# 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)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 thre e 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.1 T he 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 Manita Cervin died intestate in 1978, and one-half of the cash

s urrender 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 admini strative 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 fr om the children, as reimbursement for the insurance

premiums paid by decedent on their behalf from th e time of his

wife’s death to his own death.

At the time of his death, Alto Cervin owned a fift y percent

undivided community interest in four parcels of real estate, and

h is children owned equal shares of the other fifty perc ent

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 estate2 At trial, the Commissioner accepted the estate’s valuation of

the two lesser-valued properties.

4 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 b ecause 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 disc ount, 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 d ecedent’s gross estate

includes one hundred percent of the insurance proceeds, but that

the estate could exclude the receivables owed by Bennett and NitaCarol, and (2) the estate was entitled to a twenty percent discount

in valuin g the two pieces of property at issue. The estate then

sought an award of litigation costs pursuant to section 7430 of the

I nternal Revenue Code, and moved for reconsideration of the

insurance proceeds issue in light of our decision in Estate of5

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 t hat 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

. P ark v. Commissioner

, 25 F.3d 1289,

1291 (5th Cir.), cert. denied

, 115 S. Ct. 673 ( 1994); H arris 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 de nial of a request for litigation costs for abuse of

discretion. N alle 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,6

we must determine to what extent Alto Cervin possessed incidents of

ownership in the three life i nsurance policies at his death. To

resolve this question, state law must be considered. S ee Treas.

Reg. § 20.2042-1(c)(5); Broday v. United States

, 45 5 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. S ee 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 t he 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 of3 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 Cav enaugh 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 B rown 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 Ce rvin’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 t he 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 onehalf of t he 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. Because8

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 consi der 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 inter est 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 A lto 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 Cervi n’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 upon9

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 u nmatured 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 det ermining 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 i s 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 as serts 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).10

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 C ourt 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 Commi ssioner’s position is not only completely without

support, it is also inconsistent with Brown v. Lee itself and would

nullif y 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 t o 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 in clude “life

insurance policies and the effects thereof.” Tex. Rev. Civ. Stat.

art. 23(1) (West 1969) (current version at Tex. Gov’t Code Ann. §11

312.011(13) (West 1988)). The Texas Supreme Court in B rown v. Lee

considered the 1957 amendments at length and noted that “the right

to receive ins urance proceeds payable at a future but uncertain

date is ‘property.’” 371 S.W.2d a t 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 owners hip 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., th e proceeds rights]

has ordinaril y been resolved by allocating one-half of the

cash surrender value to the deceased’s estate and the other

one-half, plu s ownership of the unmatured chose, to the

surviving spouse.

Id. The Commissioner asserts that this sentence sets forth the

rule that settlement of an unins ured 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 d iscern where the Commissioner finds

justification for her proposition. Support is certainly not found

in the text of the quoted sentenc e itself, for nowhere does it4 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 th is 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 mention that settlement under Texas law is accomplish ed 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 B rown v. Lee court recognized that the Texas

legislature defined property to i nclude the right to receive

insurance proceeds payable at a later date. We do not think that

the Texas Supreme Court i ntended 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

hu sband; 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. 4many 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 a ttempting to seek

compensation. The evidence shows that Manita Cervin’s heirs had an

agreement with their father not to be compensated for their onehalf interest in the policies, and the Commissioner does not argue that they were guilty of laches.

13 Indeed, the s econd 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, inclu des the

full process of administration, distribution and closing.” Black’s

L aw Dictionary 1373 (6th ed. 1990). The cash surrender value of

the policies was never distributed to Bennett Cervin and Nita-Carol14

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 atte mpts 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. I d. 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 fe deral 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 in6 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. I d. at 159-60. Analyzing S cott

, the Cavenaugh Court

held that:

Although the community property laws of California and Texas

differ in many respects, neither the IRS nor the Tax Cou rt has

produced authority confirming a meaningful variation between

California and Texas law on this issue [i.e., regarding

ownershi p of life insurance policies]. Specifically, S cott ’s

treatment of a marital communi ty 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 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.” I d

. 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 C avenaugh Court a lso cited the case of A mason v.

Franklin Life Ins. Co.

, 428 F.2d 1144 (5th Ci r. 1970), for the

proposition that “the death of [the uninsured w ife] without a

partition created a tenancy-in-common between Mr. Cavenaugh and her

estate’s designated heirs vis à vis the policy.” C avenaugh

, 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 tenancyin-common between Alto Cervin and the children that wa s created

when Manita Cervin died intestate. 6compelled by the synergy of Amason and Brown v. Lee

.

Cavenaugh , 51 F.3d at 603-04.

Despi t e 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 B rown v. Lee doe s not establish a

contrary definition of settlement, and thus the rule set forth in

Scott is applicable here.

16 The Commissioner also runs afoul the Treasury Regulat ions,

which provide an example directly on point:

For exa mple, 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 the ir son as

beneficiary but retaining the right to surrender the policy.

Und er 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 owner ship,” 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 a bove example expressly

contemplates that one-half of the value would be included in the

uninsured wife’s gross estate and still holds that the decedent17

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 t hose 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 in terest 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 d eath 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 Cerv in’s one-half

interest in the policy rights passed to Bennett Cervin and NitaCarol Cervin Miskovitch under section 45 of the Texas Probate Code

(West 1980). Section 2042(2) of the Internal Revenue Code

therefore dictates that t he Cervin estate need include only onehalf of the value of the proceeds ($65,462.88) in the gross estate7 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

accou n ts receivable of $35,268.16 from the children as

r eimbursement for the premiums paid by the decedent on the

children’s behalf.

18 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

“subs tantially justified”; (2) that the party has “substantially

prevailed” with respect to the am ount 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 th at the estate has

substantially prevailed with respect to the amount in controversy

regarding the insurance proceeds, and t he 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 est ate has not met the19

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 “substantial ly justified” means “‘justified to a

degree that could satisfy a reasonable person’ and having a

‘reasonable basis both in law and fact.’” N a lle , 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 necessar y 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 po licies is includible in the

decedent’s gr oss estate, the Commissioner runs afoul of a legal

principle set forth in a Treasury Regulation, a Revenue Ruling, and

a Nin th 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 Te xas 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 merely20

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 s tate 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

posit ion even after C avenaugh established that an insured wife’s

interest in an insurance policy may not b e settled even when her

estate tax return lists such an asset. S ee 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. S ee Na lle , 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 Commissione r’s

position was not substantially justified when she had ignored state

law that clearly supported the taxpayer’s position. S ee 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 in21

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. C f. Estate of Perry v. Commissioner

, 931

F.2d 1044, 1046 (5th Cir. 1991). Where the Commissioner elects to

litigate an untenable position of state l aw, she “does so at the

risk of incur ring 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, and22

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

jus tified 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 t erm 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 Def iciency. 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 o n August 13, 1992), L ennox 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 of23

sal es 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 s hould apply.

The Cervin estate unsuccessfully protested the Notice of Proposed

Adjustment, and t he 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-ofownership theory at some point after issuing the Notice of

Defic iency but before trial, arguing instead that the estate had

simply not presented adequate evidence to justify the twenty-five

percent discount. Relying on M inahan 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 espous ed 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 va luation 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 by24

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 M inahan

. 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 issua nce of the Notice of Deficiency did the

Commissioner abandon her reliance on the unity-of-ownership theory.

Moreover, shortly before trial the Commissioner agreed tha t 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 ab ove 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.