, as "qualified terminable
interest property" in order
to obtain the marital deduc-
tion for such property for
federal estate tax purposes.
Whether or not my executors
make such an election, I
hereby exonerate my executors
from any liability resulting
from making or failing to
make such an election."
The order was signed by the probate court judge and was
also signed "Approved as to form" by the guardian ad litem,
Mr. Rae, and the attorney for the estate, Mr. Lunn.
On or about November 9, 1988, shortly before the due
date for the petitioner's estate tax return, petitioner's
attorney filed with the Internal Revenue Service an
Application for Extension of Time to File U.S. Estate
(and Generation-Skipping Transfer) Tax Return and/or Pay
Estate (and Generation-Skipping Transfer) Tax(es) on Form
4768. Petitioner requested an extension of time to file
until May 23, 1989, for the following reasons:
The Decedent's estate includes numerous
interrelated closely-held businesses, some
of which have experienced serious financial
problems. Significant questions of valuation
remain unresolved despite diligent efforts
to resolve them. Furthermore, a number of
significant, unresolved contingent creditors'
claims remain outstanding against the estate.
The executor intends to make an election under
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Section 2057 [sic] (b)(7)(B)(v), but cannot, at
this time, determine which portion of the estate
is to be treated as "qualified terminable
interest property."
Along with the application for an extension of time to
file, petitioner's attorney sent a payment of estate tax in
the amount of $156,424 and requested an extension of time
to pay any additional amount of estate tax for the
following reason:
The amount of estate taxes can not [sic] be
determined because the size of the gross estate
is unascertainable (for the reasons set forth
above under "Extension of Time to File"), and
the executor's election to treat property passing
to the surviving spouse as qualified terminable
interest property cannot be made. Nevertheless,
a payment of $156,424 against the amount of
estate taxes estimated to be due is paid with
this application.
Petitioner's attorney did not explain how the estate tax
payment of $156,424 was computed.
On May 22, 1989, the executor filed the petitioner's
United States Estate (and Generation-Skipping Transfer)
Tax Return on IRS Form 706. According to the return, the
decedent and Mrs. Rapp owned community property worth
$11,255,444.12 at the time of the decedent's death. The
return reports that the decedent's total gross estate,
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consisting of one-half the community property in the
aggregate amount of $5,627,722.06, is composed of the
following assets:
Real estate, Sch. A $1,041,375.00
Stocks and bonds, Sch. B 2,374,002.67
Mortgages, notes, and cash, Sch. C 1,537,013.93
Insurance on decedent's life, Sch. D 25,000.00
Jointly owned property, Sch. E 105,576.96
Other miscellaneous property, Sch. F
Partnerships 292,500.00
Leasehold on bldg. and lot 115,000.00
Option agreement 20,000.00
Overpayment of Federal income tax 1,991.00
Jewelry and furs 100,262.50
Household furnishings 15,000.00
Total 5,627,722.06
A Schedule M--Bequests, Etc. to Surviving Spouse,
was filed with the petitioner's estate tax return. The
executor answered "no" to question 1 on Schedule M. That
question asks:
Did any property pass to the surviving spouse as
a result of a qualified disclaimer? If "Yes",
attach a copy of the written disclaimer required
by section 2518(b).
No written disclaimer was attached to the petitioner's
estate tax return.
In response to question 2 on Schedule M, the executor
checked the space provided to "elect to claim a marital
deduction for qualified terminable interest property (QTIP)
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under section 2056(b)(7)." Schedule M states that the
executor intended to claim the marital deduction only with
respect to so much of the residue of the decedent's estate
as reduces the total estate tax payable to $156,424. The
following statement is set forth on part 2 of Schedule M:
A fraction of each of the above assets allocated
to the testamentary QTIP trust established under
Article FIFTH of decedent's last Will dated
July 9, 1986, as construed by Court Order
Modifying Decedent's Trust dated October 31, 1988
shall be subject to the QTIP election hereunder.
The numerator of such fraction shall be the
minimum amount of federal estate tax marital
deduction under Section 2056(b)(7) necessary to
reduce the Federal Estate Tax to $156,424 (based
on the values as finally determined for federal
estate tax purposes of all assets includible in
the decedent's taxable estate) and the denomina-
tor shall be the final federal estate tax value
of the property passing to the trust established
under Article FIFTH of the decedent's will, as
modified by the order modifying decedent's trust
dated October 31, 1988, after taking into account
all liabilities of the estate. * * * The fore-
going provisions shall be interpreted based on
the Executor's intent that the elective property
will reflect its proportionate share of any
increase or decline in value in the whole of the
property listed above or any subsequently
discovered property allocable to such trust and
that the total federal estate tax payable
hereunder shall not exceed $156,424.
The record of this case does not explain why the executor
intended to pay estate taxes of $156,424.
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On Part 1 of Schedule M, which calls for a list of
"Property Interests Which Are Not Subject to a QTIP
Election", the executor reported the property specifically
devised to Mrs. Rapp, consisting of the couple's residence,
the household furnishings, and the decedent's personal
effects, in the aggregate amount of $435,262.50. On
part 2 of Schedule M, which calls for a list of "Property
Interests Which Are Subject to a QTIP Election", the
executor reported $3,444,087.28. That amount is composed
of the value of the assets available for distribution to
the testamentary trust, $5,086,882.60 (i.e., total gross
estate, $5,627,722.06, less assets devised to Mrs. Rapp,
$435,262.50, and assets jointly owned with other
individuals, $105,576.96), less the portion of the property
that was not subject to the QTIP election, $802,510.21, and
the aggregate nonmarital deductions claimed on the return,
$840,285.11. The marital deduction claimed on the return
is $3,683,899.38. It consists of the total interests
passing to Mrs. Rapp, $3,879,349.78 (i.e., $3,444,087.28
plus $435,262.50) less Federal estate taxes, $156,424, and
other death taxes, $39,026.40.
In the notice of deficiency issued to petitioner,
respondent determined that petitioner had "failed to fully
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substantiate" the marital deduction. Respondent allowed
the deduction to the extent of the property that had been
specifically devised to Mrs. Rapp, $435,262.50, but
disallowed the deduction to the extent of the property that
had been distributed to the testamentary trust.
OPINION
For purposes of computing Federal estate taxes,
section 2056(a) permits an allowance of marital deduction
to be deducted from the gross estate. Sec. 2056(a). In
general, the allowance of marital deduction consists of
the value of any interest in property which passes or has
passed from the decedent to his or her surviving spouse.
Id. However, as a general rule, the marital deduction
does not include the value of any property in which the
decedent's spouse is given a life estate or other
terminable interest and in which another person is given
an interest that may permit the other person to possess or
enjoy any part of the property after the interest of the
surviving spouse terminates or fails. Sec. 2056(b)(1).
An exception to the limitation applicable to life
estates or other terminable interests is provided by
section 2056(b)(7) in the case of "qualified terminable
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interest property". Under section 2056(b)(7)(A),
"qualified terminable interest property", herein referred
to as QTIP, is treated as passing only to the surviving
spouse, and no part of the property is treated as passing
to any person other than the surviving spouse. Section
2056(b)(7)(B)(i) defines QTIP as follows:
(i) In general.--The term "qualified terminable
interest property" means property--
(I) which passes from the decedent,
(II) in which the surviving spouse has a
qualifying income interest for life, and
(III) to which an election under this paragraph
applies.
A "qualifying income interest for life" is defined by
section 2056(b)(7)(B)(ii) as follows:
(ii) Qualifying income interest for life.--The
surviving spouse has a qualifying income interest
for life if--
(I) the surviving spouse is entitled to
all the income from the property, payable
annually or at more frequent intervals, or
has a usufruct interest for life in the
property, and
(II) no person has a power to appoint any
part of the property to any person other
than the surviving spouse.
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After concessions by the parties, the sole issue for
decision in this case is whether the property distributed
to the testamentary trust established under the decedent's
will is QTIP, as defined by section 2056(b)(7)(B)(i), with
the result that the value of that property is eligible to
be included in the allowance of marital deduction provided
by section 2056(a). Petitioner bears the burden of proving
eligibility for the deduction. Rule 142(a), Tax Court
Rules of Practice and Procedure. All Rule references in
this opinion are to the Tax Court Rules of Practice and
Procedure.
As originally written, Article Fifth of the decedent's
1986 will provides that the residue of the decedent's
property, after the payment of certain debts and expenses,
is to be placed in trust for the benefit of the decedent's
surviving spouse, and, upon her death, to be divided
equally between the decedent's two sons. The will does not
give Mrs. Rapp the right to receive income from the trust.
It provides that she is entitled to receive distributions
of income and principal from the trust if the cotrustees
make the determination in their "absolute discretion" that
she is in need of funds "for her proper health, education
and support." Thus, under the decedent's 1986 will,
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Mrs. Rapp is not entitled to receive "all the income from
the property, payable annually or at more frequent
intervals", as required by section 2056(b)(7)(B)(ii)(I).
Accordingly, as the decedent's 1986 will was originally
written, the property which formed the corpus of the
testamentary trust is not QTIP and is not eligible to be
included in the marital deduction. Sec. 2056(b)(1).
The decedent's 1986 will was reformed by the order of
the probate court issued on October 31, 1988, quoted above.
As reformed, Article Fifth (b) of the decedent's will
directs the trustees to "pay the net income from the corpus
of the trust annually or at more frequent intervals to or
for the benefit of LAURA B. RAPP, during her lifetime."
The reformed will also expressly authorizes the executor to
elect to treat the property held in the trust as QTIP.
Petitioner argues that the corpus of the trust can be
included in the marital deduction for four reasons. First,
petitioner argues that on the date of the decedent's death
Mrs. Rapp had an enforceable right under California law to
obtain reformation of the decedent's 1986 will as approved
by the order of the probate court and that the order of the
probate court should be respected for Federal estate tax
purposes. Second, petitioner argues that the QTIP rules
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are applied as of the date of the QTIP election, not the
date of the decedent's death. Third, petitioner argues
that as of the date of the decedent's death, Mrs. Rapp
was entitled to receive annual distributions of all of
the income from the trust because the actions of the co-
trustees and the guardian ad litem in consenting to the
reformation constituted a "qualified disclaimer" under
section 2518. Fourth, petitioner argues that, as of the
date of decedent's death, Mrs. Rapp was entitled to receive
annual distributions of all of the income from the trust
because the cotrustees were obligated to make such
distributions to Mrs. Rapp under a fiduciary duty to look
after her best interests.
Enforceable Right Under California Law to All Trust Income
As a general rule, State law determines the property
rights and interests created by a decedent's will, but
Federal law determines the tax consequences of those rights
and interests. E.g., De Oliveira v. United States, 767
F.2d 1344, 1347 (9th Cir. 1985). In this case,
petitioner's eligibility to include the value of the trust
property in the marital deduction, for Federal estate tax
purposes, depends upon the nature of the interest that
Mrs. Rapp received in the trust under the decedent's 1986
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will. The nature of Mrs. Rapp's interest in the trust is a
matter of California State law. See, e.g., Estate of Heim
v. Commissioner, 914 F.2d 1322, 1327 (9th Cir. 1990), affg.
T.C. Memo. 1988-433.
Petitioner argues that the order of the probate court
reforming the decedent's will should be respected for
Federal estate tax purposes. However, the law is clear,
and both parties to this case agree, that we are not bound
by the action of a State trial court, such as the order of
the probate court, that has not been affirmed by the
State's highest court. Commissioner v. Estate of Bosch,
387 U.S. 456 (1967); Ahmanson Found. v. United States, 674
F.2d 761, 773-775 (9th Cir. 1981); see Estate of Nicholson
v. Commissioner, 94 T.C. 666, 673-674, 680 (1990). If the
action of the probate court is to be respected for Federal
estate tax purposes, it must be in conformity with
California law, and in the absence of a determination by
the California Supreme Court, we are charged with the
responsibility of making that determination. Commissioner
v. Estate of Bosch, supra at 465. Thus, we must decide
whether Mrs. Rapp had an enforceable right under California
law to obtain annual distributions of all of the income
- 26 -
from the trust for life, as required by the order of the
probate court. See id.
Petitioner begins by arguing that the order of the
probate court must be presumed to be "a bona fide
recognition of enforceable rights" under California law
and that respondent has failed to rebut that presumption.
In support of that argument, petitioner cites section
20.2056(e)-2(d)(2), Estate Tax Regs. (currently sec.
20.2056(c)-2(d)(2), Estate Tax Regs.), which provides as
follows:
If as a result of the controversy involving the
decedent's will, or involving any bequest or
devise thereunder, a property interest is
assigned or surrendered to the surviving spouse,
the interest so acquired will be regarded as
having "passed from the decedent to his surviving
spouse" only if the assignment or surrender was a
bona fide recognition of enforceable rights of
the surviving spouse in the decedent's estate.
Such a bona fide recognition will be presumed
where the assignment or surrender was pursuant to
a decision of a local court upon the merits in an
adversary proceeding following a genuine and
active contest. However, such a decree will be
accepted only to the extent that the court passed
upon the facts upon which deductibility of the
property interest depends. If the assignment or
surrender was pursuant to a decree rendered by
consent, or pursuant to an agreement not to
contest the will or not to probate the will, it
will not necessarily be accepted as a bona fide
evaluation of the rights of the spouse.
- 27 -
We are not convinced that there was a "genuine and
active contest" in the probate court or that the order of
the probate court constitutes "a decision of a local court
upon the merits in an adversary proceeding", so as to
trigger the presumption set forth in the above regulation.
Sec. 20.2056(e)-2(d)(2), Estate Tax Regs. In this
connection, it is significant that the guardian ad litem
stated during the hearing before the probate court that a
"benefit" would be realized by the entire Rapp family if
the estate tax of approximately $2 million were postponed
until Mrs. Rapp's death. He stated as follows:
Under those circumstances the benefit to
the entire family, the entire estate, by post-
poning the tax until the surviving spouse dies,
I believe is also a benefit on the person I have
been appointed to represent.
We do not accept petitioner's assertion that the
investigation conducted by the executor proves that the
proceeding before the probate court was adversarial in
nature. To the contrary, it is equally likely that the
executor's investigation was undertaken to justify
petitioner's position before this Court in order to obtain
the "benefit" of postponing the estate tax.
- 28 -
In any event, we do not accept petitioner's assertion
that the order of the California probate court is "a
decision of a local court upon the merits in an adversary
proceeding following a genuine and active contest." Sec.
20.2056(e)-2(d)(2), Estate Tax Regs. To the contrary, the
record of the hearing before the probate court shows that
the court granted Mrs. Rapp's petition after ascertaining
the opinion of the guardian ad litem that his clients "will
not be adversely affected by this petition" and determining
that no objection had been filed to the petition. No
witnesses were called to testify, and no documents were
introduced into evidence. We find nothing in the record of
this case to show that the probate court "passed upon the
facts upon which deductibility of the property interests
depends." Sec. 20.2056(e)-2(d)(2), Estate Tax Regs.
Rather, the order of the probate court appears to have been
"rendered by consent" such that it "will not necessarily
be accepted as a bona fide evaluation of the rights of the
spouse." Sec. 20.2056(e)-2(d)(2), Estate Tax Regs. Thus,
we reject petitioner's assertion that the order of the
probate court must be presumed to be a bona fide
recognition of Mrs. Rapp's enforceable rights under
California law. We proceed to review California law
- 29 -
to determine whether Mrs. Rapp was entitled under the
decedent's will to receive annual distributions of all of
the income from the testamentary trust.
Under California law, the nature of the interest given
by a testator to his or her surviving spouse is determined
in accordance with the testator's intent, as determined by
a construction of the language used in the will. E.g.,
Gill v. Stone (In re Estate of Dodge), 491 P.2d 385 (Cal.
1971); Hembree v. Quinn (In re Estate of Russell), 444
P.2d 353 (Cal. 1968); Kime v. Barnard (Estate of Kime),
193 Cal. Rptr. 718 (Cal. Ct. App. 1983); Talbot v.
Bachelor (Estate of Casey), 198 Cal. Rptr. 170 (Cal. Ct.
App. 1982); Cullinan v. Dunne (Estate of Lindner), 149 Cal.
Rptr. 331 (Cal. Ct. App. 1978). Evidence concerning the
circumstances surrounding the testator's execution of the
will, so-called extrinsic evidence, is generally admissible
"to determine whether a seemingly clear instrument or term
is actually ambiguous." Hoover v. Hartman, 186 Cal. Rptr.
669, 673 (Cal. Ct. App. 1982); see also Saleen v. Aulman
(In re Estate of Taff), 133 Cal. Rptr. 737, 740-741 (Cal.
Ct. App. 1976). If extrinsic evidence renders the language
of the will susceptible of two or more meanings, then the
extrinsic evidence can be used to resolve the ambiguity.
- 30 -
Hembree v. Quinn, supra at 361. However, if the extrinsic
evidence does not render the will ambiguous, the extrinsic
evidence is disregarded and the plain language of the will
is relied upon to determine the testator's intent. Estate
of Heim v. Commissioner, 914 F.2d at 1325.
Irrespective of whether extrinsic evidence is
considered, the objective of the courts in California is to
determine the testator's intent from the language used and
not to write a new will for the testator. In Talbot v.
Batchelor, supra at 172 the court stated as follows:
Further, whether or not resort is had to
extrinsic evidence, the court must determine the
intent of the testator from the language used.
The court in interpreting the will may not decide
what the testator should have done or even that
the testator desired to accomplish a particular
objective. The court determines only what the
testator did do by the manner in which he
expressed himself. * * * In short, the court,
under the guides of interpretation, may not write
a new will for the testator.
We note that the California Probate Code provides
special rules for a "marital deduction gift", defined as
"a transfer of property that is intended to qualify for
the marital deduction." Cal. Probate Code sec. 21520(b)
(West 1991). For this purpose, the "marital deduction" is
defined as "the federal estate tax deduction allowed for
- 31 -
transfers under Section 2056 of the Internal Revenue Code".
Cal. Probate Code sec. 21520(a) (West 1991). If an
instrument contains a marital deduction gift, the
California Probate Code provides a liberal construction
to allow a marital deduction, as follows:
(a) The provisions of the instrument,
including any power, duty, or discre-
tionary authority given to a fiduciary,
shall be construed to comply with the
marital deduction provisions of the
Internal Revenue Code.
(b) The fiduciary shall not take any
action or have any power that impairs
the deduction as applied to the marital
deduction gift. [Cal. Probate Code
sec. 21522(a) and (b) (West 1991).]
These special rules do not apply unless there is sufficient
evidence to find that the decedent intended the gift to
qualify for the marital deduction. See Estate of Heim v.
Commissioner, supra at 1329.
In this case, as mentioned above, the language of the
decedent's 1986 will gives Mrs. Rapp an interest in only so
much of the income from the trust as is paid "for her
proper health, education and support" in the absolute
discretion of the cotrustees. This language is clear and
unambiguous and cannot be construed to give Mrs. Rapp the
- 32 -
right "to all the income from the property, payable
annually or at more frequent intervals", as required by
the definition of qualifying income interest for life, set
forth in section 2056(b)(7)(B)(ii)(I). Further, there is
no mention of the marital deduction in the decedent's will
nor any evidence from the language of the will that the
decedent intended the trust property to qualify for the
marital deduction.
Notwithstanding the seemingly unambiguous language
used in the decedent's will, the Court allowed petitioner
to introduce extrinsic evidence of the facts and
circumstances surrounding the execution of the decedent's
1986 will, over respondent's objection. As discussed
above, the introduction of such evidence is permissible
under California law. E.g., Hembree v. Quinn, supra at
361-362; Hoover v. Hartman, supra at 673.
Petitioner introduced the testimony of seven witnesses
into evidence and, based thereon, claims to have presented
substantial direct and indirect evidence "that the Decedent
intended that the residue of his estate qualify for the
marital deduction." As direct evidence of such intent,
petitioner cites the testimony of three witnesses and
argues in its post-trial brief that the decedent told his
- 33 -
accountant, Mr. Lippert, "that he was changing his estate
plan to take advantage of the unlimited marital deduction"
and led Mr. Lippert "to believe that * * * [the decedent]
had instructed Attorney Clark to change his Will so that it
would qualify for the unlimited marital deduction."
Petitioner also argues that the decedent told Mrs. Rapp
that "when he died everything would be hers" and that the
decedent told his niece, Mrs. Josephson, that "whatever he
earned in his lifetime was going to be his wife's, and
ultimately his sons[']."
As "indirect evidence" that the decedent intended the
residue of his estate to qualify for the marital deduction,
petitioner argues in its post-trial brief that the decedent
told his wife, his son, and his banker, Mr. Bruce Bell,
"that his estate plan had been drafted to avoid or defer
taxes, and that there would be minimal taxes due upon his
death." Petitioner also cites as indirect evidence the
decedent's statements made to Mrs. Josephson, his
investment adviser, Mr. Parneet Kongkeo, and his friend,
Mr. John Pabigian, about "the importance of estate planning
and deferring taxes." Petitioner further cites the fact
that the decedent had shown "an article to his CPA
discussing the marital deduction and the changes in the
- 34 -
estate tax laws." According to petitioner, the statements
made by the decedent to those individuals "are simply not
reconcilable with the Will as drafted" and "Under
California law the Will is therefore ambiguous".
Even assuming that we accept petitioner's
characterization of the testimony of its seven witnesses,
we do not agree that any of the testimony proves either
that the decedent intended the corpus of the testamentary
trust to qualify for the marital deduction, or that any of
the language used in the decedent's 1986 will is ambiguous.
The testimony of petitioner's witnesses consists of general
statements made by the decedent to his family, friends, and
business associates about estate planning and death taxes.
None of petitioner's witnesses, other than Mrs. Rapp, ever
saw the decedent's 1986 will, and in no case did the
decedent discuss specific provisions of his will with any
of them. None of the decedent's statements specifically
refers to his 1986 will, let alone uncovers an ambiguity in
the language used in the will.
The picture that emerges from the testimony of
petitioner's witnesses is that the decedent was a
successful businessman who was knowledgeable about the
Federal income tax consequences of his leasing business,
- 35 -
who usually sought to minimize taxes, who wanted to provide
for Mrs. Rapp and his sons, and who attempted to educate
himself about estate planning and death taxes by reading
articles and discussing those matters with various friends
and business associates. Prior to the time the decedent
executed his 1986 will, the record shows that the decedent
was aware of the QTIP provisions of the marital deduction.
This is shown by the fact that he had discussed an article
on that subject with his accountant, Mr. Lippert, during
1984, 1985, or 1986. We can even infer from the testimony
of petitioner's witnesses that the decedent considered
using a so-called QTIP trust in his will. However, there
is no evidence that the decedent actually did so. The
language of Article Fifth (b) of his 1986 will does not
give Mrs. Rapp the right to receive the annual income from
the trust. Rather, Article Fifth (b) gives Mrs. Rapp only
so much of the income from the trust as the cotrustees in
their "absolute discretion" deem necessary "for her proper
health, education and support". The decedent's 1986 will
does not use the term "marital deduction", "QTIP", or the
like, or otherwise give any indication that the decedent
intended the corpus of the testamentary trust to be
eligible for the marital deduction. Nor is there any
- 36 -
extrinsic evidence that uncovers an ambiguity, in the sense
of a double meaning, in the language used in the decedent's
1986 will from which we could infer that the decedent
intended the trust to be eligible for the marital
deduction. We simply have no basis to conclude from the
record of this case that the decedent intended Mrs. Rapp to
be "entitled to all the income from the property, payable
annually or at more frequent intervals" as required by
section 2056(b)(7)(B) (ii)(I). See Estate of Heim v.
Commissioner, 914 F.2d at 1330.
QTIP Rules Must Be Applied as of the Date of the Election
Petitioner's second argument is that the date for
determining whether property or an interest in property
passing to the surviving spouse qualifies as QTIP is the
date of the QTIP election and not the date of the
decedent's death. According to petitioner, the trust
property in this case qualifies as QTIP because on the date
the QTIP election was made, Mrs. Rapp was entitled to all
of the income from the trust. In support of that argument,
petitioner cites recent opinions issued by the U.S. Courts
of Appeals for the Sixth, Eighth, and Fifth Circuits in
Estate of Spencer v. Commissioner, 43 F.3d 226 (6th Cir.
- 37 -
1995), revg. T.C. Memo. 1992-579; Estate of Robertson v.
Commissioner, 15 F.3d 779 (8th Cir. 1994), revg. 98 T.C.
678 (1992); and Estate of Clayton v. Commissioner, 976 F.2d
1486 (5th Cir. 1992), revg. 97 T.C. 327 (1991).
The facts of each of the cases relied upon by
petitioner, Estate of Spencer, Estate of Robertson, and
Estate of Clayton, are similar. The estate plan of the
decedent in each of those cases included one or more trusts
in which the surviving spouse was given a qualifying income
interest for life, as defined by section
2056(b)(7)(B)(ii)(I), and at least one other trust in which
the surviving spouse was not given a qualifying income
interest for life. The decedent in each of the cases had
clearly articulated his intention that some or all of the
residue of his estate would pass to the “QTIP trust”. The
controversy arose because each decedent had also given his
personal representative the discretion to determine what
portion, if any, of the residue of his estate should pass
to the “QTIP trust”, and what portion should pass to the
non-QTIP trust. The Commissioner argued that the personal
representative’s discretion to direct property away from
the “QTIP trust” constituted an impermissible power to
appoint property away from the surviving spouse, contrary
- 38 -
to section 2056(b)(7)(B)(ii)(II), and precluded the
property from meeting the requirement, imposed by section
2056(b)(7)(B)(i)(I), that it be property “which passes from
the decedent”.
In each of the three cases, the Court of Appeals
rejected the Commissioner’s reading of section 2056(b)(7)
as contrary to the statute. Estate of Spencer v.
Commissioner, supra at 230-231; Estate of Robertson v.
Commissioner, supra at 783-784; Estate of Clayton v.
Commissioner, supra at 1497. All of the courts noted that
the election is one of the elements of the definition of
QTIP, sec. 2056(b)(7)(B)(i)(III), and at least one of those
courts reasoned that the statute requires the validity of
the QTIP election to be determined as of the time the
election is made, rather than as of the date of the
decedent’s death, Estate of Spencer v. Commissioner, supra
at 231; Estate of Robertson v. Commissioner, supra at 783-
784; Estate of Clayton v. Commissioner, supra at 1498.
In each of the cases, when the court tested the
validity of the election, it found that the property in the
“QTIP trust” met the definition of QTIP because, in
accordance with the decedent’s expressed interest, the
surviving spouse was entitled to all of the income from the
- 39 -
property for life, payable annually or at more frequent
intervals, and no person had a power to appoint any part of
the property to any person other than the surviving spouse.
Thus, in each case the court held that the surviving spouse
had a qualifying interest for life in the property held by
the “QTIP trust”, as required by section 2056(b)(7)(B)(i)
(II), and that the decedent’s estate was entitled to
include the value of the property held by the “QTIP trust”
in the marital deduction.
The tacit premise of petitioner’s second argument is
that we should test the validity of the QTIP election based
upon the interest that Mrs. Rapp received under the order
of the probate court reforming the decedent’s 1986 will.
However, as discussed above, we are not bound by the order
of the probate court in determining what interest in the
trust passed from the decedent to Mrs. Rapp under
California law. Commissioner v. Estate of Bosch, 387 U.S.
at 465. In fact, as discussed in the prior section of this
opinion, we found that the order of the probate court was
not in accordance with the decedent’s intent as determined
from the language used in the decedent’s 1986 will and,
thus, was not in accordance with California law.
Accordingly, we found that Mrs. Rapp’s interest in the
- 40 -
trust was the interest described by the decedent’s 1986
will, as originally drafted. Under the decedent’s 1986
will, Mrs. Rapp did not have the right to any income from
the trust property. She was entitled to receive income
from the trust only if the cotrustees determined in their
“absolute discretion” that she needed funds “for her proper
health, education and support.”
In this case, therefore, it does not matter when the
validity of the QTIP election is tested, as of the date of
the decedent’s death or as of the date of the election. At
no time did Mrs. Rapp have a qualifying income interest for
life in the trust, as defined by section 2056(b)(7)(B)(ii),
which passed from the decedent, as required by section
2056(b)(7)(B)(i)(I), and at no time did the trust property
in this case qualify as QTIP.
The Order of the Probate Court Is a "Qualified Disclaimer"
Under Section 2518(b)
Petitioner's third argument is that the order of the
probate court is, in effect, a "qualified disclaimer" as
defined by section 2518(b). Petitioner argues that the
trustees and the guardian ad litem "consented" to the
probate court's order reforming the decedent's will and, in
effect, disclaimed "the right and/or power of the Trustees
- 41 -
to accumulate income of the marital trust during Laura's
lifetime." Petitioner takes this position in the
alternative to its position, discussed above, that the
order of the probate court was "a decision of a local court
upon the merits in an adversary proceeding". According to
petitioner, "the effect of such a qualified disclaimer is
that the income interest must be deemed to have passed from
the Decedent to Laura [i.e., Mrs. Rapp]."
Respondent argues that the Court should not consider
this issue, viz, whether the probate court's order meets
the requirements of a qualified disclaimer under State or
Federal law, because it was raised for the first time in
petitioner's post-trial brief. As a result, respondent
complains, the Government was deprived of an opportunity to
introduce evidence at trial that would have had a bearing
on the issue. In this regard, respondent notes that one of
the cotrustees, Mr. David Rapp, and the guardian ad litem,
Mr. Rae, were not called to testify at trial, and respon-
dent did not examine the other cotrustee, Mr. Richard Rapp,
about this issue. Respondent also raises a number of
substantive issues about whether the probate court's order
constitutes a qualified disclaimer under either Federal or
California State law. Finally, respondent argues in the
- 42 -
alternative that, even if the order of the probate court
does constitute a qualified disclaimer, Mrs. Rapp did not
thereby receive a qualifying income interest for life as
required by section 2056(b)(7)(B)(i)(II).
In general, if a person makes a qualified disclaimer
with respect to an interest in property, then the Federal
estate, gift, and generation-skipping transfer tax
provisions apply "as if the interest had never been
transferred to such person." Sec. 2518(a); see sec.
25.2518-1(b), Gift Tax Regs. The interest is treated as
passing directly from the transferor of the property to
the person entitled to receive it as a result of the
disclaimer. Sec. 25-2518-1(b), Gift Tax Regs. If property
is treated as passing from the decedent to his or her
surviving spouse as a result of a qualified disclaimer,
then the value of the property can be included in the
marital deduction. See DePaoli v. Commissioner, 62 F.3d
1259 (10th Cir. 1995), revg. T.C. Memo. 1993-577; sec.
20.2056(d)-1(b), Estate Tax Regs.
Petitioner raised its contention that the probate
court order constituted a qualified disclaimer under
section 2518 for the first time in its post-trial brief.
In deciding whether to permit a party to raise a new issue
- 43 -
on brief, we must determine whether considerations of
surprise and prejudice require the Court to protect the
opposing party from having to face a belated issue at a
time when the opportunity to present pertinent evidence is
limited. Ware v. Commissioner, 92 T.C. 1267, 1268 (1989),
affd. 906 F.2d 62 (2d Cir. 1990). In cases where the
opposing party is surprised by the issue, in the sense that
the proponent did not give "fair warning" of his intent to
raise it, and is prejudiced by being foreclosed from
introducing evidence that would have a bearing on the new
issue, we have declined to consider the new issue. See,
e.g., Sundstrand Corp. v. Commissioner, 96 T.C. 226, 346-
348 (1991). On the other hand, we have permitted a party
to raise a new issue on brief where we have found that
there would be no prejudice to the opposing party. See,
e.g., Ware v. Commissioner, supra at 1268-1269; Pagel, Inc.
v. Commissioner, 91 T.C. 200, 210-213 (1988), affd. 905
F.2d 1190 (8th Cir. 1990).
In this case, respondent received no warning, prior to
petitioner's post-trial brief, that petitioner intended to
contend that the probate court's order constituted a
qualified disclaimer under section 2518. Also, at the time
this issue was raised, respondent was foreclosed from
- 44 -
examining the cotrustees and the guardian ad litem about
the various factual elements of the definition of qualified
disclaimer under section 2518(b) and section 278 of the
California Probate Code. Therefore, respondent would be
prejudiced if we were to consider this issue.
Moreover, even if we were to agree to consider this
issue, we would have to find, on the basis of the record
made at trial, that petitioner did not meet its burden of
proving that the probate court's order constituted a
qualified disclaimer. See Rule 142. As quoted above, a
qualified disclaimer is "an irrevocable and unqualified
refusal by a person to accept an interest in property".
Sec. 2518(b). Petitioner argues in its post-trial brief
that "The interest disclaimed was the right and/or power of
the Trustees to accumulate income of the marital trust
during Laura's lifetime." However, there is nothing in the
record of this case to prove that the trustees disclaimed
anything. The order of the probate court on which
petitioner relies is the action of the probate court and
not the action of any of the parties to that proceeding.
See Harris v. Commissioner, 340 U.S. 106, 110 (1950).
Neither of the trustees in this case, Mr. Richard Rapp or
his brother, testified that either of them made a qualified
- 45 -
disclaimer of anything. In fact, to the contrary, on
Schedule M of the decedent's estate tax return, one of the
trustees, Mr. Richard Rapp, acting in his capacity as
executor, answered "no" to question No. 1: "Did any
property pass to the surviving spouse as a result of a
qualified disclaimer?" Mr. Richard Rapp also failed to
attach to the petitioner's estate tax return a written
disclaimer as required by question No. 1. Finally, there
is no testimony or other evidence to show what interest in
property was being disclaimed, as required both by section
25.2518-2(b)(1), Gift Tax Regs. and by California Probate
Code section 278(b), or that the requisite interest passed
to the surviving spouse by operation of law without any
direction on the part of the persons purporting to make the
disclaimer. See DePaoli v. Commissioner, supra; Estate of
Bennett v. Commissioner, 100 T.C. 42, 67, 72-73 (1993).
Fiduciary Duty Compels Trustees To Pay All Trust Income
to Mrs. Rapp
Petitioner's final argument is that this case is
governed by the opinion of the Court of Appeals for the
Ninth Circuit in Estate of Ellingson v. Commissioner, 964
F.2d 959 (9th Cir. 1992), revg. 96 T.C. 760 (1991).
According to petitioner, "Under the Ellingson case, the
- 46 -
marital deduction should be allowed, because the Trustees
had a fiduciary duty to * * * [Mrs. Rapp] to comply with
the QTIP rules." Petitioner's post-trial brief further
states as follows:
Petitioner submits that the Trustees were under a
fiduciary duty to commit to pay all of the income
to Laura [i.e., Mrs. Rapp], both because of her
need to receive such income and because it would
be detrimental to her legitimate interests under
the Will to pay a large estate tax at the
Decedent's death.
The thrust of petitioner's argument is that the
trustees are bound to pay all of the income of the trust to
Mrs. Rapp because otherwise the trust would not qualify for
the marital deduction and the estate would be liable for
estate taxes of more than $2 million, and that would be
contrary to Mrs. Rapp's best interests. Petitioner argues
that Mrs. Rapp, thus, had a "qualifying income interest for
life" in the trust, as required by section 2056(b)(7)(B)
(ii), and the trust property qualifies as QTIP.
In support of this argument, petitioner cites section
16081(a) of the California Probate Code, under which
trustees are directed to "act in accordance with fiduciary
principles and * * * not act in bad faith" even if a trust
instrument confers absolute, sole, or uncontrolled
- 47 -
discretion on the trustee. Petitioner also cites section
16040(a) of the California Probate Code, which requires a
trustee to administer the trust:
with the care, skill, prudence, and diligence
under the circumstances then prevailing that a
prudent person acting in a like capacity and
familiar with such matters would use in the
conduct of an enterprise of like character and
with like aims to accomplish purposes of the
trust as determined from the trust instrument.
Petitioner's argument is based upon a misreading of
the Estate of Ellingson case. In that case, the settlor's
estate plan provided for the creation of a "Marital
Deduction Trust" upon his death under which his surviving
spouse received the "entire net income" of the trust for
her life. However, the trust agreement contained a proviso
under which the trustees, one of whom was the surviving
spouse, were authorized to accumulate income in excess of
"the amount which the Trustee deems to be necessary for
* * * [the surviving spouse's] needs, best interests and
welfare". Estate of Ellingson v. Commissioner, supra at
960.
The Court of Appeals found, on the basis of a fully
stipulated record, that the settlor intended the trust
property to constitute QTIP and to qualify for the marital
- 48 -
deduction. Id. at 963-964. Notwithstanding the decedent's
expressed intent that the trust qualify for the marital
deduction, the "accumulation proviso" seemed to mean that
the surviving spouse was not entitled to all of the income
from the trust and, therefore, the surviving spouse did not
have a "qualifying income interest for life" as defined by
section 2056(b)(7)(B)(ii). Thus, there was a conflict
between the provisions of the trust agreement under which
the surviving spouse was to receive the "entire net income"
of the trust and the accumulation proviso under which the
trustee was authorized to accumulate income deemed to be in
excess of the amount necessary for the surviving spouse's
"best interests".
In the Ellingson case, the Court of Appeals resolved
the ambiguity in the trust agreement by interpreting the
language used in the accumulation proviso in accordance
with the "the settlor's clearly manifested intent" that the
marital deduction property qualify for the QTIP deduction.
Id. at 965. The Court of Appeals concluded that because
the trustees had chosen to make the QTIP election, the
"best interests" of the surviving spouse, as that phrase
was used in the accumulation proviso, required the trustees
to pay all of the income of the trust to the surviving
- 49 -
spouse during her lifetime. Otherwise, they would be
forced to sell the family farm in order to pay estate taxes
in excess of $8 million, and that would not be in the "best
interests" of the surviving spouse. Id. at 964. On the
other hand, if the trustees had chosen to decline to make
the QTIP election, then the "best interests" of the
surviving spouse would permit the accumulation of income.
Petitioner is asking this Court to do something that
the Court of Appeals in Ellingson did not do. Petitioner
asks us to find that the trustees are required to pay all
of the income from the trust to Mrs. Rapp on the ground
that it is in Mrs. Rapp's "best interests", for the trust
to qualify for the marital deduction. Unlike the Ellingson
case, however, there is no evidence in the trust instrument
that the decedent intended such result. Therefore, the
Ellingson case does not govern this one. In fact, the
Court of Appeals specifically distinguished its opinion
from Wisely v. United States, 893 F.2d 660 (4th Cir. 1990);
Estate of Doherty v. Commissioner, 95 T.C. 446 (1990); and
Estate of Nicholson v. Commissioner, 94 T.C. 666 (1990),
which it described as cases in which there was "no clearly
manifested intent" in the instrument that the trust
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property qualify as QTIP. See Estate of Ellingson v.
Commissioner, 964 F.2d at 964-965.
Petitioner also cites Estate of Mittleman v.
Commissioner, 522 F.2d 132 (D.C. Cir. 1975), revg. T.C.
Memo. 1973-112, in support of its position. That case was
decided before the QTIP provisions were enacted. It
involves section 2056(b)(5), which contains a similar
requirement to the definition of qualifying income interest
for life found in section 2056(b)(7)(B)(i)(II). Section
2056(b)(5) permits a marital deduction with respect to
property in which the surviving spouse is given a life
estate with a general power of appointment. It requires
the surviving spouse to be "entitled for life to all the
income from the entire interest, or all the income from a
specific portion thereof, payable annually or at more
frequent intervals". Sec. 2056(b)(5).
In Estate of Mittleman, supra at 133 n.1, the
decedent's will gave the residue of his property to a trust
"To provide for the proper support, maintenance, welfare
and comfort" of his surviving spouse for her entire
lifetime. The issue in that case was whether the quoted
language conveyed all of the income from the trust payable
annually or at more frequent intervals. After examining
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the language of the will as a whole, as well as extrinsic
evidence, the court found "beyond peradventure that the
testator intended a gift of the entire trust income to the
wife, and distribution thereof promptly enough to qualify
the trust property for the marital deduction." Id. at 137.
Therefore, Estate of Mittleman, is not apposite to this
case in which, as discussed above, our examination of the
language of the will and extrinsic evidence fails to show
that the decedent intended Mrs. Rapp to receive all the
income from the trust property payable annually or at more
frequent intervals.
For the foregoing reasons, we find that the property
distributed to the testamentary trust created under the
decedent's 1986 will is not QTIP and is not eligible to be
included in the marital deduction claimed by petitioner for
Federal estate tax purposes. To reflect that finding and
concessions of the parties,
Decision will be entered
under Rule 155.