Opinion ID: 742603
Heading Depth: 2
Heading Rank: 2

Heading: United States v. Allen

Text: 42 The problem with the Gradow dicta is that, in its effort to escape the hypothetical posed by the taxpayer, it lost sight of the very principle the court was trying to apply; namely, the notion that adequate and full consideration under the exception to section 2036(a) requires only that the sale not deplete the gross estate. Gradow was correct in observing that it is not unreasonable to require that, at a minimum, the sale accomplish an equilibrium for estate tax purposes. Gradow, 11 Cl.Ct. at 813-14. Indeed, United States v. Allen, 293 F.2d 916, when properly construed, stands simply for that proposition. 43 In Allen, the decedent had created, and made a donative transfer of assets to, an irrevocable inter vivos trust, reserving a three-fifth interest in the income for life, her two children to receive the remainder in the entire corpus and the other two-fifths of the income. Id. at 916. Thereafter, being advised that her retention of the three-fifths of the life estate would result in the inclusion of three-fifths of the trust corpus in her gross estate at her death, the decedent sold her life estate to one of her children for a little over its actuarial value. She died shortly thereafter. Id. at 916-17. The trial court, although finding that the transfer of the life estate was made in contemplation of death, found that the consideration paid for it was adequate and full, thereby removing the property from the taxpayer's estate. The Tenth Circuit reversed. Using the language that Gradow later quoted, the Tenth Circuit determined that the adequacy of the consideration paid for the life estate should be measured not against the interest received by the purchaser, but rather by the amount that would prevent depletion of the transferor's gross estate. Id. at 918 & n. 2. 44 It does not seem plausible, however, that Congress intended to allow such an easy avoidance of the taxable incidence befalling reserved life estates. This result would allow a taxpayer to reap the benefits of property for his lifetime and, in contemplation of death, sell only the interest entitling him to the income, thereby removing all of the property which he has enjoyed from his gross estate. Giving the statute a reasonable interpretation, we cannot believe this to be its intendment. It seems certain that in a situation like this, Congress meant the estate to include the corpus of the trust or, in its stead, an amount equal in value. Id. at 918; but cf. 5 Boris I. Bittker & Lawrence Lokken, Federal Taxation of Income, Estates and Gifts p 126.3.5, at 126-27 (1993) (noting that Allen may have stretch[ed] the statutory language in a good cause). 45 Crucial to a proper reading of Allen is the factual basis of the Tenth Circuit's holding. The decedent, Maria Allen, had gratuitously transferred a remainder interest in an irrevocable trust to her two children, reserving a life estate in three-fifths for herself. Under section 811 of the 1939 Internal Revenue Code (the precursor to sections 2035 and 2036), this transaction retained the value of the full fee interest in three-fifths of the trust corpus in Maria Allen's gross estate for estate tax purposes. For this very reason, Maria Allen, at age seventy-eight, subsequently sold to one of her children her three-fifths life estate for an amount ($140,000) slightly in excess of its actuarial value ($135,000). The intended result of this sale was to remove the value of the entire fee interest in three-fifths of the trust corpus from Maria Allen's gross estate; as long as she retained the life estate, section 811 would pull the date-of-death value of her three-fifths remainder interest ($900,000) into her gross estate. Therefore, unlike the hypothetical addressed in Gradow or the facts of the case here presented, the actuarial value of the transferred interest, the life estate, would not have prevented depletion of the gross estate in Allen. See Jordan, Sales of Remainder Interests, at 699 (The conclusion in Allen that adequate consideration for the sale of a retained life estate equals the value of the trust corpus includible in the gross estate derives from the special punitive nature of section 2035 of the Code ..., and not from the proposition that the transfer of a split-interest removes the entire underlying property from the gross estate.). 12 C. In Pari Materia 46 As alluded to above, significant problems arise when adequate and full consideration is given one meaning under section 2512 and quite another for the purposes of section 2036(a). In a pair of companion cases in 1945, the Supreme Court set forth the general principle that, because the gift and estate taxes complement each other, the phrase adequate and full consideration must mean the same thing in both statutes. See Merrill v. Fahs, 324 U.S. 308, 309-11, 65 S.Ct. 655, 656, 89 L.Ed. 963 (1945) ( 'The gift tax was supplementary to the estate tax. The two are in pari materia and must be construed together.' ) (quoting Estate of Sanford v. Commissioner, 308 U.S. 39, 43-45, 60 S.Ct. 51, 56, 84 L.Ed. 20 (1939)); Commissioner v. Wemyss, 324 U.S. 303, 65 S.Ct. 652, 89 L.Ed. 958 (1945); Estate of Friedman v. Commissioner, 40 T.C. 714, 718-19, 1963 WL 1403 (1963) (The phrase 'an adequate and full consideration in money or money's worth,' common to both the estate and gift tax statutes here pertinent, is to be given an 'identical construction' in regard to each of them.) (citing Fahs, 324 U.S. at 309-11, 65 S.Ct. at 656). In Fahs, the Court observed: 47 Correlation of the gift tax and the estate tax still requires legislative intervention. [citations] But to interpret the same phrases in the two taxes concerning the same subject matter in different ways where obvious reasons do not compel divergent treatment is to introduce another and needless complexity into this already irksome situation. Id. at 313, 65 S.Ct. at 657. 48 The purpose of gift and estate taxes was articulated clearly in Wemyss: The section taxing as gifts transfers that are not made for 'adequate and full [money] consideration' aims to reach those transfers which are withdrawn from the donor's estate. Wemyss, 324 U.S. at 307, 65 S.Ct. at 655. In Wemyss, the donor received no consideration in money's worth to replenish his estate for the transfer of stock to his bride, and therefore his estate was depleted by the amount of the transfer. The bride's relinquishment of her interest in an existing trust provided no augmentation to the donor's estate. The following rule emerges: unless a transfer that depletes the transferor's estate is joined with a transfer that augments the estate by a commensurate (monetary) amount, there is no adequate and full consideration for the purposes of either the estate or gift tax. We thus come full circle to the equilibrium rule set forth in United States v. Allen and cited in Gradow. 49 The problem that appears to have vexed the Claims Court in Gradow when it considered the remainder sale hypothetical posed by the taxpayer (and the Pittman district court and the Tax Court in D'Ambrosio who chose to follow the Gradow approach) is that, believing themselves to be between the Scylla of estate tax evasion and the Charybdis of misconstruction of the gift tax statute, they looked for guidance to a line of estate tax decisions more confusing than the task they faced. In Allen, as was observed, the amount required to prevent depletion of the gross estate caused by the in contemplation of death sale of Maria Allen's retained life estate was indeed the value of the underlying estate, as that was the amount by which Maria Allen's gross estate was depleted. See note 12, supra, and accompanying text. See also Lowndes, Consideration and the Federal Estate and Gift Taxes, at 51 ([T]he estate and gift taxes limit the consideration which will prevent a taxable transfer to an adequate and full consideration in money or money's worth, that is, to a consideration which will serve as a substitute for the transferred property in the transferor's taxable estate.). The actuarial value of Maria Allen's life estate simply would not, and did not, prevent the depletion of her estate. This concern is not implicated by the sale of a remainder interest for its actuarial value. 50 The sale of a remainder interest for its actuarial value does not deplete the seller's estate. The actuarial value of the remainder interest equals the amount that will grow to a principal sum equal to the value of the property that passes to the remainderman at termination of the retained interest. To reach this conclusion, the tables assume that both the consideration received for the remainder interest and the underlying property are invested at the table rate of interest, compounded annually. Jordan, Sales of Remainder Interests, at 692-93 (citing Keith E. Morrison, The Widow's Election: The Issue of Consideration, 44 Tex. L.Rev. 223, 237-38 (1965)). In other words, the actuarial tables are premised on the recognition that, at the end of the actuarial period, there is no discernible difference between (1) an estate holder retaining the full fee interest in the estate and (2) an estate holder retaining income from the life estate and selling the remainder interest for its actuarial value----in either case, the estate is not depleted. This is so because both interests, the life estate and the remainder interest, are capable of valuation. Recognizing this truism, the accumulated value of a decedent's estate is precisely the same whether she retains the fee interest or receives the actuarial value of the remainder interest outright by a sale prior to her actual death. Id. at 691-92; Morrison, The Issue of Consideration, at 237-38. 51 Two possible objections----which are more properly directed at the wisdom of accepting actuarial factors than at the result just described----should be addressed. The first, to paraphrase the Claims Court in Gradow, is that the fee interest holder, in such a situation, might squander the proceeds from the sale of the remainder interest and, therefore, deplete the estate. See Gradow, 11 Cl.Ct. at 816 (noting that [t]he fond hope that a surviving spouse would take pains to invest, compound, and preserve inviolate all [proceeds from a sale of the remainder interest], knowing that it would thereupon be taxed without his or her having received any lifetime benefit, is a slim basis for holding the actuarial value of a remainder interest is adequate and full consideration under section 2036(a)). This objection amounts to a misapprehension of the estate tax. 13 Whether an estate holder takes the talents received from the sale of the remainder interest and purchases blue chip securities, invests in highly volatile commodities futures, funds a gambling spree, or chooses instead to bury them in the ground, may speak to the wisdom of the estate holder, see Matthew 25:14-30, but it is of absolutely no significance to the proper determination of whether, at the time of the transfer, the estate holder received full and adequate consideration under section 2036(a). If further explanation is required, we point out that Gradow itself seems to have reached the same conclusion in an earlier portion of the opinion. See Gradow, 11 Cl.Ct. at 813 (Even if the consideration is fungible and easily consumed, at least theoretically the rest of the estate is protected from encroachment for lifetime expenditures.). See also Jordan, Sales of Remainder Interests, at 695-96 & n.105; Morrison, The Issue of Consideration, at 236-44. 52 The second objection is no more availing. If a sale of a remainder interest for its actuarial value----an amount, it is worth noting, that is nothing more than the product of the undisputed fair market value of the underlying estate multiplied by an actuarial factor designed to adjust for the investment return over the actuarial period----constitutes adequate and full consideration under section 2036(a), then the estate holder successfully freezes the value of the transferred remainder at its date-of-transfer value. Accordingly, any post-transfer appreciation of the remainder interest over and above the appreciation percentage anticipated by the actuarial tables passes to the remainderman free of the estate tax. But, of course, this is a problem only if the proceeds of the sale are not invested in assets which appreciate as much (or depreciate as little) as the remainder. Moreover, those who recall the Great Depression, as well as more recent times, 14 know that assets frequently do not appreciate. Indeed, Melton's ranch did not appreciate, but rather at his death was worth less than eighty-two percent of its value when the remainder was sold. Finally, to the extent that this freeze concern is legitimate, we note, as discussed infra, that Congress, through the passage in 1987 of former section 2036(c) and, later, its 1990 repeal and the enactment then of section 2702, has spoken to the issue. 53 D. Section 2036(a)'s Bona Fide Sale Requirement 54 The magistrate judge below, and the government at oral argument, asserted that the requirement that a sale for adequate and full consideration be bona fide under section 2036(a) takes on a heightened significance in the context of intrafamily transfers. 55 Although the presumption in an intrafamily transfer is that the transfer between related parties is a gift, the presumption that an intrafamily transaction is gratuitous 'may be rebutted by an affirmative showing that there existed at the time of the transaction a real expectation of repayment and intent to enforce the collection of the indebtedness.'  Estate of Musgrove v. United States, 33 Fed. Cl. 657, 662 (1995) (citations omitted); accord Kincaid v. United States, 682 F.2d 1220, 1225-26 (5th Cir.1982); Slappey Drive Ind. Park v. United States, 561 F.2d 572, 584 n. 21 (5th Cir.1977); Dillin v. United States, 433 F.2d 1097, 1103 (5th Cir.1970). 56 Heightened scrutiny serves the purpose of allowing inquiry beyond form to the substance of transactions in order to determine the appropriate tax consequences. But here, where the intrafamily transaction comports in substance with the government's own regulations, the government would have us take the opposite approach. The government argues that we should ignore the economic reality of a remainder interest sale and decide the tax issue based solely on the identity of the parties. 57 To the extent the bona fide qualifier in section 2036(a) has any independent meaning beyond requiring that neither transfers nor the adequate and full consideration for them be illusory or sham, it might be construed as permitting legitimate, negotiated commercial transfers of split-interests that would not otherwise qualify as adequate consideration using the actuarial table values set forth in the Treasury Regulations to qualify under the exception. Such a result comports with the same construction the term is given in the gift tax regulations. The gift tax regulations prevent an ironclad operation of the gift tax statute from transforming every bad bargain into a gift by the losing party. See Weller v. Commissioner, 38 T.C. 790, 805-07, 1962 WL 1155 (1962); 5 Bittker & Lokken, Federal Taxation, at 121-31. See also id. at 126-20. Accordingly, the term bona fide preceding sale in section 2036 is not, as the government seems to suggest, an additional wicket reserved exclusively for intrafamily transfers that otherwise meet the Treasury Regulations' valuation criteria. The government implicitly asserts that the term bona fide in section 2036(a) permits the IRS to declare that the same remainder interest, sold for precisely the same (actuarial) amount but to different purchasers, would constitute adequate and full consideration for a third party but not for a family member. This construction asks too much of these two small words. In addition to arguing that adequate and full consideration means different things for gift tax purposes than it does for estate tax purposes, the government would also have us give bona fide not only a different construction depending on whether we are applying the gift or estate tax statute, but also different meanings depending upon the identity of the purchaser in a section 2036(a) transaction. We do not believe that Congress intended, nor do we believe the language of the statute supports, such a construction. 58 Certainly an intrafamily transfer----like any other----must be a bona fide sale for the purposes of section 2036(a). But assuming, as we must here, that a family member purports to pay the appropriate value of the remainder interest, 15 the only possible grounds for challenging the legitimacy of the transaction are whether the transferor actually parted with the remainder interest and the transferee actually parted with the requisite adequate and full consideration. Accordingly, we do not find convincing the government's position that the term bona fide as used in section 2036(a) presents an adequate basis for imposing a dual system of valuation under the statute. E. IntraFamily Transactions 59 At oral argument the government pursued a line of reasoning not fully anticipated by their brief's Gradow /no-bona-fide-transaction theory. Stated concisely, the government asserted that, because the purpose of section 2036(a) is to reach those split-interest transfers that amount to testamentary substitutes and include the underlying asset's value in the gross estate, the adequate and full consideration for intrafamily transfers----which are generally testamentary in nature because the interest passes to the natural objects of one's bounty in the next generation----must be measured against the entire value of the underlying asset in order to accomplish section 2036(a)'s purpose. 16 This argument is necessarily at odds with Gradow 's fundamental principles of grammar approach that rested on a construction of the bona fide sale exception that did not purport to distinguish between either the identity or the subjective intent of the parties. 17 We reject the government's proffered construction as not supported by the statutory language. 60 Moreover, a policy-based argument to preclude intrafamily transfers of split-interests for full actuarial value if the transaction appears to have been undertaken in contemplation of death embraces a concept that the Congress chose to abandon twenty years ago----the notion that the subjective intent of an asset holder should determine the tax consequences of his transfer. 61 Given the similarity between the government's argument and the old gift-in-contemplation-of-death scheme, a brief review is appropriate. Recognizing that the most obvious way to defeat the estate tax would be through inter vivos gifts, the estate tax, from its inception, contained a provision including in the gross estate certain inter vivos transfers intended to take effect in possession or enjoyment at or after the decedent's death and those made in contemplation of death. 5 Bittker & Lokken, supra, at 126-30 (citing Revenue Act of 1916, Pub.L. No. 271, 39 Stat. 756). Although the Federal Gift Tax, enacted in 1932, reduced the tax avoidance possible through the use of inter vivos transfers, its lower rates and separate exemptions continued the need for estate tax treatment of gifts made in contemplation of death. Id. at 126-31. Accordingly, Congress enacted the predecessor to section 2035 to reach inter vivos transfers of property used as substitutes for testamentary dispositions. Hope v. United States, 691 F.2d 786, 790 (5th Cir.1982) (citing United States v. Wells, 283 U.S. 102, 115-20, 51 S.Ct. 446, 451-52, 75 L.Ed. 867 (1931)). Death was  'contemplated' within the meaning of the statutory presumption if the dominant motive for the transfer [was] the creation of a substitute for testamentary disposition designed to avoid the imposition of estate taxes. Id. (citation omitted). In 1976, Congress amended section 2035 to omit the contemplation of death provision, placing in its stead an absolute rule including in the gross estate all gifts made by the decedent within three years of death. 18 The congressional intent----relevant to the present case as well----was patent: 62 Congress was troubled by the inordinate number of lawsuits by taxpayers who attempted to establish life motives for transfers otherwise taxable under the statute. The statutory change in section 2035 bore a rational relationship to a legitimate congressional purpose: eliminating factbound determinations hinging upon subjective motive. Estate of Ekins v. Commissioner, 797 F.2d 481, 486 (7th Cir.1986) (citing H.R.Rep. No. 94-1380, 94th Cong., 2d Sess. 12 (1976), reprinted in 1976 U.S.C.C.A.N. 2897, 3366) (emphasis added)); Hope, 691 F.2d at 788 n. 3 (same). 63 Section 2035 was amended again in 1981 to eliminate the three year rule, subject to certain exceptions, for persons dying after 1981. The Economic Recovery Act of 1981, Pub.L. 97-34, Title IV, §§ 403(b)(3)(B), 424(a), 95 Stat. 301, 317; § 2035(d)(1). 19 64 It is safe to say that, with the possible exception of gifts causa mortis, the present transfer tax scheme eschews subjective intent determinations in favor of the objective requirements set forth in the statutes. Therefore, section 2036(a) permits the conclusion that a split-interest transfer was testamentary when, and if, the objective requirement that the transfer be for an adequate and full consideration is not met. Section 2036(a) does not, however, permit a perceived testamentary intent, ipse dixit, to determine what amount constitutes an adequate and full consideration. Unless and until the Congress declares that intrafamily transfers are to be treated differently, see I.R.C. §§ 2701-2704 (West Supp.1996) discussed below, we must rely on the objective criteria set forth in the statute and Treasury Regulations to determine whether a sale comes within the ambit of the exception to section 2036(a). The identity of the transferee or the perceived testamentary intent of the transferor, provided all amounts transferred are identical, cannot result in transfer tax liability in one case and a tax free transfer in another. 20 F. Former Section 2036(c) and Chapter 14 65 The final obstacle preventing our acceptance of the government's construction of section 2036(a) is Congress' enactment of section 2036(c) in 1987 and its retroactive repeal and enactment of chapter 14 in 1990. Although we are not faced with the need to determine the applicability of the 1990 estate freeze provisions to the facts of this case, 21 we find that the abuses of the type which the government perceives in the challenged transaction were addressed by Congress when it passed section former 2036(c) in 1987 and, subsequently in 1990, when it chose to replace former section 2036(c) with the special valuation rules of chapter 14. 66 Congress enacted former section 2036(c) in 1987 to address certain estate freezing techniques 22 enabling taxpayers to take advantage of the assumptions underlying the valuation tables in the Treasury Regulations. Omnibus Budget Reconciliation Act of 1987, Pub.L. No. 100-203, 101 Stat. 1330-1431; see also Mitchell M. Gans, GRIT's, GRAT's and GRUT's: Planning and Policy, 11 Va. Tax Rev. 761, 791 & n.63 (1992). Under the terms of former section 2036(c), the exception contained in subsection [2036](a) for a bona fide sale shall not apply to a transfer described in paragraph (1) if such transfer is to a member of the transferor's family. I.R.C. § 2036(c)(2) (West 1989), repealed by P.L. 101-508, sec. 11601, 104 Stat. 1388 (1990). See also id. at § 2036(c)(3)(B) (defining family to include a relationship by legal adoption). 23 A paragraph (1) transfer involved a transfer by the holder of a substantial interest in an enterprise while retaining an interest in the income or rights of the transferred enterprise. Former § 2036(c)(1)(A)-(B). Although enterprise as used in the legislative history and the subsequent interpretation offered by the IRS was capable of a more restrictive application, the reach of former section 2036(c) could have potentially embrace[d] almost any activity relating to property held for personal use as well as business or investment property. Karen C. Burke, Valuation Freezes after the 1988 Act: The Impact of Section 2036(c) on Closely Held Businesses, 31 Wm. & Mary L.Rev. 67, 91 (1989) (citing H.R. Conf. Rep. No. 495, 100th Cong., 1st Sess. 996, reprinted in 1987 U.S.C.C.A.N. 2313-1245, 2313-1742; I.R.S. Notice 89-99, 1989-38 I.R.B. 4); Bruce Bettigole, Use of Estate Freeze Severely Restricted by Revenue Act of '87, 68 J. Tax'n 132, 133 (1988) (Read literally, this provision would destroy the effectiveness of sales of remainder interests.... [B]ecause of the client's retained interest in the 'enterprise' (i.e., property), upon his death the full fair market value of the remainder interest will be included in his gross estate.). 67 In response to severe criticism of former section 2036(c) passed in 1987, Congress enacted the Omnibus Budget Reconciliation Act of 1990, Pub.L. No. 101-508, 104 Stat. 1388, which repealed former section 2036(c) retroactively and replaced it with the valuation rules set forth in I.R.C. sections 2701-2704. See 5 Bittker & Lokken, supra, 136-3 to 136-4. Under section 2702, transfers of interests in trust to a member of the transferor's family trigger special valuation rules. 24 The general rule of section 2702 values the remainder interest transferred as having the value of the full fee interest by setting the value of the retained interest at zero. I.R.C. § 2702(a)(2). In other words, the general rule of section 2702 seems to accomplish, explicitly, precisely what the government argues that 2036(a) accomplishes by implication. 25 Because there are overwhelming indications that the estate freeze provisions adopted by Congress in 1990 were designed to address the perceived shortcomings of section 2036(a), we find unconvincing the government's suggestion on brief that there is nothing in [section] 2702 or its legislative history indicating that a transfer with a retained life estate, even if within [section] 2702, was not already subject to the provisions of [section] 2036(a). 68 Accordingly, we hold that the sale of a remainder interest for its actuarial value as calculated by the appropriate factor set forth in the Treasury Regulations constitutes an adequate and full consideration under section 2036(a).