1 26 U.S.C. 2056(b)(7) (1988). United States Court of Appeals,

Fifth Circuit.

No. 92–4196.

ESTATE OF Arthur M. CLAYTON, Jr., Deceased, Mary Magdalene Clayton and The First

National Bank of Lamesa, Independent Co–Executors, Petitioners–Appellants,

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent–Appellee.

Nov. 17, 1992.

Appeal from a Decision of the United States Tax Court.

Before POLITZ, Chief Judge, and WISDOM and WIENER, Circuit Judges.

WIENER, Circuit Judge.

This federal estate tax case concerns the eligibilit y, for purposes of the Marital Deduction, of

that portion of a legacy in trust for the benefit of the surviving spouse for which a timely Qualified

Terminable Interest Property (QTIP) election was made by the surviving spouse in her capacity as

Independent Executrix. On appeal Petitioners–Appellants, Mary Magdalene Clayton (Surviving

Spouse) and The First National Bank of Lamesa (the Bank), as I ndependent Co–Executors of the

Estate of Arthur M. Clayton, Jr. (Testator), seek reversal of the Tax Court's holding that the porti on

of the residue of Testator's est at e passing to a trust created in the testament for the benefit of

Surviving Spouse (Trust B) is not eligible for a marital deduction because a provision in the testament

specifies that any porti on of the residue for which a t imely QTIP election is not made will pass to and

constitute a part of the corpus of another trust created in the testament (Trust A).

The Co–Executors contend that the Tax Court's holding, sustai ning the position of

Respondent–Appellee, the Commissioner of Internal Revenue (the Commissioner), that the subject

testamentary provision is "tantamount" to a proscribed power of appointment, cannot be squared with

the plain language of the QTIP provision 1 of the United States Internal Revenue Code of 1954, as2 26 U.S.C. §§ 1–9602.

3 Pub.L. No. 97–34, § 403(d), 95 Stat. 172, 302. amended (the Code), 2 which was added to t he Co de by t he Economic Recovery Act of 1981

(ERTA). 3 Considering the same uncontested, straightforward facts upon which the Tax Court made

its legal determination, we reach precisely the opposite conclusion. For the reasons set forth below,

we reverse the Tax Court's judgment and hold that the porti on of the residue of Testator's estate for

which the t imely QTIP election was made and which passes to and constitutes the corpus of Trust

B is eligible for the marital deduction. We therefore remand this case to the Tax Court to redetermine

the estate tax deficiency, if any, after allowin g t he marital deduction consistent herewith, and to

calculate the net amount of estate tax and interest, if any, that is due and owing to the Commissioner

from the estate of the Testator—or vice versa—after thus redetermining the deficiency.

I

FACTS AND PROCEEDINGS

The facts found by the Tax Court, largely on the basis of stipulations, reflect that Testator,

a Texas domiciliary, died there on December 22, 19 87, survived by Surviving Spouse (his second

wife) and his four children from his first marriage. Testator had executed a Last Will and Testament

(the Will) on April 8, 1982, and a First Codicil (the Codicil) to the Will on June 23, 1982. In the Will,

Testator created several

t rusts, two of which are for the benefit of Surviving Spouse during her

lifetime: The first, Trust A, is a "Credit Shelter Trust" to be funded with properties or interests in

properties from the Testator's estate equal in value to the amount exempt from federal estate tax by

virtue of the Unified Credit.

The second trust, Trust B, is a "Marital Deduction Trust" or "QTIP Trust" to be funded with

that portion of the residue of Decedent's estate for which a t imely QTIP election is made. Trust B

is created for the benefit of Surviving Spouse "for and during the rest of her life." Upon her death,

the remainder of Trust B is to "be added to and become part of the corpus of Trust "A', for the use

and benefit of [Testator's] then living children." It is undisputed that Trust A is ineligible for the

Marital Deduction.4 See IRC § 2518.

Central to the instant case is Article THIRD, paragraph D of the Will:

In the event my executors fail or refuse to make the election under Secti on 2056(b)(7)(B)(II)(v) of the Internal Revenue Code of 1954, as amended [QTIP election],

with respect to my Trust "B" property on the return of tax imposed by Section 2001 of the

Internal Revenue Code of 1954, as amended, then the property with respect to which such

election was not made shall pa ss t o and become a part of the corpus of Trust "A" for the

benefit of my Trust "A" beneficiaries.

Also c ent ral t o the instant case is the mandate in Article SIXTH, paragraph A of the Will,

regarding current income of Trust B:

[I]n no event shall the amount distributable by my tru st ees from Trust "B" to [Surviving

Spouse] during any year be less than the current net income, to include all taxable net income

under the [Code] as then existing, of Trust "B" during that year.

[In the Will, Testator also (1) leaves lesser assets to Surviving Spouse outright; (2) specifies that if

Surviving Spouse should make a "qualified disclaim er" 4 of any porti on of the Trust B assets such

porti on would pass to and form part of the corpus of yet a third trust, for the benefit of Testator's

chil dren; and (3) gives Surviving Spouse the power to appoint assets of various trusts in favor of

Testator's children, both by deed during her lifet ime or by her Last Will, but specifies that the power

of appointment by deed during her lifet ime could not be exercised with respect to assets of Trust "B";

neither could those powers of appointment be exercised in favor of Surviving Spouse, her estate, her

creditors, or the creditors of the estate.]

In paragraph V. of Article EIGHTH of the Will, Testator spells out his intentions concerning

QTIP treatment of Trust B property :

It is my intention that the assets of the Trust "B" be eligible to be treated, for federal estate

tax purposes, as a [sic] "qualified terminable interest property " within the meaning of Section

2056 of the Internal Revenue Code, as amended. In no event shall my Trust "B" trustees be

deemed to have any authority or power over Trust "B" assets which would prevent Trust "B"

assets from bein g eligible to be treated as qualified terminable trust [sic] properties, if my

executors make the timely election to have such properties treated as such.

The Will nominates Surviving Spouse and the Bank to serve as co-trustees of all trusts created

therein and as Independent Co–Executors. In both instances t he Will specifies that if Surviving

Spouse does not or cannot serve, the Bank is to serve alone. The Co–Executors are granted the same

powers, duties, privileges, authorities, and responsibilities as those granted to the co-trustees under5 Internal Revenue Service Tech.Ad.Mem. 86–31–005 (Apr. 23, 1986), reprinted in 1 Fed.Est.

& Gift Tax Rep. (CCH ¶ 7533.30, p. 9444). the terms of the Will.

In due course following the death of Testator, an Application for Probate of a Written Will

and for Letters Testamentary (the application) was filed in the proper court. In an apparent effort to

comply with the po sit io n o f the Internal Revenue Service (IRS) announced in a 1986 Technical

Advice Memorandum, 5 the application requested:

That the qualification of the [Bank] as an Independent Co–Executor be deferred until it makes

and files its oath as required by law after the estate's Federal Estate Tax Return has been filed,

and the time for t imely filing of the return has expired.... The request is made that Letters

Testamentary issue first to [Surviving Spouse] as sole independent executrix of the est at e upon her making and filing her oath, and that when the [Bank] as Independent Co-executor

shall qualify by filing its oath, new Letters Testamentary shall issue to [Surviving Spouse and

the Bank] as Independent Co–Executors of the estate.

The Will was admitted to probate and issuance of Letters Testamentary was authorized by

an order which states that Surviving Spouse and the Bank are qualified t o act as Independent

Co–Executors and to receive Letters Testamentary. In conformity with the application, however, that

order directed that init ially Letters Testamentary issue only to Surviving Spouse as sole Independent

Executrix until such time as the Bank should execute and file its oath as required by law, following

the filing of the estate's Federal Estate Return, Form 706, at which time new Letters Testamentary

would be issued to Surviving Spouse and the Bank as Independent Co–Executors. When new Letters

Testamentary were eventually issued jointly to Surviving Spouse and the Bank as Co–Executors, the

Form 706 had already been prepared, signed by Surviving Spouse as sole Independent Executrix, and

mailed to the appropriate office of the IRS together with payment of the estate taxes as calculated

on the Form 706.

When Surviving Spouse executed the Form 706 as sole Independent Executrix, she checked

the appropriate box on Schedule M, "Bequests, etc. to Surviving Spouse," required to elect "to claim

a marital deduction for Qualified Terminable Interest Property (QTIP) under Section 2056(b)(7)."

The total value of deductible property interests left outright to Surviving Spouse (for which a QTIP

election was neither required nor appropriate) was $78,950.00; the total value of terminable interest6 See IRC §§ 6214, 7442.

7 Estate of Clayton v. C.I.R., 97 T.C. 327 (1991).

8 See IRC § 7483.

9 See id. § 7482.

10 McIngvale v. C.I.R., 936 F.2d 833 (5th Cir.1991). property for which the QTIP election was made was $1,077,635, being the value of an undivided

.563731 interest in specified bonds, notes and cash listed on Schedules B and C of the Form 706 (the

securities). Thus, the total amount claimed as the marital deduction was $1,156,585.

The Commissioner's decision to disallow the Marital Deduction to the extent claimed by the

estate for the undivided .563731 interest in the securities—for which the QTIP election was timely

made—is reflected in a statement contained i n t he Notice of Deficiency issued by the IRS to

Surviving Spouse and the Bank as Independent Co–Executors: "the marital deduction is $78,950.00

rather than $1,156,585.00 as reported on the Estate Tax Return. Accordingly, the reported taxable

estate is increased $1,077,635.00." In response to the Commissioner's Notice of Deficiency, t he

Co–Executors filed a timely petition for redetermination in the Tax Court, the proper court to hear

such cases. 6 That court's opinion was filed on September 16, 1991, 7 and its decision was entered on

December 18, 1991, finally disposing of the lone contested issue of the case. The Co–Executors, on

behalf of the estate, t imely filed a Notice of Appeal to this court, 8 which has jurisdiction to review

such cases. 9

II

ANALYSIS

A. Standard of Review

"Our standard of review for appeals from the United States Tax Court is th e same as for

appeals from the district court: We review findings of fact for clear error and legal conclusions de

novo. " 10 As the facts of the instant case are largely stipulated and totally undisputed, our standard

of review of the facts thus found is not a matter of concern. The issue we here review is a purely

legal one.11 See generally 5 B ORIS I. B ITTKER

, F EDERAL T AXATION OF I NCOME

, E STATES AND G IFTS

(1984 & Cum.Supp. # 2, 1992); 4 J ACOB R ABKIN & M ARK H. J OHNSON

, F EDERAL I NCOME

, G IFT

AND E STATE T AXATION (MB, 1963 & Supp.1992); 239–4th J EFFREY N. P ENNEL

, T AX

M ANAGEMENT : E STATES

, G IFTS

, AND T RUSTS P ORTFOLIOS : E STATE T AX M ARITAL D EDUCTION

(BNA, Inc. 1992). B. Issue

Like the uncontested facts of this case, the sole legal issue before us is a straightforward one.

As posed by the Tax Court, "[t]he issue in this case is whether an estate tax marital deduction should

be allowed for the property in Trust B for which a t imely election was made pursu ant to Secti on

2056(b)(7)." Thus stated, the issue is concise but only skeletal; the true substance of that issue is

encapsulated entirely in the previously quoted provision from Article THIRD, paragraph D, of the

Will, which specifies that any porti on of the residue of the estate for which the executor does not elect

QTIP shall pass to and become a part of the corpus of Trust A, a trust concededly not eligible for

QTIP treatment. Posed even more precisely, the question we must answer is "Does the effect of that

testamentary provision, causing the undivided interest in the securities for which the QTIP election

is not made to be excluded from the corpus of Trust B (the QTIP Trust) when it is funded, so taint

the entire residuary bequest that the value of the undivided interest in those assets for which the QTIP

election is made and which will form the corpus of Trust B when funded cannot be eligible for the

marital deduction?"

C. Estate Tax Marital Deduction: An Historical Perspective

This case is ultimately decided on the legal meaning of the plain and unambiguous words of

the Will and Code § 2056. This is a true "eight-corners" case, determinable within the four corners

of the W ill and t he four corners of the statute. Nevertheless, Code § 2056 as the sole statutory

well-spring of the estate tax marital deduction (the Marital Deduction)—as well as both the general

exception thereto (the terminable interest) and the one among the several exceptions to that general

exception for terminable interests with which we are here co ncerned (QTIP)—can be completely

understood and appreciated only when vi ewed in the perspective of their collective historical

development. 11

From 1916 to 1942, the federal estate tax law took into account t he differences between12 See B ITTKER

, supra note 11, at 129–3 & 4.

13 See § 402, Revenue Act of 1942, 56 Stat. 798.

14 B ITTKER

, supra note 11, at 129–4.

15 Fernandez v. Wiener, 326 U.S. 340, 66 S.Ct. 178, 90 L.Ed. 116 (1945).

16 B ITTKER

, supra note 11, at 129–5. Some have suggested that this treatment in the Revenue

Act of 1942 and its approbation by the Supreme Court in Fernandez v. Wiener can only be

understood in the context of the extreme fixation of Congress on raising revenue to finance the

war effort for World War II, and the equally pervasive patriotism of those times, which even

seeped uphill to the Supreme Court. How else, they ask rhetorically, could one explain that the

majority opinion in Korematsu v. United States, 323 U.S. 214, 65 S.Ct. 193, 89 L.Ed. 194

(1944), the landmark case condoning internment of Americans of Japanese ancestry, was written

by Associate Justice Hugo Black, one of the most ardent and active advocates of the Bill of

Rights and individual freedoms ever to sit on the Court.

17 Revenue Act of 1948.

18 R ABKIN & J OHNSON

, supra note 11, at 53–33. co mmunit y property states and common law states. Abiding by state law, however, produced a

disparity between community property states and common law states. 12 The first effort of Congress

to eliminat e that disparity was included in the 1942 amendments to the Inter nal Revenue Code of

1939. 13 As a result of the 1942 enactment, however, the value of the entire community property was

taxed in full in the estate of the first spouse to die. 1 4 Rather than creating equality, the 1942

enactment put married couples residing in community property states at a distinct disadvantage.

Despit e t his new geographical disparity [between community property and common law

states], the Supreme Court upheld the constitutionality of the 1942 Economic Source Rule

in Fernandez v. Weiner, [sic] 15 decided in 1945. 16

In the first major tax bill after World War II, 17 Congress undid the result of Wiener, which had

been so unpalatable to community property states, enacting for the first time the "new concept of

"estate-splitting' as a corollary to "income-splitting' between husband and wife." 18 The vehicle

employed for so doing was the Marital Deduction.

The original Marital Deduction was quite obviously a device designed to allow estate

"equalization," i.e., to recognize the 50–50 situation in community property jurisdictions while

allowing common law couples to equalize, through the Marital Deduction, their combi ned estate19 B ITTKER

, supra note 11, at 129–6.

20 See id. at 129–17.

21 Id. at 129–16. (emphasis added)

22 Tax Reform Act of 1976, Pub.L. No. 94–455, 94th Cong., 1st Sess. (1976) U.S.Code Cong.

& Admin.News 1976, p. 2897 (hereinafter 1976 TRA). irrespective of which spouse was actually the wealthier. 19 An essent ial feature of the Marital

Deduction from its very beginning, however, was that any property of the first spouse to die that

passed untaxed to the surviving spouse should be taxed in the estate of the surviving spouse. This

concept persists to the present time; and it is an indispensable ingredient of the result we reach today.

A corollary of taxability in the estate of the surviving spouse was and remains the exclusion

of "terminable interests" from the category of properties for which the Marital Deduction is available.

An interest that terminates does not form part o f t he deat h estate of the surviving spouse, so if a

terminable interest in property were deductible in the first estate, such property would escape tax in

the estates of both spouses. 20 Thus, in 1948 and today, "[t]o qualify for the Marital Deduction, an

interest in property must

... avoid being disqualified by a complex set of rules relating to "terminable

interests'. " 21 As shall be shown, however, a number of exceptions to the terminable interest exception

are recognized.

In 1976 Congress liberalized the Marital Deduction significantly by establishing dual

yardsticks for measuring the maximum est ate tax Marital Deduction. 2 2 For decedents dying after

December 31, 1976, the maximum Marital Deduction was the greater of $250,000 or one-half of the

adjusted gross estate. Nevertheless, many other features of Code § 2056, including the unavailability

of the Marital Deduction for terminable interest property

, remained essentially unaffected by the TRA

of 1976.

D. Backdrop for QTIP

During the five years following 1976 no statutory changes of particular signifi cance to the

Marital Deduction occurred. The stage was set, however, for t he mo st dramatic and expansive

liberalization of the Marital Deduction in history. Not surprisingly, the overarching consideration of23 R ABKIN & J OHNSON

, supra note 11, at 53–33.

24 See generally, B ITTKER

, supra note 11, at 129–58 to 129–65.

25 Id. at 129–6. the sweeping Marital Deduction changes of 1981 was the resurgence of the decades-old concept of

marital property as the unitary estate of both spouses, and 1948's "new concept" for "estate-splitting"

as a corollary to "income-splitting" between husband and wife. 23

Leading to the 1981 enac t ment of ERTA was the burgeoning realization that an

ever-increasing number of testators were encountering a serious dilemma: They could not provide

maximum lifet ime benefits to their surviving spouses and, at the same time, control who would be the

ultimate recipients of the property after the death of the surviving spouse. Congress recognized that

the ranks of such testators included a growing number of those who expect to be survived by children

of a first marriage and by a spouse of a subsequent marriage. Under pre–1982 Marital Deduction

rules, particularly the one prohibiting the deduction of terminable interests, such a testator faced a

classic Catch–22 decision: He could either 1) provide maximum financial benefits and security for

the surviving spouse but only at the risk that the survivor might waste the property or appoint it to

successors other than the children o f t he t est ator's first marriage; or 2) ensure that the property

would devolve to his children of a prior marriage (or other objects of his bounty) but at the cost of

losing the Marital Deduction and risking underendowment o f the surviving spouse. Even the

pre–1982 vehicle of the power-of-appointment marital trust would not allow such a testator to ensure

ultimate inheritance by children of his first marriage. 24

The strong sense of Congress was that if the concept of the marital property regime as a single

unit, preservable intact until the death of the second spouse, was to realize its full potential, something

truly new and in no vat ive would be required. None can quarrel with that description of the

fundamental change in the Marital Deduction wrought by ERTA: the u nlimited Marital Deduction.

"Congress flew into the wild blue yonder in 1981 by exempting all transfers bet ween husband and

wife

... subject [only] to rules

... to insure [sic] that the exempted property will be taxed if and when

the surviving spouse disposes of it by gratuitous transfer, whether inter vivos or at death." 2526 See, e.g., H.Rep. No. 97–201, 97th Cong., 1st Sess., at 159–60, reprinted in 1981–2 CB

352, 377–78 U.S.Code Cong. & Admin.News 1981, p. 105: "[T]he committee ... believes that an

individual should be free to pass his entire estate to a surviving spouse without the imposition of

any additional tax.... In addition, the committee believes that [such a] simplification of the estate

and gift taxes can be achieved by allowing an unlimited deduction for transfers between

spouses.... In addition, the committee believes that present limitations on the nature of interests

qualifying for the marital deduction should be liberalized to permit certain transfers of terminable

interests to qualify for the marital deduction.... [U]nless certain interests which do not grant the

spouse total control are eligible for the unlimited marital deduction, a decedent would be forced

to choose between surrendering control of the entire estate to avoid imposition of estate tax at his

death or reducing his tax benefits at his death to insure [sic] inheritance by the children. The

committee believes that the tax laws should be neutral and that tax consequences should not

control an individual's disposition of property.... Nevertheless, the committee believes that

property subject to terminable interests qualifying for the marital deduction should be taxable, as

under present law, upon the death of the second spouse (or, if earlier, when the spouse disposes

of the terminable interest in such property)." See, also, 127 C ONG .R EC . 17,289 (July 24, 1981)

(statement of Senator Symms). "Mr. President, the tax bill we are currently considering has

incorporated some major estate tax reforms.... However, the enactment of an unlimited marital

deduction without any change being made in the qualitative requirements for qualification would

present an estate owner a difficult choice in many cases.... The point becomes more significant as

divorce and remarriage increase, which has occurred. The property owner would like to be sure

that upon the death of his spouse his children by a prior marriage or marriages share in his

property, including the marital deduction property.... However, for the substantial property

owner who must pay a tax if the marital deduction is not used[,] the inability to satisfy each of

two objectives—postponing payment of tax and being able to control the disposition of the

property—remains and the tax pull would be substantial to make maximum use of the deduction.

A qualification test for marital deduction purposes which eliminates the general power of

appointment requirement would permit satisfaction of both objectives and provide more flexibility

in estate planning.... Yes, Mr. President, the Treasury supports the amendment." Thus, to retain the "article of faith" that property which i s untaxed in the estate of the first

spouse to die must be taxable in the estate of the surviving spouse, Code § 2056's general denial of

marital deduction treatment for terminable interests was preserved as an exception to the new general

rule of unlimit

ed deductibility of i nt erspo usal transfers. Even so, Congress realized that, without

something else, the afor esaid dilemma would persist for many testators. The well-verbalized

realization by Congr ess 26 t hat married testators—particularly those with children of a former

marriage—would be left with a Hobson's Choice as long as terminable interest property was ineligible

for the Marital Deduction, prompted genuine creativity. Out of thin air and from the whole cloth,

Congress invented a brand new, theretofore unseen concept: Qualified Terminable Interest Property.

If "unlimit

ing" the Marital Deduction was a flight into the wild blue yonder, Congress truly "slipped27 John Gillespie Magee, Jr., High Flight, reprinted in B ERKE B REATHED

, B LOOM C OUNTY

B ABYLON : F IVE Y EARS OF B ASIC N AUGHTINESS 96 (1986). the surly bonds of earth" 27 with the advent of QTIP.

E. Qualified Terminable Interest Property

In the perspective of the long history of continual expansion and liberalization of the Marital

Deduction during the decades since its introduction in 1948, and against the backdrop of the adopti on

in 1981 of the unlimited marital deduction, the intent, function and purpose of QTIP is not difficult

to discern. Unmistakably, the Marital Deduction is the embodiment of a strong public policy. By

itself, ERTA's removal of the dollar and percentage limitations on the Marital Deduction to make it

"unlimited" was purely quantitative. Although transfers to the surviving spouse in outright ownership

or fee simple title were freed of all quantitative limit s, other categories of property—principally

terminable interests—would remain totally excluded from deductibility unless something qualitative

were done. QTIP was invented to produce the desired qualitative expansio n o f t he classes of

property eligible for the Marital Deduction, i.e., to extend, for the first time ever, the availability of

the Marital Deduction to those types of terminable interests in property that Congress dei g ned to

"qualify." Hence the moniker "qualified terminable interest property" and the acronym "QTIP."

As thus created by Congress, QTIP is an exception-to-the-exception for non-deductibility

of terminable interests in general. And, as is universally recognized and applauded, Congress

accomplished this revolutionary change using uncommonly clear and cohesive language, particularly

for tax provisions, with the insertion of subsection (b)(7) in Code § 2056.

1. Statutory Scheme

Subsection (a) of Code § 2056 states the broad, general grant of a deduction from the estate

of the first spouse to die. The amount of the deduction is the value of any interest in property which

passes or has passed from the decedent to the surviving spouse, to the extent that such i nterest i s

included in determining the value of the decedent's gross estate.

Subsection (b) of Code § 2056 expresses the general, terminable interest exception to

subsection (a)'s general grant of the deduction. As it has the effect of limiting a public policy matter,28 IRC § 2056(b)(3).

29 Id. § 2056(b)(5).

30 Id. § 2056(b)(6).

31 Id. § 2056(b)(8).

32 (7) Election with respect to life estate for surviving spouse.—

(A) In general.—In the case of qualified terminable interest property—

(i) for purposes of subsection (a), such property shall be treated as passing

to the surviving spouse, and

(ii) for purposes of paragraph (1)(A), no part of such property shall be

treated as passing to any person other than the surviving spouse.

(B) Qualified terminable interest property defined.—For purposes of this

paragraph—

(i) In general.—The term "qualified terminable 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. this exception to the unlimit ed Marital Deduction must be co nstrued narrowly. By its title, the

exception applies to a "Life Estate or Other Terminable Interest." Code § 2056(b)(1) defines

"terminable interest" and states generally that a deduction will not be allowed for such an interest.

There then follow, however, a number of particular excep t io ns to that general terminable

interest excepti o n. Part icular types of terminable interests that are in fact deductible by virtue of

b eing exceptions-to-the-exception include 1) a legacy conditioned on survivorship for a lim ited

period, 28 2) a life estate with powe r o f appointment in the surviving spouse, 2 9 3) life insurance or

annuity payments with power of appointment in the surviving spouse, 30 and 4) a charitable remainder

trust. 31 QTIP is another specific "counter-exception" to the general exception o f Co de § 2056(b)

denying a marital deduction for terminable interest property. The entire statutory concept of QTIP

is contained in Code § 2056(b)(7); as it is succinct, we reproduce the relevant portion in the

margin. 32(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.

Subclause (II) shall not apply to a power exercisable only at or after the death of

the surviving spouse. To the extent provided in regulations, an annuity shall be

treated in a manner similar to an income interests in property (regardless of

whether the property from which the annuity is payable can be separately

identified).

(iii) Property includes interest therein.—The term "property" includes an

interest in property.

(iv) Specific portion treated as separate property.—A specific portion of

property shall be treated as separate property.

(v) Election.—An election under this paragraph with respect to any

property shall be made by the executor on the return of tax imposed by section

2001. Such an election, once made, shall be irrevocable.

Id. § 2056(b)(7). 2. Important QTIP Features

A. Election. Gifts or bequests of terminable interests that appear to be eligible for the Marital

Deduction are nonetheless not automatically deductible. An irrevocable, affirmative election must

be made on the estate tax return by the executor before an apparently deductible terminable interest

meets the definition of QTIP.

It is axiomatic that any estate tax election which is not made inter vivos by the testator can

only be made (a) by someone else (b) aft er the death of the decedent. And we are aware of no

post-mortem estate tax election that is required to be made earlier than the time for filing the Form

706. In keeping with the Congressional purposes of 1) eliminating the need for t est ators to risk

predicting the future, and 2) providing both flexib ilit y and the opportunity for post-mortem estate

planning either to minimize or "optimize" the estate tax impact on the combined marital property of

the spouses, the QTIP election can be made at any time before such filing date. Still, like other estate

tax elections (and other exceptions to the terminable interest rules), the effect of the QTIP election33 B ITTKER

, supra note 11 at 129–31 (citing IRC § 2056(b)(1)(A) and Treas.Regs. §

20.2056(b)–1(e)(2)).

34 IRC § 2056(b)(7)(B)(iii).

35 Id. § 2056(b)(7)(B)(iv).

36 See B ITTKER supra note 11, at 129–61 & 62. is retroactive to the instant of death, irrespective of when it is actually made. Significantly, the party

statutorily vested with the exclusive right to make the post-m ortem QTIP election is not the surviving

spouse, as one might expect, but the executor. Congress obviously did this as an extension of the

testator's volition but with all of the guesswork removed.

Congress also recognized the need for post-mortem flexibility when it vested the executor

w ith the additional opti on of making a partial QTIP election. The election need not be "all o r

nothing"; rather, the executor may choose QTIP treatment for any percentage or share of the

property interest, from zero to 100%.

B. Property. A limitation which was clear prior to ERTA was that, "[i]n applying the

terminable interest rules, it [was] essential to honor the statutory distinction between an "interest' in

property and the underlying property itself." 33 In ERTA, Congress recognized that if this distinction

were made applicable to QTIP, it could prove unduly restrictive of the kinds of property int erest

(other than perfect ownership or fee simple title) that would be eligible for the deduction. Such a

po t ent ial restriction was eliminated by the inclusion of a new definition of p roperty. "The term

"property ' includes an interest in property ." 34 This feature dovetails with the p artial QTIP election.

C. Separate Shares. The QTIP portion of Code § 2056 35 which follows on the heels of the

definition of property mandates that "[a] specific porti on of property shall be treated as separate

property ." Like the partial election and the definition of property to include an "interest in property,"

the "separate share" concept enhances post-m o rt em flexibility and planning. "[T]he Treasury

construes the "specific portion' rule to permit the executor to elect Q–TIP treatment for a fraction

or percentage of an otherwise qualifying trust." 36 Of interest in t he inst ant case is the position

announced by the Treasury, in proposed regulations, that would permit separate trusts to be created37 Prop.Treas.Regs. § 20.2056(b)–7(b).

38 R ABKIN & J OHNSON

, supra note 11, at 53–61.

39 Id. at 53–66 (internal citation omitted).

40 IRC § 2056(a). by a partial election:

[T]he trust may be divided into separate trusts to reflect a partial election that has been made

or is to be made. 37

"[A]s

... the statute provides that "a specific porti on of property shall be treated as separate property ,'

the executor can

elect only for a portion of corpus. This greatly extends the usefulness of this

provision." 38 "In case of a qualified terminable interest property trust, "property' includes an interest

in property

, and a "specific portion' of property is treated as separate property

. Thus it is possible

to obtain the Marital Deduction for a specific porti on of the corpus of the trust for which the spouse

is entitled to the income interest." 39

D. Property Passing to the Surviving Spouse. Entitlement to the Marital Deduction for any

property

, including QTIP, requires the property pass to a person who as a matter o f law is the

"surviving spouse" of the testator. That requirement is not an issue in the instant case.

E. Property Passing from the Decedent. Another requirement of the Marital Deduction is

that property for which the deduction is claimed in fact be an "interest in property which passes or

has passed from the decedent...." 40 That the decimal int erest in the securities "passes from the

decedent" within the meaning of Code § 2056 is not in dispute here.

F. Property Included in Determining the Value of the Gross Estate. Also uncontested in the

instant case is that the value of the undivided interest in the securities was included in determining the

value of the testator's gross esta t e, as is required for any legacy to be eligible for the Marital

Deduction.

3. Definition as Substance

The position of the Commissioner and the judgm ent of the Tax Court rises or falls on the

definition of QTIP. The same is t rue for t he opposite position of the Co–Executors and for the41 IRC § 2056(b)(7)(B)(v).

holding we make today.

The Code contains a three-pronged functional definition of QTIP, which is followed

immediately by specific definitions of terms used in that tripartite definition. As the definition of

QTIP begins with the statement that " "qualified terminable interest property ' means property —," the

first step is to identify the "property" to be tested under the elements of the definition. Relying on

two specifically defined terms—that "property " includes an interest in property ; and that a "specific

portion" of property is to be treated as separate property —the Co– Executors argue that the

"property" under examination here is the separate, undivided .563731 interest in the securities that

was identified on the Form 706 as t he property to which the QTIP election applies. Relying on

n othing that has either been cited to us or that our independent research has pr oduced, the

Commissioner and the Tax Court insist t hat t he "pro perty" here under examination is the entire

residue of testator's estate, being the maximum amount of property and interests in property with

which Trust B could be funded were a total QTIP election to be made. For reasons explained in more

detail below, we agree wi t h the position of the Co–Executors and reject the position of the

Commissioner and the Tax Court.

The second step is to see if the identified "separate interest in property " (the undivided interest

in the securities for which the QTIP election was made) meets the Code's definition of QTIP. That

is done by testing it for compliance with each of the three prongs of that statutory definition.

All agree that one of those prongs, i.e., that the separate interest in property "passes from the

decedent," is met. We conclude that a second prong, is met, i.e., that the property be an interest "to

which an election under this paragraph applies." We reach that conclusion by observing that e lection

is a defined term: "An election under this paragraph in respect to any property shall be made by the

executor on the return

... [and]

... shall be irrevocable." 4 1 Here, Surviving Spouse as Independent

Executrix duly and t imely completed the Form 706, checked the appropriate box on Schedule M, and

identified the property "in respect to" which that election is made, i.e., the undivided .563731 interest

in the securities listed on Schedules B and C. Thus, the property being test ed fo r eligibility is the42 Id. § 2056(b)(7)(B)(i)(II) (emphasis added).

43 Id. § 2056(b)(7)(B)(ii)(II).

44 Estate of How ard v. C.I.R., 910 F.2d 633 (9th Cir.1990).

45 R ABKIN & J OHNSON

, supra note 11, at 53–63 (citing Treas.Reg. § 20.2056(b)–5(f)(g). See

Rev.Rule 72–283, 1972–1 C.B. 311 (first payment may be delayed until one year after trust

created). same property to which the election made by the Independent Executrix applies.

The third prong requires that the separate interest in property be one "in which the surviving

spouse has a qualifying income interest for life. " 42 This phrase too is a defined term of art: Such an

interest is one in which "the surviving spouse is entitled to all the income ... payable annually or at

more frequent intervals

... [and of which] no person has a power to appoint any part of the property

to any person other than surviving spouse." 43

Under the terms of the Will, Surviving Spouse is expressly given the right for life to receive

all income from Trust B, the corpus of which is the separate property interest in questi on. The

executors and trustees are directed to pay such income to her no less frequently than annually. Even

so, "[t]he statute does not require that each day income accumulates that the income be paid

immediately to the spouse." 44 In fact, "[n]o provision need be made for paying income before the

executor distributes the property to the trustee, ..." 45 Clearly, the annual-income-for-life element is

met even if the income is not disbursed until a year after the trust is funded—an event that can only

occur during or at the end of the orderly administratio n o f the estate. Obviously funding of every

testamentary

trust occurs after the death of the testator; the executor cannot possibly ascertain on

"day one" the amount of the income. Just as obviously, then, the beneficiary must wait a reasonable

time before the income is actually received. But receipt and entitlement are not congruent. The

requirement of life income interest is met as long as the eventual disbursements include all income

accruing from and after the moment of the testator's death.

The other definitional element of "qualifying income interest for life" is that no one may have

a power to appoint any of the property to anyone other than the surviving spouse. We have already

determined that the "property" being considered is the undivided interest in the securities for which46 Prop.Treas.Reg. § 2056(b)–7(b)(3) (41 Fed.Reg. 21, 350 March 21, 1987).

47 98 T.C. No. 47, 4976 (1992) (emphasis added). the executor made a t imely QTIP election. No reasonable reading or construction of the Will or the

statute can validate the position of the Commissioner, as endorsed by the Tax Court, that the

I ndependent Executrix's QTIP election itself is "tantamount" to a power of appointment to th e

testator's children. Clearly, the estate's entitlement to a QTIP deduction is not meant to be abrogated

simply because making a partial election for a separate interest in the property

, i.e., not making a full

election as to all interest in the property

, results in a porti on of the estate's residue—one that would

have passed to Trust B under a full election—passing to Trust A. To embrace the Commissioner's

flawed logic and deliberate disregard for the plain wording of the pertinent part of Code § 2056

would be to engage in pure sophistry.

Besides being unable to direct our attenti on to anything that might support their interpretation,

the Commissioner and the Tax Court cannot escape the effects of their own interpretative

pronouncements on the election prong of the QTIP definit io n. As shall be seen, such

pronouncements implicitly acknowledge that the election element of the definition is viewed in the

past tense, i.e., that although the effect of the election is tested as of the instant of the testator's death,

the definitional eligibility of the separate terminable interest under examination is tested as though

QTIP election had already been made.

In the Treasury's own proposed regulation interpreting the definition of QTIP, cited to us by

the Commissioner in the appendix to her brief, the Department identifies the "property " as that "which

the executor elect ed to treat as qualified terminable interest property." 46 Likewise, the Tax Court,

in citing its decision in the instant case to support its judgment in Estate of Willard E. Robertson v.

C.I.R., refers to the election element of the definition pertaining to property "for which an election

has been made." 47

4. Additional Flaw s in the Commissioner's Position

The Commissioner misses the mark by insist ing that the QTIP provision should be construed

narrowly because it is an exc e ption to the prohibition of deducting terminable interest under theMarit al Deduction. As we have noted, however, it is Code § 2056(b)'s general prohibit io n o f

deducting terminable interests that is the exception. It i s an excepti on to the broad rul e of

deductibility of interspousal transfers which in turn implements the clear will of Congress favoring,

as a matter of public policy, deferral of estate tax until the death of the second spouse—to the extent

such deferral is desired by the parties. It is that general, terminable interest exception that must be

narrowly construed. As QTIP is an exception to that exception, however, QTIP enjoys the same

favored position and liberal construction as is properly afforded to the Marital Deduction itself.

More importantly, there is nothing in the plain wording of the entire QTIP subsection which,

when viewed in light of the definition of terms therein provided, even remotely supports the position

of the Commissioner that if anything occurs after the death of t he testator—such as the QTIP

election—to prevent even a modicum of property which under the testament would have passed from

the decedent to the surviving spouse, the deduction is unavailable for all otherwise eligible property

.

To reach tha t st rained result, the Commissioner would have us ignore the overarching truism that

many acts must be done and many facts must be determined after the death of the testator in order

to determine the tax able estate. The question is not w hen those determinations are made or when

those acts are performed but whether their effects relate back, ab initio to the moment of death. For

example, a qualified disclaimer by the Surviving Spouse has precisely the effect of the QTIP election

here: Both are volit ional act s; both can be made only after the death of the testator; both relate

back, ab initio, to the date of death of the testator; and both have the effect of causing estate

property which would otherwise pass to the Surviving Spouse to pass instead directly to or for the

benefit of other parties. Likewise, while seldom volitional, the death of the Surviving Spouse within

six months following the death of the testator who conditions the legacy on survivorship would have

the same effect, but again retroactive to the moment of the testator's death.

Curiously, the Commissioner and the Tax Court appear to view QTIP legislation as some sort

of Congressional paternalism aimed at ensuring the financial stability of the surviving spouse. Clearly

such protectionism played no part in it. If the intention had been to dangle the carrot of deductibility

in front of testators to induce them to ensure the financial well-be ing of the surviving spouse,48 Clayton, 97 T.C. at 336.

Congress would surely have given the power to make the QTIP election to the surviving spouse, not

the executor. The point we here emphasize is that for tax purposes Congress was and is interested

only in that portion of terminable interest property for which the QTIP election is made; it has no

interest whatsoever in the porti on o f any terminable interest property for which the election is n ot

made. Being ineligible for the Marital Deduction, that pro perty is taxed right where the

Commissioner and Congress want it taxed—in the estate of the first spouse to die. Congress could

not care less whether the porti on of the terminable interest property for which the QTIP election is

not made goes to the surviving spouse, to the children, or to a stranger. Obviously, that is why

Congress placed the election in the definition of QTIP property

. If Congress had intended the result

advocated by the Commissioner, it could have 1) defined the property without reference to the

election, 2) specified a subsequent election, and 3) provided separately for the election to apply to

all property meeting the definition, thereby separating the election from the definition. Facially, the

statute eschews any such separation.

From whence it came we know not, but the Tax Court here made the pronouncement that the

QTIP election gave the executor "control over trust assets [that] is tantamount to a power to appoint

property that was subject to the qualifying income interest." 48 That unsubstantiated, conclusionary

stat ement can only be the product of a circular argument—one that we reject. First, the QTIP

election cannot vest the executor with control over "trust assets" before they become trust assets!

The undivided interests in the securities for which the election is made are estate assets but they do

not become trust assets until the trust is funded, even though the economic effect of funding is

retroacti ve to the instant of death. Assets used to fund each testamentary trust get there by virtue

of the provisions of the Will and the administration of the estate. The same analysis is applicable to

that porti on of the quotati on from the Tax Court's opinion that refers to property that w as subject

to the qualifying income interest. No income interest is qualifying until it meets the full definition

for QTIP, including the election prong. As we have just noted, one of the three essential elements

in the definition of such property interest is that it be property fo r which—in the Tax Court's own49 Robertson, 98 T.C. No. 47 at 4976 (emphasis added).

50 P ENNELL

, supra note 11, at C & A 5 (Supp. 8/10/92). "This is not a proper result, because

no abuse is involved, and its extrapolation from Clayton [ ] is unwarranted.... Nothing in the

government's proposed QTIP regulations anticipates or warns taxpayers about this unwarranted

result." Id. words—"an election has been made." 49

Additionally, the Commissioner appears to have seized on a gratui tous statement from the Tax

Court opinion in the instant case to bootstrap an even more adventuresome government position, i.e.,

that "any QTIP trust that pours nonelected property over is flawed, apparently even if the bypass trust

is QTIPable in its own right." 50 Such an arbitrary and unsupport ed misconstruction of the statute

cannot be justified by any reasonable reading. It can only be explained as overzealousness in revenue

collection, deliberate disregard for t he clear purpose, intent and policy behind the statute, and an

historic aversion to the Marital Deduction which is well documented in the Tax Court Reports, the

Federal Reporter System, Treasury Regulations, Revenue Rulings, Technic a l Advice Memoranda,

Private Letter Rulings, and the like.

"Loophole" is a term frequently used as a pejorative in the context of taxation. Although it

is usually reserved for taxpayers and their professional advisors, in truth the Commissioner and the

Service are no less active in probing tax statutes for loopholes. Historically, that has been part of the

game, leaving to Congress the damage control of plugging loopholes through technical amendments.

The position taken by the IRS and advocated by the Commissioner in the instant case, however, goes

beyond mere probing for loopholes overlooked by Congress. Rather, it reflects an effort to batter

such a hole in the statutory wall where none exists. We will not approbate such overreaching. From

every standpoint—history, expressed intent, logic, reading in pari materiae with other post-m ortem

provisions, and—above all—the plain language of the statute—the posi ti on of the Co–Executors

meets muster while the Commissioner's fails.

5. The End Result

Having thoroughly parsed the statute, examined the terms as therein defined and eliminated

the flawed construction of the Commissioner, we now reassemble Humpty Dumpty by reconstitutingthe statutory definition of QTIP by replacing all terms of art with their statutory, jurisprudential or

regulatory definitions:

"Qualified Terminable Interest Property mean s a separate interest in property, which was

included in determining the value of the gross estate, and (1) which passes from the decedent,

(2) from which the surviving spouse is ent it led t o all income for life, payable no less

f requently than annually, no part of which can be appointed by any person (inclu ding the

surviving spouse) to any person other than the surviving spouse, and (3) which the executor

elect ed to treat as Qualified Terminable Interest Property."

When all definitions are thus factored into the applicable Code section's tripartite definition

o f QTIP, it is clear beyond cavil that the election given to the executor by Congress is not

"tantamount" to a power of appointment, and does not divest the surviving spouse of anything about

which Congress was or is concerned. The provisions of the Will that effect the funding of Trust B

with a terminable interest in that separate decimal fraction of the estate's residual assets for which the

election is made, and which effect the funding of Trust A with that porti on of the residue for which

the election is not made (including the "other" separate interest in t he securit ies) are indisputably

effec t ive as o f t he moment of death, albeit retroactively from the time the election is made. Such

retroactivity is an expected and indispensable characteristic of all estate tax elections, not to mention

many no n-t ax aspects of Will implementation. Even though Trust B is not f unded until after the

QTIP election is made, the Surviving Spouse as QTIP beneficiary of that tr ust is entitled to and

assured of receiving every dollar of net income generated by such corpus from and after the instant

of the testator's death. Neither the corpus of that trust nor the income thereof can be appointed by

any person to any person other than the Surviving Spouse.

Congress clearly could not care less about the post-m ortem disposition of that porti on of the

residue of the testator's estate for which the QTIP election was no t made, because every dollar's

worth of that property was taxed currently in the estate of the Testator as the first spouse to di e.

That is the very reason for allowing a partial election and for treating specific portions of interests

in property separately. As such the Will and the administration of the Testator's estate, including the

partial QTIP election, met the only conditions that Congress has placed on the abilit y to defer estate

tax on a terminable interest via the Marital Deduction, i.e., that the specific porti on of the terminable

interest property for which the election is made be taxed in the estate of the surviving spouse, and thatall other property and interests in property —ter minable or not—be taxed in the estate of the first

spouse to die.

III

CONCLUSION

The Marital Deduction of Code § 2056 excludes from taxability in the estate of the fi rst

spouse to die those properties or interests in property used in calculating the gross estate that pass

from the decedent to the Surviving Spous e. Fo r decedents dying after December 31, 1981, the

Marital Deduction is unlimit ed in both quantum and share. Although the Marital Deduction is not

generally available for interspousal transfers of terminable interests in property

, Code § 2056 contains

express exceptions. One such exception exists for terminable interest property that meets the Code's

defi n ition of "qualified terminable interest property ." That exception is set forth in full in Code §

2056(b)(7), and the particular type o f t erminable interest for which the exception is

available—"qualified terminable interest property"—is defined in sub-subsection (B) thereof.

As s u b-subsection (B)(iii) defines the term "property " to include an "interest in property ";

and as sub-subsection (B)(iv) mandates that a "specific portion" of property be treated as a "separate

property ," any testing of terminable interest "property " which is the object of an interspousal transfer

must treat such interest as a specific porti on of the property

, separate and apart from the underlying

property

. Conducting such a test to determine eligibility for the Marital Deduction by virtue of being

qualified terminable interest property must begin with the statutory definition.

That definiti o n, found in sub-subsection (B)(i), opens with the statement that the term

"qualified terminable interest property " mea ns "property." Focusing on the separate interest in

property being tested in the instant case—an undivided .563731 interest in the securities listed on the

Form 706—we conclude that it meets each of the three prongs of the definition. First, it is a separate

interest in property to which the QTIP election applies. To borrow the words of the Tax Court and

the Treasury respectively, it is property "for which an election has been made" or "which the executor

elected to treat as qualified terminable interest property ." The separate interest in property here under

examination meets the "election" prong of the definition as set forth in sub-subsection (B)(i)(III).That the separate interest in property meets a second prong, the one set forth in sub-section

(B)(i)(I)—a separate interest in property "which passes from the decedent,"—is not in dispute.

The remaining prong, set forth in sub-subsection (B)(i)(II)—a separate interest in property

in which the surviving spouse has a qualifying income interest for life—is met by virtue of the

unambiguous language of the Will. The trustees of Trust B are commanded to pay all net income

generated by the corpus of that trust—beginning with the death of the testator—to the Survi ving

Spouse at least annually for the remainder of her life. Under equally unambiguous language of the

Will, the corpus of Tru st B will consist of any portion of the residue of testator's estate which the

Independent Executor elected to treat as QTIP, here the undivided .563731 inte rest in the subject

securities. Because the election and income provisions under the trust are retroactively effective, a b

initio, to the moment of the testator's death, the income interest of the Surviving Spouse covers the

period that begins with the testator's death and ends with the Surviving Spouse's death.

Moreover, by the express language of the Will, no party—including Surviving Spouse—has

the power or authority to appoint any part of the separate interest in property

, which passes from the

decedent, as to which QTIP election was made, and in which the Surviving Spouse has an annually

payable income interest for life. The Will contains no express power of appointment of the interest

for which the election is made; in fact, the Will expressly negates such possibility. And we reject out

of hand the strained construction of the partial election and its effect on the funding of t h e several

residuary trusts as being "tantamount" to a power of appointment.

Therefore we hold that the terminable interest in property for which the Marital Deduction

was taken on Testator's Form 706 by virtue of the QTIP election is eligible for that deduction. To

disallow it for the circular reasoning advanced by the Commissioner would defy logic, common sense,

and the purpose for which QTIP was designed and implemented.

We perceive no appropriate basis for the Commissioner's concern with separate interests in

property for which no election was made and for which no deduction was taken, i.e., the balance of

the residue of testator's estate, including the remaining undivided .436269 interest in the subject

securities. No QTIP election was made for it; no deduction was claimed for it; and federal estatetaxes were timely paid on it. Neither do we perceive a reason for the Commissioner's concern that

such other separate interests in property could have passed to Trust B and formed a part of the

corpus thereof if the QTIP election had been made for it. By definition, the Commissioner need only

be concerned with separate interests in property for which the QTIP election is made, not that for

which no election is made—except to see that tax is paid on it in the estate of the first spouse to die.

And the Independent Co–Executrix did that in a complete and timely manner.

Finally, as we hold that the subject clause in the Will does not make the QTIP election here

"tantamount" to a power of appointment for purposes of Code § 2056(b)(7)(B)(ii)(II), the identity

of the party or parties serving in such capacity is of no consequence. It is irrelevant that under the

Will a party other than Surviving Spouse might have served with her as Independent Co–Executor

or in her stead as sole Independent Executor.

For the foregoing reasons, the judgment of the Tax Court is reversed and the case remanded

to that court for redetermination of the estate tax deficiency in the estate of the Testator, allowing

the Marital Deduction for the qualified terminable interest property for which the Surviving Spouse,

in her capac i ty as Independent Executrix, duly made the QTIP election on the Form 706. Such

redetermination shall include consid erat io n of any other applicable adjustments not at issue in this

appeal, as well as interest.

REVERSED AND REMANDED.