Opinion ID: 592206
Heading Depth: 2
Heading Rank: 5

Heading: Qualified Terminable Interest Property

Text: 33 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 adoption 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 limits, 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 expansion of the 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 deigned to qualify. Hence the moniker qualified terminable interest property and the acronym QTIP. 34 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.
35 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 that passes or has passed from the decedent to the surviving spouse, to the extent that such interest is included in determining the value of the decedent's gross estate. 36 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, this exception to the unlimited Marital Deduction must be construed 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. 37 There then follow, however, a number of particular exceptions to that general terminable interest exception. Particular types of terminable interests that are in fact deductible by virtue of being exceptions-to-the-exception include 1) a legacy conditioned on survivorship for a limited period, 28 2) a life estate with power of appointment in the surviving spouse, 29 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 of Code § 2056(b)'s denial of 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
38 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. 39 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) after 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 testators to risk predicting the future, and 2) providing both flexibility 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 election 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-mortem 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. 40 Congress also recognized the need for post-mortem flexibility when it vested the executor with the additional option of making a partial QTIP election. The election need not be all or nothing; rather, the executor may choose QTIP treatment for any percentage or share of the property interest, from zero to 100%. 41 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 interest (other than perfect ownership or fee simple title) that would be eligible for the deduction. Such a potential restriction was eliminated by the inclusion of a new definition of property. The term 'property' includes an interest in property. 34 This feature dovetails with the partial QTIP election. 42 C. Separate Shares. The QTIP portion of Code § 2056 which follows on the heels of the definition of property mandates that [a] specific portion of property shall be treated as separate property. 35 Like the partial election and the definition of property to include an interest in property, the separate share concept enhances post-mortem 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 the instant case is the position announced by the Treasury, in proposed regulations, that would permit separate trusts to be created by a partial election: 43 [T]he trust may be divided into separate trusts to reflect a partial election that has been made or is to be made. 37 44 [A]s ... the statute provides that 'a specific portion 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 portion of the corpus of the trust for which the spouse is entitled to the income interest. 39 45 D. Property Passing to the Surviving Spouse. Entitlement to the Marital Deduction for any property, including QTIP, requires that the property pass to a person who as a matter of law is the surviving spouse of the testator. That requirement is not an issue in the instant case. 46 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 interest in the securities passes from the decedent within the meaning of Code § 2056 is not in dispute here. 47 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 estate, as is required for any legacy to be eligible for the Marital Deduction.
48 The position of the Commissioner and the judgment of the Tax Court rises or falls on the definition of QTIP. The same is true for the opposite position of the Co-Executors and for the holding we make today. 49 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 the property to which the QTIP election applies. Relying on nothing that has either been cited to us or that our independent research has produced, the Commissioner and the Tax Court insist that the property 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 with the position of the Co-Executors and reject the position of the Commissioner and the Tax Court. 50 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. 51 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 election 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. 41 Here, Surviving Spouse as Independent Executrix duly and timely 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 tested for eligibility is the same property to which the election made by the Independent Executrix applies. 52 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 53 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 question. 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 administration of 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. 54 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 which the executor made a timely 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 Independent Executrix's QTIP election itself is tantamount to a power of appointment to the 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 portion 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 of the plain wording of the pertinent part of Code § 2056 would be to engage in pure sophistry. 55 Besides being unable to direct our attention 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 definition. 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. 56 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 elected 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. Commissioner, refers to the election element of the definition pertaining to property for which an election has been made. 47 57
58 The Commissioner misses the mark by insisting that the QTIP provision should be construed narrowly because it is an exception to the prohibition of deducting terminable interest under the Marital Deduction. As we have noted, however, it is Code § 2056(b)'s general prohibition of deducting terminable interests that is the exception. It is an exception to the broad rule 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. 59 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 the 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 that strained 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 taxable estate. The question is not when 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 volitional acts; 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. 60 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-being of the surviving spouse, 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 portion of any terminable interest property for which the election is not made. Being ineligible for the Marital Deduction, that property 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 portion 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, or 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. 61 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 statement 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 retroactive 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 portion of the quotation from the Tax Court's opinion that refers to property that was 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 for which--in the Tax Court's own words--an election has been made. 49 62 Additionally, the Commissioner appears to have seized on a gratuitous 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 unsupported misconstruction of the statute cannot be justified by any reasonable reading. It can only be explained as overzealousness in revenue collection, deliberate disregard for the clear purpose, intent and policy behind the statute, and a historic aversion to the Marital Deduction which is well documented in the Tax Court Reports, the Federal Reporter System, Treasury Regulations, Revenue Rulings, Technical Advice Memoranda, Private Letter Rulings, and the like. 63 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-mortem provisions, and--above all--the plain language of the statute--the position of the Co-Executors meets muster while the Commissioner's fails.
64 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 reconstituting the statutory definition of QTIP by replacing all terms of art with their statutory, jurisprudential, or regulatory definitions: 65 Qualified Terminable Interest Property means 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 entitled to all income for life, payable no less frequently than annually, no part of which can be appointed by any person (including the surviving spouse) to any person other than the surviving spouse, and (3) which the executor elected to treat as Qualified Terminable Interest Property. 66 When all definitions are thus factored into the applicable Code section's tripartite definition of 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 portion of the residue for which the election is not made (including the other separate interest in the securities) are indisputably effective as of the 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 non-tax aspects of will implementation. Even though Trust B is not funded until after the QTIP election is made, the Surviving Spouse as QTIP beneficiary of that trust 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. 67 Congress clearly could not care less about the post-mortem disposition of that portion of the residue of the testator's estate for which the QTIP election was not made, because every dollar's worth of that property was taxed currently in the estate of the Testator as the first spouse to die. 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 ability to defer estate tax on a terminable interest via the Marital Deduction, i.e., that the specific portion of the terminable interest property for which the election is made be taxed in the estate of the surviving spouse, and that all other property and interests in property--terminable or not--be taxed in the estate of the first spouse to die. III