Estate Rose v. Commissioner IRS ( 1996 )

Opinions of the United
1996 Decisions States Court of Appeals
for the Third Circuit
11-26-1996
Estate Rose v. Commissioner IRS
Precedential or Non-Precedential:
Docket 95-7643
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UNITED STATES COURT OF APPEALS
FOR THE THIRD CIRCUIT
No. 95-7643
ESTATE OF ROSE D'AMBROSIO, Deceased,
VITA D'AMBROSIO, Executrix,
Appellant
v.
COMMISSIONER OF INTERNAL REVENUE SERVICE
ON APPEAL FROM THE UNITED STATES TAX COURT
(Tax Court Docket No. 94-06724)
Argued June 4, 1996
Before: COWEN, NYGAARD and LEWIS, Circuit Judges.
(Opinion Filed: November 26, 1996)
HARVEY R. POE, ESQUIRE (Argued)
Poe & Rotunda
256 Columbia Turnpike
Columbia Commons, Suite 202
Florham Park, NJ 07932
Attorney for Appellant
CHARLES BRICKEN, ESQUIRE (Argued)
GARY R. ALLEN, ESQUIRE
GILBERT S. ROTHENBERG, ESQUIRE
United States Department of Justice
Tax Division
P.O. Box 502
Washington, DC 20044
Attorneys for Appellee
OPINION OF THE COURT
NYGAARD, Circuit Judge.
Vita D'Ambrosio, executrix of the estate of Rose D'Ambrosio,
appeals from a judgment of the United States Tax Court upholding
a statutory notice of deficiency filed against the estate by the
Commissioner of Internal Revenue. The tax court held that, even
though the decedent had sold her remainder interest in closely
held stock for its fair market value, 26 U.S.C. § 2036(a)(1)
brought its entire fee simple value back into her gross estate.
We will reverse and remand with the direction that the tax court
enter judgment in favor of appellant.
I.
The facts in this case have been stipulated by the parties.
Decedent owned, inter alia, one half of the preferred stock of
Vaparo, Inc.; these 470 shares had a fair market value of
$2,350,000. In 1987, at the age of 80, decedent transferred her
remainder interest in her shares to Vaparo in exchange for an
annuity which was to pay her $296,039 per year and retained her
income interest in the shares. There is no evidence in the
record to indicate that she made this transfer in contemplation
of death or with testamentary motivation. According to the
actuarial tables set forth in the Treasury Regulations, the
annuity had a fair market value of $1,324,014. The parties
stipulate that this was also the fair market value of the
remainder interest.
Decedent died in 1990, after receiving only $592,078 in
annuity payments and $23,500 in dividends. Her executrix did not
include any interest in the Vaparo stock when she computed
decedent's gross estate. The Commissioner disagreed, issuing a
notice of deficiency in which she asserted that the gross estate
included the full, fee simple value of the Vaparo shares at the
date of death, still worth an estimated $2,350,000, less the
amount of annuity payments decedent received during life. The
estate then petitioned the tax court for redetermination of the
alleged tax deficiency.
The tax court, relying largely on Gradow v. United States,
11 Cl. Ct. 808 (1987), aff'd, 897 F.2d 516 (Fed Cir. 1990), and
Estate of Gregory v. Commissioner, 39 T.C. 1012 (1963), ruled in
favor of the Commissioner. Eschewing any attempt to construe the
language of either the Code or the applicable Treasury
Regulations, the tax court reasoned that the transfer of the
remainder interest in the Vaparo stock was an abusive tax
avoidance scheme that should not be permitted:
In the instant case, we conclude that Decedent's
transfer of the remainder interest in her preferred
stock does not fall within the bona fide sale exception
of section 2036(a). Decedent's gross estate would be
depleted if the value of the preferred stock, in which
she had retained a life interest, was excluded
therefrom. Decedent's transfer of the remainder
interest was of a testamentary nature, made when she
was 80 years old to a family-owned corporation in
return for an annuity worth more than $1 million less
than the stock itself. Given our conclusion that
Decedent did not receive adequate and full
consideration under section 2036(a) for her 470 shares
of Vaparo preferred stock, we hold that her gross
estate includes the date of death value of that stock,
less the value of the annuity.
Estate of D'Ambrosio v. Commissioner, 105 T.C. 252, ___ (1995).
The executrix now appeals; we have jurisdiction under 26 U.S.C. §
7482. Both parties agree that our standard of review for this
issue of law is plenary.
II.
Our nation's tax laws have, for several generations, imposed
a tax upon decedents' estates. Under 26 U.S.C. § 2033, a
decedent's gross estate includes "[t]he value of all property to
the extent of any interest therein of the decedent at the time of
his death." In addition the Code contains, among other
provisions, § 2036(a), which provides, in pertinent part:
The value of the gross estate shall include the value
of all property to the extent of any interest therein
of which the decedent has at any time made a transfer
(except in case of a bona fide sale for adequate and
full consideration in money or money's worth), by trust
or otherwise, under which he has retained for his life
or for any period not ascertainable without reference
to his death or for any period which does not in fact
end before his death--
(1) the possession or enjoyment of, or the right to
the income from the property[.]
Section 2036(a) effectively discourages manipulative transfers of
remainder interests which are really testamentary in character by
"pulling back" the full, fee simple value of the transferred
property into the gross estate, except when the transfer was "a
bona fide sale for adequate and full consideration."
There is no dispute that Rose D'Ambrosio retained a life
interest in the Vaparo stock and sold the remainder back to the
company. The issue is whether the sale of a remainder interest
for its fair market value constitutes "adequate and full
consideration" within the meaning of § 2036(a). Appellant argues
that it does. The Commissioner takes the position that only
consideration equal to the fee simple value of the property is
sufficient. Appellant has the better argument.
A.
The tax court and the Commissioner rely principally on four
cases, Gradow v. United States, 11 Cl. Ct. 808 (1987), aff'd for
the reasons set forth by the claims court, 897 F.2d 516 (Fed.
Cir. 1990); United States v. Past, 347 F.2d 7 (9th Cir. 1965);
Estate of Gregory v. Commissioner, 39 T.C. 1012 (1963); United
States v. Allen, 293 F.2d 916 (10th Cir. 1961). We find these
cases either inapposite or unpersuasive; we will discuss them in
chronological order.
In Allen, the decedent set up an irrevocable inter vivostrust in
which she retained a partial life estate and gave the
remainder (as well as the remaining portion of the income) to her
children. Apparently realizing the tax liability she had created
for her estate under the predecessor of § 2036, she later
attempted to sell her retained life interest to her son for an
amount slightly in excess of its fair market value. After she
died, the estate took the position that, because decedent had
divested herself of her retained life interest for fair market
value, none of the trust property was includable in her gross
estate. The Court of Appeals disagreed, holding that
consideration is only "adequate" if it equals or exceeds the
value of the interest that would otherwise be included in the
gross estate absent the transfer. See 293 F.2d at 917. Although
acknowledging that the decedent owned only a life estate, which
she could not realistically hope to sell for its fee simple
value, the court nevertheless rejected the estate's argument,
opining:
It does not seem plausible, however, that Congress
intended to allow such an easy avoidance of the taxable
incidence befalling reserved life estates. This result
would allow a taxpayer to reap the benefits of property
for his lifetime and, in contemplation of death, sell
only the interest entitling him to the income, thereby
removing all of the property which he has enjoyed from
his gross estate. Giving the statute a reasonable
interpretation, we cannot believe this to be its
intendment. It seems certain that in a situation like
this, Congress meant the estate to include the corpus
of the trust or, in its stead, an amount equal in
value.
Id. at 918 (citations omitted).
Allen, however, is inapposite, as the Commissioner now
concedes, because it involved the sale of a life estate after the
remainder had already been disposed of by gift, a testamentary
transaction with a palpable tax evasion motive. This case, in
contrast, involves the sale of a remainder for its stipulated
fair market value. Nevertheless, we agree with its rationale
that consideration should be measured against the value that
would have been drawn into the gross estate absent the transfer.
As the tax court persuasively reasoned in a later case:
[W]here the transferred property is replaced by other
property of equal value received in exchange, there is
no reason to impose an estate tax in respect of the
transferred property, for it is reasonable to assume
that the property acquired in exchange will find its
way into the decedent's gross estate at his death
unless consumed or otherwise disposed of in a
nontestamentary transaction in much the same manner as
would the transferred property itself had the transfer
not taken place. . . .
In short, unless replaced by property of equal
value that could be exposed to inclusion in the
decedent's gross estate, the property transferred in a
testamentary transaction of the type described in the
statute must be included in his gross estate.
Estate of Frothingham v. Commissioner, 60 T.C. 211, 215-16 (1973)
(emphasis added).
Gregory presents a closer factual analogy to D'Ambrosio's
situation. Gregory was a "widow's election" case involving the
testamentary disposition of community property. Typically in
such cases, the husband wishes to pass the remainder interest in
all of the marital property to his children, while providing for
the lifetime needs of his surviving spouse. In a community
property state, however, half of the marital property belongs to
the wife as a matter of law, so he cannot pass it by his own
will. To circumvent this problem, the will is drafted to give
the widow a choice: take her one-half share in fee simple,
according to law, or trust over her half of the community
property in exchange for a life estate in the whole. Put another
way, she trades the remainder interest in her half of the
community property in exchange for a life estate in her husband's
half.
In Gregory, the widow exchanged property worth approximately
$66,000 for a life estate with an actuarial value of only around
$12,000; by the time she died eight years later, the property she
gave up had appreciated to approximately $102,000. The tax court
compared the $102,000 outflow to the $12,000 consideration and
concluded that the widow's election did not constitute a bona
fide sale for an adequate and full consideration. 39 T.C.
1015-16. It also stated that "the statute excepts only those
bona fide sales where the consideration received was of a
comparable value which would be includable in the transferor's
gross estate." Id. at 1016 (emphasis added).
We believe that the Gregory court erred in its analysis,
although it reached the correct result on the particular facts of
that case. There is no way to know ex ante what the value of an
asset will be at the death of a testator; although the date of
death can be estimated through the use of actuarial tables, the
actual appreciation of the property is unknowable, as are the
prevailing interest, inflation and tax rates. Consequently,
there is no way to ever be certain in advance whether the
consideration is adequate and thus no way to know what tax
treatment a transfer will receive. This level of uncertainty all
but destroys any economic incentive to ever sell a remainder
interest; yet, Congress never said in § 2036 that all transfers
of such interests will be taxed at their fee simple value or that
those transfers are illegal. Instead, it clearly contemplated
situations in which a sale of a remainder would not cause the
full value of the property to fall into the gross estate.
Without some express indication from Congress, we will not
presume it intended to eliminate wholesale the transfers of
remainder interests. Therefore, rather than evaluate the
adequacy of the consideration at the time the decedent dies, we
will compare the value of the remainder transferred to the value
of the consideration received, measured as of the date of the
transfer. Here, we need not address that valuation issue,
because it is stipulated that the fair market value of the stock
was the same on the date of transfer as it was on the date of
death.
In Gregory, however, the $12,000 the decedent received was
grossly inadequate against the value of the property she
transferred, regardless of the valuation date. The court was
therefore correct that the transfer was not for adequate and full
consideration. Because of that gross inadequacy, however, the
holding of Gregory does not extend to the issue now before us:
whether, when a remainder is sold for its stipulated fair market
value, the consideration received is inadequate because it is
less than the fee simple value of the property.
The Past case was factually somewhat different, in that it
involved a divorce settlement, but the substance of the
transaction was the same as in Gregory: the sale of a remainder
in one-half of the marital property in exchange for a life estate
in the whole. In that case, however, the court valued the
property the divorcing spouse gave up at about $244,000 and the
life estate she received at about $143,000; as a result, it held
that the consideration was inadequate. 347 F.2d at 13-14. In
making these valuations, however, the court took the fee simple
value of the trust property and divided it in half. This was
analytically incorrect, however, because the divorcing wife never
gave up the life estate in her half of the marital property. She
contributed only her remainder interest in that half, and that is
the value that should have been used in the court's analysis.
Alternatively, the Past court could have used the fee simple
value of the wife's share, but it would then have needed to
measure that against the value of the life estate in both halves
of the property. Had the court employed this latter methodology,
it would have seen that the $287,000 value of the life estate
exceeded the $244,000 she contributed and would have found
adequate consideration. Instead, it compared "apples and
oranges" and, we believe, reached the wrong result.
B.
The facts in Gradow were similar to those in Gregory; both
are "widow's election" cases. That case is particularly
significant, however, because the court focused on the statutory
language of § 2036. The court began its analysis, however, with
a discussion of Gregory, Past and Allen. While acknowledging
that it was not bound by those three cases, the Gradow court
found them persuasive, for two reasons: 1) "the most natural
reading of § 2036(a) leads to the same result[;]" and 2) their
holding is "most consistent with the purposes of § 2036(a)." 11
Cl. Ct. at 813. We will discuss these rationales in turn.
1.
We examine first the Gradow court's construction of the
statute. It opined that
there is no question that the term "property" in the
phrase "The gross estate shall include ... all property
... of which the decedent has at any time made a
transfer" means that part of the trust corpus
attributable to plaintiff. If § 2036(a) applies, all
of Betty's former community property is brought into
her gross estate. Fundamental principles of grammar
dictate that the parenthetical exception which then
follows--"(except in case of a bona fide sale...)"--
refers to a transfer of that same property, i.e. the
one-half of the community property she placed into the
trust.
Id. (ellipses in original). We disagree; although the Gradowcourt's
rationale appears plausible, we note that the court, in
quoting the statute, left out significant portions of its
language. Below is the text of § 2036, with the omitted words
emphasized:
The value of the gross estate shall include the value
of all property to the extent of any interest thereinof which the
decedent has at any time made a transfer
(except in case of a bona fide sale for an adequate and
full consideration in money or money's worth), by trust
or otherwise, under which he has retained for his life
* * * (1) the possession or enjoyment of, or the right
to the income from, the property * * *
After parsing this language, we cannot agree with the Gradowcourt's
conclusions that "property" refers to the fee simple
interest and that adequate consideration must be measured against
that value. Rather, we believe that the clear import of the
phrase "to the extent of any interest therein" is that the gross
estate shall include the value of the remainder interest, unless
it was sold for adequate and fair consideration.
In addition to § 2036, Treas. Reg. § 20.2036-1 also
addresses this issue. It provides, in pertinent part (emphases
added):
(a) In general. A decedent's gross estate
includes under section 2036 the value of any interestin property
transferred by the decedent . . . except to
the extent that the transfer was for an adequate and
full consideration in money or money's worth if the
decedent retained or reserved (1) for his life . . .
(i) The use, possession, right to the income, or
other enjoyment of the transferred property, . . .
Appellant refers us to the emphasized words "interest" and
"transferred" in § 20.2036-1(a) and argues that "adequate and
full consideration" must be measured against the interest
transferred. The Commissioner, on the other hand, looks at the
phrase "of the transferred property" in § 20.2036-1(a)(i) and
concludes that, because one cannot retain any lifetime interest
in a remainder, "property" must refer to the fee simple interest.
The regulation, unfortunately, is not exactingly drafted and
does not parse "cleanly" under either party's interpretation.
The Commissioner is of course correct that one cannot enjoy any
sort of life interest in a remainder. On the other hand,
appellant validly asks why, if the drafters of the regulation
meant to include the full value of the property, they referred to
the value of any "interest in property transferred." On balance,
we believe that, if some words of the regulation must be
construed as surplusage, it is more reasonable and faithful to
the statutory text to render inoperative the word "transferred"
in § 20.2036-1(a)(i) than it would be to strike "interest" in the
first part of the section. We think it is likely that, although
the choice of verbiage was less than precise, the drafters meant
merely to refer to the "transferred" property so as to
distinguish it from other property owned by the estate. It
strains the judicial imagination, however, to conclude that the
drafters used the term of art "interest in property" when they
meant simply "property."
2.
The Gradow court also believed that its construction of §
2036 was "most consistent" with its purposes. 11 Cl. Ct. at 813.
The tax court in this case, although recognizing that the issue
has spawned considerable legal commentary and that scholars
dispute its resolution, 105 T.C. at ___, was persuaded that
decedent's sale of her remainder interest was testamentary in
character and designed to avoid the payment of estate tax that
otherwise would have been due. Id. at ___. It noted
particularly that the transfer was made when decedent was eighty
years old and that the value of the annuity she received was over
$1 million less than the fee simple value of the stock she gave
up. Id. Again, we disagree.
We too are cognizant that techniques for attempting to
reduce estate taxes are limited only by the imagination of estate
planners, and that new devices appear regularly. There is, to be
sure, a role for the federal courts to play in properly limiting
these techniques in accordance with the expressed intent of
Congress. Under long-standing precedent, for example, we measure
"consideration" in real economic terms, not as it might be
evaluated under the common law of contract or property. E.g.,
Commissioner v. Wemyss, 324 U.S. 303, 65 S. Ct. 652 (1945)
(promise of marriage insufficient consideration, for gift tax
purposes, for tax-free transfer of property); Merrill v. Fahs,
324 U.S. 308, 65 S. Ct. 655 (1945) (same). Likewise, when the
transfer of the remainder interest is essentially gratuitous and
testamentary in character, we focus on substance rather than form
and require that the full value of trust property be included in
the gross estate, unless "the settlor absolutely, unequivocally,
irrevocably, and without possible reservations, parts with all of
his title and all of his possession and all of his enjoyment of
the transferred property." See Commissioner v. Estate of Church,
335 U.S. 632, 645, 69 S. Ct. 322, 329 (1949) (gratuitous transfer
of remainder in trust for family members with possibility of
reverter to estate); accord Helvering v. Hallock, 309 U.S. 106,
110, 60 S. Ct. 444, 447 (consolidation of three cases involving
"dispositions of property by way of trust in which the settlement
provides for return or reversion of the corpus to the donor upon
a contingency terminable at his death").
On the other hand, it is not our role to police the
techniques of estate planning by determining, based on our own
policy views and perceptions, which transfers are abusive and
which are not. That is properly the role of Congress, whose
statutory enactments we are bound to interpret. As stated
supra, we think the statutory text better supports appellant's
argument.
Even looking at this case in policy terms, however, it is
difficult to fathom either the tax court's or the Commissioner's
concerns about the "abusiveness" of this transaction. A
hypothetical example will illustrate the point.
A fee simple interest is comprised of a life estate and a
remainder. Returning to the widow's election cases, assume that
the surviving spouse's share of the community property is valued
at $2,000,000. Assuming that she decides not to accept the
settlement and to keep that property, its whole value will be
available for inclusion in the gross estate at death, but only as
long as the widow lives entirely on the income from the property.
If she invades principal and sells some of the property in order
to meet living expenses or purchase luxury items, then at least
some of that value will not be included in the gross estate. Tax
law, of course (with the exception of the gift tax), imposes no
burdens on how a person spends her money during life.
Next, assume that same widow decides to sell her remainder
and keep a life estate. As long as she sells the remainder for
its fair market value, it makes no difference whether she
receives cash, other property, or an annuity. All can be
discounted to their respective present values and quantified. If
she continues to support herself from the income from her life
estate, the consideration she received in exchange for the
remainder, if properly invested, will still be available for
inclusion in the gross estate when she dies, as Frothingham and
Gregory require. On the other hand, if her life estate is
insufficient to meet her living expenses, the widow will have to
invade the consideration she received in exchange for her
remainder, but to no different an extent than she would under the
previous hypothetical in which she retained the fee simple
interest. In sum, there is simply no change in the date-of-death
value of the final estate, regardless of which option she
selects, at any given standard of living.
On the other hand, if the full, fee simple value of the
property at the time of death is pulled back into the gross
estate under § 2036(a), subject only to an offset for the
consideration received, then the post-sale appreciation of the
transferred asset will be taxed at death. Indeed, it will be
double-taxed, because, all things being equal, the consideration
she received will also have appreciated and will be subject to
tax on its increased value. In addition, it would appear
virtually impossible, under the tax court's reasoning, ever to
sell a remainder interest; if the adequacy of the consideration
must be measured against the fee simple value of the property at
the time of the transfer, the transferor will have to find an
arms-length buyer willing to pay a fee simple price for a future
interest. Unless a buyer is willing to speculate that the future
value of the asset will skyrocket, few if any such sales will
take place.
Another potential concern, expressed by the Gradow court, is
that, under appellant's theory, "[a] young person could sell a
remainder interest for a fraction of the property's [current, fee
simple] worth, enjoy the property for life, and then pass it
along without estate or gift tax consequences." 11 Cl. Ct. at
815. This reasoning is problematic, however, because it ignores
the time value of money. Assume that a decedent sells his son a
remainder interest in that much-debated and often-sold parcel of
land called Blackacre, which is worth $1 million in fee simple,
for its actuarial fair market value of $100,000 (an amount which
implicitly includes the market value of Blackacre's expected
appreciation). Decedent then invests the proceeds of the sale.
If the rates of return for both assets are equal and decedent
lives exactly as long as the actuarial tables predict, the
consideration that decedent received for his remainder will equal
the value of Blackacre on the date of his death. The equivalent
value will, accordingly, still be included in the gross estate.
Moreover, decedent's son will have only a $100,000 basis in
Blackacre, because that is all he paid for it. He will then be
subject to capital gains taxes on its appreciated value if he
decides to ever sell the property. Had Blackacre been passed by
decedent's will and included in the gross estate, the son would
have received a stepped-up basis at the time of his father's
death or the alternate valuation date. We therefore have great
difficulty understanding how this transaction could be abusive.
On this appeal, the Commissioner likewise argues for the
Gradow rule on the rationale that "the retained life interest is
in closely held stock whose dividend treatment is subject to the
control of decedent and her family. In such circumstances, the
amount of the dividend income that decedent was to receive from
her life income interest in the Vaparo preferred stock was
susceptible of manipulation[.]" Commissioner's Brief at 33.
There is no evidence, however, that the Vaparo dividends weremanipulated,
and the Commissioner directs us to no authority that
we should presume so. In addition, implicit in her argument is
the proposition that the life estate was overvalued by the
executor and the remainder correspondingly undervalued. Such a
position, however, is directly contrary to the Commissioner's own
stipulation regarding the values of those interests.
The Commissioner also asserts that the D'Ambrosio estate
plan is "calculated to deplete decedent's estate in the event
that she should not survive as long as her actuarially projected
life expectancy." Commissioner's Brief at 34-35. We note first
that the Commissioner does not argue that decedent transferred
her remainder in contemplation of imminent death under such
circumstances that the tables should not be applied. Leaving
aside the untimely death of Rose D'Ambrosio, any given transferor
of a remainder is equally likely to outlive the tables, in which
case she would collect more from her annuity, the gross estate
would be correspondingly larger and the Commissioner would
collect more tax revenue than if the remainder had never been
transferred.
3.
Several courts have followed the holding in Gradow, but none
of their opinions provides any cogent analysis that persuade us
it is sound. See Pittman v. United States, 878 F. Supp. 833, 835
(E.D.N.C. 1994) (applying Gradow without analysis); Wheeler v.
United States, No. SA-94-CA-964, 77 A.F.T.R.2d (RIA) 96-1405, 96-1411,
1996 WL 266420, *4-*5 (W.D. Tex. Jan. 26, 1996) (similar). Two
other courts have questioned the soundness of Gradow, but have
either applied it reluctantly or decided the case on other
grounds. See Parker v. United States, 894 F. Supp. 445, 447
(N.D. Ga. 1995); Estate of McLendon v. Commissioner, Nos. 20324-
90, 20325-90, T.C. Memo. 1993-459, 66 T.C.M. 946, T.C.M.
(P-H) ¶ 93,459, 1993 WL 391134, n.24 and accompanying text (Tax
Ct. Sept. 30, 1993), rev'd on other grounds, 77 A.F.T.R.2d (RIA) 666
(5th Cir. 1995).
The holdings of Gradow and the earlier cases such as Gregoryhave
inspired considerable legal commentary, most of it critical.
See Jacques T. Schlenger et al., Cases Addressing Sale of
Remainder Wrongly Decided, 22 Estate Planning 305 (1995)
(reproducing Professor Pennell's remarks criticizing Pittman as a
"mindless" decision); 2 A. James Casner, Estate Planning §
6.15.2, at 6-146-50, 6-158 (Supp. 1995) (Professor Casner,
criticizing Gradow court as lacking understanding of future
interests, economics and time value of money); Jacques T.
Schlenger et al., Property Included in Estate Despite Sale of
Remainder Interest, 23 Estate Planning 132 (1996) (criticizing
reasoning of tax court in D'Ambrosio); Richard B. Stephens et
al., Federal Estate and Gift Taxation ¶ 4.08[1], at 4-138 (6th
ed. 1991) (stating that payment of full consideration for
remainder interest alone is sufficient under § 2036, but noting
Gregory, Past and Gradow in a footnote); Peter M. Weinbaum, Are
Sales of Remainder Interests Still Available in Light of a New
Decision?, 14 Estate Planning 258 (1987) (criticizing Gradow for
quoting and analyzing § 2036(a) out of context and for ignoring
the value of the life estate in the wife's community property as
consideration received in the transfer). As discussed supra, we
find this criticism to be well-taken.
III.
Because we conclude that the tax court erred as a matter of
law when it determined that the consideration received by Rose
D'Ambrosio for her remainder interest was not adequate and full,
we will reverse and remand for it to enter judgment in favor of
the estate.
Estate of Rose D'Ambrosio v. Commissioner of Internal Revenue
No. 95-7643
COWEN, Circuit Judge, dissenting.
Today the majority holds that a tax-avoidance approach
previously considered "too good to be true" can, at least in
limited circumstances, actually be true. I respectfully dissent.
The tax court's opinion is supported by well-established case law
and the plain language of the Internal Revenue Code. It should
be affirmed.
I.
The value of a gross estate includes the value of all
property held by the decedent on the date of death. I.R.C. §
2033. Pursuant to section 2036(a), for federal estate tax
purposes the gross estate also includes any property that is the
subject of an inter vivos transfer and in which the taxpayer
reserves an income interest in that property until death. The
sole exception authorized by section 2036(a) is a "bona fide
sale" in which the transferor receives "adequate and full
consideration" in exchange for the transferred property. I.R.C.
§ 2036(a). The majority holds that under section 2036(a),
"adequate and full consideration" must be provided merely for
that portion of the taxpayer's property interest actually
transferred, rather than for the full value of the property that
is the basis for the ongoing income interest.
The majority excludes from the computation of "full and
adequate consideration" the value of decedent's life interest in
the transferred stock, on the grounds that D'Ambrosio retained
that interest. The intended purpose of section 2036 is to
prevent decedents from avoiding estate taxes by selling their
property to a third party but retaining the benefits of ownership
during their lives. It includes in a decedent's gross estate the
date-of-death value of
all property to the extent of any interest therein of
which the decedent has at any time made a transfer
(except in the case of a bona fide sale for an adequate
and full consideration in money or money's worth), by
trust or otherwise, under which he has retained for his
life . . . the possession or enjoyment of, or the right
to the income from, the property.
I.R.C. § 2036(a). When a taxpayer makes a transfer with a
retained life interest, the powerful arm of section 2036(a) pulls
into the gross estate the full value of the transferred property,
not merely the value of the remainder interest.
The majority accepts the view of the estate that the
decedent "sold" only the remainder interest to Vaparo. This view
of section 2036 sanctions tax evasion: It enables strategic
segmentation of the property into multiple interests, with
"adequate and full consideration" now required only for a
specific transferred segment, rather than the indivisible whole.
Such an interpretation of section 2036(a) thwarts its very
purpose, enabling taxpayers to avoid paying estate taxes on
property while retaining the income benefits of ownership. I
would affirm the tax court's holding that "adequate and full
consideration" assesses whether the consideration received is
equal to the value of the property that would have remained in
the estate but for the transfer, not whether it is commensurate
with the value of the artfully separated portion of the property
technically transferred.
II.
The well-reasoned case law construing section 2036(a)
supports the ruling of the tax court. That law correctly tests
the adequacy of the consideration received by a taxpayer against
the amount that otherwise would be included in that taxpayer's
gross estate. The majority distinguishes these cases by focusing
on irrelevant distinctions, and overlooks the commanding
principle that a taxpayer who fails to convey all interests in an
asset, continuing to derive some benefit from the asset until
death, must include the entire asset in the taxpayer's estate.
In Gradow v. United States, 11 Cl. Ct. 808 (1987),
aff'd, 897 F.2d 516 (Fed. Cir. 1990), the surviving spouse
transferred her full community property interest into a trust
that held all of the couple's community property. Thereafter,
the trust paid her all of the trust income during her life, and
distributed the entire corpus of the trust to her son upon her
death. Gradow's executor asserted that decedent's retained life
interest was received in exchange for adequate and full
consideration, so that none of the trust's assets were includable
in her gross estate. The court disagreed, holding that the
consideration paid by the decedent had to cover not only the
remainder interest that was left to her son in the trust, but
also her half of the underlying community property.
Other courts have acknowledged and followed this rule.
See United States v. Past, 347 F.2d 7 (9th Cir. 1965)
(consideration decedent received from trust had to be measured
against the total value of the property she contributed to the
trust, not only against the remainder interest in the property);
United States v. Allen, 293 F.2d 916 (10th Cir. 1961) (decedent
who received most of trust's income for life but before death
sold her remainder interest to her children had to include the
value of the trust assets corresponding to the percentage of the
trust's income that she received); Estate of Gregory v.
Commissioner, 39 T.C. 1012, 1016 (1963) (decedent who received a
life estate in exchange for transferring property to a trust
failed to qualify for exception because "[t]he statute excepts
only those bona fide sales where the consideration received was
of a comparable value which would be includable in the
transferor's gross estate").
The paramount purpose of section 2036(a) is to prevent
the depletion of estate assets when individuals retain the use
and enjoyment of those assets until death. In Commissioner v.
Estate of Church, 335 U.S. 632, 69 S. Ct. 322 (1949), the Supreme
Court emphatically noted that
an estate tax cannot be avoided by any trust transfer
except by a bona fide transfer in which the settlor,
absolutely, unequivocally, irrevocably, and without
possible reservations, parts with all of his title and
all of his possession and all of his enjoyment of the
transferred property.
Id. at 645. D'Ambrosio clearly fails this requirement that all
title, enjoyment, and possession of the transferred property be
unequivocally halted. Commenting on the forerunner to section
2036(a) more than a half century ago, the Supreme Court stated
that the law
taxes not merely those interests which are deemed to
pass at death according to refined technicalities of
the law of property. It also taxes inter vivostransfers that
are too much akin to testamentary
dispositions not to be subjected to the same excise.
Helvering v. Hallock, 309 U.S. 106, 112, 60 S. Ct. 444, 448
(1940).
These cases clearly demonstrate that the concept of
"adequate and full consideration," as used in sections 2035
through 2038, must be construed with reference to the special
problems posed by trying to prevent testamentary-type transfers
from evading estate tax. The bona fide sale analysis, which
exempts property from inclusion in the gross estate pursuant to
section 2036(a), cannot focus merely on the value of the limited
property interest that is sold. It must also consider the
property that would otherwise be included in the decedent's gross
estate.
III.
The estate asserts that the tax court erred because it
misunderstood or disregarded the "economic reality" of a sale of
a remainder interest. To the contrary, it was precisely the tax
court's awareness of the economic realities of a retained
interest transaction that led it to follow well-established law.
Executrix D'Ambrosio alleges that Gradow is inapposite and, in
any event, was erroneously decided. She states that
if the Decedent had retained and invested the dividends
from the Vaparo Stock and from the annuity payments
received during her life, the potential value of her
gross estate as a result of the sale would be worth no
less on the date of her death, than if she had never
sold the remainder interest in the Vaparo Stock or if
she had sold the entire interest in the Vaparo Stock
and invested the proceeds therefrom for the rest of her
life.
Appellant's brief at 11.
This view ignores the very reason for section 2036(a).
Its purpose is precisely to prevent taxpayers from retaining the
practical benefits of asset ownership during their lifetime while
divesting themselves for estate tax purposes of a portion of that
property. As the court in Gradow correctly explained:
[The "economic reality" argument] flies squarely in the
face of the Supreme Court's analysis as to the
assumptions and purposes behind 2036(a). [T]he Court
has taught that while tax limitation is perfectly
legitimate, § 2036(a) is a reflection of Congress'
judgment that transfers with retained life estates are
generally testamentary transactions and should be
treated as such for estate tax purposes. The fond hope
that a surviving spouse would take pains to invest,
compound, and preserve inviolate all life income from
half of a trust, knowing that it would thereupon be
taxed without his having received any lifetime benefit,
is a slim basis for putting a different construction on
§ 2036(a) than the one heretofore consistently adopted.
11 Cl. Ct. at 815-816.
Even if the annuity decedent received were not an
attempt to deplete her property for estate tax purposes, courts
have consistently held that section 2036(a) does not exempt
transfers of property in which the taxpayer retains an income
interest in his or her underlying assets. As the Tenth Circuit
concluded in Allen:
It does not seem plausible . . . that Congress intended
to allow such an easy avoidance of the taxable
incidence befalling reserved life estates. This result
would allow a taxpayer to reap the benefits of property
for his lifetime and, in contemplation of death, sell
only the interest entitling him to the income, thereby
removing all of the property which he has enjoyed from
his gross estate. . . . [I]n a situation like this,
Congress meant the estate to include the corpus of the
trust or, in its stead, an amount equal in value.
293 F.2d at 918 (citations omitted).
IV.
I would affirm the decision of the tax court. I
respectfully dissent.