Estate of D'Ambrosio v. Commissioner, 101 F.3d 309 (3d Cir. 1996)
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UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT
ESTATE OF ROSE D'AMBROSIO, Deceased, VITA D'AMBROSIO, Executrix, Appellant
v.
COMMISSIONER OF INTERNAL REVENUE SERVICE
101 F.3d 309
No. 95-7643
ON APPEAL FROM THE UNITED STATES TAX COURT
(Tax Court Docket No. 94-06724)
DATES: Argued June 4, 1996
Opinion Filed: November 26, 1996
JUDGES: Before: COWEN, NYGAARD and LEWIS, Circuit Judges.
COUNSEL: 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.
at 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 were manipulated, 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 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. (CCH) 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 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.
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.
.
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