Davis v. Cir ( 2005 )

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
RALPH H. DAVIS; EVELYN DAVIS, 
Personal Representative,
No. 03-72240
Petitioners-Appellants,
v.  IRS No.
210-02
COMMISSIONER OF INTERNAL
OPINION
REVENUE,
Respondent-Appellee.

Appeal from a Decision of the
United States Tax Court
Submitted December 10, 2004*
San Francisco, California
Filed January 24, 2005
Before: Jerome Farris, Dorothy W. Nelson, and
Ronald M. Gould, Circuit Judges.
Opinion by Judge Gould
*This panel unanimously finds this case suitable for decision without
oral argument. See Fed. R. App. P. 34(a)(2).
1047
1050 DAVIS v. CIR
COUNSEL
Richard S. Calone, Jason W. Harrel, Richard S. Calone, LLP,
Stockton, California, for the petitioner-appellant.
Eileen J. O’Connor, Assistant Attorney General, Jonathan S.
Cohen, Karen D. Utiger, Tax Division, Department of Justice,
for the respondent-appellee.
DAVIS v. CIR 1051
OPINION
GOULD, Circuit Judge:
Petitioner Evelyn L. Davis, the personal representative of
the estate of her late husband, Ralph H. Davis, appeals a Tax
Court decision upholding the determination of a deficiency in
the taxes paid on the Davis estate. Mrs. Davis claims that the
terms of an amended trust included in the Davis estate give
her an unrestricted right to all of the trust income for life, and
that her interest in the trust income qualifies for a marital
deduction pursuant to Internal Revenue Code section
2056(b)(7). We have jurisdiction pursuant to 26 U.S.C. sec-
tion 7482(a), and we affirm.
I
On February 24, 1993, decedent Ralph H. Davis executed
both a “Will” and a “Declaration of Trust.” The Will
bequeathed the residue of the decedent’s estate to his daugh-
ters, Carol Tawney Pencke and Mary Martha Bennett. The
Declaration of Trust stated that during Ralph H. Davis’s life-
time, “he shall be entitled to all of the net income . . . from
the trust estate, payable in convenient installments, and he
may withdraw such sums as he desires from principal at any
time or times.” The Declaration of Trust also named Pencke
and Bennett as successor beneficiaries following the death of
Ralph H. Davis. If either daughter predeceased Mr. Davis, her
interest would pass to her descendants, per stirpes.
The decedent then married Evelyn L. Davis, and on April
9, 1996 subsequently executed a “Codicil” and an “Amend-
ment to Declaration of Trust” (“Amendment”). The Amend-
ment stated in part:
2. Life Estate to Surviving Spouse of Trustor: After
the death of trustor survived by his spouse and dur-
ing the lifetime of his surviving spouse, the trustee
1052 DAVIS v. CIR
shall pay to or apply for the benefit of the surviving
spouse, in quarter annual or more frequent install-
ments, all of the net income from the trust estate as
the trustee, in the trustee’s reasonable discretion,
shall determine to be proper for the health, educa-
tion, or support, maintenance, comfort and welfare
of grantor’s surviving spouse in accordance with the
surviving spouse’s accustomed manner of living.
3. Designation of Successor Trustees: The first
successor trustee of the Ralph H. Davis Trust shall
be his spouse, Evelyn L. Davis. In the event Evelyn
L. Davis shall die, become incapacitated or other-
wise be unable to administer the trust estate, then
grantor’s daughters, Carol Tawney Pencke and Mary
Martha Bennett, or the survivor of them shall serve
as co-trustees without bond.
4. Guideline — Other Sources: Beneficiary: In
making distributions to grantor’s surviving spouse,
the trustee, in her reasonable discretion, may con-
sider any other income or resources of the benefi-
ciary known to the trustee and reasonably available.
5. Invasion of Principal for Surviving Spouse —
Narrow Standard: If the trustee shall determine that
the income from this trust and that the income and
principal from the surviving spouse’s own trust shall
be insufficient to maintain surviving spouse’s health,
support and maintenance, the trustee may, after sur-
viving spouse has exhausted all assets of her own
trust, invade the principal of this trust for the benefit
of surviving spouse, in the trustee’s reasonable dis-
cretion.
Ralph H. Davis died on July 14, 1997, leaving a gross
estate of $1,180,823.00. Mrs. Davis, as the personal represen-
tative of the Davis estate, claimed a marital deduction in the
DAVIS v. CIR 1053
amount of $573,216.00 under Internal Revenue Code sections
2056(a), 2056(b)(5) and 2056(b)(7).
The Commissioner reduced the marital deduction by
$564,862.00, allowing the estate to deduct only $8,354.00 in
life insurance proceeds that passed directly to the surviving
spouse and disallowing the deduction for the funds passing in
the amended trust. The Commissioner issued a notice of defi-
ciency in the amount of $220,593.00. The estate appealed the
determination of deficiency to the Tax Court, which held for
the Commissioner. On this appeal, Mrs. Davis has abandoned
her claim for a deduction under section 2056(b)(5), but con-
tinues to claim that the terms of the Amendment qualify for
a marital deduction under section 2056(b)(7).
II
[1] Under the Internal Revenue Code, the taxable estate of
a decedent is computed by taking the gross estate defined in
section 2031 and subtracting the deductions listed in sections
2053, 2054, 2055 and 2056. I.R.C. § 2051. Section 2056
describes the marital deduction.1 Although property passing
from a decedent to a surviving spouse generally qualifies for
a marital deduction from the federal estate tax, I.R.C.
§ 2056(a), life estates and other terminable interests passing
to a surviving spouse are not deductible unless they qualify
for an exception under section 2056(b)(5) or section
2056(b)(7). I.R.C. § 2056(b)(1).2
1
The purpose of allowing a marital deduction is to treat a husband and
wife as a single unit for computing estate taxation. Any assets not taxed
in a decedent’s estate are taxable in the surviving spouse’s estate under
section 2044.
2
The marital deduction is “to be strictly construed and applied.”
Comm’r v. Estate of Bosch, 387 U.S. 456, 464 (1967); see also Estate of
Shedd v. Comm’r, 237 F.2d 345, 357 (9th Cir. 1956) (“[S]tatutory exemp-
tions from taxes of this kind should be strictly construed against the tax-
payer, and are held applicable only to subject matter or beneficiaries
clearly within their terms.”). The taxpayer bears the burden of showing
that he or she meets every condition of a tax exemption or deduction. Dep-
uty v. du Pont, 308 U.S. 488, 493 (1940); White v. United States, 305 U.S.
281, 292 (1938).
1054 DAVIS v. CIR
[2] To qualify for a marital deduction under section
2056(b)(7), a marital trust must consist of property “(I) which
passes from the decedent, (II) in which the surviving spouse
has a qualifying income interest for life, and (III) to which an
election under [section 2056(b)(7)] applies.” I.R.C.
§ 2056(b)(7)(B)(i). A deduction under section 2056(b)(7) is
also known as a Qualified Terminable Interest Property, or
QTIP, deduction. A surviving spouse has a “qualifying
income interest for life” if he or she is “entitled to all the
income from the property, payable annually or at more fre-
quent intervals, or has a usufruct interest for life in the proper-
ty,” and “no person has a power to appoint any part of the
property to any person other than the surviving spouse.”
I.R.C. § 2056(b)(7)(B)(ii).
The Treasury Regulations elaborate on the requisite degree
of control required to claim a QTIP deduction: A surviving
spouse is “entitled for life to all of the income” if he or she
is “unqualifiedly designated as the life beneficiary of a trust.”
Treas. Reg. § 20.2056(b)-5(f)(1).3 He or she “must have such
command over the income that it is virtually hers.”4 Treas.
Reg. § 20.2056(b)-5(f)(8). To meet these standards, a surviv-
ing spouse must show that he or she “(i) is entitled to the
income until the trust terminates, or (ii) has the right, exercis-
able in all events, to have the corpus distributed to her at any
time during her life.” Treas. Reg. § 20.2056(b)-5(f)(6). A trust
does not qualify for a QTIP deduction “to the extent that the
income is required to be accumulated in whole or in part or
may be accumulated in the discretion of any person other than
the surviving spouse . . .” Treas. Reg. § 20.2056(b)-5(f)(7).
3
Treasury regulations are the authoritative interpretation of the Internal
Revenue Code so long as they are reasonable. Cottage Sav. Ass’n v.
Comm’r, 499 U.S. 554, 560-61 (1991); Sessler v. United States, 7 F.3d
1449, 1451 n.2 (9th Cir. 1993).
4
The principles of Treas. Reg. § 20.2056(b)-5(f) apply to determine the
definition of the phrase “entitled for life to all of the income.” Treas. Reg.
§ 20.2056(b)-7(d)(2).
DAVIS v. CIR 1055
In Estate of Ellingson v. Commissioner, we considered a
“Marital Deduction Trust” that named the surviving spouse as
a co-trustee and provided that “if the income so payable to the
Surviving Settlor shall, at any time or times, exceed the
amount which the Trustee deems to be necessary for his or
her needs, best interests and welfare, the Trustee may accu-
mulate the same, as the Trustee deems advisable.” 964 F.2d
959, 960 (9th Cir. 1992). We concluded that, under the cir-
cumstances in that case, the “best interests and welfare” lan-
guage was sufficiently broad to entitle the surviving spouse
“to all the income from the property” for life under section
2056(b)(7)(B)(ii)(I). Id. at 964-65. In dicta, we noted that
other language, such as “necessary or proper to provide for
. . . care, comfortable maintenance, and support and reason-
able comfort” and “usual and customary standard of living”
would not fall within the terms of section 2056(b)(7) because
“reformation of the interest-creating instrument would [be]
required to grant the QTIP deduction.” Id.; see also Estate of
Rapp v. Comm’r, 140 F.3d 1211, 1213, 1218 (9th Cir. 1998)
(holding insufficient for QTIP purposes a trust that gave sur-
viving children discretion to distribute income to provide for
the surviving spouse’s “health, education and support”);
Wisely v. United States, 893 F.2d 660 (4th Cir. 1990); Estate
of Nicholson v. Comm’r, 94 T.C. 666, 668-74 (1990).
[3] When a decedent chooses to limit the degree of control
that his or her surviving spouse has over the income from a
terminable interest property, the decedent also precludes the
possibility that his or her estate may claim a QTIP deduction
under section 2056(b)(7). A section 2056(b)(7) marital deduc-
tion is available only when a decedent leaves a surviving
spouse complete control over the income from a property for
life.5 Conversely, if a surviving spouse’s interest in the prop-
erty income is limited and thus cannot be equated with virtual
5
A surviving spouse may take a marital deduction for a specific portion
of a property if the income from that portion is entirely under the spouse’s
control. I.R.C. § 2056(b)(7)(B)(iv).
1056 DAVIS v. CIR
ownership, an estate may not claim a marital deduction under
section 2056(b)(7).6
III
We next consider whether the interest granted to Evelyn L.
Davis under the Declaration of Trust and the Amendment
qualifies for a marital deduction under section 2056(b)(7).
In determining whether an interest that passes in trust to a
surviving spouse qualifies for a QTIP deduction under section
2056(b)(7), we first look to state law to determine the nature
and extent of the property interest granted to the surviving
spouse, and then turn to federal law to determine whether
these property rights are ultimately subject to taxation. United
States v. Craft, 535 U.S. 274, 278 (2002) (quoting Drye v.
United States, 528 U.S. 49, 58 (1999)); Estate of Heim v.
Comm’r, 914 F.2d 1322, 1327 (9th Cir. 1990).7
A
[4] We first examine how California law views the property
interest that Ralph H. Davis bequeathed to Evelyn L. Davis
under the amended trust. Under California law, a trust must
be construed “according to the intention of the testator as
expressed therein, and this intention must be given effect as
far as possible.” Newman v. Wells Fargo Bank, N.A., 926 P.2d
6
The surviving spouse’s complete control of trust income sufficient to
qualify for the marital deduction under section 2056(b)(7) is not defeated
by allowances for trust administration specifically enumerated in the stat-
ute and regulations. See, e.g., Estate of Howard v. Comm’r, 910 F.2d 633,
635-37 (9th Cir. 1990).
7
We review Tax Court decisions in the same manner as we review civil
decisions of district courts rendered after a bench trial. Rapp, 140 F.3d at
1214-15; Heim, 914 F.2d at 1325 (quoting I.R.C. § 7482(a)(1)). The par-
ties have stipulated to all the relevant facts. The only remaining issues are
matters of statutory and testamentary interpretation that we review de
novo. Ellingson, 964 F.2d at 960.
DAVIS v. CIR 1057
969, 973 (Cal. 1996) (quoting Estate of Wilson, 193 P. 581,
582 (1920)). A court must ascertain the intention of the testa-
tor by reading the trust instrument as a cohesive whole. Ike v.
Doolittle, 70 Cal. Rptr. 2d 887, 900-01 (Ct. App. 1998). If the
intention of the testator is unambiguous from the face of the
instrument, the rules of statutory construction do not apply,
and the plain language of the trust governs its interpretation.
Burkett v. Capovilla, 5 Cal. Rptr. 3d 817, 819-20 (Ct. App.
2003).
[5] When read as a whole, the Declaration of Trust and the
Amendment unambiguously indicate that Ralph H. Davis
intended to leave to his surviving spouse an interest in the
trust income that is explicitly restricted by the purposes listed
in the trust. The phrase “all of the net income from the trust
estate” is limited by the language that follows it and does not
give Mrs. Davis an unrestricted interest in any more income
than is “proper for [her] health, education, or support, mainte-
nance, comfort and welfare . . . in accordance with [her]
accustomed manner of living.” Any other construction would
render the limiting language superfluous. It would also create
a tension with other terms in the trust documents: In contrast
to the narrow interest he granted to Mrs. Davis in the Amend-
ment, in the original Declaration of Trust, Ralph H. Davis
gave himself an unrestricted right to “all of the net income”
from the trust estate without any limiting terms. This differ-
ence in language indicates that Mr. Davis intended to
bequeath his wife a more limited interest than he had during
his own life. See Ellingson, 964 F.2d at 964.
[6] The Davis estate argues that California Probate Code
section 21522, which governs “marital deduction gifts,” oper-
ates to reform the terms of the Amendment.8 We disagree.
8
California Probate Code section 21522 states:
If an instrument contains a marital deduction gift:
(a) The provisions of the instrument, including any power,
duty, or discretionary authority given to a fiduciary, shall be con-
1058 DAVIS v. CIR
Under section 21522, “a ‘marital deduction gift’ is ‘a gift that
is intended to qualify for the marital deduction.’ ” Heim, 914
F.2d at 1329 (citing former Cal. Prob. Code § 1030(d),
renumbered as Cal. Prob. Code § 21520 (1991)). Under Cali-
fornia law, we look to the instruments that created the trust to
determine whether the decedent intended a gift to his or her
surviving spouse to qualify for a marital deduction under sec-
tion 2056(b)(7). Newman, 926 P.2d at 973.
[7] Here, neither the Declaration of Trust nor the Amend-
ment contains any language suggesting that Mr. Davis
intended the interest passing to his surviving spouse in trust
to qualify for a marital deduction under section 2056(b)(7),
and the estate has not presented any other evidence from
which we might infer such an intent. The Davis estate argues
that the language “pay to or apply for the benefit of the sur-
viving spouse, in quarter annual or more frequent install-
ments, all of the net income from the trust estate” in the
Amendment is sufficiently similar to the language “entitled to
all the income from the property, payable annually or at more
frequent intervals” in Code section 2056(b)(7)(B)(ii)(I) to
infer that Ralph H. Davis intended, but failed, to mirror the
requirements of 2056(b)(7). We do not agree that an intent to
qualify for a marital deduction can be attributed to Ralph H.
Davis on the basis of this slight similarity in language.
Although a showing that a settlor quoted at length from sec-
tion 2056(b)(7) might be evidence that he or she intended the
trust to fall within the terms of that provision, here Ralph H.
Davis employed commonly used terms, and the language he
chose only vaguely resembles that of section 2056(b)(7).
strued to comply with the marital deduction provisions of the
Internal Revenue Code.
(b) The fiduciary shall not take any action or have any power
that impairs the deduction as applied to the marital deduction gift.
(c) The marital deduction gift may be satisfied only with property
that qualifies for the marital deduction.
DAVIS v. CIR 1059
California Probate Code section 21522 does not operate to
reform a trust instrument simply because some decedents may
desire to reduce or avoid estate taxes. Heim, 914 F.2d at 1330.
A rational person in the position of Ralph H. Davis might
have wished that his estate be taxed at his death, as it would
have been under the original Declaration of Trust, with the
aim that Mrs. Davis would have only a limited interest in the
trust income and that the remainder would pass to his daugh-
ters.
[8] Because Ralph H. Davis did not leave his wife “a gift
. . . intended to qualify for the marital deduction,” section
21522 of the California Probate Code does not apply to
reform the terms of the Amendment. See id. at 1329. Thus we
determine that Mrs. Davis’s interest is limited under Califor-
nia law, and the Declaration of Trust and the Amendment do
not give her an unqualified right to all of the income from the
trust for life.
B
We next consider the federal issue whether the property
interest bequeathed by Ralph H. Davis to Evelyn L. Davis
under California law qualifies for a marital deduction under
Internal Revenue Code section 2056(b)(7).
[9] Under the terms of the Amendment, Mrs. Davis is nei-
ther “entitled to the income until the trust terminates,” nor in
possession of “the right, exercisable in all events, to have the
corpus distributed to her at any time during her life.” See
Treas. Reg. § 20.2056(b)-5(f)(6). The Amendment provides
that Mrs. Davis may collect such income as the trustee, “in
the trustee’s reasonable discretion, shall determine to be
proper for the health, education, or support, maintenance,
comfort and welfare of grantor’s surviving spouse in accor-
dance with the surviving spouse’s accustomed manner of liv-
ing.” This restrictive language precludes Mrs. Davis from
1060 DAVIS v. CIR
having “such command over the income that it is virtually
hers.” See Treas. Reg. § 20.2056(b)-5(f)(8).
The Davis estate argues that the trust qualifies for a QTIP
deduction under section 2056(b)(7) because the terms of the
Amendment allegedly create a “general power of appoint-
ment” under section 2041. We reject this argument. Sections
2041 and 2056 are distinct provisions of the Internal Revenue
Code. These sections do not cross-reference each other, and
the requirements under section 2056 are different than those
under section 2041. Consequently, a surviving spouse might
have a general power of appointment under section 2041, but
not have the requisite control over the income to qualify for
a deduction under section 2056. See BORIS I. BITTKER AND
LAWRENCE LOKKEN, FEDERAL TAXATION OF INCOME, ESTATES
AND GIFTS § 129.4.3 (2d ed. 1993 & Supp. 2004). Even if sec-
tion 2041 did apply to determining whether an interest quali-
fied as a QTIP, the Amendment does not give Mrs. Davis the
requisite “general power of appointment” because her powers
are limited by an “ascertainable standard.” See Treas. Reg.
§ 20.2041-1(c)(2).
Although Mrs. Davis is the sole trustee, this does not save
the otherwise defective trust for two reasons. First, even when
acting as trustee, Mrs. Davis can properly only make such dis-
tributions to herself as are permitted by the Amendment,
hemmed in by the requirement that income given her be
“proper for the health, education, or support, maintenance,
comfort and welfare of grantor’s surviving spouse in accor-
dance with the surviving spouse’s accustomed manner of liv-
ing.” Second, Mrs. Davis “might not remain co-trustee until
she dies.” See Ellingson, 964 F.2d at 962. The possibility —
however remote — that the surviving spouse might resign or
become incapacitated prevents a provision naming the surviv-
ing spouse as trustee from automatically qualifying an other-
wise deficient trust for the marital deduction under section
2056(b)(7). Id. Under the terms of the Amendment, in the
event that Mrs. Davis were to “become incapacitated or other-
wise be unable to administer the trust estate” she would no
DAVIS v. CIR 1061
longer serve as trustee. Trust income could then accumulate
“in the discretion of” either one or both of successor trustees
Pencke and Bennett, both “person[s] other than the surviving
spouse . . . ,” precluding a deduction under section
2056(b)(7). See Treas. Reg. § 20.2056(b)-5(f)(7); see also
Ellingson, 964 F.2d at 962.
The argument that the Amendment should be reformed to
meet the terms of section 2056(b)(7) because Ralph H. Davis
allegedly intended the amended trust to qualify for a QTIP
deduction is likewise unavailing. As we discussed in section
II.B., neither the Declaration of Trust nor the Amendment
contains any indication that Ralph H. Davis intended the trust
to qualify for a QTIP deduction. Even if Davis had clearly
expressed that he intended the trust to qualify for a section
2056(b)(7) deduction, this intent would not reform an other-
wise facially defective trust so that it complied with QTIP
requirements. See Shedd, 237 F.2d at 346 (“A court must
interpret a will according to the language that the testator
actually used — not according to what the court might guess
that the decedent might have said if he had chosen the right
words.”).
[10] Ralph H. Davis did not bequeath to Evelyn L. Davis
an interest sufficient to qualify for a marital deduction under
section 2056(b)(7). Under California law, the unambiguous
terms of the Declaration of Trust and the Amendment give
Mrs. Davis an interest limited to the amount of income proper
for her “health, education, or support, maintenance, comfort
and welfare” in accordance with her “accustomed manner of
living.” This limitation is inconsistent with a conclusion that
Mrs. Davis had virtual ownership of the income from the
trust’s assets. Because this limitation prevents Mrs. Davis
from having complete control over the trust income, the Davis
estate may not claim a marital deduction under section
2056(b)(7) for the interest passing in trust, and the Tax Court
correctly upheld the determination of a deficiency in the taxes
paid on the Davis estate.
AFFIRMED.