Estate of Rapp v. Commissioner
This text of 1996 T.C. Memo. 10 (Estate of Rapp v. Commissioner) is published on Counsel Stack Legal Research, covering United States Tax Court primary law. Counsel Stack provides free access to over 12 million legal documents including statutes, case law, regulations, and constitutions.
Opinion
*16 Decision will be entered under Rule 155.
MEMORANDUM FINDINGS OF FACT AND OPINION
WHALEN,
| Additions to Tax | ||
| Deficiency | Sec. 6653(a)(1)(A) | Sec. 6653(a)(1)(B) |
| 50% interest on: | ||
| $ 1,685,271 | $ 84,264 | $ 1,685,271 |
Unless stated otherwise, all section references are to the Internal Revenue Code in effect for the date of the decedent's death.
After concessions, the sole issue for decision is whether petitioner is eligible to deduct, as an allowance of marital deduction under
FINDINGS OF FACT
The parties have stipulated some of the facts that are pertinent to this case. The stipulation of facts filed by the parties and the exhibits attached thereto are*17 incorporated herein by this reference.
The decedent, Mr. Bert B. Rapp, died on February 23, 1988. He was a California resident at that time. The executor of the decedent's estate, Mr. Richard Rapp, the decedent's son, was also a California resident when the instant petition was filed. Originally, the decedent's other son, Mr. David Rapp, served as coexecutor, but he relinquished that position before this action was commenced.
In addition to his two sons, the decedent was survived by his wife of approximately 35 years, Mrs. Laura Rapp. The decedent first met his wife in 1946, approximately 7 years before they were married. At that time, the decedent owned an automobile service station and garage. Mrs. Rapp was employed, but she also worked for the decedent in the evenings and sometimes on weekends. The decedent did not pay Mrs. Rapp for her services. After the Rapps were married, Mrs. Rapp continued to work for the decedent until the birth of their sons. After that time, Mrs. Rapp was not employed outside the home.
Over the years, the decedent's business enterprises prospered. His principal business was Motor Transportation Service Systems (MTSS), a corporation engaged in vehicle*18 leasing. He was president of MTSS and owned one-third of its outstanding stock worth $ 938,194 at the time of his death. In addition to MTSS, the decedent was a partner in several partnerships, and he owned shares in mutual funds, several parcels of real property, promissory notes, and shares of stock in other corporations.
Mrs. Rapp managed the household budget and paid household expenses. She did not take an active role in either her husband's business or his investment activities. The decedent put several investments and at least one venture in his wife's name, but Mrs. Rapp played no active role in their management. The decedent was satisfied with Mrs. Rapp's management of their household expenses.
In 1972, Mrs. Rapp was involved in an automobile accident. As a result of the accident, she was in a coma for 8 days, and she spent a total of 5 months in the hospital. The accident left her with poor vision and other medical problems. After the accident, Mrs. Rapp often complained about her physical limitations. She believed that she would never again be able to work. The decedent believed that the accident greatly affected his wife's personality and was partially to blame for some*19 of the marital discord that the Rapps later suffered.
The decedent was not an attorney or an accountant. In conducting his business affairs, he relied on the advice of professionals. However, he attempted to become knowledgeable about the legal and tax consequences of his business transactions. The decedent consulted frequently with Mr. Laurence Clark, an attorney, and with Mr. George Lippert, a certified public accountant. Neither Mr. Clark nor Mr. Lippert is an expert in estate planning.
Most of the decedent's legal affairs were handled by Mr. Clark, who is licensed to practice law in the State of California. Mr. Clark engaged in a general practice of law. He maintained a professional and personal relationship with the decedent until the decedent's death.
Mr. Clark had minimal experience in estate planning and in handling estates with assets of more than $ 1.2 million. Nevertheless, in 1978, he prepared wills for both the decedent and Mrs. Rapp (the 1978 wills). These wills were essentially identical.
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*16 Decision will be entered under Rule 155.
MEMORANDUM FINDINGS OF FACT AND OPINION
WHALEN,
| Additions to Tax | ||
| Deficiency | Sec. 6653(a)(1)(A) | Sec. 6653(a)(1)(B) |
| 50% interest on: | ||
| $ 1,685,271 | $ 84,264 | $ 1,685,271 |
Unless stated otherwise, all section references are to the Internal Revenue Code in effect for the date of the decedent's death.
After concessions, the sole issue for decision is whether petitioner is eligible to deduct, as an allowance of marital deduction under
FINDINGS OF FACT
The parties have stipulated some of the facts that are pertinent to this case. The stipulation of facts filed by the parties and the exhibits attached thereto are*17 incorporated herein by this reference.
The decedent, Mr. Bert B. Rapp, died on February 23, 1988. He was a California resident at that time. The executor of the decedent's estate, Mr. Richard Rapp, the decedent's son, was also a California resident when the instant petition was filed. Originally, the decedent's other son, Mr. David Rapp, served as coexecutor, but he relinquished that position before this action was commenced.
In addition to his two sons, the decedent was survived by his wife of approximately 35 years, Mrs. Laura Rapp. The decedent first met his wife in 1946, approximately 7 years before they were married. At that time, the decedent owned an automobile service station and garage. Mrs. Rapp was employed, but she also worked for the decedent in the evenings and sometimes on weekends. The decedent did not pay Mrs. Rapp for her services. After the Rapps were married, Mrs. Rapp continued to work for the decedent until the birth of their sons. After that time, Mrs. Rapp was not employed outside the home.
Over the years, the decedent's business enterprises prospered. His principal business was Motor Transportation Service Systems (MTSS), a corporation engaged in vehicle*18 leasing. He was president of MTSS and owned one-third of its outstanding stock worth $ 938,194 at the time of his death. In addition to MTSS, the decedent was a partner in several partnerships, and he owned shares in mutual funds, several parcels of real property, promissory notes, and shares of stock in other corporations.
Mrs. Rapp managed the household budget and paid household expenses. She did not take an active role in either her husband's business or his investment activities. The decedent put several investments and at least one venture in his wife's name, but Mrs. Rapp played no active role in their management. The decedent was satisfied with Mrs. Rapp's management of their household expenses.
In 1972, Mrs. Rapp was involved in an automobile accident. As a result of the accident, she was in a coma for 8 days, and she spent a total of 5 months in the hospital. The accident left her with poor vision and other medical problems. After the accident, Mrs. Rapp often complained about her physical limitations. She believed that she would never again be able to work. The decedent believed that the accident greatly affected his wife's personality and was partially to blame for some*19 of the marital discord that the Rapps later suffered.
The decedent was not an attorney or an accountant. In conducting his business affairs, he relied on the advice of professionals. However, he attempted to become knowledgeable about the legal and tax consequences of his business transactions. The decedent consulted frequently with Mr. Laurence Clark, an attorney, and with Mr. George Lippert, a certified public accountant. Neither Mr. Clark nor Mr. Lippert is an expert in estate planning.
Most of the decedent's legal affairs were handled by Mr. Clark, who is licensed to practice law in the State of California. Mr. Clark engaged in a general practice of law. He maintained a professional and personal relationship with the decedent until the decedent's death.
Mr. Clark had minimal experience in estate planning and in handling estates with assets of more than $ 1.2 million. Nevertheless, in 1978, he prepared wills for both the decedent and Mrs. Rapp (the 1978 wills). These wills were essentially identical. Each of the 1978 wills provided that all household furniture and furnishings, clothing, personal effects, and automobiles of the testator were to be given to the surviving spouse. *20 All other property of the testator was given to the testator's two sons to be held in trust during the life of the surviving spouse. As cotrustees, Messrs. David and Richard Rapp were given the power to disburse such amounts from the principal and income of the trust estate as they would decide is necessary "in their absolute discretion" for the "health, education and support" of the surviving spouse. Upon the death of the surviving spouse, the trust was to cease and the cotrustees were directed to distribute the balance of the trust estate to the testator's two sons or their living issue. In 1982, the decedent executed a codicil that amended his 1978 will by changing the last successor trustee and the last successor executor but made no change in the substantive provisions of the will.
Mr. Clark also prepared the wills that the decedent and Mrs. Rapp executed on July 9, 1986 (the 1986 wills). These wills revoked the 1978 wills but were substantively the same, with only minor changes in language and form, and with changes in the identity of successor executors and alternate trustees. The decedent's and Mrs. Rapp's 1986 wills were identical to one another in all material aspects.
*21 Like the 1978 wills, the 1986 wills provide that all of the household furniture and furnishings, clothing, personal effects, and automobiles of the testator are given to the surviving spouse. All other property of the testator is given to the testator's two sons, Richard Rapp and David Rapp, to be held in trust during the life of the surviving spouse. The trustee of the trust is given the power to disburse such amounts from the principal and income of the trust as the trustee decides is necessary "in his absolute discretion" for the "proper health, education and support" of the surviving spouse. Article Fifth (b) of the decedent's will states as follows: If at any time, in the absolute discretion of the Trustee or coTrustees, my wife, LAURA B. RAPP, should for any reason be in need of funds for her proper health, education and support, the Trustee may in his absolute discretion pay to or apply for the benefit of my wife, such amounts from the principal and income of the trust estate, up to the whole thereof, as the Trustee may from time to time deem necessary or advisable for her use and benefit.
Before he prepared the 1986 wills, Mr. Clark had become acquainted with the size and complexity of the decedent's business and financial holdings due to the fact that he had handled legal matters for the decedent and his businesses beginning in the mid-1970's. The decedent had also given Mr. Clark a personal financial statement dated April 30, 1986, listing assets of $ 13,530,671, liabilities of $ 3,357,915, and a net worth of $ 10,172,756. The financial statement detailed the investments that the Rapps owned in 1986.
The decedent and Mrs. Rapp executed their 1986 wills during a meeting in Mr. Clark's office. Prior to that time, Mr. Clark had not consulted with Mrs. Rapp about the provisions of her 1986 will. During the meeting, Mr. Clark read parts of the decedent's 1986 will to the decedent and Mrs. Rapp. Mr. Clark told Mrs. Rapp that her 1986 will was essentially the same as the decedent's, and that she would not understand it because it was technical. At the time the wills were signed, Mr. Clark did not discuss the estate tax consequences of the 1986 wills with either*23 the decedent or Mrs. Rapp.
The 1986 wills were executed during a difficult time in the decedent's marriage to Mrs. Rapp. During the mid-1980's, the decedent had considered divorcing his wife. Mr. Clark advised the decedent that a divorce would be disruptive to the decedent's business ventures. Mr. Clark put the decedent in contact with a marriage counselor in 1984. The Rapps remained married until Mr. Rapp's death in 1988.
From time to time, the decedent discussed estate tax matters with his friends and acquaintances. On those occasions, he urged them to plan to avoid estate taxes. He did not disclose any specific provisions of his will or his wife's will, except to say that his sons would be cotrustees and that his wife, children, and grandchildren would not have to worry about the estate. The decedent stated that he trusted Mr. Richard Rapp to handle financial matters and to look after Mrs. Rapp in the event of his death. The decedent also told his friends that he caused his will to be updated to account for changes in the law, and he advised them to do the same. The decedent told Mr. Bruce Bell, an employee of Wells Fargo Bank who supervised the decedent's and MTSS's loan accounts*24 with the bank, that there would be minimal estate taxes and minimal liquidity problems at the time of his death.
The decedent also discussed the estate tax marital deduction with his accountant, Mr. Lippert. Sometime between 1984 and 1986, the decedent showed Mr. Lippert an article about the marital deduction permitted for Federal estate tax purposes. The decedent told Mr. Lippert that he was "moving forward in that area." On other occasions, the decedent told Mr. Lippert that his estate tax matters were "moving forward and * * * under control." Mr. Lippert also discussed with the decedent how to provide liquidity to pay estate taxes on death. After the decedent's death, Mr. Lippert was surprised to learn that the testamentary trust created under the decedent's 1986 will was not eligible for the marital deduction.
The decedent's 1986 will was admitted to probate on May 5, 1988, before the Superior Court of California, County of Los Angeles (referred to herein as the probate court). Initially, the coexecutors, Messrs. David and Richard Rapp, retained Mr. Clark to handle the probate of the decedent's estate. As the proceedings went on, however, they became displeased with Mr. Clark's*25 handling of the estate. They grew dissatisfied with the time it took Mr. Clark to file required papers, and they felt uncomfortable with some of the advice that he gave to them. They also became aware that the decedent's 1986 will would require the payment of substantial Federal estate taxes. Mr. Richard Rapp felt that Mr. Clark was uncooperative and was more concerned with avoiding a malpractice suit than with settling the estate's problems. Further, Mr. Richard Rapp was unhappy because Mr. Clark threatened to withdraw as counsel for MTSS in a litigation matter if he were removed as counsel for the decedent's estate. After the other matter was resolved, Mr. Richard Rapp caused the decedent's estate to retain different counsel.
On August 19, 1988, Mrs. Rapp filed with the probate court a document entitled Petition For Modification of Trust Created Under Article Fifth of Decedent's Will Admitted to Probate In Order to Carry Out Decedent's Intent. Mrs. Rapp's petition alleges: it was decedent's intention that the Trust created under Article Fifth of his Will for the benefit of Petitioner [i.e., Mrs. Rapp] during her lifetime was intended to qualify for the QTIP election and that*26 decedent believed that the Trustees would pay all of the income from the Trust, at least annually, to or for the benefit of Petitioner during her lifetime.
A hearing on Mrs. Rapp's petition was set for September 29, 1988, and Mrs. Rapp served a copy of her petition and a copy of the notice of *27 hearing on the decedent's sons, both in their capacity as cotrustees and as beneficiaries, on Mr. David Rapp's two minor children, and on Mr. Clark. On or about September 28, 1988, the probate court appointed Matthew S. Rae, Esquire, as guardian ad litem for the minor children of Mr. David Rapp, who were contingent remaindermen under the will, and for the unborn, unknown, and/or unascertained lawful issue of the decedent's two sons.
In advance of the hearing on Mrs. Rapp's petition, Mr. Richard Rapp made a survey of his father's friends and associates to determine the decedent's intent at the time his 1986 will was executed. He also caused a search to be made of the decedent's financial records and files. Mr. Richard Rapp believed that Mr. Clark would not make a credible witness, and Mr. Rapp concluded that he could not defeat his mother's petition for reformation of the decedent's will.
The hearing on Mrs. Rapp's petition took place on September 29, 1988. The Commissioner of Internal Revenue was not notified of the proceeding and did not enter an appearance. Mr. Clark was notified of the hearing, but he did not voluntarily appear at the hearing. The probate court granted Mrs. Rapp's*28 petition on October 31, 1988, and the Court's order became final on April 30, 1989.
The order of the probate court dated October 31, 1988, reads as follows: The Petition for Modification of Trust Created Under Article Fifth of Decedent's Will Admitted to Probate in Order to Carry Out Decedent's Intent, came on the 29th day of September, 1988 in Department 11 at 9:15 a.m. for hearing and settlement by the above-entitled Court, the Honorable Richard C. Hubbell, Judge presiding, with Clark R. Byam of HAHN & HAHN, appearing on behalf of Laura B. Rapp; Gerald E. Lunn, Jr., appearing on behalf of Richard L. Rapp and David L. Rapp, Co-Executors of the Will of Bert Rapp, deceased and Matthew S. Rae, Jr., Guardian Oral argument was presented by all parties present and all parties then submitted the matter for the Court's determination. Based upon the written pleadings and oral argument, the Court finds as follows: (1) All notices of the hearing have been given as required by law. The Court Orders: (1) That Article FIFTH (b) of decedent's Will is modified as*29 follows: "(b) During the lifetime of my wife, LAURA B. RAPP, the Trustee or coTrustees shall pay the net income from the corpus of the trust annually or at more frequent intervals to or for the benefit of LAURA B. RAPP, during her lifetime. In addition to the net income, the Trustee or coTrustees shall pay as much of the principal from the Trust to or for the benefit of my wife as shall be needed to provide for the reasonable health, education and support of my wife during her lifetime. Any income accrued or held undistributed at the time of my wife's death shall be distributed to her estate." (2) that the following is added as Subsection (i) to Article FIFTH: "(i) I authorize my executor to elect to treat the trust created under this Article FIFTH, or any portion thereof, as "qualified terminable interest property" in order to obtain the marital deduction for such property for federal estate tax purposes. Whether or not my executors make such an election, I hereby exonerate my executors from any liability resulting from making or failing to make such an election."
On or about November 9, 1988, shortly before the due date for the petitioner's estate tax return, petitioner's attorney filed with the Internal Revenue Service an Application for Extension of Time to File U.S. Estate (and Generation-Skipping Transfer) Tax Return and/or Pay Estate (and Generation-Skipping Transfer) Tax(es) on Form 4768. Petitioner requested an extension of time to file until May 23, 1989, for the following reasons: The Decedent's estate includes numerous interrelated closely-held businesses, some of which have experienced serious financial problems. Significant questions of valuation remain unresolved despite diligent efforts to resolve them. Furthermore, a number of significant, unresolved contingent creditors' claims remain outstanding against the estate. The executor intends to make an election under Section 2057 [sic] (b) (7) (B) (v), but cannot, at this time, determine which portion of the estate is to be treated as "qualified terminable interest property." The amount of estate taxes can not [sic] be determined because the size of the gross estate is unascertainable (for the reasons set forth above under "Extension of Time to File"), and the executor's election to treat property passing to the surviving spouse as qualified terminable interest property cannot be made. Nevertheless, a payment of $ 156,424 against the amount of estate taxes estimated to be due is paid with this application.
On May 22, 1989, the executor filed the petitioner's United States Estate (and Generation-Skipping Transfer) Tax Return on IRS Form 706. According to the return, the decedent and Mrs. Rapp owned community property worth $ 11,255,444.12 at the time of the decedent's death. The return reports that the decedent's total gross estate, consisting of one-half the community property in the aggregate amount of $ 5,627,722.06, is composed of the following assets:
| Real estate, Sch. A | $ 1,041,375.00 |
| Stocks and bonds, Sch. B | 2,374,002.67 |
| Mortgages, notes, and cash, Sch. C | 1,537,013.93 |
| Insurance on decedent's life, Sch. D | 25,000.00 |
| Jointly owned property, Sch. E | 105,576.96 |
| Other miscellaneous property, Sch. F | |
| Partnerships | 292,500.00 |
| Leasehold on bldg. and lot | 115,000.00 |
| Option agreement | 20,000.00 |
| Overpayment of Federal income tax | 1,991.00 |
| Jewelry and furs | 100,262.50 |
| Household furnishings | 15,000.00 |
| Total | 5,627,722.06 |
*32 A Schedule M--Bequests, Etc. to Surviving Spouse, was filed with the petitioner's estate tax return. The executor answered "no" to question 1 on Schedule M. That question asks: Did any property pass to the surviving spouse as a result of a qualified disclaimer? If "Yes", attach a copy of the written disclaimer required by section 2518(b).
In response to question 2 on Schedule M, the executor checked the space provided to "elect to claim a marital deduction for qualified terminable interest property (QTIP) under A fraction of each of the above assets allocated to the testamentary QTIP trust established under Article FIFTH of decedent's last Will dated July 9, 1986, as construed by Court Order Modifying Decedent's Trust dated October 31, 1988 shall be subject to the QTIP election hereunder. The numerator of such fraction*33 shall be the minimum amount of federal estate tax marital deduction under
On Part 1 of Schedule M, which calls for a list of "Property Interests Which Are Not Subject to a QTIP Election", the executor reported the property*34 specifically devised to Mrs. Rapp, consisting of the couple's residence, the household furnishings, and the decedent's personal effects, in the aggregate amount of $ 435,262.50. On part 2 of Schedule M, which calls for a list of "Property Interests Which Are Subject to a QTIP Election", the executor reported $ 3,444,087.28. That amount is composed of the value of the assets available for distribution to the testamentary trust, $ 5,086,882.60 (i.e., total gross estate, $ 5,627,722.06, less assets devised to Mrs. Rapp, $ 435,262.50, and assets jointly owned with other individuals, $ 105,576.96), less the portion of the property that was not subject to the QTIP election, $ 802,510.21, and the aggregate nonmarital deductions claimed on the return, $ 840,285.11. The marital deduction claimed on the return is $ 3,683,899.38. It consists of the total interests passing to Mrs. Rapp, $ 3,879,349.78 (i.e., $ 3,444,087.28 plus $ 435,262.50) less Federal estate taxes, $ 156,424, and other death taxes, $ 39,026.40.
In the notice of deficiency issued to petitioner, respondent determined that petitioner had "failed to fully substantiate" the marital deduction. Respondent allowed the deduction to*35 the extent of the property that had been specifically devised to Mrs. Rapp, $ 435,262.50, but disallowed the deduction to the extent of the property that had been distributed to the testamentary trust.
OPINION
For purposes of computing Federal estate taxes,
An exception to the limitation applicable to life estates or other terminable interests is provided by (i) In general.--The term "qualified terminable interest property" means 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 this paragraph applies. (ii) Qualifying income interest for life.--The surviving spouse has a qualifying income interest for life if-- (I) the surviving spouse is entitled to all the income from the property, payable annually or at more frequent intervals, or has a usufruct interest for life in the property, and (II) no person has a power to appoint any part of the property to any person other than the surviving spouse.
After concessions by the parties, the sole issue for decision in this case is whether the property distributed to the testamentary trust established under the decedent's will is QTIP, as defined*37 by
As originally written, Article Fifth of the decedent's 1986 will provides that the residue of the decedent's property, after the payment of certain debts and expenses, is to be placed in trust for the benefit of the decedent's surviving spouse, and, upon her death, to be divided equally between the decedent's two sons. The will does not give Mrs. Rapp the right to receive income from the trust. It provides that she is entitled to receive distributions of income and principal from the trust if the cotrustees make the determination in their "absolute discretion" that she is in need of funds "for her proper health, education and support." Thus, under the decedent's 1986 will, Mrs. Rapp is not entitled to receive "all the income from the property, payable annually or at more frequent intervals", as required*38 by
The decedent's 1986 will was reformed by the order of the probate court issued on October 31, 1988, quoted above. As reformed, Article Fifth (b) of the decedent's will directs the trustees to "pay the net income from the corpus of the trust annually or at more frequent intervals to or for the benefit of LAURA B. RAPP, during her lifetime." The reformed will also expressly authorizes the executor to elect to treat the property held in the trust as QTIP.
Petitioner argues that the corpus of the trust can be included in the marital deduction for four reasons. First, petitioner argues that on the date of the decedent's death Mrs. Rapp had an enforceable right under California law to obtain reformation of the decedent's 1986 will as approved by the order of the probate court and that the order of the probate court should be respected for Federal estate tax purposes. Second, petitioner argues that the QTIP rules are applied as of the date*39 of the QTIP election, not the date of the decedent's death. Third, petitioner argues that as of the date of the decedent's death, Mrs. Rapp was entitled to receive annual distributions of all of the income from the trust because the actions of the cotrustees and the guardian ad litem in consenting to the reformation constituted a "qualified disclaimer" under section 2518. Fourth, petitioner argues that, as of the date of decedent's death, Mrs. Rapp was entitled to receive annual distributions of all of the income from the trust because the cotrustees were obligated to make such distributions to Mrs. Rapp under a fiduciary duty to look after her best interests.
As a general rule, State law determines the property rights and interests created by a decedent's will, but Federal law determines the tax consequences of those rights and interests. E.g.,
Petitioner argues that the order of the probate court reforming the decedent's will should be respected for Federal estate tax purposes. However, the law is clear, and both parties to this case agree, that we are not bound by the action of a State trial court, such as the order of the probate court, that has not been affirmed by the State's highest court.
Petitioner begins by arguing that the order of the probate court must be presumed to be "a bona fide recognition of enforceable rights" under California law and that respondent has failed to rebut that presumption. In support of that argument, petitioner cites section 20.2056(e)-2(d)(2), Estate Tax Regs. (currently sec. 20.2056(c)-2(d)(2), Estate Tax Regs.), which provides as follows: If as a result of the controversy involving the decedent's will, or involving any bequest or devise thereunder, a property interest is assigned or surrendered to the surviving spouse, the interest so acquired will be regarded as having "passed from the decedent to his surviving spouse" only if the assignment or surrender was a bona fide recognition of enforceable rights of the surviving spouse in the decedent's estate. Such a bona fide recognition will be presumed*42 where the assignment or surrender was pursuant to a decision of a local court upon the merits in an adversary proceeding following a genuine and active contest. However, such a decree will be accepted only to the extent that the court passed upon the facts upon which deductibility of the property interest depends. If the assignment or surrender was pursuant to a decree rendered by consent, or pursuant to an agreement not to contest the will or not to probate the will, it will not necessarily be accepted as a bona fide evaluation of the rights of the spouse.
We are not convinced that there was a "genuine and active contest" in the probate court or that the order of the probate court constitutes "a decision of a local court upon the merits in an adversary proceeding", so as to trigger the presumption set forth in the above regulation. Sec. 20.2056(e)-2(d)(2), Estate Tax Regs. In this connection, it is significant that the guardian ad litem stated during the hearing before the probate court that a "benefit" would be realized by the entire Rapp family if the estate tax of approximately $ 2 million were postponed until Mrs. Rapp's death. He stated as follows: Under those circumstances*43 the benefit to the entire family, the entire estate, by postponing the tax until the surviving spouse dies, I believe is also a benefit on the person I have been appointed to represent.
In any event, we do not accept petitioner's assertion that the order of the California probate court is "a decision of a local court upon the merits in an adversary proceeding following a genuine and active contest." Sec. 20.2056(e)-2(d)(2), Estate Tax Regs. To the contrary, the record of the hearing before the probate court shows that the court granted Mrs. Rapp's petition after ascertaining the opinion of the guardian ad litem that his clients "will not be adversely affected by this petition" and determining that no objection had been filed to the petition. No witnesses were called to testify, and no documents were introduced into*44 evidence. We find nothing in the record of this case to show that the probate court "passed upon the facts upon which deeductibility of the property interests depends." Sec. 20.2056(e)-2(d)(2), Estate Tax Regs. Rather, the order of the probate court appears to have been "rendered by consent" such that it "will not necessarily be accepted as a bona fide evaluation of the rights of the spouse." Sec. 20.2056(e)-2(d)(2), Estate Tax Regs. Thus, we reject petitioner's assertion that the order of the probate court must be presumed to be a bona fide recognition of Mrs. Rapp's enforceable rights under California law. We proceed to review California law to determine whether Mrs. Rapp was entitled under the decedent's will to receive annual distributions of all of the income from the testamentary trust.
Under California law, the nature of the interest given by a testator to his or her surviving spouse is determined in accordance with the testator's intent, as determined by a construction of the language used in the will. E.g.,
Irrespective of whether extrinsic evidence is considered, the objective of the courts in California is to determine the testator's intent from the language used and not to write a new will for the testator. In Further, whether or not resort is had to extrinsic evidence, the court must determine the intent of the testator from the language used. The court in interpreting the will may not decide what the testator should have done or even that the testator desired to accomplish a particular objective. The court determines only what the testator did do by the manner in which he expressed himself. * * * In short, the court, under the guides of interpretation, may not write a new will for the testator.
We note that the California Probate Code provides special rules for a "marital deduction gift", defined as "a transfer of property that is intended to qualify for the marital deduction." (a) The provisions of the instrument, including any power, duty, or discretionary authority given to a fiduciary, shall be construed 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. [
In this case, as mentioned above, the language of the decedent's 1986 will gives Mrs. Rapp an interest in only so much of the income from the trust as is paid "for her proper health, education and support" in the absolute discretion of the cotrustees. This language is clear and unambiguous*48 and cannot be construed to give Mrs. Rapp the right "to all the income from the property, payable annually or at more frequent intervals", as required by the definition of qualifying income interest for life, set forth in
Notwithstanding the seemingly unambiguous language used in the decedent's will, the Court allowed petitioner to introduce extrinsic evidence of the facts and circumstances surrounding the execution of the decedent's 1986 will, over respondent's objection. As discussed above, the introduction of such evidence is permissible under California law. E.g.,
Petitioner introduced the testimony of seven witnesses into evidence and, based thereon, claims to have presented substantial direct and indirect evidence "that the Decedent intended that the residue of his estate qualify for the marital deduction." *49 As direct evidence of such intent, petitioner cites the testimony of three witnesses and argues in its post-trial brief that the decedent told his accountant, Mr. Lippert, "that he was changing his estate plan to take advantage of the unlimited marital deduction" and led Mr. Lippert "to believe that * * * [the decedent] had instructed Attorney Clark to change his Will so that it would qualify for the unlimited marital deduction." Petitioner also argues that the decedent told Mrs. Rapp that "when he died everything would be hers" and that the decedent told his niece, Mrs. Josephson, that "whatever he earned in his lifetime was going to be his wife's, and ultimately his sons[']."
As "indirect evidence" that the decedent intended the residue of his estate to qualify for the marital deduction, petitioner argues in its post-trial brief that the decedent told his wife, his son, and his banker, Mr. Bruce Bell, "that his estate plan had been drafted to avoid or defer taxes, and that there would be minimal taxes due upon his death." Petitioner also cites as indirect evidence the decedent's statements made to Mrs. Josephson, his investment adviser, Mr. Parneet Kongkeo, and his friend, Mr. *50 John Pabigian, about "the importance of estate planning and deferring taxes." Petitioner further cites the fact that the decedent had shown "an article to his CPA discussing the marital deduction and the changes in the estate tax laws." According to petitioner, the statements made by the decedent to those individuals "are simply not reconcilable with the Will as drafted" and "Under California law the Will is therefore ambiguous".
Even assuming that we accept petitioner's characterization of the testimony of its seven witnesses, we do not agree that any of the testimony proves either that the decedent intended the corpus of the testamentary trust to qualify for the marital deduction, or that any of the language used in the decedent's 1986 will is ambiguous. The testimony of petitioner's witnesses consists of general statements made by the decedent to his family, friends, and business associates about estate planning and death taxes. None of petitioner's witnesses, other than Mrs. Rapp, ever saw the decedent's 1986 will, and in no case did the decedent discuss specific provisions of his will with any of them. None of the decedent's statements specifically refers to his 1986 will, let*51 alone uncovers an ambiguity in the language used in the will.
The picture that emerges from the testimony of petitioner's witnesses is that the decedent was a successful businessman who was knowledgeable about the Federal income tax consequences of his leasing business, who usually sought to minimize taxes, who wanted to provide for Mrs. Rapp and his sons, and who attempted to educate himself about estate planning and death taxes by reading articles and discussing those matters with various friends and business associates. Prior to the time the decedent executed his 1986 will, the record shows that the decedent was aware of the QTIP provisions of the marital deduction. This is shown by the fact that he had discussed an article on that subject with his accountant, Mr. Lippert, during 1984, 1985, or 1986. We can even infer from the testimony of petitioner's witnesses that the decedent considered using a so-called QTIP trust in his will. However, there is no evidence that the decedent actually did so. The language of Article Fifth (b) of his 1986 will does not give Mrs. Rapp the right to receive the annual income from the trust. Rather, Article Fifth (b) gives Mrs. Rapp only so much*52 of the income from the trust as the cotrustees in their "absolute discretion" deem necessary "for her proper health, education and support". The decedent's 1986 will does not use the term "marital deduction", "QTIP", or the like, or otherwise give any indication that the decedent intended the corpus of the testamentary trust to be eligible for the marital deduction. Nor is there any extrinsic evidence that uncovers an ambiguity, in the sense of a double meaning, in the language used in the decedent's 1986 will from which we could infer that the decedent intended the trust to be eligible for the marital deduction. We simply have no basis to conclude from the record of this case that the decedent intended Mrs. Rapp to be "entitled to all the income from the property, payable annually or at more frequent intervals" as required by
Petitioner's second argument is that the date for determining whether property or an interest in property passing to the surviving spouse qualifies as QTIP is the date of the QTIP*53 election and not the date of the decedent's death. According to petitioner, the trust property in this case qualifies as QTIP because on the date the QTIP election was made, Mrs. Rapp was entitled to all of the income from the trust. In support of that argument, petitioner cites recent opinions issued by the U.S. Courts of Appeals for the Sixth, Eighth, and Fifth Circuits in
The facts of each of the cases relied upon by petitioner,
In each of the three cases, the Court of Appeals rejected the Commissioner's reading of
In each of the cases, when the court tested the validity of the election, it found that the property in the "QTIP trust" met the definition of QTIP because, in accordance with the decedent's expressed interest, the surviving spouse was entitled to all of the income from the property for life, payable annually or at more frequent intervals, and no person had a power to appoint any part of the property to any person other than the surviving spouse. Thus, in each case the court held that the surviving spouse had a qualifying*56 interest for life in the property held by the "QTIP trust", as required by
The tacit premise of petitioner's second argument is that we should test the validity of the QTIP election based upon the interest that Mrs. Rapp received under the order of the probate court reforming the decedent's 1986 will. However, as discussed above, we are not bound by the order of the probate court in determining what interest in the trust passed from the decedent to Mrs. Rapp under California law.
In this case, therefore, it does not matter when the validity of the QTIP election is tested, as of the date of the decedent's death or as of the date of the election. At no time did Mrs. Rapp have a qualifying income interest for life in the trust, as defined by
Petitioner's third argument is that the order of the probate court is, in effect, a "qualified disclaimer" as defined by section 2518(b). Petitioner argues that the trustees and the guardian ad litem "consented" to the probate court's order reforming the decedent's will and, in effect, disclaimed "the right and/or power of the Trustees to accumulate income of the marital trust during Laura's lifetime." Petitioner takes this position in the *58 alternative to its position, discussed above, that the order of the probate court was "a decision of a local court upon the merits in an adversary proceeding". According to petitioner, "the effect of such a qualified disclaimer is that the income interest must be deemed to have passed from the Decedent to Laura [i.e., Mrs. Rapp]."
Respondent argues that the Court should not consider this issue, viz, whether the probate court's order meets the requirements of a qualified disclaimer under State or Federal law, because it was raised for the first time in petitioner's post-trial brief. As a result, respondent complains, the Government was deprived of an opportunity to introduce evidence at trial that would have had a bearing on the issue. In this regard, respondent notes that one of the cotrustees, Mr. David Rapp, and the guardian ad litem, Mr. Rae, were not called to testify at trial, and respondent did not examine the other cotrustee, Mr. Richard Rapp, about this issue. Respondent also raises a number of substantive issues about whether the probate court's order constitutes a qualified disclaimer under either Federal or California State law. Finally, respondent argues in the alternative*59 that, even if the order of the probate court does constitute a qualified disclaimer, Mrs. Rapp did not thereby receive a qualifying income interest for life as required by
In general, if a person makes a qualified disclaimer with respect to an interest in property, then the Federal estate, gift, and generation-skipping transfer tax provisions apply "as if the interest had never been transferred to such person." Sec. 2518(a); see sec. 25.2518-1(b), Gift Tax Regs. The interest is treated as passing directly from the transferor of the property to the person entitled to receive it as a result of the disclaimer. Sec. 25-2518-1(b), Gift Tax Regs. If property is treated as passing from the decedent to his or her surviving spouse as a result of a qualified disclaimer, then the value of the property can be included in the marital deduction. See
Petitioner raised its contention that the probate court order constituted a qualified disclaimer under section 2518 for the first time in its*60 post-trial brief. In deciding whether to permit a party to raise a new issue on brief, we must determine whether considerations of surprise and prejudice require the Court to protect the opposing party from having to face a belated issue at a time when the opportunity to present pertinent evidence is limited.
In this case, respondent received no warning, prior to petitioner's post-trial brief, that petitioner intended to contend that the probate court's order constituted a qualified disclaimer under section 2518. Also, at the time this issue was raised, respondent was foreclosed from examining the cotrustees and the guardian ad litem about the various factual elements of the definition of qualified disclaimer under section 2518(b) and
Moreover, even if we were to agree to consider this issue, we would have to find, on the basis of the record made at trial, that petitioner did not meet its burden of proving that the probate court's order constituted a qualified disclaimer. See
Petitioner's final argument is that this case is governed by the opinion of the Court of Appeals for the Ninth Circuit in Petitioner submits that the Trustees were under a fiduciary duty to commit to pay all of the income to Laura [i.e., Mrs. Rapp], both because of her need to receive such income and because it would be detrimental to her legitimate interests under the Will to pay a large estate tax at the Decedent's death.
The thrust of petitioner's argument is that the trustees are bound to pay all of the income of the trust to Mrs. Rapp*64 because otherwise the trust would not qualify for the marital deduction and the estate would be liable for estate taxes of more than $ 2 million, and that would be contrary to Mrs. Rapp's best interests. Petitioner argues that Mrs. Rapp, thus, had a "qualifying income interest for life" in the trust, as required by
In support of this argument, petitioner cites with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent person acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of like character and with like aims to accomplish purposes of the trust as determined from the trust instrument.
Petitioner's argument is based upon a misreading of the *65
The Court of Appeals found, on the basis of a fully stipulated record, that the settlor intended the trust property to constitute QTIP and to qualify for the marital deduction.
In the
Petitioner is asking this Court to do something that the Court of Appeals in
Petitioner also cites
In
For the foregoing reasons, we find that the property distributed to the testamentary trust created under the decedent's 1986 will is not QTIP and is not eligible to be included in the marital deduction claimed by petitioner for Federal estate tax purposes. To reflect that finding and concessions of the parties,
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Cite This Page — Counsel Stack
1996 T.C. Memo. 10, 71 T.C.M. 1709, 1996 Tax Ct. Memo LEXIS 16, Counsel Stack Legal Research, https://law.counselstack.com/opinion/estate-of-rapp-v-commissioner-tax-1996.