United States Court of Appeals,
Fifth Circuit.
No. 93-5594.
ESTATE OF Herbert R. CAVENAUGH, Deceased, William Monroe Kerr,
Independent Administrator, Petitioner-Appellant
v.
COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
May 10, 1995.
Appeal from A Decision of the United States Tax Court.
Before JONES and DeMOSS, Circuit Judges, and TRIMBLE*, District
Judge.
EDITH H. JONES, Circuit Judge:
The Estate of Herbert Cavenaugh invested considerable
intellectual and creative resources to minimize its tax liability.
It excluded the value of property Herbert received upon the death
of his first wife Mary Jane because of the technical possibility
that he might not be entitled to all of the income from the
property, and it excluded half of the life insurance proceeds paid
on his death to the estate, asserting that Texas law still
recognized Mary Jane's community interest in the proceeds.
Unimpressed by the estate's acumen, the Commissioner of Internal
Revenue assessed a hefty deficiency. Imputing the full value of
both of these interests to Herbert's estate, the Tax Court upheld
the Commissioner's calculation of tax due. See 100 T.C. 407, 1993
WL 153230 (1993). This court accepts the essential propriety of
*
District Judge of the Western District of Louisiana,
sitting by designation.
1
that court's interpretation of the federal tax code but affirms the
judgment only as to Herbert's interest in the residuary trust
created by Mary Jane's will. We reverse the portion of the
deficiency attributable to the life insurance policy because the
IRS misread Texas community property law.
I.
The relevant facts are uncomplicated. Herbert and Mary Jane
Cavenaugh were married for many years and resided in Texas, a
community property state. In 1980, they purchased a renewable term
life insurance policy on Herbert's life. In 1983, Mary Jane died
testate; her will left Herbert certain property interests which
he—as executor of her estate—elected to exclude from her gross
estate as property eligible for the Marital Deduction.
In 1986, Herbert died, leaving his estate as sole beneficiary
of approximately $650,000 in life insurance proceeds. His
estate—the appellant here—excluded from Herbert's gross estate
one-half of the term life insurance death benefit paid to the
estate and those property interests that had passed from Mary Jane
to Herbert on her death in 1983.
II.
The QTIP Deduction
Section 2001 of the Internal Revenue Code imposes a tax on
each decedent's taxable estate. The taxable estate equals the
value of the gross estate, which consists of all property owned by
the taxpayer upon death, less applicable deductions. Upon Mary
Jane's death in 1983, Herbert, as executor of the estate, elected
2
to exclude from the gross estate the value of certain properties
transferred to him by virtue of her will. Section 2056(a) now
authorizes an unlimited (in dollars) deduction from the decedent's
gross estate of property transferred to a surviving spouse. Often
referred to as the "Marital Deduction," this provision postpones
taxation on such property until the surviving spouse disposes of
the exempted property by gratuitous transfer, whether inter vivos
or at death. See Estate of Clayton v. C.I.R., 976 F.2d 1486, 1492
(5th Cir.1992).
To ensure that none of this property escapes taxation, section
2056(b) provides an exception to subsection (a)'s grant of an
unlimited Marital Deduction for "terminable interests." Code
section 2056(b) excludes "terminable" interests1 in property from
eligibility for the Marital Deduction. But a number of particular
exceptions to this general terminable interest exception are
recognized; among the particular types of terminable interests
that are in fact deductible by virtue of being
exceptions-to-the-exception is the Qualified Terminable Interest
Property ("QTIP") created by the Congress in 1981. Subsection
2056(b)(7)(B)(i) defines QTIP as 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 to exclude
is made. An election to claim a marital deduction for qualified
1
These are defined as interests which will terminate or fail
on the lapse of time, the occurrence of an event or contingency,
or on the failure of an event or contingency to occur. See §
2056(b)(1).
3
terminable interest property once made is irrevocable. Section
2056(b)(7)(B)(v).
Herbert exercised such an election on behalf of Mary Jane's
estate in 1983 and accordingly excluded the properties at issue
here from her gross estate. Nevertheless, Herbert's estate now
claims that this election was unavailable since the transferred
property was ineligible for QTIP treatment. Hence the estate
attempts to circumvent Section 2044(a), which requires inclusion in
Herbert's estate of the value of all property in which the decedent
had a qualifying interest for life.
The estate advances two arguments why the initial election
was defective: (1) The income interest that Herbert received could
not constitute a "qualifying income interest for life;" (2) Mary
Jane's will precluded the executor, Herbert, from exercising the
necessary election. This second theory, however, collapses into
the first argument since section 2044 defines petitioner's tax
liability independently of the constraints of Mary Jane's will.
Specifically, this section requires the inclusion of the property
in Herbert's gross estate if the "decedent had a qualifying income
interest for life" when "a deduction was allowed with respect to
the transfer of such property to the decedent." Since there is no
dispute that such a deduction was allowed by the Commissioner,
whether the property received by Herbert was a qualifying income
interest for life becomes dispositive. The viability of a QTIP
election, in other words, presents a question of federal, not state
law, and such an election, once made and approved by IRS, is
4
irrevocable.
This court reviews de novo the Tax Court's conclusion that
this property did qualify. McIngvale v. Commissioner, 936 F.2d
833, 835-36 (5th Cir.1991). A qualifying income interest for life
is a defined term of art for an interest 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." Estate of Clayton, 976 F.2d at 1496 (quoting §
2056(b)(7)(B)(ii)(II)) (alterations in original). Consequently,
the statute imposes two definitional elements: (1) Herbert must be
entitled to all of the income; and (2) no person can be authorized
to appoint any part of the property to anybody but Herbert. These
determinations must be made as of the date of Mrs. Cavenaugh's
death. Id. at 1497. Applicable regulations incorporate state law
to determine whether the income distribution requirements are
satisfied. Treas.Reg. § 20.2056(b)-5(e).
Herbert received two types of interests in property. Mary
Jane bequeathed him specifically defined interests in their home
and other real property.2 Her will also created a residuary trust
whose net income was to be paid to Herbert during his lifetime
only. Only Herbert's interest in the residuary trust is at issue
in this appeal.
2
Mrs. Cavenaugh's will assigns Herbert a life estate in the
family home, but permitted him the power to sell it provided that
the interest from such sale was invested in another home for Dr.
Cavenaugh with any balance of her interest to be added to her
estate's residuary trust.
5
Herbert's estate and the IRS part company over the scope of
his interest as a beneficiary of the residuary trust. The precise
question is whether Herbert was entitled to receive all of the
income during his life. Herbert's estate contends that since no
provision of Mary Jane's will nor of Texas law3 precludes the
accumulation of trust income (as opposed to its distribution
currently to Herbert), the possibility existed that some of this
income might go to Mary Jane's descendants (the Cavenaugh children)
upon Herbert's death. Thus, it urges the QTIP deduction's
statutory requirement that Herbert be entitled to all of the income
of the residuary trust payable at least annually might not be
satisfied. Moreover, the trustee by resort to accumulation is also
technically authorized to appoint part of this property to somebody
other than Herbert.
Fortunately, this court need not enter the fray between the
Ninth Circuit in Estate of Howard v. Commissioner, 910 F.2d 633
(1990), and the Tax Court in Estate of Shelfer v. Commissioner, 103
T.C. 10, 1994 WL 373509, 1994 U.S.Tax Ct. LEXIS 50 (1994) (refusing
to follow Estate of Howard since Shelfer resides in Eleventh
Circuit), in determining whether a technical possibility that any
income will not go to the surviving spouse destroys eligibility for
QTIP treatment.4 The significance petitioner derives from the lack
3
The parties agree that the nature of the interest Herbert
received is decided under Texas law.
4
In any event, Judge Wiener's opinion in Estate of Clayton,
976 F.2d at 1497, cites the Estate of Howard opinion approvingly.
6
of an express prohibition on accumulation (in either the will or
under Texas law) is misplaced. Whether the surviving spouse is
entitled to all the income is not measured by an abstract principle
of law but merely by reference to the decedent's intent. See
generally Estate of Clayton, 976 F.2d at 1488-1490 (eligibility for
QTIP measured by reference to four corners of will); Perfect Union
Lodge No. 10 v. Interfirst Bank, 748 S.W.2d 218 (Tex.1988) (wills
are construed to give effect to the actual intention of the
testator). In other words, whether Mary Jane intended that Herbert
receive all of the income from these property interests and whether
she did—or did not—authorize any other person to appoint part of
this property to somebody other than her spouse is dispositive.
"The cardinal rule for construing a will requires that the
testator's intent be ascertained by looking to the provisions of
the instrument as a whole." Id. The best evidence the estate
identifies that Mary Jane did not intend for Herbert to receive all
of the income in at least annual intervals is Paragraph B of
Article V of her will. That paragraph requires that the net income
from the trust be paid to Herbert for as long as he lives "monthly
or at the end of such other periods as may be necessary or
desirable in the discretion of the Trustee." (emphasis added).
Herbert's estate reasons that Mary Jane thus imposed on the trustee
"no limitations on its discretion to distribute" and thereby "left
to the professional trustee all of the considerations and decisions
about how much and when distributions of income should be made."
Although this provision plainly provides the trustee with some
7
latitude in determining when income distributions should be made,
reading that clause to manifest an intent to permit the trustee to
exercise absolute discretion in choosing when to pay income to Dr.
Cavenaugh is unwarranted.
To begin, the will specifically states that the payments of
income should be made periodically. Normally, a trustee is
required to make payments of income at reasonable intervals.
Bogert, TRUSTS AND TRUSTEES, § 814 (2d ed. 1981). A reasonable
interval is ordinarily semiannually or quarterly. 2A Scott,
TRUSTS, § 182, at 550 (4th ed. 1987). If anything, the inclusion
of "monthly" evinces an intent to distribute the income at more
frequent intervals than "reasonableness" requires.
Resort to the reading advanced by the estate would render the
word "monthly" wholly meaningless. Texas presumes that a testator
would not include useless expressions in her will. Republic
National Bank v. Fredericks, 155 Tex. 79, 283 S.W.2d 39, 44 (1955).
Notably, no authorization in the will exists for the trustee
to accumulate income during Herbert's life, and Mary Jane
interestingly neglected to provide for the disposition of
accumulated income. In contrast, Mary Jane did explicitly provide
that after Herbert's death income could be accumulated and added to
the trust corpus and that the trustee shall have "sole and absolute
discretion" to distribute income and corpus to her children.
Finally, paragraph D of Article V of the will gives Herbert
the express right to withdraw the greater of $5,000 or five percent
of the corpus of the residuary trust in any calendar year.
8
Presumably, the trust settlor intends that the trust income be
distributed before corpus is invaded. Since Herbert is entitled to
require distributions of corpus annually, it is unlikely that Mary
Jane did not intend to entitle him to distributions of income as
often. Taken cumulatively, it is easy to conclude that Herbert's
estate was compelled to include the value of his interest in the
trust, already made the subject of a QTIP election on Mary Jane's
estate tax return, in its return.
III.
Life Insurance Proceeds
The conflict between the Commissioner and the Estate over the
proper taxation of term life insurance proceeds paid to Herbert's
estate raises a much closer question. Internal Revenue Code §
2042(1) dictates that "the value of the gross estate shall include
* * * the amount receivable by the executor as insurance under
policies on the life of the decedent." Section 20.2042-1(b)(2) of
the Regulations, however, excludes life insurance proceeds payable
to the estate to the extent that they belong to the decedent's
spouse under state community property law. Herbert's estate labors
to avail itself of this exception by insisting that one-half of the
$650,000 proceeds still belonged to Mary Jane's residuary trust.5
Although the Commissioner ridicules this argument as "pure
metaphysics," the truth of the matter is decided under state law.
Broday v. United States, 455 F.2d 1097, 1099 (5th Cir.1972).
5
Her executor did not specifically include any interest in
the insurance policy in the gross estate.
9
Therein lies the rub.
In Texas, the status of property is fixed at the time of
acquisition or inception of title. Colden v. Alexander, 141 Tex.
134, 171 S.W.2d 328, 334 (1943). Since Herbert's term life
insurance policy was purchased initially with community property in
1980, ordinarily Mary Jane would retain a one-half community
interest in the policy and its proceeds: "[I]f life insurance is
purchased during a marriage and paid for with community funds, the
"policy rights' or incidents of ownership and the "proceeds rights'
or the rights to receive the proceeds in the future constitute
community property." Freedman v. United States, 382 F.2d 742, 745
(5th Cir.1967), citing Brown v. Lee, 371 S.W.2d 694 (Tex.1963).
Two factual wrinkles obscure this simplicity: (1) Mary Jane died
in 1983; (2) Herbert personally had to renew the policy in 1984,
1985 and 1986.
Prompted by these complications, the IRS fires three broadside
assaults on the suggestion that Mary Jane6 continued to sustain an
unmatured interest in the proceeds. First, the IRS posits that
because the marital community dissolved at her death any community
interest in the policy or unmatured right to the proceeds
terminated upon expiration of the last one-year term of the policy
paid with community funds. Alternatively, the Commissioner argues
that Texas caps Mary Jane's community interest at one-half the cash
surrender or interpolated terminal reserve value of the policy at
6
Or the residuary trust created by her estate.
10
her death.7 As the term policy here had no cash surrender value
nor any value computed by the interpolated terminal reserve method,
the Commissioner reasons the remaining $650,000 of value must be
ascribed to Herbert's estate. The final challenge recasts the lack
of monetary value at the moment of her death into an extirpating
force. The Commissioner explains that the absence of monetary
value removed the need for partition of Mary Jane's community
interest in the policy, thereby transforming Mary Jane's communal
right into an "extinguished" interest.
"Under circumstances where the uninsured spouse predeceases
the insured spouse, settlement of the decedent's community interest
in the unmatured chose has ordinarily been resolved by allocating
one-half of the cash surrender value to the deceased's estate and
the other one-half ... to the surviving spouse." Brown v. Lee, 371
S.W.2d 694, 696 (1963) (emphasis added). Significantly, however,
Mary Jane's property was not settled or partitioned prior to
Herbert's death. Accordingly, the normal rule of Brown is
inverted: "[W]here settlement of the deceased wife's community
interest in the policies was not made prior to the death of the
insured ... the wife's community interest was never extinguished
and the policies retained their community status up to the time of
7
Estate of Wien v. Commissioner, 441 F.2d 32, 34 (5th
Cir.1971), requires that the value of Mary Jane's community
interest in the policy be determined at the date of her death.
This unexceptionable principle is hardly probative in answering
whether Mary Jane's residuary trust preserved an interest in a
speculative investment vehicle that ultimately produced a
sizeable return on account of the occurrence of a contingency,
i.e. Herbert's death while covered.
11
maturity. Consequently, the proceeds are community." Id.
Elaborating on the consequences of treating life insurance
purchased by the community as community property, Amason v.
Franklin Life Insurance Co., 428 F.2d 1144 (5th Cir.1970), provides
a mandatory lesson on the treatment of insurance proceeds received
after the dissolution of the marital community where no partition
has yet occurred. The case holds explicitly that divorce does not
"automatically divest either spouse of his or her interest in the
policy," that this interest is preserved in both benefits of
ownership of the policy and the eventual proceeds from the policy,
and that the need to pay premiums subsequent to the divorce from
separate funds cannot terminate either spouse's right to the
proceeds. Id. at 1146-1148. Furthermore, Amason prescribes the
tenancy-in-common as the proper prism to assess the legal
relationship. Id. at 1147 ("After divorce each spouse owns an
undivided one-half interest in that property as a tenant in common
in the same fashion as if they had never been married.")
Hence Amason instructs that the death of Mary Jane without a
partition created a tenancy-in-common between Mr. Cavenaugh and her
estate's designated heirs vis à vis the policy.8 Moreover, this
tenant in common relationship continues until the proceeds are
paid. Nonetheless, persuasively distinguishing death from divorce
or adopting a limiting principle in cases where the policy has no
cash value at the moment of the uninsured spouse's death would
8
This is true at least until the term covered by the prior
payment of a premium expires.
12
still permit the Commissioner to prevail. Yet previous resort to
these exact maneuvers failed to capture any bounty for the Internal
Revenue Service. See Scott v. Commissioner, 374 F.2d 154, 159-160
(9th Cir.1967).
In Scott, a remarkably similar case9, the precise question
tackled by the court was how much of the insurance proceeds the
husband must include in his estate. Critically, the cash surrender
value of the policy at the date of the wife's death was zero.
Interestingly, the Commissioner advanced a familiar logic:
[The wife's] only interest at her death, and therefore the
only interest that passed ... under her will was the right to
receive one-half of the cash surrender value of the policies.
The theory ... is that while the insured husband is alive the
only value that can be realized is the cash surrender value,
and that the right to receive the face amount of the policies
upon the husband's death ... is kept alive only by payment of
further premiums by the husband after the wife's death.
Consequently to the extent that the proceeds receivable at the
husband's death exceed the cash surrender value at the wife's
death, this is attributable to those premiums, which were not
paid from community property the marital community having been
dissolved by the death of the wife. Accordingly, the entire
proceeds, less one-half the cash surrender value at the time
of the wife's death, are part of the husband's estate.
Id. at 159. Dismissing this argument, the Ninth Circuit recognized
that under California community property law, "the right to have
the contract of insurance continued in force by virtue of payment
of premiums from its issuance" is itself a "valuable right" even
when the policy at dissolution has no cash surrender value. Id. at
9
There the wife also predeceased the insured husband, her
estate had similarly listed zero value of the policy in its
earlier return, the husband and named beneficiaries had paid more
than $4,000 in additional premiums to prevent the policy from
lapsing after the wife's death, and his estate claimed only half
the value of the proceeds in its gross estate.
13
159-160. The question in California law was not whether the
community interest in the life insurance policy lapsed after the
death of the uninsured spouse but was instead the proportion of
ownership attributable to the uninsured spouse's estate.
Although the community property laws of California and Texas
differ in many respects, neither the IRS nor the Tax Court has
produced authority confirming a meaningful variation between
California and Texas law on this issue. Specifically, Scott's
treatment of a marital community dissolved via death—construction
of a tenant in common relationship—accords with the solution to
dissolution adopted by Amason in the context of divorce. This
parallelism is not only logical, but appears compelled by the
synergy of Amason and Brown v. Lee.10
Furthermore, Scott 's holding that the community interest is
not commuted by a zero cash surrender value harmonizes with Texas
law. "Even though the policy provides only for term insurance and
has no cash value, it is still a property right." Seaman v.
Seaman, 756 S.W.2d 56, 58 (Tex.App.1988) (citation omitted). The
contrary position of the IRS conflates "value" with a "property
interest." Within and without Texas, property is distinct from
value; surely one can own property that is worthless by any market
measure, but still is not subject to confiscation by the state or
10
Recall that Brown held that the community interest of the
deceased uninsured wife in the proceeds was not extinguished sans
partition or laches. Brown, 371 S.W.2d at 696.
14
invasion by other members of the public.11
Mitchell v. Mitchell, 448 S.W.2d 807, 811 (Tex.App.1969), does
not hold otherwise. That case resolved a dispute between the
original wife and the second wife of the deceased over an interest
in the proceeds of his federal group life insurance policy.
Applying federal law, the court concluded that the first wife could
have no interest in the policy because the federal statute strictly
assigned all interests to the "widow." Id. Preservation of a
community interest in the coverage afforded by the federal policy
would violate the conditions of the federal statute. Citing this
court, Mitchell observed: "The words "payable' and "widow' * * *
in the * * * statute do not refer to the status of the beneficiary
at the time the policy * * * is issued and the beneficiary is
designated, but are clearly applicable to the status of the
beneficiary when the policy matures and becomes due and payable."
Id. (alterations in original). To effectuate this design, the
Mitchell court held that "the term "widow' clearly means [only] the
woman surviving on the death of the man to whom she was legally
married at the time of his death." Thus, the original wife's
interest was truncated by operation of the statute and not because
of its lack of cash value.
Now confronted by the Commissioner's final bolt, this court
11
To illustrate in the term insurance context, consider a
policy "worthless" as measured by cash surrender or interpolated
reserve value. If the insured could no longer obtain insurance
for health or other eligibility reasons, the right to renewal at
a set annual premium would suddenly represent considerable value.
15
must divine whether each yearly renewal of a one-year term life
insurance policy by means of increasing premiums creates a (new)
separate policy or continues to relate to the initial (communal)
investment. Because Texas follows the inception of title doctrine,
the choice is binary: If the community received all of what it
bargained for in the original policy while Mary Jane lived, the
post-communal renewals are separate property, but if elements of
the contract remained unexpired at Mary Jane's death then the
community interest survives. Examining the terms of the policy
discloses several guarantees of more than de minimis import to the
community's transaction.
A. The Cavenaughs purchased the unrestricted right to renew
the policy for a period of up to 21 years at a fixed (albeit
increasing) rate. The security of this protection is compounded by
two provisions that expressly permit exercise of this right
"without proof of insurability" and entitle the owner of the policy
to "automatic conversion" to any whole life insurance policy issued
by the insurer. In economic terms, the Cavenaughs negotiated a
one-year term life insurance policy plus an option with a
defined—and lengthy—exercise period. This option alone might
suffice to track the coverage afforded by the later renewals back
to the community. See Demler v. Demler, 836 S.W.2d 696
(Tex.App.1992) (options earned during marriage were community
property).
B. The policy also became uncontestable after two years and no
longer excluded payment upon suicide of the insured.
16
C. The annual dividends (of at least 3.5%) payable to the
Cavenaughs increase in a non-linear progression as the policy is
renewed for extended terms. For example, in year 1 of the policy
the Cavenaughs were scheduled to receive $2,730, for the second
year $2,379, and the fourth year $2,944.50. But by renewing the
policy through year 10, they could expect to receive $5,726.50
annually and by year 15 the return would jump to $8,970. Hence the
financial terms of subsequent renewals for one-year increments were
not completely independent. By continuing coverage after Mary
Jane's death, Mr. Cavenaugh apparently reaped some benefit from the
four years of prior insurance.
Taking these factors together, we believe it unlikely that a
Texas court would dismiss these benefits produced by the community
as trivial. Employing the time of acquisition rule, Mr.
Cavenaugh's later actions could not therefore convert the character
of the property.
In the absence of any argument or evidence by the IRS that
might justify assigning less than one-half of the proceeds to Mary
Jane's unpartitioned community interest, we see no basis to deviate
from applying the conventional principles of Texas community
property law to the proceeds. Accordingly, the Tax Court erred in
determining that Herbert's estate should include for tax purposes
100% of the proceeds of the term life insurance purchased initially
by the community. The tax liability must be recalculated,
17
attributing one-half of the proceeds to his estate.12
For the foregoing reasons, the judgment of the United States
Tax Court is AFFIRMED in part, and REVERSED in part.
DeMOSS, Circuit Judge, specially concurring and dissenting:
I concur fully with the rationale, reasoning and conclusion
set forth in Part II of the panel opinion relating to the
appropriateness of, and the enforceability of, the QTIP election
made by Herbert in his capacity as independent executor of the
estate of his first wife, Mary Jane. I also concur with the
panel's reasoning and analysis set forth in Part III, Life
Insurance Proceeds, of the foregoing opinion, in so far as such
opinion concludes: (i) that prior to her death, Mary Jane had a
community property interest in the term life insurance policy which
was taken out during her marriage to Herbert, which insured
Herbert's life and which was payable to "the estate of the
insured"; and (ii) that, contrary to the contentions urged by the
12
Judge DeMoss's dissent argues forcefully that all of the
life insurance proceeds should have been included in Herbert's
estate either because of the impact of the QTIP election, which
requires inclusion of property subject to that election in the
estate of the later-deceased spouse, and/or because exclusion of
the proceeds from Herbert's estate does not comport with § 2042
of the Internal Revenue Code, implemented by Treas.Reg. §
20.2042-1(b)(2). Neither of these theories was advanced by IRS
in this court or made a basis for the Tax Court's decision. We
are loathe to speculate, much less rule on the propriety of
arguments that neither competent counsel nor a specialist court
employed. Moreover, the dissent's QTIP-founded theory of taxing
the entire life insurance proceeds in Herbert's estate seems to
conflict with the parties' stipulation that if the residuary
trust property subject to Article V of Mary Jane's will should be
included in Herbert's estate because of the QTIP election, its
value is $43,254.00. This stipulation would appear to render the
dissent's reliance on § 2056 less attractive to IRS.
18
Commissioner, dissolution of the marital community between Herbert
and Mary Jane did not automatically terminate Mary Jane's interest
in the policy; Mary Jane's interest in the policy was not limited
to one-half the cash surrender value or interpolated terminal
reserve value thereof at her death; and the lack of monetary value
in the policy at the moment of her death did not result in an
"extinguishment" of her interest.
I part company with my distinguished colleagues in concluding
that the foregoing determinations were sufficient to demonstrate
that the Tax Court erred in holding that Herbert's estate should
include 100% of the proceeds of the life insurance policy. I reach
the contrary conclusion based on either or both of the following
reasons:
(1) Section 2044 of the Internal Revenue Code mandates that a
decedents estate must include the value of any property as to
which a valid QTIP election under Section 2056(b)(7) was made;
and
(2) Section 2042 of the Internal Revenue Codes mandates that a life
insurance policy made payable to the estate of the decedent
must be included in the gross estate of the decedent, and the
requirements of Treasury Regulation Section 20.2042-1(b)(2)
are not satisfied in this case.
I write now to set forth the supporting analysis for these
reasons.
SECTION 2044 MANDATES INCLUSION OF QTIP PROPERTY
The community property interest which Mary Jane owned in the
life insurance policy on Herbert's life during their marriage was
inheritable under the intestate succession statute of Texas or
devisable under the terms of her will. Mary Jane did leave a will
which was admitted to probate and Article V of that will is a true
19
residuary disposition by which Mary Jane devised "all of the rest
and residue of the property which I may own at the time of my
death, whether real, personal or mixed, and wherever situated" to
the trustee of the trust created under Article V. Consequently,
after Mary Jane's death, the life insurance policy on Herbert's
life was owned 50% by Herbert as his separate estate and 50% by the
trust created under Article V of her will. Under the terms of Mary
Jane's will, Herbert was a lifetime beneficiary of the trust
created under Article V; and we have concluded in Part II of the
panel opinion that Herbert had sufficient income rights in the
property in Article V to make such property eligible for a QTIP
election. In his capacity as independent executor, Herbert
expressly elected to treat all of the assets passing under Mary
Jane's will, including expressly those passing under Article V, as
being covered by the QTIP election and no estate taxes were due and
owing therefore on Mary Jane's estate. The basic concept of the
marital deduction under Section 2056(a) in general and a QTIP
election under Section 2056(b)(7) is a postponement of (an not an
exemption from) estate taxes at the time of the death of the first
spouse to die. Likewise, Congress intended by passage of Section
2044 that upon the death of the second spouse the gross estate of
the second spouse "shall include the value of any property in which
the decedent [the second spouse] had a qualifying income interest
for life." Note that the definition says that it is the value of
the "property" not the value of the "qualifying income interest for
life." For example, suppose husband and wife owned as community
20
property a piece of commercial property on which the improvements
were subject to a long term lease to a national tenant. Wife dies
leaving a will which devises her one-half interest in the property
to a trust of which her husband is a beneficiary for his life for
all of the income from the property and upon his death the trust
continues for the benefit of their children. Upon the wife's death
a QTIP election is exercised as to this property and no portion of
the value of that property is included for tax purposes in the
wife's estate. Upon the subsequent death of the husband, his gross
estate must include the value of the wife's interest in the
property, not just the value of his lifetime revenue interest.
Therefore, it seems clear to me that in the case before us, the
value of the life insurance on Herbert's life (the property) as to
which Herbert (the decedent) had a qualifying income interest for
life as the beneficiary of the trust under Article V of Mary Jane's
will, must now be included in Herbert's estate for tax purposes.
PROCEEDS OF LIFE INSURANCE UNDER SECTION 2042
It is stipulated in this case that the life insurance policy
on Herbert's life was payable to "the estate of the insured." The
express terms of Section 2042 therefore mandate that the proceeds
of such policy are includable as part of the gross estate of
Herbert's estate. The only possible grounds upon which Herbert's
estate could avoid the inclusion of 100% of the insurance proceeds
would be to demonstrate that the circumstances defined in Treasury
Regulation Section 20.2042-1(b)(2) were applicable. This
regulation states:
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(2) If the proceeds of an insurance policy made payable to the
decedent's estate are community assets under the local
community property law and, as a result, one-half of the
proceeds belongs to the decedent's spouse, then only one-half
of the proceeds is considered to be receivable by or for the
benefit decedent's estate. (Emphasis added)
As the panel majority indicates in the first paragraph of
Section III of their opinion, "Herbert's estate labors to avail
itself of this exception by insisting that one-half of the $650,000
proceeds still belong to Mary Jane's residuary trust." The panel
majority then proceeds to demonstrate (accurately in my opinion)
why the grounds asserted by the Commissioner to defeat the position
asserted by Herbert's estate missed their mark and are not
themselves sufficient to support the conclusion of the tax court
that 100% of the insurance proceeds had to be included in Herbert's
estate. However, nowhere does the panel majority address the
satisfaction of the requirements of the Treasury Regulation quoted
above, and in my view on the basis of the record in this case,
there is no way those requirements can be met.
First of all, there are serious definition problems which
Herbert's estate cannot satisfy. After the death of Mary Jane
(which terminated the community estate between Herbert and Mary
Jane) the life insurance policy was no longer a "community asset"
but rather it was an asset of the tenancy in common between the
separate estate of Herbert as to 50% and the trust created under
Article V of Mary Jane's will as to 50%. Note that the Regulation
says "are community assets" not "were community assets."
Consequently, the proceeds of that policy when made payable by the
occurrence of Herbert's death were payable 50% to Herbert's
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separate estate and 50% to the trust under Article V of Mary Jane's
will. Satisfaction of the requirements of the Regulation is
further complicated by the factual circumstance that Herbert had
remarried and at the time of his death, his second wife, Cindy, was
his "spouse." There is nothing in the record whatsoever to
demonstrate that Cindy ever acquired any interest from any source
in the life insurance policy on Herbert's life. Consequently, none
of the policy proceeds belongs to "the decedent's spouse." I see
nothing in the regulations which would permit us to construe the
term "the decedent's spouse" to mean "a trust created under the
will of a former spouse." Since the statute (Section 2042)
mandates the inclusion in the decedent's gross estate of "the
amount receivable by the executor as insurance under policies on
the life of the decedent," the burden would be upon Herbert's
estate to demonstrate its entitlement to the exclusion contemplated
by the Treasury Regulation; and since neither the facts nor the
legal concepts permit that to be done, I think we are obligated to
affirm the decision of the tax court requiring the inclusion of
100% of the life insurance proceeds even though we do not agree
with the grounds or reasons upon which the tax court arrived at
that conclusion.
Accordingly, I dissent from the conclusion of the panel
majority requiring a recalculation of the tax liability
"attributing [only] one-half of the proceeds of the insurance
policy to Herbert's estate."
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