T.C. Memo. 1997-443
UNITED STATES TAX COURT
ESTATE OF ARTHUR C. EDWARDS, DECEASED, KENNETH EDWARDS, EDWARD
EDWARDS AND JAMES EDWARDS, AS TRUSTEES OF THE ARTHUR C. EDWARDS
SETTLEMENT TRUST, PERSONAL REPRESENTATIVE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8214-93. Filed September 29, 1997.
Owen G. Fiore and Glenn M. Alperstein, for petitioner.
Debra Lynn Reale and S. Katy Lin, for respondent.
MEMORANDUM OPINION
FAY, Judge: This case is before us on petitioner's motion
for summary judgment pursuant to Rule 121.1 Respondent filed a
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect as of the date of decedent’s
(continued...)
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response in opposition to petitioner's motion. Both petitioner
and respondent submitted memoranda in support of their positions.
Respondent determined a deficiency in petitioner's Federal
estate tax of $14,107,060. The deficiency was due primarily to
respondent's increased valuation of decedent's stock in his
closely held corporations, as well as respondent's disallowance
of certain deductions for claims against the estate. The parties
have resolved the valuation issues.
The disallowed deductions relate to various claims on dece-
dent's closely held stock. Specifically, Ann Goss, decedent's
former wife, holds a claim to the income from the stock for her
life, and his three children hold a claim to the remainder
interest in the stock. Respondent has conceded that the estate
is entitled to a deduction for Ann Goss' interest in the stock.
Therefore, the issue for decision is whether petitioner is
entitled to deduct the value of the decedent's children's
remainder interest in the stock as a claim against the estate
under section 2053(a)(3).
We may grant a motion for summary judgment under Rule 121
"if the pleadings, answers to interrogatories, depositions,
admissions, and any other acceptable materials, together with the
affidavits, if any, show that there is no genuine issue as to any
1
(...continued)
death, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
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material fact and that a decision may be rendered as a matter of
law." Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C.
518, 520 (1992), affd. 17 F.3d 965 (7th Cir. 1994). The moving
party bears the burden of proving that there is no genuine issue
of material fact and that a decision may be rendered as a matter
of law. Celotex Corp. v. Catrett, 477 U.S. 317, 322-323 (1986);
Preece v. Commissioner, 95 T.C. 594, 597 (1990).
The facts presented below are stated solely for the purpose
of deciding petitioner's motion for summary judgment.
Background
Some of the facts have been stipulated by the parties. The
stipulation of facts and the attached exhibits are incorporated
herein by this reference. A hearing on petitioner's motion for
summary judgment was held on June 16, 1997, in Washington, D.C.
The decedent died on November 6, 1988. He was a resident of
California at that time.
Decedent was survived by his three children and his former
wife, Ann Goss. Decedent married Ann Goss in 1927, and they
resided in California at all times during the marriage. Decedent
and Ann Goss separated in 1967, and formal divorce proceedings
commenced on September 11, 1969. At the time of the divorce
proceedings, decedent and Ann Goss jointly owned 61.6 percent of
the stock in Dunn-Edwards Corporation (the Company) and 40
percent of the stock in Highland Properties, Inc. (Highland
Properties).
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Decedent, at the time of the divorce, desired to maintain
control of the Company. Ann Goss was not opposed to decedent's
desire to run the Company, because she recognized that the
Company had prospered under his stewardship. However, in return,
Ann Goss demanded certain property rights that she may not have
otherwise received in a dissolution proceeding, such as alimony
that would continue after her remarriage. On March 6, 1970, in
order to meet these goals, decedent and Ann Goss entered into a
written property settlement agreement (the 1970 PSA) incident to
the divorce proceedings. Pursuant to the 1970 PSA, Ann Goss
received one-half of the jointly owned stock. In addition, she
agreed to place her shares of stock in trust (the voting trust),
and then execute a voting trust agreement in favor of decedent.
Pursuant to the terms of the voting trust, decedent would be
entitled to vote her shares of stock in the Company and Highland
Properties for 21 years or until his death, if sooner. In
return, decedent agreed to pay alimony that would not terminate
upon her remarriage. Further, decedent and Ann Goss agreed to
maintain their reciprocal will provisions. At that time, each of
their wills provided that the stock in the Company and Highland
Properties would pass, in trust, to the surviving spouse for
life, with the remainder to the three children.
On March 10, 1970, decedent's marriage to Ann Goss was
dissolved by a Los Angeles County Superior Court interlocutory
order. The Los Angeles County Superior Court entered a final
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judgment of dissolution of marriage on March 12, 1970 (the final
judgment). The 1970 PSA was incorporated into the final judg-
ment. At the time the final judgment was entered, each of the
Edwards children was over 21 years old.
A disagreement between Ann Goss and decedent arose concern-
ing some of the terms of the 1970 PSA. In order to resolve the
disagreement, decedent, Ann Goss, their three children, and the
Company entered into a second property settlement agreement on
January 20, 1984 (the 1984 PSA). On June 6, 1984, a stipulation
for modification of judgment and order thereon was entered by the
California Superior Court (the 1984 court order). The 1984 court
order incorporated the 1984 PSA into the final judgment in place
of paragraph 14 of the 1970 PSA. Paragraph 14 had dealt with the
reciprocal will provisions of petitioner and Ann Goss. In the
1984 court order, decedent was prohibited from modifying, without
prior approval of the court, the Arthur C. Edwards settlement
trust (settlement trust), a revocable living trust that he had
created in 1981. Under the terms of the settlement trust,
decedent was to receive the income from his stock in the Company
and Highland Properties during his life; at his death, Ann Goss
was to receive such income for life; and, at her death, the trust
property was to be distributed to the three children.
On November 6, 1988, the date of decedent's death, the fair
market values of decedent's interests in the Company and Highland
Properties, respectively, were $18,113,960 and $106,184. Pur-
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suant to the terms of the settlement trust, outlined supra, Ann
Goss possessed an income interest in this property for her life.
The parties have agreed that the fair market value of that income
interest was $6,741,453.
After decedent's death, a Federal estate tax return was
filed by the executors of decedent's estate. In the return, the
executors claimed deductions for the value of Ann Goss' life
interest in decedent's stock and the value of the Edwards
children's remainder interest. Respondent, in the notice of
deficiency, disallowed both deductions. Respondent has subse-
quently conceded that the claim of Ann Goss is deductible. The
deductibility of the remainder interest of the Edwards children,
however, is still in dispute.
Discussion
Section 2053(a)(3) provides that the value of the gross
estate is determined by deducting the amount of claims against
the estate. Section 2053(c)(1)(A) limits the deduction for
claims founded on a promise or agreement to the amount of claims
that were contracted for full and adequate consideration. One
purpose of this consideration requirement is to prevent decedents
from reducing their gross estate through contractually arranged
transfers that serve a "donative or testamentary intent." Estate
of Huntington v. Commissioner, 100 T.C. 313, 316 (1993), affd. 16
F.3d 462 (1st Cir. 1994); see also United States v. Stapf, 375
U.S. 118, 130-133 (1963). However, liabilities imposed by law
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and not founded on a promise or agreement are deductible from the
gross estate regardless of the ability to show consideration.
Sec. 20.2053-4, Estate Tax Regs.
A claim founded on a divorce decree is a liability imposed
by law and deductible without regard to the limitations of
section 2053(c)(1)(A). See Harris v. Commissioner, 340 U.S. 106
(1950); Estate of Robinson v. Commissioner, 63 T.C. 717 (1975).
Petitioner asserts that the claim of the Edwards children is
founded on the divorce decree and is therefore deductible as a
claim imposed by law.2 Respondent disagrees, arguing that the
claim is founded on the 1970 PSA, not the divorce decree.
In order for the claim to be imposed at law, the divorce
decree, rather than the agreement between the parties, must be
the "operative element" of a claim. Estate of Satz v. Commis-
sioner, 78 T.C. 1172, 1179 (1982). Whether the divorce decree is
the "operative element" depends upon whether the divorce court
has the power to vary the terms of the agreement between the
parties--here the rights of the Edwards children vis-a-vis the
stock. Harris v. Commissioner, supra at 109-110; Estate of
Fenton v. Commissioner, 70 T.C. 263, 271-274 (1978). If the
divorce court has the power to prescribe a property settlement
2
Petitioner also asserts that the Edwards children's claim
is supported by full and adequate consideration. At the hearing,
the parties indicated that more facts needed to be developed
before this alternative theory would be ripe for summary judg-
ment. Consequently, we offer no opinion as to whether the
Edwards children's claim is supported by adequate consideration.
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with terms different from those agreed to by the spouses, then it
is the decree that fixes the right of the spouses, and, under the
rationale of Harris v. Commissioner, supra, any subsequent claim
by a spouse is founded on that decree. Estate of Fenton v.
Commissioner, supra at 272. The fact that a property settlement
agreement is incorporated into the divorce decree is not
determinative in ascertaining whether the decree is the operative
element of a claim. Id.
Petitioner argues that the claim of decedent's children is
based upon the final judgment because the 1984 PSA was
incorporated into it. Petitioner notes that, where a marriage
settlement agreement3 is incorporated into a divorce decree, the
Court of Appeals for the Ninth Circuit has stated: "A marriage
settlement agreement loses its status as an independent contract
when it is incorporated into a final divorce decree." Spirtos v.
Moreno, 56 F.3d 1007, 1008 (9th Cir. 1995). Because the 1984 PSA
was incorporated into the final judgment, under California law,
the parties can only enforce the terms of the agreement through
actions on the judgment, and not by actions on the 1984 PSA. See
Hough v. Hough, 160 P.2d 15 (Cal. 1945); In re Marriage of
Umphrey, 267 Cal. Rptr. 218 (Ct. App. 1990). Therefore,
3
For the purposes of this opinion, the terms "marriage
settlement agreement" and "property settlement agreement" are
used interchangeably.
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petitioner concludes that the claim of the Edwards children is
imposed by law and deductible under section 2053(a)(3).
Petitioner's argument in this regard does not carry the day.
The fact that the 1984 PSA was merged, or incorporated, into the
final judgment is not dispositive of the critical issue before
us. Our inquiry must focus on the extent of the California
divorce court's power to modify the terms of the 1984 PSA before
incorporating it into the final judgment.
In this regard, our examination of California law indicates
that, absent exceptional circumstances, a California divorce
court lacks the power to modify a property settlement agreement
before incorporating it into a divorce decree. See Flynn v.
Flynn, 265 P.2d 865 (Cal. 1954); Adams v. Adams, 177 P.2d 265
(Cal. 1947). The Court of Appeals for the Ninth Circuit has
addressed this question in Gray v. United States, 541 F.2d 228
(9th Cir. 1976). In Gray, the decedent husband and his wife had
entered into a property settlement agreement, whereby the husband
agreed to maintain an insurance policy on his life, designating
his wife as the beneficiary. Id. at 230. The husband died in a
plane crash shortly after the divorce court had entered a divorce
decree, wherein the court approved the property settlement
agreement and ordered the parties to carry out its provisions.
Id. The proceeds of the policy were paid directly to the wife;
the executor included the proceeds in the gross estate and
claimed a deduction for that same amount. Id. at 231. The
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District Court held that the claim was founded on a divorce
decree and thereby deductible under section 2053, and the
Government appealed. Id.
The Court of Appeals for the Ninth Circuit reversed the
District Court. The Court of Appeals for the Ninth Circuit
agreed with the Government's position that a claim is founded on
the court decree only where "the court entering the decree had
the power to modify or alter the terms of the agreement." Id. at
231. The Court of Appeals, in concluding that the wife's claim
was founded on the marriage settlement agreement, observed that
"under California law a California court entering a divorce
decree, in the absence of fraud, has no power to modify or alter
the property agreement". Id. at 232. According to the Ninth
Circuit, the fact that the divorce court ordered the parties to
carry out the terms of the agreement only imposed an additional
method for enforcing its terms and did not change the conclusion
that the wife's claim was founded on the agreement.
Petitioner attempts to distinguish the present case by
noting that the law relating to property settlement agreements
has changed since the Ninth Circuit decided Gray v. United
States, supra, and cites a number of cases where the divorce
court altered the terms of a marriage settlement agreement. See
Adkins v. Adkins, 186 Cal. Rptr. 818 (Ct. App. 1983); Brennan v.
Brennan, 177 Cal. Rptr. 520 (Ct. App. 1981); Moore v. Moore, 169
Cal. Rptr. 619 (Ct. App. 1980). Petitioner's attempts to
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distinguish the case at bar from Gray v. United States, supra,
fall short.
In each of the above cases, the presence of exceptional
circumstances, such as fraud or overreaching, gave the court
grounds to set aside the agreements. See Adkins v. Adkins, supra
at 822 (sufficient showing of extrinsic fraud for the court to
set aside a marital settlement agreement where the husband,
unable to read or write, signed the agreement based on his wife's
misleading representations); Brennan v. Brennan, supra at 525
(sufficient showing of extrinsic fraud for the court to set aside
a marriage settlement agreement where the wife, unrepresented by
counsel, relied to her detriment on the advice of her husband and
his attorney); Moore v. Moore, supra at 624 (wife's waiver of her
interest in the community property set aside where she was not
represented by counsel and spoke only limited English). More-
over, in each of these cases, the court set aside a property
settlement agreement after a divorce decree had been previously
entered. None of the cases involves a court's power to modify an
agreement prior to entering the decree.
Petitioner makes the assertion that the property settlement
agreement in Gray v. United States, supra, was based on the pre-
1967 California law, which is not applicable to decedent.
Specifically, petitioner claims that the agreement in Gray was a
"pre-1967 Integrated Property Settlement Agreement" that was not
incorporated into the divorce decree. However, petitioner has
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not shown that any change in California law endowed the divorce
court with power to alter the 1984 PSA prior to accepting it and
incorporating it into the final judgment. According to a leading
treatise, the law in California regarding a divorce court's power
to modify a property settlement agreement before entering a
decree has not substantially changed from the time Gray v. United
States, supra, was decided. See 11 Witkin, Summary of Cal. Law,
ch. XVI, sec. 296 (9th ed. 1990) (citing Adams v. Adams, 177 P.2d
265 (Cal. 1947)). We conclude that the California divorce court
lacked sufficient power to modify the 1970 PSA and the 1984 PSA,
and therefore the Edwards children's claim is founded on those
agreements.
Petitioner has not demonstrated that it is entitled to
judgment as a matter of law. Courts have often expressed
reservations about extending the rationale of Harris v.
Commissioner, 340 U.S. 106 (1950), to encompass transfers to the
children of a decedent. See Rosenthal v. Commissioner, 205 F.2d
505 (2d Cir. 1953), revg. 17 T.C. 1047 (1951); Spruance v.
Commissioner, 60 T.C. 141 (1973), affd. without published opinion
505 F.2d 731 (3d Cir. 1974); Estate of Hartshorne v.
Commissioner, 48 T.C. 882 (1967), affd. 402 F.2d 592 (2d Cir.
1968); Estate of Keller v. Commissioner, 44 T.C. 851 (1965). In
Rosenthal v. Commissioner, supra at 508, the Court of Appeals for
the Second Circuit opined:
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The rationale of both the Harris and Converse
decisions rests basically on the divorce court's power,
if not duty, to settle property rights as between the
parties, either by adopting their own agreement as in
the Harris case, or by having the matter litigated as
in the Converse case. We do not find this rationale
applicable to a decree ordering payments to adult
offspring of the parties or to minors beyond their
needs for support--the only payments with which we are
now concerned, since that part of the taxpayer's
undertakings necessary for the support of his children
during their minority is concededly not taxable.
[Citations omitted]. While neither the Nevada statute,
Nev. Comp. Laws secs. 9462, 9463 (Supp. 1931-1941),
[Fn. ref. omitted.] nor interpretive decisions indicate
the precise limits of the divorce court's authority in
this area, courts of other jurisdictions operating
under similar statutes have been restricted in their
power to make awards of property to children to amounts
appropriate merely for the maintenance of minor
children. [Citations omitted.] * * *. But since such
a decree provision depends for its validity wholly upon
the consent of the party to be charged with the
obligation and thus cannot be the product of litigation
in the divorce court, we do not consider the rationale
of the Harris decision applicable to the present case.
We therefore conclude that the arrangements here made
for the taxpayer's daughters beyond their support
during minority do not obtain exemption from the
federal gift tax by simply receiving the court's
imprimatur. * * *
Rosenthal v. Commissioner, supra at 508. Like the taxpayer in
Rosenthal, petitioner has not demonstrated that the California
divorce court had the power to modify the provisions of the
property settlement agreements that dealt with the agreed-upon
transfers to the Edwards children. Further, significant policy
concerns are raised by expanding the rule in Harris v. Commis-
sioner, supra, to cover transfers made to a spouse's children.
As we have noted: "To construe the statute as suggested by
petitioner would open a means for a divorcing parent to transfer
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property to his adult children free of both gift tax and estate
tax". Estate of Hartshorne v. Commissioner, supra at 895
(quoting Estate of Keller v. Commissioner, 44 T.C. 851, 860
(1965).
Petitioner has not cited a case wherein we have expanded the
rationale of Harris v. Commissioner, supra, and applied it to
property transfers to children on the theory that the transfers
were founded on a divorce decree. In fact, when faced with the
contrary authority cited above, petitioner merely puts forth an
argument that it is up to the legislature, not the courts, to
cure any abuse of the laws. This argument does not persuade us
that petitioner is entitled to judgment as a matter of law.
Accordingly, we conclude petitioner is not entitled to summary
judgment.
To reflect the foregoing,
An order denying petitioner's
motion for summary judgment will be
issued.