Estate of Cavenaugh v. Commissioner

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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