Estate of Clayton v. Commissioner

United States Court of Appeals,

Fifth Circuit.

No. 92–4196.

ESTATE OF Arthur M. CLAYTON, Jr., Deceased, Mary Magdalene Clayton and The First
National Bank of Lamesa, Independent Co–Executors, Petitioners–Appellants,

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellee.

Nov. 17, 1992.

Appeal from a Decision of the United States Tax Court.

Before POLITZ, Chief Judge, and WISDOM and WIENER, Circuit Judges.

WIENER, Circuit Judge.

This federal estate tax case concerns the eligibility, for purposes of the Marital Deduction, of

that portion of a legacy in trust for the benefit of the surviving spouse for which a timely Qualified

Terminable Interest Property (QTIP) election was made by the surviving spouse in her capacity as

Independent Executrix. On appeal Petitioners–Appellants, Mary Magdalene Clayton (Surviving

Spouse) and The First National Bank of Lamesa (the Bank), as Independent Co–Executors of the

Estate of Arthur M. Clayton, Jr. (Testator), seek reversal of the Tax Court's holding that the portion

of the residue of Testator's estate passing to a trust created in the testament for the benefit of

Surviving Spouse (Trust B) is not eligible for a marital deduction because a provision in the testament

specifies that any portion of the residue for which a timely QTIP election is not made will pass to and

constitute a part of the corpus of another trust created in the testament (Trust A).

The Co–Executors contend that the Tax Court's holding, sustaining the position of

Respondent–Appellee, the Commissioner of Internal Revenue (the Commissioner), that the subject

testamentary provision is "tantamount" to a proscribed power of appointment, cannot be squared with

the plain language of the QTIP provision1 of the United States Internal Revenue Code of 1954, as

1
26 U.S.C. 2056(b)(7) (1988).
amended (the Code),2 which was added to the Code by the Economic Recovery Act of 1981

(ERTA).3 Considering the same uncontested, straightforward facts upon which the Tax Court made

its legal determination, we reach precisely the opposite conclusion. For the reasons set forth below,

we reverse the Tax Court's judgment and hold that the portion of the residue of Testator's estate for

which the timely QTIP election was made and which passes to and constitutes the corpus of Trust

B is eligible for the marital deduction. We therefore remand this case to the Tax Court to redetermine

the estate tax deficiency, if any, after allowing the marital deduction consistent herewith, and to

calculate the net amount of estate tax and interest, if any, that is due and owing to the Commissioner

from the estate of the Testator—or vice versa—after thus redetermining the deficiency.

I

FACTS AND PROCEEDINGS

The facts found by the Tax Court, largely on the basis of stipulations, reflect that Testator,

a Texas domiciliary, died there on December 22, 1987, survived by Surviving Spouse (his second

wife) and his four children from his first marriage. Testator had executed a Last Will and Testament

(the Will) on April 8, 1982, and a First Codicil (the Codicil) to the Will on June 23, 1982. In the Will,

Testator created several trusts, two of which are for the benefit of Surviving Spouse during her

lifetime: The first, Trust A, is a "Credit Shelter Trust" to be funded with properties or interests in

properties from the Testator's estate equal in value to the amount exempt from federal estate tax by

virtue of the Unified Credit.

The second trust, Trust B, is a "Marital Deduction Trust" or "QTIP Trust" to be funded with

that portion of the residue of Decedent's estate for which a timely QTIP election is made. Trust B

is created for the benefit of Surviving Spouse "for and during the rest of her life." Upon her death,

the remainder of Trust B is to "be added to and become part of the corpus of Trust "A', for the use

and benefit of [Testator's] then living children." It is undisputed that Trust A is ineligible for the

Marital Deduction.

2
26 U.S.C. §§ 1–9602.
3
Pub.L. No. 97–34, § 403(d), 95 Stat. 172, 302.
 Central to the instant case is Article THIRD, paragraph D of the Will:

In the event my executors fail or refuse to make the election under Section
2056(b)(7)(B)(II)(v) of the Internal Revenue Code of 1954, as amended [QTIP election],
with respect to my Trust "B" property on the return of tax imposed by Section 2001 of the
Internal Revenue Code of 1954, as amended, then the property with respect to which such
election was not made shall pass to and become a part of the corpus of Trust "A" for the
benefit of my Trust "A" beneficiaries.

Also central to the instant case is the mandate in Article SIXTH, paragraph A of the Will,

regarding current income of Trust B:

[I]n no event shall the amount distributable by my trustees from Trust "B" to [Surviving
Spouse] during any year be less than the current net income, to include all taxable net income
under the [Code] as then existing, of Trust "B" during that year.

[In the Will, Testator also (1) leaves lesser assets to Surviving Spouse outright; (2) specifies that if

Surviving Spouse should make a "qualified disclaimer"4 of any portion of the Trust B assets such

portion would pass to and form part of the corpus of yet a third trust, for the benefit of Testator's

children; and (3) gives Surviving Spouse the power to appoint assets of various trusts in favor of

Testator's children, both by deed during her lifetime or by her Last Will, but specifies that the power

of appointment by deed during her lifetime could not be exercised with respect to assets of Trust "B";

neither could those powers of appointment be exercised in favor of Surviving Spouse, her estate, her

creditors, or the creditors of the estate.]

In paragraph V. of Article EIGHTH of the Will, Testator spells out his intentions concerning

QTIP treatment of Trust B property:

It is my intention that the assets of the Trust "B" be eligible to be treated, for federal estate
tax purposes, as a [sic] "qualified terminable interest property" within the meaning of Section
2056 of the Internal Revenue Code, as amended. In no event shall my Trust "B" trustees be
deemed to have any authority or power over Trust "B" assets which would prevent Trust "B"
assets from being eligible to be treated as qualified terminable trust [sic] properties, if my
executors make the timely election to have such properties treated as such.

The Will nominates Surviving Spouse and the Bank to serve as co-trustees of all trusts created

therein and as Independent Co–Executors. In both instances t he Will specifies that if Surviving

Spouse does not or cannot serve, the Bank is to serve alone. The Co–Executors are granted the same

powers, duties, privileges, authorities, and responsibilities as those granted to the co-trustees under

4
See IRC § 2518.
the terms of the Will.

In due course following the death of Testator, an Application for Probate of a Written Will

and for Letters Testamentary (the application) was filed in the proper court. In an apparent effort to

comply with the position of the Internal Revenue Service (IRS) announced in a 1986 Technical

Advice Memorandum,5 the application requested:

That the qualification of the [Bank] as an Independent Co–Executor be deferred until it makes
and files its oath as required by law after the estate's Federal Estate Tax Return has been filed,
and the time for timely filing of the return has expired.... The request is made that Letters
Testamentary issue first to [Surviving Spouse] as sole independent executrix of the estate
upon her making and filing her oath, and that when the [Bank] as Independent Co-executor
shall qualify by filing its oath, new Letters Testamentary shall issue to [Surviving Spouse and
the Bank] as Independent Co–Executors of the estate.

The Will was admitted to probate and issuance of Letters Testamentary was authorized by

an order which states that Surviving Spouse and the Bank are qualified to act as Independent

Co–Executors and to receive Letters Testamentary. In conformity with the application, however, that

order directed that initially Letters Testamentary issue only to Surviving Spouse as sole Independent

Executrix until such time as the Bank should execute and file its oath as required by law, following

the filing of the estate's Federal Estate Return, Form 706, at which time new Letters Testamentary

would be issued to Surviving Spouse and the Bank as Independent Co–Executors. When new Letters

Testamentary were eventually issued jointly to Surviving Spouse and the Bank as Co–Executors, the

Form 706 had already been prepared, signed by Surviving Spouse as sole Independent Executrix, and

mailed to the appropriate office of the IRS together with payment of the estate taxes as calculated

on the Form 706.

When Surviving Spouse executed the Form 706 as sole Independent Executrix, she checked

the appropriate box on Schedule M, "Bequests, etc. to Surviving Spouse," required to elect "to claim

a marital deduction for Qualified Terminable Interest Property (QTIP) under Section 2056(b)(7)."

The total value of deductible property interests left outright to Surviving Spouse (for which a QTIP

election was neither required nor appropriate) was $78,950.00; the total value of terminable interest

5
Internal Revenue Service Tech.Ad.Mem. 86–31–005 (Apr. 23, 1986), reprinted in 1 Fed.Est.
& Gift Tax Rep. (CCH ¶ 7533.30, p. 9444).
property for which the QTIP election was made was $1,077,635, being the value of an undivided

.563731 interest in specified bonds, notes and cash listed on Schedules B and C of the Form 706 (the

securities). Thus, the total amount claimed as the marital deduction was $1,156,585.

The Commissioner's decision to disallow the Marital Deduction to the extent claimed by the

estate for the undivided .563731 interest in the securities—for which the QTIP election was timely

made—is reflected in a statement contained in the Notice of Deficiency issued by the IRS to

Surviving Spouse and the Bank as Independent Co–Executors: "the marital deduction is $78,950.00

rather than $1,156,585.00 as reported on the Estate Tax Return. Accordingly, the reported taxable

estate is increased $1,077,635.00." In response to the Commissioner's Notice of Deficiency, the

Co–Executors filed a timely petition for redetermination in the Tax Court, the proper court to hear

such cases.6 That court's opinion was filed on September 16, 1991,7 and its decision was entered on

December 18, 1991, finally disposing of the lone contested issue of the case. The Co–Executors, on

behalf of the estate, timely filed a Notice of Appeal to this court,8 which has jurisdiction to review

such cases.9

II

ANALYSIS

A. Standard of Review

"Our standard of review for appeals from the United States Tax Court is the same as for

appeals from the district court: We review findings of fact for clear error and legal conclusions de

novo."10 As the facts of the instant case are largely stipulated and totally undisputed, our standard

of review of the facts thus found is not a matter of concern. The issue we here review is a purely

legal one.

6
See IRC §§ 6214, 7442.
7
Estate of Clayton v. C.I.R., 97 T.C. 327 (1991).
8
See IRC § 7483.
9
See id. § 7482.
10
McIngvale v. C.I.R., 936 F.2d 833 (5th Cir.1991).
B. Issue

Like the uncontested facts of this case, the sole legal issue before us is a straightforward one.

As posed by the Tax Court, "[t]he issue in this case is whether an estate tax marital deduction should

be allowed for the property in Trust B for which a timely election was made pursuant to Section

2056(b)(7)." Thus stated, the issue is concise but only skeletal; the true substance of that issue is

encapsulated entirely in the previously quoted provision from Article THIRD, paragraph D, of the

Will, which specifies that any portion of the residue of the estate for which the executor does not elect

QTIP shall pass to and become a part of the corpus of Trust A, a trust concededly not eligible for

QTIP treatment. Posed even more precisely, the question we must answer is "Does the effect of that

testamentary provision, causing the undivided interest in the securities for which the QTIP election

is not made to be excluded from the corpus of Trust B (the QTIP Trust) when it is funded, so taint

the entire residuary bequest that the value of the undivided interest in those assets for which the QTIP

election is made and which will form the corpus of Trust B when funded cannot be eligible for the

marital deduction?"

C. Estate Tax Marital Deduction: An Historical Perspective

This case is ultimately decided on the legal meaning of the plain and unambiguous words of

the Will and Code § 2056. This is a true "eight-corners" case, determinable within the four corners

of the Will and the four corners of the statute. Nevertheless, Code § 2056 as the sole statutory

well-spring of the estate tax marital deduction (the Marital Deduction)—as well as both the general

exception thereto (the terminable interest) and the one among the several exceptions to that general

exception for terminable interests with which we are here concerned (QTIP)—can be completely

understood and appreciated only when viewed in the perspective of their collective historical

development.11

From 1916 to 1942, the federal estate tax law took into account the differences between

11
See generally 5 BORIS I. BITTKER, FEDERAL TAXATION OF INCOME, ESTATES AND GIFTS
(1984 & Cum.Supp. # 2, 1992); 4 JACOB RABKIN & MARK H. JOHNSON, FEDERAL INCOME, GIFT
AND ESTATE TAXATION (MB, 1963 & Supp.1992); 239–4th JEFFREY N. PENNEL, TAX
MANAGEMENT: ESTATES, GIFTS, AND TRUSTS PORTFOLIOS: ESTATE TAX MARITAL DEDUCTION
(BNA, Inc. 1992).
community property states and common law states. Abiding by state law, however, produced a

disparity between community property states and common law states.12 The first effort of Congress

to eliminate that disparity was included in the 1942 amendments to the Internal Revenue Code of

1939.13 As a result of the 1942 enactment, however, the value of the entire community property was

taxed in full in the estate of the first spouse to die.14 Rather than creating equality, the 1942

enactment put married couples residing in community property states at a distinct disadvantage.

Despite this new geographical disparity [between community property and common law
states], the Supreme Court upheld the constitutionality of the 1942 Economic Source Rule
in Fernandez v. Weiner, [sic]15 decided in 1945.16

In the first major tax bill after World War II,17 Congress undid the result of Wiener, which had

been so unpalatable to community property states, enacting for the first time the "new concept of

"estate-splitting' as a corollary to "income-splitting' between husband and wife."18 The vehicle

employed for so doing was the Marital Deduction.

The original Marital Deduction was quite obviously a device designed to allow estate

"equalization," i.e., to recognize the 50–50 situation in community property jurisdictions while

allowing common law couples to equalize, through the Marital Deduction, their combined estate

12
See BITTKER, supra note 11, at 129–3 & 4.
13
See § 402, Revenue Act of 1942, 56 Stat. 798.
14
BITTKER, supra note 11, at 129–4.
15
Fernandez v. Wiener, 326 U.S. 340, 66 S.Ct. 178, 90 L.Ed. 116 (1945).
16
BITTKER, supra note 11, at 129–5. Some have suggested that this treatment in the Revenue
Act of 1942 and its approbation by the Supreme Court in Fernandez v. Wiener can only be
understood in the context of the extreme fixation of Congress on raising revenue to finance the
war effort for World War II, and the equally pervasive patriotism of those times, which even
seeped uphill to the Supreme Court. How else, they ask rhetorically, could one explain that the
majority opinion in Korematsu v. United States, 323 U.S. 214, 65 S.Ct. 193, 89 L.Ed. 194
(1944), the landmark case condoning internment of Americans of Japanese ancestry, was written
by Associate Justice Hugo Black, one of the most ardent and active advocates of the Bill of
Rights and individual freedoms ever to sit on the Court.
17
Revenue Act of 1948.
18
RABKIN & JOHNSON, supra note 11, at 53–33.
irrespective of which spouse was actually the wealthier.19 An essential feature of the Marital

Deduction from its very beginning, however, was that any property of the first spouse to die that

passed untaxed to the surviving spouse should be taxed in the estate of the surviving spouse. This

concept persists to the present time; and it is an indispensable ingredient of the result we reach today.

A corollary of taxability in the estate of the surviving spouse was and remains the exclusion

of "terminable interests" from the category of properties for which the Marital Deduction is available.

An interest that terminates does not form part of the deat h estate of the surviving spouse, so if a

terminable interest in property were deductible in the first estate, such property would escape tax in

the estates of both spouses.20 Thus, in 1948 and today, "[t]o qualify for the Marital Deduction, an

interest in property must ... avoid being disqualified by a complex set of rules relating to "terminable

interests'."21 As shall be shown, however, a number of exceptions to the terminable interest exception

are recognized.

In 1976 Congress liberalized the Marital Deduction significantly by establishing dual

yardsticks for measuring the maximum estate tax Marital Deduction.22 For decedents dying after

December 31, 1976, the maximum Marital Deduction was the greater of $250,000 or one-half of the

adjusted gross estate. Nevertheless, many other features of Code § 2056, including the unavailability

of the Marital Deduction for terminable interest property, remained essentially unaffected by the TRA

of 1976.

D. Backdrop for QTIP

During the five years following 1976 no statutory changes of particular significance to the

Marital Deduction occurred. The stage was set, however, for the most dramatic and expansive

liberalization of the Marital Deduction in history. Not surprisingly, the overarching consideration of

19
BITTKER, supra note 11, at 129–6.
20
See id. at 129–17.
21
Id. at 129–16. (emphasis added)
22
Tax Reform Act of 1976, Pub.L. No. 94–455, 94th Cong., 1st Sess. (1976) U.S.Code Cong.
& Admin.News 1976, p. 2897 (hereinafter 1976 TRA).
the sweeping Marital Deduction changes of 1981 was the resurgence of the decades-old concept of

marital property as the unitary estate of both spouses, and 1948's "new concept" for "estate-splitting"

as a corollary to "income-splitting" between husband and wife.23

Leading to the 1981 enactment of ERTA was the burgeoning realization that an

ever-increasing number of testators were encountering a serious dilemma: They could not provide

maximum lifetime benefits to their surviving spouses and, at the same time, control who would be the

ultimate recipients of the property after the death of the surviving spouse. Congress recognized that

the ranks of such testators included a growing number of those who expect to be survived by children

of a first marriage and by a spouse of a subsequent marriage. Under pre–1982 Marital Deduction

rules, particularly the one prohibiting the deduction of terminable interests, such a testator faced a

classic Catch–22 decision: He could either 1) provide maximum financial benefits and security for

the surviving spouse but only at the risk that the survivor might waste the property or appoint it to

successors other than the children of the testator's first marriage; or 2) ensure that the property

would devolve to his children of a prior marriage (or other objects of his bounty) but at the cost of

losing the Marital Deduction and risking underendowment of the surviving spouse. Even the

pre–1982 vehicle of the power-of-appointment marital trust would not allow such a testator to ensure

ultimate inheritance by children of his first marriage.24

The strong sense of Congress was that if the concept of the marital property regime as a single

unit, preservable intact until the death of the second spouse, was to realize its full potential, something

truly new and innovative would be required. None can quarrel with that description of the

fundamental change in the Marital Deduction wrought by ERTA: the unlimited Marital Deduction.

"Congress flew into the wild blue yonder in 1981 by exempting all transfers between husband and

wife ... subject [only] to rules ... to insure [sic] that the exempted property will be taxed if and when

the surviving spouse disposes of it by gratuitous transfer, whether inter vivos or at death."25

23
RABKIN & JOHNSON, supra note 11, at 53–33.
24
See generally, BITTKER, supra note 11, at 129–58 to 129–65.
25
Id. at 129–6.
 Thus, to retain the "article of faith" that property which is untaxed in the estate of the first

spouse to die must be taxable in the estate of the surviving spouse, Code § 2056's general denial of

marital deduction treatment for terminable interests was preserved as an exception to the new general

rule of unlimited deductibility of interspo usal transfers. Even so, Congress realized that, without

something else, the aforesaid dilemma would persist for many testators. The well-verbalized

realization by Congress26 that married testators—particularly those with children of a former

marriage—would be left with a Hobson's Choice as long as terminable interest property was ineligible

for the Marital Deduction, prompted genuine creativity. Out of thin air and from the whole cloth,

Congress invented a brand new, theretofore unseen concept: Qualified Terminable Interest Property.

If "unlimiting" the Marital Deduction was a flight into the wild blue yonder, Congress truly "slipped

26
See, e.g., H.Rep. No. 97–201, 97th Cong., 1st Sess., at 159–60, reprinted in 1981–2 CB
352, 377–78 U.S.Code Cong. & Admin.News 1981, p. 105: "[T]he committee ... believes that an
individual should be free to pass his entire estate to a surviving spouse without the imposition of
any additional tax.... In addition, the committee believes that [such a] simplification of the estate
and gift taxes can be achieved by allowing an unlimited deduction for transfers between
spouses.... In addition, the committee believes that present limitations on the nature of interests
qualifying for the marital deduction should be liberalized to permit certain transfers of terminable
interests to qualify for the marital deduction.... [U]nless certain interests which do not grant the
spouse total control are eligible for the unlimited marital deduction, a decedent would be forced
to choose between surrendering control of the entire estate to avoid imposition of estate tax at his
death or reducing his tax benefits at his death to insure [sic] inheritance by the children. The
committee believes that the tax laws should be neutral and that tax consequences should not
control an individual's disposition of property.... Nevertheless, the committee believes that
property subject to terminable interests qualifying for the marital deduction should be taxable, as
under present law, upon the death of the second spouse (or, if earlier, when the spouse disposes
of the terminable interest in such property)." See, also, 127 CONG.REC. 17,289 (July 24, 1981)
(statement of Senator Symms). "Mr. President, the tax bill we are currently considering has
incorporated some major estate tax reforms.... However, the enactment of an unlimited marital
deduction without any change being made in the qualitative requirements for qualification would
present an estate owner a difficult choice in many cases.... The point becomes more significant as
divorce and remarriage increase, which has occurred. The property owner would like to be sure
that upon the death of his spouse his children by a prior marriage or marriages share in his
property, including the marital deduction property.... However, for the substantial property
owner who must pay a tax if the marital deduction is not used[,] the inability to satisfy each of
two objectives—postponing payment of tax and being able to control the disposition of the
property—remains and the tax pull would be substantial to make maximum use of the deduction.
A qualification test for marital deduction purposes which eliminates the general power of
appointment requirement would permit satisfaction of both objectives and provide more flexibility
in estate planning.... Yes, Mr. President, the Treasury supports the amendment."
the surly bonds of earth"27 with the advent of QTIP.

E. Qualified Terminable Interest Property

In the perspective of the long history of continual expansion and liberalization of the Marital

Deduction during the decades since its introduction in 1948, and against the backdrop of the adoption

in 1981 of the unlimited marital deduction, the intent, function and purpose of QTIP is not difficult

to discern. Unmistakably, the Marital Deduction is the embodiment of a strong public policy. By

itself, ERTA's removal of the dollar and percentage limitations on the Marital Deduction to make it

"unlimited" was purely quantitative. Although transfers to the surviving spouse in outright ownership

or fee simple title were freed of all quantitative limits, other categories of property—principally

terminable interests—would remain totally excluded from deductibility unless something qualitative

were done. QTIP was invented to produce the desired qualitative expansion of the classes of

property eligible for the Marital Deduction, i.e., to extend, for the first time ever, the availability of

the Marital Deduction to those types of terminable interests in property that Congress deigned to

"qualify." Hence the moniker "qualified terminable interest property" and the acronym "QTIP."

As thus created by Congress, QTIP is an exception-to-the-exception for non-deductibility

of terminable interests in general. And, as is universally recognized and applauded, Congress

accomplished this revolutionary change using uncommonly clear and cohesive language, particularly

for tax provisions, with the insertion of subsection (b)(7) in Code § 2056.

1. Statutory Scheme

Subsection (a) of Code § 2056 states the broad, general grant of a deduction from the estate

of the first spouse to die. The amount of the deduction is the value of any interest in property which

passes or has passed from the decedent to the surviving spouse, to the extent that such interest is

included in determining the value of the decedent's gross estate.

Subsection (b) of Code § 2056 expresses the general, terminable interest exception to

subsection (a)'s general grant of the deduction. As it has the effect of limiting a public policy matter,

27
John Gillespie Magee, Jr., High Flight, reprinted in BERKE BREATHED, BLOOM COUNTY
BABYLON: FIVE YEARS OF BASIC NAUGHTINESS 96 (1986).
this exception to the unlimited Marital Deduction must be construed narrowly. By its title, the

exception applies to a "Life Estate or Other Terminable Interest." Code § 2056(b)(1) defines

"terminable interest" and states generally that a deduction will not be allowed for such an interest.

There then follow, however, a number of particular exceptions to that general terminable

interest exception. Part icular types of terminable interests that are in fact deductible by virtue of

being exceptions-to-the-exception include 1) a legacy conditioned on survivorship for a limited

period,28 2) a life estate with power of appointment in the surviving spouse,29 3) life insurance or

annuity payments with power of appointment in the surviving spouse,30 and 4) a charitable remainder

trust.31 QTIP is another specific "counter-exception" to the general exception of Code § 2056(b)

denying a marital deduction for terminable interest property. The entire statutory concept of QTIP

is contained in Code § 2056(b)(7); as it is succinct, we reproduce the relevant portion in the

margin.32

28
IRC § 2056(b)(3).
29
Id. § 2056(b)(5).
30
Id. § 2056(b)(6).
31
Id. § 2056(b)(8).
32
(7) Election with respect to life estate for surviving spouse.—

(A) In general.—In the case of qualified terminable interest property—

(i) for purposes of subsection (a), such property shall be treated as passing
to the surviving spouse, and

(ii) for purposes of paragraph (1)(A), no part of such property shall be
treated as passing to any person other than the surviving spouse.

(B) Qualified terminable interest property defined.—For purposes of this
paragraph—

(i) In general.—The term "qualified terminable 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.
2. Important QTIP Features

A. Election. Gifts or bequests of terminable interests that appear to be eligible for the Marital

Deduction are nonetheless not automatically deductible. An irrevocable, affirmative election must

be made on the estate tax return by the executor before an apparently deductible terminable interest

meets the definition of QTIP.

It is axiomatic that any estate tax election which is not made inter vivos by the testator can

only be made (a) by someone else (b) aft er the death of the decedent. And we are aware of no

post-mortem estate tax election that is required to be made earlier than the time for filing the Form

706. In keeping with the Congressional purposes of 1) eliminating the need for testators to risk

predicting the future, and 2) providing both flexibility and the opportunity for post-mortem estate

planning either to minimize or "optimize" the estate tax impact on the combined marital property of

the spouses, the QTIP election can be made at any time before such filing date. Still, like other estate

tax elections (and other exceptions to the terminable interest rules), the effect of the QTIP election

(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.

Subclause (II) shall not apply to a power exercisable only at or after the death of
the surviving spouse. To the extent provided in regulations, an annuity shall be
treated in a manner similar to an income interests in property (regardless of
whether the property from which the annuity is payable can be separately
identified).

(iii) Property includes interest therein.—The term "property" includes an
interest in property.

(iv) Specific portion treated as separate property.—A specific portion of
property shall be treated as separate property.

(v) Election.—An election under this paragraph with respect to any
property shall be made by the executor on the return of tax imposed by section
2001. Such an election, once made, shall be irrevocable.

Id. § 2056(b)(7).
is retroactive to the instant of death, irrespective of when it is actually made. Significantly, the party

statutorily vested with the exclusive right to make the post-mortem QTIP election is not the surviving

spouse, as one might expect, but the executor. Congress obviously did this as an extension of the

testator's volition but with all of the guesswork removed.

Congress also recognized the need for post-mortem flexibility when it vested the executor

with the additional option of making a partial QTIP election. The election need not be "all or

nothing"; rather, the executor may choose QTIP treatment for any percentage or share of the

property interest, from zero to 100%.

B. Property. A limitation which was clear prior to ERTA was that, "[i]n applying the

terminable interest rules, it [was] essential to honor the statutory distinction between an "interest' in

property and the underlying property itself."33 In ERTA, Congress recognized that if this distinction

were made applicable to QTIP, it could prove unduly restrictive of the kinds of property interest

(other than perfect ownership or fee simple title) that would be eligible for the deduction. Such a

potential restriction was eliminated by the inclusion of a new definition of property. "The term

"property' includes an interest in property."34 This feature dovetails with the partial QTIP election.

C. Separate Shares. The QTIP portion of Code § 205635 which follows on the heels of the

definition of property mandates that "[a] specific portion of property shall be treated as separate

property." Like the partial election and the definition of property to include an "interest in property,"

the "separate share" concept enhances post-mortem flexibility and planning. "[T]he Treasury

construes the "specific portion' rule to permit the executor to elect Q–TIP treatment for a fraction

or percentage of an otherwise qualifying trust."36 Of interest in the instant case is the position

announced by the Treasury, in proposed regulations, that would permit separate trusts to be created

33
BITTKER, supra note 11 at 129–31 (citing IRC § 2056(b)(1)(A) and Treas.Regs. §
20.2056(b)–1(e)(2)).
34
IRC § 2056(b)(7)(B)(iii).
35
Id. § 2056(b)(7)(B)(iv).
36
See BITTKER supra note 11, at 129–61 & 62.
by a partial election:

[T]he trust may be divided into separate trusts to reflect a partial election that has been made
or is to be made.37

"[A]s ... the statute provides that "a specific portion of property shall be treated as separate property,'

the executor can elect only for a portion of corpus. This greatly extends the usefulness of this

provision."38 "In case of a qualified terminable interest property trust, "property' includes an interest

in property, and a "specific portion' of property is treated as separate property. Thus it is possible

to obtain the Marital Deduction for a specific portion of the corpus of the trust for which the spouse

is entitled to the income interest."39

D. Property Passing to the Surviving Spouse. Entitlement to the Marital Deduction for any

property, including QTIP, requires the property pass to a person who as a matter of law is the

"surviving spouse" of the testator. That requirement is not an issue in the instant case.

E. Property Passing from the Decedent. Another requirement of the Marital Deduction is

that property for which the deduction is claimed in fact be an "interest in property which passes or

has passed from the decedent...."40 That the decimal interest in the securities "passes from the

decedent" within the meaning of Code § 2056 is not in dispute here.

F. Property Included in Determining the Value of the Gross Estate. Also uncontested in the

instant case is that the value of the undivided interest in the securities was included in determining the

value of the testator's gross estate, as is required for any legacy to be eligible for the Marital

Deduction.

3. Definition as Substance

The position of the Commissioner and the judgment of the Tax Court rises or falls on the

definition of QTIP. The same is true for t he opposite position of the Co–Executors and for the

37
Prop.Treas.Regs. § 20.2056(b)–7(b).
38
RABKIN & JOHNSON, supra note 11, at 53–61.
39
Id. at 53–66 (internal citation omitted).
40
IRC § 2056(a).
holding we make today.

The Code contains a three-pronged functional definition of QTIP, which is followed

immediately by specific definitions of terms used in that tripartite definition. As the definition of

QTIP begins with the statement that " "qualified terminable interest property' means property—," the

first step is to identify the "property" to be tested under the elements of the definition. Relying on

two specifically defined terms—that "property" includes an interest in property; and that a "specific

portion" of property is to be treated as separate property—the Co–Executors argue that the

"property" under examination here is the separate, undivided .563731 interest in the securities that

was identified on the Form 706 as t he property to which the QTIP election applies. Relying on

nothing that has either been cited to us or that our independent research has produced, the

Commissioner and the Tax Court insist that the "pro perty" here under examination is the entire

residue of testator's estate, being the maximum amount of property and interests in property with

which Trust B could be funded were a total QTIP election to be made. For reasons explained in more

detail below, we agree with the position of the Co–Executors and reject the position of the

Commissioner and the Tax Court.

The second step is to see if the identified "separate interest in property" (the undivided interest

in the securities for which the QTIP election was made) meets the Code's definition of QTIP. That

is done by testing it for compliance with each of the three prongs of that statutory definition.

All agree that one of those prongs, i.e., that the separate interest in property "passes from the

decedent," is met. We conclude that a second prong, is met, i.e., that the property be an interest "to

which an election under this paragraph applies." We reach that conclusion by observing that election

is a defined term: "An election under this paragraph in respect to any property shall be made by the

executor on the return ... [and] ... shall be irrevocable."41 Here, Surviving Spouse as Independent

Executrix duly and timely completed the Form 706, checked the appropriate box on Schedule M, and

identified the property "in respect to" which that election is made, i.e., the undivided .563731 interest

in the securities listed on Schedules B and C. Thus, the property being tested for eligibility is the

41
IRC § 2056(b)(7)(B)(v).
same property to which the election made by the Independent Executrix applies.

The third prong requires that the separate interest in property be one "in which the surviving

spouse has a qualifying income interest for life."42 This phrase too is a defined term of art: Such an

interest is one in which "the surviving spouse is entitled to all the income ... payable annually or at

more frequent intervals ... [and of which] no person has a power to appoint any part of the property

to any person other than surviving spouse."43

Under the terms of the Will, Surviving Spouse is expressly given the right for life to receive

all income from Trust B, the corpus of which is the separate property interest in question. The

executors and trustees are directed to pay such income to her no less frequently than annually. Even

so, "[t]he statute does not require that each day income accumulates that the income be paid

immediately to the spouse."44 In fact, "[n]o provision need be made for paying income before the

executor distributes the property to the trustee, ..."45 Clearly, the annual-income-for-life element is

met even if the income is not disbursed until a year after the trust is funded—an event that can only

occur during or at the end of the orderly administration of the estate. Obviously funding of every

testamentary trust occurs after the death of the testator; the executor cannot possibly ascertain on

"day one" the amount of the income. Just as obviously, then, the beneficiary must wait a reasonable

time before the income is actually received. But receipt and entitlement are not congruent. The

requirement of life income interest is met as long as the eventual disbursements include all income

accruing from and after the moment of the testator's death.

The other definitional element of "qualifying income interest for life" is that no one may have

a power to appoint any of the property to anyone other than the surviving spouse. We have already

determined that the "property" being considered is the undivided interest in the securities for which

42
Id. § 2056(b)(7)(B)(i)(II) (emphasis added).
43
Id. § 2056(b)(7)(B)(ii)(II).
44
Estate of Howard v. C.I.R., 910 F.2d 633 (9th Cir.1990).
45
RABKIN & JOHNSON, supra note 11, at 53–63 (citing Treas.Reg. § 20.2056(b)–5(f)(g). See
Rev.Rule 72–283, 1972–1 C.B. 311 (first payment may be delayed until one year after trust
created).
the executor made a timely QTIP election. No reasonable reading or construction of the Will or the

statute can validate the position of the Commissioner, as endorsed by the Tax Court, that the

Independent Executrix's QTIP election itself is "tantamount" to a power of appointment to the

testator's children. Clearly, the estate's entitlement to a QTIP deduction is not meant to be abrogated

simply because making a partial election for a separate interest in the property, i.e., not making a full

election as to all interest in the property, results in a portion of the estate's residue—one that would

have passed to Trust B under a full election—passing to Trust A. To embrace the Commissioner's

flawed logic and deliberate disregard for the plain wording of the pertinent part of Code § 2056

would be to engage in pure sophistry.

Besides being unable to direct our attention to anything that might support their interpretation,

the Commissioner and the Tax Court cannot escape the effects of their own interpretative

pronouncements on the election prong of the QTIP definition. As shall be seen, such

pronouncements implicitly acknowledge that the election element of the definition is viewed in the

past tense, i.e., that although the effect of the election is tested as of the instant of the testator's death,

the definitional eligibility of the separate terminable interest under examination is tested as though

QTIP election had already been made.

In the Treasury's own proposed regulation interpreting the definition of QTIP, cited to us by

the Commissioner in the appendix to her brief, the Department identifies the "property" as that "which

the executor elected to treat as qualified terminable interest property."46 Likewise, the Tax Court,

in citing its decision in the instant case to support its judgment in Estate of Willard E. Robertson v.

C.I.R., refers to the election element of the definition pertaining to property "for which an election

has been made."47

4. Additional Flaws in the Commissioner's Position

The Commissioner misses the mark by insisting that the QTIP provision should be construed

narrowly because it is an exception to the prohibition of deducting terminable interest under the

46
Prop.Treas.Reg. § 2056(b)–7(b)(3) (41 Fed.Reg. 21, 350 March 21, 1987).
47
98 T.C. No. 47, 4976 (1992) (emphasis added).
Marital Deduction. As we have noted, however, it is Code § 2056(b)'s general prohibition of

deducting terminable interests that is the exception. It is an exception to the broad rul e of

deductibility of interspousal transfers which in turn implements the clear will of Congress favoring,

as a matter of public policy, deferral of estate tax until the death of the second spouse—to the extent

such deferral is desired by the parties. It is that general, terminable interest exception that must be

narrowly construed. As QTIP is an exception to that exception, however, QTIP enjoys the same

favored position and liberal construction as is properly afforded to the Marital Deduction itself.

More importantly, there is nothing in the plain wording of the entire QTIP subsection which,

when viewed in light of the definition of terms therein provided, even remotely supports the position

of the Commissioner that if anything occurs after the death of the testator—such as the QTIP

election—to prevent even a modicum of property which under the testament would have passed from

the decedent to the surviving spouse, the deduction is unavailable for all otherwise eligible property.

To reach that strained result, the Commissioner would have us ignore the overarching truism that

many acts must be done and many facts must be determined after the death of the testator in order

to determine the taxable estate. The question is not when those determinations are made or when

those acts are performed but whether their effects relate back, ab initio to the moment of death. For

example, a qualified disclaimer by the Surviving Spouse has precisely the effect of the QTIP election

here: Both are volit ional act s; both can be made only after the death of the testator; both relate

back, ab initio, to the date of death of the testator; and both have the effect of causing estate

property which would otherwise pass to the Surviving Spouse to pass instead directly to or for the

benefit of other parties. Likewise, while seldom volitional, the death of the Surviving Spouse within

six months following the death of the testator who conditions the legacy on survivorship would have

the same effect, but again retroactive to the moment of the testator's death.

Curiously, the Commissioner and the Tax Court appear to view QTIP legislation as some sort

of Congressional paternalism aimed at ensuring the financial stability of the surviving spouse. Clearly

such protectionism played no part in it. If the intention had been to dangle the carrot of deductibility

in front of testators to induce them to ensure the financial well-being of the surviving spouse,
Congress would surely have given the power to make the QTIP election to the surviving spouse, not

the executor. The point we here emphasize is that for tax purposes Congress was and is interested

only in that portion of terminable interest property for which the QTIP election is made; it has no

interest whatsoever in the portion of any terminable interest property for which the election is not

made. Being ineligible for the Marital Deduction, that property is taxed right where the

Commissioner and Congress want it taxed—in the estate of the first spouse to die. Congress could

not care less whether the portion of the terminable interest property for which the QTIP election is

not made goes to the surviving spouse, to the children, or to a stranger. Obviously, that is why

Congress placed the election in the definition of QTIP property. If Congress had intended the result

advocated by the Commissioner, it could have 1) defined the property without reference to the

election, 2) specified a subsequent election, and 3) provided separately for the election to apply to

all property meeting the definition, thereby separating the election from the definition. Facially, the

statute eschews any such separation.

From whence it came we know not, but the Tax Court here made the pronouncement that the

QTIP election gave the executor "control over trust assets [that] is tantamount to a power to appoint

property that was subject to the qualifying income interest."48 That unsubstantiated, conclusionary

statement can only be the product of a circular argument—one that we reject. First, the QTIP

election cannot vest the executor with control over "trust assets" before they become trust assets!

The undivided interests in the securities for which the election is made are estate assets but they do

not become trust assets until the trust is funded, even though the economic effect of funding is

retroactive to the instant of death. Assets used to fund each testamentary trust get there by virtue

of the provisions of the Will and the administration of the estate. The same analysis is applicable to

that portion of the quotation from the Tax Court's opinion that refers to property that was subject

to the qualifying income interest. No income interest is qualifying until it meets the full definition

for QTIP, including the election prong. As we have just noted, one of the three essential elements

in the definition of such property interest is that it be property for which—in the Tax Court's own

48
Clayton, 97 T.C. at 336.
words—"an election has been made."49

Additionally, the Commissioner appears to have seized on a gratuitous statement from the Tax

Court opinion in the instant case to bootstrap an even more adventuresome government position, i.e.,

that "any QTIP trust that pours nonelected property over is flawed, apparently even if the bypass trust

is QTIPable in its own right."50 Such an arbitrary and unsupport ed misconstruction of the statute

cannot be justified by any reasonable reading. It can only be explained as overzealousness in revenue

collection, deliberate disregard for the clear purpose, intent and policy behind the statute, and an

historic aversion to the Marital Deduction which is well documented in the Tax Court Reports, the

Federal Reporter System, Treasury Regulations, Revenue Rulings, Technical Advice Memoranda,

Private Letter Rulings, and the like.

"Loophole" is a term frequently used as a pejorative in the context of taxation. Although it

is usually reserved for taxpayers and their professional advisors, in truth the Commissioner and the

Service are no less active in probing tax statutes for loopholes. Historically, that has been part of the

game, leaving to Congress the damage control of plugging loopholes through technical amendments.

The position taken by the IRS and advocated by the Commissioner in the instant case, however, goes

beyond mere probing for loopholes overlooked by Congress. Rather, it reflects an effort to batter

such a hole in the statutory wall where none exists. We will not approbate such overreaching. From

every standpoint—history, expressed intent, logic, reading in pari materiae with other post-mortem

provisions, and—above all—the plain language of the statute—the position of the Co–Executors

meets muster while the Commissioner's fails.

5. The End Result

Having thoroughly parsed the statute, examined the terms as therein defined and eliminated

the flawed construction of the Commissioner, we now reassemble Humpty Dumpty by reconstituting

49
Robertson, 98 T.C. No. 47 at 4976 (emphasis added).
50
PENNELL, supra note 11, at C & A 5 (Supp. 8/10/92). "This is not a proper result, because
no abuse is involved, and its extrapolation from Clayton [ ] is unwarranted.... Nothing in the
government's proposed QTIP regulations anticipates or warns taxpayers about this unwarranted
result." Id.
the statutory definition of QTIP by replacing all terms of art with their statutory, jurisprudential or

regulatory definitions:

"Qualified Terminable Interest Property means a separate interest in property, which was
included in determining the value of the gross estate, and (1) which passes from the decedent,
(2) from which the surviving spouse is entitled t o all income for life, payable no less
frequently than annually, no part of which can be appointed by any person (including the
surviving spouse) to any person other than the surviving spouse, and (3) which the executor
elected to treat as Qualified Terminable Interest Property."

When all definitions are thus factored into the applicable Code section's tripartite definition

of QTIP, it is clear beyond cavil that the election given to the executor by Congress is not

"tantamount" to a power of appointment, and does not divest the surviving spouse of anything about

which Congress was or is concerned. The provisions of the Will that effect the funding of Trust B

with a terminable interest in that separate decimal fraction of the estate's residual assets for which the

election is made, and which effect the funding of Trust A with that portion of the residue for which

the election is not made (including the "other" separate interest in the securit ies) are indisputably

effective as o f the moment of death, albeit retroactively from the time the election is made. Such

retroactivity is an expected and indispensable characteristic of all estate tax elections, not to mention

many non-tax aspects of Will implementation. Even though Trust B is not funded until after the

QTIP election is made, the Surviving Spouse as QTIP beneficiary of that trust is entitled to and

assured of receiving every dollar of net income generated by such corpus from and after the instant

of the testator's death. Neither the corpus of that trust nor the income thereof can be appointed by

any person to any person other than the Surviving Spouse.

Congress clearly could not care less about the post-mortem disposition of that portion of the

residue of the testator's estate for which the QTIP election was not made, because every dollar's

worth of that property was taxed currently in the estate of the Testator as the first spouse to die.

That is the very reason for allowing a partial election and for treating specific portions of interests

in property separately. As such the Will and the administration of the Testator's estate, including the

partial QTIP election, met the only conditions that Congress has placed on the ability to defer estate

tax on a terminable interest via the Marital Deduction, i.e., that the specific portion of the terminable

interest property for which the election is made be taxed in the estate of the surviving spouse, and that
all other property and interests in property—terminable or not—be taxed in the estate of the first

spouse to die.

III

CONCLUSION

The Marital Deduction of Code § 2056 excludes from taxability in the estate of the first

spouse to die those properties or interests in property used in calculating the gross estate that pass

from the decedent to the Surviving Spouse. Fo r decedents dying after December 31, 1981, the

Marital Deduction is unlimited in both quantum and share. Although the Marital Deduction is not

generally available for interspousal transfers of terminable interests in property, Code § 2056 contains

express exceptions. One such exception exists for terminable interest property that meets the Code's

definition of "qualified terminable interest property." That exception is set forth in full in Code §

2056(b)(7), and the particular type of terminable interest for which the exception is

available—"qualified terminable interest property"—is defined in sub-subsection (B) thereof.

As sub-subsection (B)(iii) defines the term "property" to include an "interest in property";

and as sub-subsection (B)(iv) mandates that a "specific portion" of property be treated as a "separate

property," any testing of terminable interest "property" which is the object of an interspousal transfer

must treat such interest as a specific portion of the property, separate and apart from the underlying

property. Conducting such a test to determine eligibility for the Marital Deduction by virtue of being

qualified terminable interest property must begin with the statutory definition.

That definition, found in sub-subsection (B)(i), opens with the statement that the term

"qualified terminable interest property" means "property." Focusing on the separate interest in

property being tested in the instant case—an undivided .563731 interest in the securities listed on the

Form 706—we conclude that it meets each of the three prongs of the definition. First, it is a separate

interest in property to which the QTIP election applies. To borrow the words of the Tax Court and

the Treasury respectively, it is property "for which an election has been made" or "which the executor

elected to treat as qualified terminable interest property." The separate interest in property here under

examination meets the "election" prong of the definition as set forth in sub-subsection (B)(i)(III).
 That the separate interest in property meets a second prong, the one set forth in sub-section

(B)(i)(I)—a separate interest in property "which passes from the decedent,"—is not in dispute.

The remaining prong, set forth in sub-subsection (B)(i)(II)—a separate interest in property

in which the surviving spouse has a qualifying income interest for life—is met by virtue of the

unambiguous language of the Will. The trustees of Trust B are commanded to pay all net income

generated by the corpus of that trust—beginning with the death of the testator—to the Surviving

Spouse at least annually for the remainder of her life. Under equally unambiguous language of the

Will, the corpus of Trust B will consist of any portion of the residue of testator's estate which the

Independent Executor elected to treat as QTIP, here the undivided .563731 interest in the subject

securities. Because the election and income provisions under the trust are retroactively effective, ab

initio, to the moment of the testator's death, the income interest of the Surviving Spouse covers the

period that begins with the testator's death and ends with the Surviving Spouse's death.

Moreover, by the express language of the Will, no party—including Surviving Spouse—has

the power or authority to appoint any part of the separate interest in property, which passes from the

decedent, as to which QTIP election was made, and in which the Surviving Spouse has an annually

payable income interest for life. The Will contains no express power of appointment of the interest

for which the election is made; in fact, the Will expressly negates such possibility. And we reject out

of hand the strained construction of the partial election and its effect on the funding of the several

residuary trusts as being "tantamount" to a power of appointment.

Therefore we hold that the terminable interest in property for which the Marital Deduction

was taken on Testator's Form 706 by virtue of the QTIP election is eligible for that deduction. To

disallow it for the circular reasoning advanced by the Commissioner would defy logic, common sense,

and the purpose for which QTIP was designed and implemented.

We perceive no appropriate basis for the Commissioner's concern with separate interests in

property for which no election was made and for which no deduction was taken, i.e., the balance of

the residue of testator's estate, including the remaining undivided .436269 interest in the subject

securities. No QTIP election was made for it; no deduction was claimed for it; and federal estate
taxes were timely paid on it. Neither do we perceive a reason for the Commissioner's concern that

such other separate interests in property could have passed to Trust B and formed a part of the

corpus thereof if the QTIP election had been made for it. By definition, the Commissioner need only

be concerned with separate interests in property for which the QTIP election is made, not that for

which no election is made—except to see that tax is paid on it in the estate of the first spouse to die.

And the Independent Co–Executrix did that in a complete and timely manner.

Finally, as we hold that the subject clause in the Will does not make the QTIP election here

"tantamount" to a power of appointment for purposes of Code § 2056(b)(7)(B)(ii)(II), the identity

of the party or parties serving in such capacity is of no consequence. It is irrelevant that under the

Will a party other than Surviving Spouse might have served with her as Independent Co–Executor

or in her stead as sole Independent Executor.

For the foregoing reasons, the judgment of the Tax Court is reversed and the case remanded

to that court for redetermination of the estate tax deficiency in the estate of the Testator, allowing

the Marital Deduction for the qualified terminable interest property for which the Surviving Spouse,

in her capacity as Independent Executrix, duly made the QTIP election on the Form 706. Such

redetermination shall include considerat ion of any other applicable adjustments not at issue in this

appeal, as well as interest.

REVERSED AND REMANDED.