REVISED May 21, 1997
UNITED STATES COURT OF APPEALS For the Fifth Circuit
No. 95-60541
ESTATE OF ALTO B. CERVIN, Deceased, Bennett W. Cervin, Executor, & Nita-Carol Cervin Miskovitch, Executor,
Petitioner-Appellant,
VERSUS
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.
Appeal from the United States Tax Court
May 9, 1997
Before POLITZ, Chief Judge, and SMITH and DUHÉ, Circuit Judges.
DUHÉ, Circuit Judge:
The Estate of Alto B. Cervin petitioned the United States Tax
Court for a redetermination of a federal estate tax deficiency
asserted against it by the Internal Revenue Service. The alleged
deficiency was based upon a determination by the Commissioner that
(1) the decedent’s gross estate should include one hundred percent
of the proceeds of three whole life insurance policies, and (2) the estate was not entitled to a twenty-five percent discount with
respect to the valuation of certain real property. The Tax Court
held that (1) the gross estate includes one hundred percent of the
proceeds of the life insurance policies, and (2) the estate was
entitled to a twenty percent discount with respect to the valuation
of the real property. The estate unsuccessfully moved for
litigation costs. It now appeals, asserting that only fifty
percent of the proceeds of the life insurance policies should be
included in the gross estate and that it is entitled to litigation
costs pursuant to section 7430 of the Internal Revenue Code.
We hold that the decedent’s gross estate includes only fifty
percent of the proceeds of the three life insurance policies, and
that the estate is entitled to reasonable litigation costs. Thus
we reverse the Tax Court’s decision and remand to the Tax Court for
a determination of such costs.
BACKGROUND
Alto B. Cervin (“decedent”) and Manita Cervin were husband and
wife, and both were domiciled in Texas. The couple had two
children, Bennett W. Cervin and Nita-Carol Cervin Miskovitch, who
are the co-executors of the Estate of Alto B. Cervin.
Alto and Manita Cervin purchased three whole life insurance
policies from Mutual Life Insurance Company of New York on the life
of Alto Cervin. Manita Cervin and the couple’s two children were
the beneficiaries. The policies were purchased with community
funds, and the premiums were paid, while the decedent and Manita
Cervin were alive, with community funds.
2 Manita Cervin died intestate in 1978, and one-half of the cash
surrender value of the insurance policies was included in her
estate. Her one-half interest in the policies passed under Texas
intestacy law to the couple’s two children. The children, however,
after consultation with their father, did not exercise their right
to receive one-half of the cash surrender value of the policies,
and the insurance policies remained in effect. For reasons of
convenience, the three agreed that Alto Cervin would continue to
pay the premiums and deal with any other administrative matters
regarding the policies.
Alto Cervin died in 1988, and his estate included one-half of
the proceeds of the life insurance policies ($65,462.88). The
estate also included accounts receivable in the amount of
$35,268.16 from the children, as reimbursement for the insurance
premiums paid by decedent on their behalf from the time of his
wife’s death to his own death.
At the time of his death, Alto Cervin owned a fifty percent
undivided community interest in four parcels of real estate, and
his children owned equal shares of the other fifty percent
interest. The overall fair market value of each of the properties
is undisputed,1 but instead of valuing its share of the properties
at fifty percent of the total fair market value, the estate
1 The four pieces of real property, with their undisputed overall fair market valuation, are as follows: (1) 657-acre farm in Ellis and Johnson Counties, TX: $650,000; (2) homestead at 4343 W. Lawther Dr., Dallas, TX: $625,000; (3) 6318 Vickery Blvd., Dallas, TX: $27,000; and (4) 1633 E. Main St., Grand Prairie, TX: $60,000.
3 discounted the value of its ownership interest by twenty-five
percent. It reasoned that an undivided fractional interest in real
property may be valued at an amount less than the fractional share
of the value of the entire property because of the difficulty in
selling only a proportionate interest in an undivided piece of real
estate. The estate’s valuation of its ownership in the properties,
less the twenty-five percent discount, thus totaled $510,750
(681,000 - 170,250), the figure that was included on Alto Cervin’s
estate tax return, filed on March 5, 1990.
Upon audit, the Commissioner determined that all of the
proceeds of the insurance policies ($130,925.76) were includible in
Alto Cervin’s gross estate, and that the estate was not entitled to
exclude the receivables from Bennett and Nita-Carol. In addition,
the Commissioner determined that the estate was not entitled to the
twenty-five percent discount on any of the properties.2 The estate
petitioned the Tax Court for a redetermination.
The Tax Court held that (1) the decedent’s gross estate
includes one hundred percent of the insurance proceeds, but that
the estate could exclude the receivables owed by Bennett and Nita-
Carol, and (2) the estate was entitled to a twenty percent discount
in valuing the two pieces of property at issue. The estate then
sought an award of litigation costs pursuant to section 7430 of the
Internal Revenue Code, and moved for reconsideration of the
insurance proceeds issue in light of our decision in Estate of
2 At trial, the Commissioner accepted the estate’s valuation of the two lesser-valued properties.
4 Cavenaugh v. Commissioner, 51 F.3d 597 (5th Cir. 1995). The Tax
Court denied both motions. The Cervin estate now appeals, arguing
that only one-half of the insurance proceeds is includible in the
gross estate and that it is entitled to reasonable litigation
costs.
STANDARDS OF REVIEW
We review the Tax Court’s findings of fact for clear error and
its legal conclusions de novo. Park v. Commissioner, 25 F.3d 1289,
1291 (5th Cir.), cert. denied, 115 S. Ct. 673 (1994); Harris v.
Commissioner, 16 F.3d 75, 81 (5th Cir. 1994). The Tax Court’s
holding that all of the proceeds of the life insurance policies are
includible in the decedent’s gross estate is based upon an
interpretation of Texas law, and is subject to de novo review. We
review the denial of a request for litigation costs for abuse of
discretion. Nalle v. Commissioner, 55 F.3d 189, 191 (5th Cir.
1995).
DISCUSSION
I. THE LIFE INSURANCE PROCEEDS
The Internal Revenue Code (the “Code”) imposes a tax on a
decedent’s taxable estate, 26 U.S.C. § 2001, which is defined as
the gross estate less allowable deductions. 26 U.S.C. § 2051. If,
as here, a policy on a decedent’s life names beneficiaries other
than the decedent’s estate, section 2042(2) of the Code mandates
that the decedent’s gross estate include the proceeds of life
insurance policies with respect to which the decedent possessed
“incidents of ownership” at his death. 26 U.S.C. § 2042(2). Thus,
5 we must determine to what extent Alto Cervin possessed incidents of
ownership in the three life insurance policies at his death. To
resolve this question, state law must be considered. See Treas.
Reg. § 20.2042-1(c)(5); Broday v. United States, 455 F.2d 1097,
1099 (5th Cir. 1972).
As an initial matter, it is necessary to define some terms at
issue in this case. The Treasury Regulations define “incidents of
ownership” as:
the right of the insured or his estate to the economic benefits of the policy. Thus, it includes the power to change the beneficiary, to surrender or cancel the policy, to assign the policy, to revoke an assignment, to pledge the policy for a loan, or to obtain from the insurer a loan against the surrender value of the policy, etc.
Treas. Reg. § 20.2042-1(c)(2). This definition is nearly identical
to what this Court has referred to as “policy rights” under Texas
law. See Commissioner v. Chase Manhattan Bank, 259 F.2d 231, 245-
46 (5th Cir. 1958). Policy rights refer to the “whole bundle of
incidents of ownership of property in a policy.” Id. at 245.
Policy rights or incidents of ownership, however, must be
distinguished from the “proceeds rights,” which are rights to
receive the proceeds of the insurance policy at maturity. In fact,
policy rights include the entire bundle of ownership “except the
right to the proceeds.” Id.
Although policy rights and proceeds rights are distinct under
Texas law, if “life insurance is purchased during a marriage and
paid for with community funds, the ‘policy rights’ or incidents of
ownership and the ‘proceeds rights’ or the rights to receive the
proceeds in the future constitute community property.” Estate of
6 Cavenaugh v. Commissioner of Internal Revenue, 51 F.3d 597, 602
(5th Cir. 1995) (quoting Freedman v. United States, 382 F.2d 742,
745 (5th Cir. 1967) (citing Brown v. Lee, 371 S.W.2d 694 (Tex.
1963))). The parties do not dispute that the life insurance
policies at issue were purchased during the Cervin marriage with
community funds, and thus they agree that Manita Cervin owned an
undivided one-half interest in both the policy rights and the
proceeds rights at her death.
Further, at the time of Manita Cervin’s death, Texas law
provided that upon dissolution of the marriage by death, the
surviving spouse is entitled to one-half of the community property,
and the children are entitled to the other half of the community
property. Tex. Prob. Code § 45 (West 1980).3 Therefore, upon
Manita Cervin’s death, one-half of the incidents of ownership in
the policies and one-half of the right to the future proceeds
passed to Alto Cervin, and the other one-half of the policy rights
and one-half of the proceeds rights descended to the children.
The parties are in full agreement as to the above analysis.
It is at the next step in the analysis, however, that the
disagreement begins. The Cervin estate argues that because one-
half of the incidents of ownership in the policies passed to the
children, upon Alto Cervin’s death he also possessed only one-half
of the incidents of ownership in the insurance policies. Because
3 In 1991, the Texas Legislature amended Tex. Prob. Code § 45, and that section now requires that all community property of a spouse who dies intestate pass to the surviving spouse when all surviving children are also children of the surviving spouse. Tex. Prob. Code § 45 (West Supp. 1997).
7 incidents of ownership determine the percentage of proceeds to be
included in the gross estate, see 26 U.S.C. § 2042(2), and because
Alto Cervin possessed one-half of the incidents of ownership, the
estate asserts that only one-half of the proceeds should be
included in the gross estate.
The Commissioner contends that the Cervin estate’s analysis is
incomplete because it does not consider whether Manita Cervin’s
community property interest in the insurance policies was settled
prior to Alto Cervin’s death. Based upon the Texas Supreme Court
case of Brown v. Lee, 371 S.W.2d 694 (Tex. 1963), the Commissioner
argues that Manita Cervin’s interest in the policies was settled
when one-half of the cash surrender value of the policies was
allocated to her estate and reported on her federal estate tax
return. Because Manita Cervin’s interest was settled prior to Alto
Cervin’s death, the Commissioner maintains that Alto Cervin died
possessing one hundred percent of the incidents of ownership in the
insurance policies, and that section 2042(2) of the Code thus
requires the inclusion of all of the proceeds in his gross estate.
Although we agree with the Commissioner that settlement of a
predeceased, uninsured spouse’s community interest in a life
insurance policy on the life of the other spouse may extinguish the
uninsured spouse’s remaining interest in the policies, we believe
that Manita Cervin’s interest in the policies was never settled.
Thus we hold in favor of the estate.
The Commissioner’s argument that Manita Cervin’s interest in
the policies was settled prior to Alto Cervin’s death is based upon
8 the following passage from Brown v. Lee:
Under circumstances where the uninsured spouse predeceases the insured spouse, settlement of the decedent’s community interest in the unmatured chose [i.e., the proceeds rights] has ordinarily been resolved by allocating one-half of the cash surrender value to the deceased’s estate and the other one-half, plus ownership of the unmatured chose, to the surviving spouse. Thompson v. Calvert, 301 S.W.2d 496 (Tex. Civ. App. 1957, no writ). But in the present case, where settlement of the deceased wife’s community interest in the policies was not made prior to the death of the insured and her heirs were not guilty of laches in failing to seek such compensation, the wife’s community interest was never extinguished and the policies retained their community status up to the time of maturity. Consequently the proceeds are community.
371 S.W.2d at 696. Simply put, the above passage sets forth two
rules for determining the proceeds rights (the rights to the
“unmatured chose”) of an uninsured spouse who predeceases the
insured spouse. The first rule holds that when the uninsured
spouse’s community interest in the policies is settled, the
uninsured spouse does not retain any right to the proceeds. The
second rule holds that when such interest is not settled, the
uninsured spouse maintains a community interest in the proceeds.
Based on no legal authority except the foregoing passage, the
Commissioner asserts that Manita Cervin’s interest in the life
insurance policies was settled when one-half of the cash surrender
value of the policies was allocated to her estate and included on
her federal estate tax return. Thus, the Commissioner concludes
that the first rule of the quoted passage mandates that full
ownership of the proceeds rights be allocated to Alto Cervin (the
then-surviving spouse), and that all of the proceeds must therefore
be included in his gross estate pursuant to section 2042(2).
9 The Commissioner’s theory is based upon the conclusion that
reporting one’s ownership interest in a life insurance policy on a
federal estate tax return can settle one’s interest in such policy
under state community property law. Neither the Commissioner nor
the Tax Court provides any authority for this novel proposition.
We fail to see how Manita Cervin’s estate, by adhering to federal
estate tax law and including her one-half interest in the cash
surrender value of the policies in her gross estate, has somehow
settled her interest in the policies under the laws of the State of
Texas.
The Commissioner’s position is not only completely without
support, it is also inconsistent with Brown v. Lee itself and would
nullify the then-recent changes in the definition of “property”
that the Brown v. Lee court was analyzing. To see why this is so,
it is necessary to consider the 1957 amendments to Texas law and
Brown v. Lee’s interpretation of those changes.
Before 1957, the legal theory of title to insurance proceeds
in Texas was somewhat unclear. In Warthan v. Haynes, 288 S.W.2d
481, 482-84 (Tex. 1956), the Texas Supreme Court held that a wife
had no community property interest in the proceeds of a life
insurance policy on the life of her husband, even when the policy
was bought during marriage and paid for with community funds. This
holding did not last long, however, because in 1957, the Texas
legislature enlarged the definition of property to include “life
insurance policies and the effects thereof.” Tex. Rev. Civ. Stat.
art. 23(1) (West 1969) (current version at Tex. Gov’t Code Ann. §
10 312.011(13) (West 1988)). The Texas Supreme Court in Brown v. Lee
considered the 1957 amendments at length and noted that “the right
to receive insurance proceeds payable at a future but uncertain
date is ‘property.’” 371 S.W.2d at 696. It referred to such
insurance proceeds as “a chose in action which matures at the death
of the insured,” and held that “[w]hen purchased with community
funds, the ownership of the unmatured chose logically belongs to
the community.” Id.
Immediately after examining the 1957 legislative changes, the
Brown v. Lee court--in the paragraph quoted in full above--
discussed the effect that settlement of an uninsured spouse’s
interest in a life insurance policy would have on her interest in
the unmatured chose. It is worth quoting the first sentence of the
paragraph again for emphasis:
Under circumstances where the uninsured spouse predeceases the insured spouse, settlement of the decedent’s community interest in the unmatured chose [i.e., the proceeds rights] has ordinarily been resolved by allocating one-half of the cash surrender value to the deceased’s estate and the other one-half, plus ownership of the unmatured chose, to the surviving spouse.
Id. The Commissioner asserts that this sentence sets forth the
rule that settlement of an uninsured spouse’s interest in the
proceeds of a life insurance policy occurs when one-half of the
cash surrender value of the policy is included on the federal
estate tax return of the uninsured spouse.
We are unable to discern where the Commissioner finds
justification for her proposition. Support is certainly not found
in the text of the quoted sentence itself, for nowhere does it
11 mention that settlement under Texas law is accomplished by
including one-half of the cash surrender value on a federal estate
tax return. Furthermore, the Commissioner’s proposed rule of law
would abrogate the 1957 enlargement of the definition of property
that the Texas legislature had promulgated shortly before Brown v.
Lee was decided. The Brown v. Lee court recognized that the Texas
legislature defined property to include the right to receive
insurance proceeds payable at a later date. We do not think that
the Texas Supreme Court intended to dispossess uninsured spouses
(and their heirs) of their newly-acquired property right merely
because they abided by federal law and included their share of the
asset on their federal estate tax return.
The sentence at issue merely states that settlement is
“resolved by allocating one-half of the cash surrender value to the
deceased’s estate.” A more plausible reading of this clause is
that settlement is effected when one-half of the cash surrender
value is actually paid to the deceased wife’s estate by the living
husband; that is what “allocate” means in this context. And in
this case, Bennett Cervin testified that he and his sister, after
consultation with their father, decided not to seek allocation of
their one-half value and to keep the insurance policies in effect.4
4 At oral argument, the Commissioner’s attorney asserted that settlement occurred when Manita Cervin’s heirs could have received one-half of the cash surrender value of the policies. We do not think that Brown v. Lee supports this assertion. The IRS attorney also contended at oral argument that this is not a case in which Alto Cervin and his children had an agreement to maintain the children’s fifty percent ownership interest in the policies. As evidence of this, he pointed to the fact that the parties amended the insurance policies such that decedent possessed sole rights to
12 Indeed, the second sentence of the much-quoted paragraph makes
reference to the heirs of the deceased wife seeking compensation.
This also suggests that the heirs of the deceased, uninsured spouse
must be compensated. Because one-half of the cash surrender value
was never distributed or allocated to the children of Alto and
Manita Cervin, Manita Cervin’s interest in the insurance policies
remained unsettled, and thus the second rule of Brown v. Lee
governs. Because Manita Cervin’s community interest was never
extinguished, under Texas law her children inherited that interest,
which is one-half of the policy rights and one-half of the
unmatured chose.5 The Estate of Alto Cervin therefore contains
only one-half interest in the policy rights and one-half interest
in the proceeds rights, and it should be taxed on one-half of the
value of the proceeds.
This reading of Brown v. Lee is fully consistent with the
definition of “settlement” in Black’s Law Dictionary:
“‘Settlement,’ in reference to a decedent’s estate, includes the
full process of administration, distribution and closing.” Black’s
Law Dictionary 1373 (6th ed. 1990). The cash surrender value of
the policies was never distributed to Bennett Cervin and Nita-Carol
many of the incidents of ownership. The fact that the children were never compensated for their one-half interest in the cash surrender value still justifies our belief that the children never settled their interest in the policies. 5 The second sentence of the quoted paragraph also notes that the heirs must not be guilty of laches in attempting to seek compensation. The evidence shows that Manita Cervin’s heirs had an agreement with their father not to be compensated for their one- half interest in the policies, and the Commissioner does not argue that they were guilty of laches.
13 Cervin Miskovitch, and thus Manita Cervin’s estate was not settled.
Furthermore, the Commissioner’s position also contradicts a
unanimous body of legal authority, which she attempts to
distinguish on the grounds that such authority involved situations
where the estate was never settled. Take, for example, Estate of
Cavenaugh v. Commissioner, 51 F.3d 597 (5th Cir. 1995). As in this
case, the uninsured wife predeceased the insured husband--both of
whom resided in Texas--and we held that only fifty percent of the
proceeds of a term life insurance policy should be included in the
estate of husband who survived his uninsured wife. Id. at 605.
It is true, as the Commissioner asserts, that in Cavenaugh we
determined that the second rule of Brown v. Lee applies because the
uninsured wife’s estate was never settled or partitioned prior to
the death of her husband. Id. at 602. The Commissioner argues
that settlement never occurred because the wife’s executor did not
include any interest in the policies in question in the gross
estate as reported on her federal estate tax returns. We think
that the Commissioner misstates the facts of Cavenaugh. It appears
that the wife’s estate did list a value of her interest in the
insurance policy at issue; that interest was listed as having a
zero value, however, because the life insurance was term insurance.
See id. at 603 n.9.
Moreover, even if we ignore the fact that the wife’s ownership
interest in the insurance was included in her gross estate in
Cavenaugh, it is clear that the Cavenaugh Court did not interpret
Brown v. Lee to mean that settlement of the uninsured’s interest in
14 the proceeds occurs merely by including the value of the uninsured
wife’s one-half interest on her estate tax return. Instead we
noted that under Brown v. Lee, “the community interest of the
deceased uninsured wife in the proceeds was not extinguished sans
partition or laches.” Id. at 604 n.10 (emphasis omitted). The
Commissioner provides no support for the proposition that the
inclusion of an asset on a federal tax return effects a partition,
and there is no evidence that the Cervin heirs were guilty of
laches. The Cavenaugh Court also cited the case of Amason v.
Franklin Life Ins. Co., 428 F.2d 1144 (5th Cir. 1970), for the
proposition that “the death of [the uninsured wife] without a
partition created a tenancy-in-common between Mr. Cavenaugh and her
estate’s designated heirs vis à vis the policy.” Cavenaugh, 51
F.3d at 603. Once again, the inclusion of Manita Cervin’s one-half
interest in the cash surrender value does not negate the tenancy-
in-common between Alto Cervin and the children that was created
when Manita Cervin died intestate.6
6 We note that the Commissioner litigated this identical issue in the Ninth Circuit, asserting that the only interest in insurance policies that passed under the uninsured wife’s will “was the right to receive one-half of the cash surrender value of the policies.” See Scott v. Commissioner, 374 F.2d 154, 159 (9th Cir. 1967). The Ninth Circuit rejected this argument based on California community property law. Id. at 159-60. Analyzing Scott, the Cavenaugh Court held that: Although the community property laws of California and Texas differ in many respects, neither the IRS nor the Tax Court has produced authority confirming a meaningful variation between California and Texas law on this issue [i.e., regarding ownership of life insurance policies]. Specifically, Scott’s treatment of a marital community dissolved via death-- construction of a tenant in common relationship--accords with the solution to dissolution adopted by Amason in the context of divorce. This parallelism is not only logical, but appears
15 The Commissioner also runs afoul the Treasury Regulations,
which provide an example directly on point:
For example, assume that the decedent purchased a policy of insurance on his life with funds held by him and his surviving wife as community property, designating their son as beneficiary but retaining the right to surrender the policy. Under the local law, the proceeds upon surrender would have inured to the marital community. Assuming that the policy is not surrendered and that the son receives the proceeds on the decedent’s death, the wife’s transfer of her one-half interest in the policy was not considered absolute before the decedent’s death. Upon the wife’s prior death, one-half of the value of the policy would have been included in her gross estate. Under these circumstances, the power of surrender possessed by the decedent as agent for his wife with respect to one-half of the policy is not, for purposes of this section, an “incident of ownership,” and the decedent is, therefore, deemed to possess an incident of ownership in only one-half of the policy.
Treas. Reg. § 20-2042-1(c)(5). Again, the Commissioner attempts to
distinguish this example on the grounds that Texas law is such that
the inclusion of one-half of the value of the policy in the wife’s
gross estate settles (and extinguishes) the wife’s interest in the
proceeds. The Commissioner continues to press this interpretation
of Brown v. Lee even though the above example expressly
contemplates that one-half of the value would be included in the
uninsured wife’s gross estate and still holds that the decedent
compelled by the synergy of Amason and Brown v. Lee. Cavenaugh, 51 F.3d at 603-04. Despite the foregoing paragraph, the Commissioner continues to assert, with success in the Tax Court, that Cavenaugh’s discussion of the similarity between Texas and California community property law refers only to the interest of heirs of an uninsured spouse in the proceeds of community life insurance where there was no settlement. Therefore, the Commissioner asserts that California and Texas community property law differ on the definition of settlement. We believe that Brown v. Lee does not establish a contrary definition of settlement, and thus the rule set forth in Scott is applicable here.
16 possesses only one-half the incidents of ownership.
Last, but not least, is the Commissioner’s own Revenue Ruling.
Rev. Rul. 75-100, 1975-1 C.B. 303. In that ruling, the
Commissioner considered facts almost identical to those in this
case. The Commissioner ruled that because the estate of the
predeceased, uninsured wife was not settled, the estate of the
husband included only one-half of the value of the proceeds because
the wife’s one-half interest passed to her children. The
Commissioner again attempts to distinguish this ruling on the
grounds that the uninsured wife’s interest was not settled in that
example. The Revenue Ruling, which applied Texas law, makes it
clear, however, that settlement is an agreement that must occur
between the husband and the heirs or legatees of the wife, and not
between the wife’s estate and the federal government: “in the
instant case, there was no settlement of W’s community interest in
the life insurance policy (between H and her legatees) between the
time of her death and that of H ten days later, nor were the
legatees of W’s estate guilty of laches in failing to seek such a
settlement.”
In conclusion, the Estate of Alto Cervin owns only one-half of
the policy rights because ownership of Manita Cervin’s one-half
interest in the policy rights passed to Bennett Cervin and Nita-
Carol Cervin Miskovitch under section 45 of the Texas Probate Code
(West 1980). Section 2042(2) of the Internal Revenue Code
therefore dictates that the Cervin estate need include only one-
half of the value of the proceeds ($65,462.88) in the gross estate
17 because it possesses only one-half of the policy rights. 26 U.S.C.
§ 2042(2).7
II. LITIGATION COSTS
The Cervin estate argues that the Tax Court erred by denying
its request for litigation costs under section 7430 of the Internal
Revenue Code. Section 7430 provides that a “prevailing party” in
a tax proceeding may recover “reasonable litigation costs incurred
in connection with such court proceeding.” 26 U.S.C. § 7430(a)(2);
accord Nalle v. Commissioner, 55 F.3d 189, 191 (5th Cir. 1995). As
defined in the statute, a party prevails if it establishes: (1)
that the “position of the United States” in the proceeding was not
“substantially justified”; (2) that the party has “substantially
prevailed” with respect to the amount in controversy or with
respect to the most significant issue or set of issues presented;
and (3) that the party has met the applicable net worth
requirements. 26 U.S.C. § 7430(c)(4)(A); Nalle, 55 F.3d at 191.
Our decision above establishes that the estate has
substantially prevailed with respect to the amount in controversy
regarding the insurance proceeds, and the Commissioner concedes
that the estate substantially prevailed with respect to the amount
in controversy regarding the valuation of the four properties. The
Commissioner also does not argue that the estate has not met the
7 Because Bennett and Nita-Carol have owned one-half of the policy rights since Manita Cervin’s death in 1978, they are responsible for one-half of the post-1978 insurance premiums. We therefore conclude that the Cervin estate must also include the accounts receivable of $35,268.16 from the children as reimbursement for the premiums paid by the decedent on the children’s behalf.
18 net worth requirements. Thus, the only element at issue is whether
the “position of the United States” with respect to the insurance
proceeds and the property valuation was substantially justified.
The term “substantially justified” means “‘justified to a
degree that could satisfy a reasonable person’ and having a
‘reasonable basis both in law and fact.’” Nalle, 55 F.3d at 191
(quoting Pierce v. Underwood, 487 U.S. 552, 565 (1988)). In
determining whether the Commissioner’s position was substantially
justified, it is necessary to ascertain whether the Commissioner
acted unreasonably, that is, whether she “knew or should have known
that her position was invalid at the onset of the litigation.”
Nalle, 55 F.3d at 191 (citing Bouterie v. Commissioner, 36 F.3d
1361, 1373 (5th Cir. 1994)).
The estate maintains that the position of the Commissioner was
not substantially justified with respect to both the insurance
proceeds issue and the property valuation matter. We agree.
A. The Life Insurance Proceeds
As noted above, in arguing that one hundred percent of the
proceeds of the life insurance policies is includible in the
decedent’s gross estate, the Commissioner runs afoul of a legal
principle set forth in a Treasury Regulation, a Revenue Ruling, and
a Ninth Circuit case--each of which contains facts exceedingly
similar to the present case. The Commissioner is not concerned
with this inconsistency, for she contends that the Texas Supreme
Court case of Brown v. Lee outlines a different rule of law in the
State of Texas. This suggested rule of law, however--that merely
19 reporting one’s ownership interest in a life insurance policy on a
federal estate tax return can settle one’s ownership interest in
the policy for purposes of state law--is nowhere to be found in
that opinion and indeed is inconsistent with the definition of
property set forth by the Texas legislature.
The unreasonableness of the Commissioner’s position is
underscored by her argument that the gross estate includes both the
full one hundred percent of the life insurance proceeds and the
receivables from Bennett and Nita-Carol representing reimbursement
of insurance premiums paid by the decedent--undisputably double
taxation. In addition, the Commissioner continued to press her
position even after Cavenaugh established that an insured wife’s
interest in an insurance policy may not be settled even when her
estate tax return lists such an asset. See 51 F.3d at 602, 603
n.9. We recognize that our cases require a finding of
unreasonableness at the onset of litigation and that Cavenaugh was
not decided until after the Tax Court’s decision. See Nalle, 55
F.3d at 191; Bouterie, 36 F.3d at 1367. Nevertheless, the
Commissioner’s insistence in her position in the face of Cavenaugh
is evidence of her single-minded pursuit of the tax on the
insurance proceeds in spite of state and federal law.
This and other circuits have held that the Commissioner’s
position was not substantially justified when she had ignored state
law that clearly supported the taxpayer’s position. See Nalle, 55
F.3d at 191-92 (citing cases). While the Commissioner’s position
in the instant case may not be as egregiously wrong as it was in
20 the cases cited by Nalle, her legal argument is unreasonable. The
fact that the Tax Court ruled for the Commissioner, while a factor
in favor of her position, is not dispositive. See Pate v. United
States, 982 F.2d 457, 459 (10th Cir. 1993); Huckaby v. United
States Dep’t of Treasury, 804 F.2d 297, 299 (5th Cir. 1986). The
Commissioner is certainly free to argue that different laws of the
fifty states can have different tax consequences in each state,
just as she may litigate the same issue in different circuits in
order to create a conflict. That does not, however, suggest that
taking an unsupported legal position in such instance is
substantially justified. Cf. Estate of Perry v. Commissioner, 931
F.2d 1044, 1046 (5th Cir. 1991). Where the Commissioner elects to
litigate an untenable position of state law, she “does so at the
risk of incurring the obligation to reimburse such taxpayers for
attorneys’ fees pursuant to the provisions of Section 7430.” Id.
B. The Property Valuation
As noted above, the Commissioner initially determined that the
estate was not entitled to any discount on any of the four parcels
of real estate. One month before trial, however, the
Commissioner’s expert prepared a report stating that the estate was
entitled to a five percent discount on the two higher-valued
properties. In addition, in the Stipulation of Facts filed on the
trial date, the Commissioner accepted the estate’s valuation of the
two lesser-valued properties. After hearing expert testimony from
both sides at trial, the Tax Court decided that a twenty percent
discount on the two higher-valued properties was appropriate, and
21 this holding has not been appealed.
On appeal, the estate asserts that the Commissioner’s position
regarding the valuation of the property was not substantially
justified because the Commissioner relied upon the discredited
unity-of-ownership theory in disallowing the twenty-five percent
discount. The Commissioner does not dispute the fact that this
circuit rejected the unity-of-ownership theory in Estate of Bright
v. United States, 658 F.2d 999, 1005-07 (5th Cir. 1981) (en banc).
Instead, she argues that the unity-of-ownership theory was never
the “position of the United States” as that term is defined in
Section 7430(c)(7) of the Code.
Section 7430(c)(7) defines “position of the United States” as
the position taken in a judicial proceeding and also as the
position taken in an administrative proceeding as of the date of
the Notice of Deficiency. 26 U.S.C. § 7430(c)(7). Although we
must determine the Commissioner’s position as of the date of the
Notice of Deficiency (filed on August 13, 1992), Lennox v.
Commissioner, 998 F.2d 244, 248 (5th Cir. 1993), establishes that
the Commissioner’s position on that date must be viewed in the
context of what caused the IRS to issue the Notice of Deficiency.
The record shows that the IRS first disallowed the twenty-five
percent discount in its Notice of Proposed Adjustment sent to the
estate on July 3, 1991. Included with the Notice of Proposed
Adjustment was the Revenue Agent’s examination report, which stated
that the discount should be disallowed for two reasons. First, the
agent noted that the Cervin estate had “presented no evidence of
22 sales of undivided fractional real estate interests which would
corroborate its theory that undivided interests sell on the market
for an amount less than their proportionate value.” Second, the
agent asserted that the unity-of-ownership theory should apply.
The Cervin estate unsuccessfully protested the Notice of Proposed
Adjustment, and the IRS, on August 13, 1992, sent the estate a
formal Notice of Deficiency. We thus conclude that issuance of the
Notice of Deficiency was based in large part upon the discredited
unity-of-ownership theory.
It is true that the Commissioner abandoned the unity-of-
ownership theory at some point after issuing the Notice of
Deficiency but before trial, arguing instead that the estate had
simply not presented adequate evidence to justify the twenty-five
percent discount. Relying on Minahan v. Commissioner, 88 T.C. 492,
501 (1987), the estate maintains that the Commissioner may not
“extricate himself from a holding of unreasonableness merely
because his valuation expert is also unreasonable.” In Minahan,
the Commissioner first espoused the unity-of-ownership theory in
support of the Notice of Deficiency, then on the date of the trial
conceded that there was no deficiency. In arguing that litigation
costs were not appropriate, the Commissioner in Minahan maintained
that his position was not unreasonable because valuation is a
factual question and reliance upon expert opinion is reasonable.
The Tax Court rejected this argument, noting that not only was the
unity-of-ownership theory untenable, but also that the
Commissioner’s valuation expert was unreasonable, as evidenced by
23 the fact that the Commissioner simply capitulated before trial.
See id. at 500.
In the present case, the Commissioner did not totally
capitulate at trial and instead presented expert testimony on the
valuation issue. Nevertheless, we are guided by Minahan. Until at
least the date of the Notice of Deficiency, the Commissioner relied
upon a discredited legal theory and maintained that the estate was
entitled to no discount on any of the four parcels of real estate.
Not until after the issuance of the Notice of Deficiency did the
Commissioner abandon her reliance on the unity-of-ownership theory.
Moreover, shortly before trial the Commissioner agreed that the
estate was entitled to a slight (five percent) discount on two of
the properties, and at trial the Commissioner capitulated as to the
other two properties. Finally, the Tax Court found the estate’s
expert to be more persuasive, determining that a twenty percent
discount was appropriate on the two contested properties. In
short, the above shows that the Commissioner’s stance on the
property valuation was unreasonable.
CONCLUSION
The Cervin estate need include one-half the value of the life
insurance proceeds and the accounts receivable from the children.
The position of the Commissioner was not substantially justified,
and thus the estate is entitled to reasonable litigation costs.
For the foregoing reasons, we REVERSE and REMAND.