Opinion ID: 742603
Heading Depth: 2
Heading Rank: 1

Heading: Gradow v. United States and the Widow's Election Cases

Text: 28 As the government's position rests principally on an analogy offered by the Claims Court in Gradow, a preliminary summary of the widow's election mechanism in the community property context is appropriate. 29 In a community property state, a husband and wife generally each have an undivided, one-half interest in the property owned in common by virtue of their marital status, with each spouse having the power to dispose, by testamentary instrument, of his or her share of the community property. Under a widow's election will, the decedent spouse purports to dispose of the entire community property, the surviving spouse being left with the choice of either taking under the scheme of the will or waiving any right under the will and taking his or her community share outright. One common widow's election plan provides for the surviving spouse to in effect exchange a remainder interest in his or her community property share for an equitable life estate in the decedent spouse's community property share. 30 In Gradow, Mrs. Gradow, the surviving spouse, was put to a similar election. If she rejected the will, she was to receive only her share of the community property. Id. 11 Cl.Ct. at 809. If she chose instead to take under her husband's will, she was required to transfer her share of the community property to a trust whose assets would consist of the community property of both spouses, with Mrs. Gradow receiving all the trust income for life and, upon her death, the trust corpus being distributed to the Gradows' son. Id. Mrs. Gradow chose to take under her husband's will and, upon her death, the executor of her estate did not include any of the trust assets within her gross estate. Id. The executor asserted that the life estate received by Mrs. Gradow was full and adequate consideration under section 2036(a) for the transfer of her community property share to the trust, but the IRS disagreed. Id. Before the Claims Court, the parties stipulated that the value of Mrs. Gradow's share of the community property exceeded the actuarial value of an estate for her life in her husband's share. Id. However, the estate contended that the value of the life estate in the husband's share equaled or exceeded the value of the remainder interest in Mrs. Gradow's share. The Claims Court did not clearly resolve that contention because it determined that the consideration flowing from Mrs. Gradow was the entire value of the property she placed in the trust, i.e., her half of the community property, and that thus the life estate was inadequate consideration, so the exception to section 2036(a) was unavailable. Id. at 810. 31 The court in Gradow concluded that the term property in section 2036(a) referred to the entirety of that part of the trust corpus attributable to Mrs. Gradow. Id. at 813. Therefore, according to the court, if the general rule of section 2036(a) were to apply, the date-of-death value of the property transferred to the trust corpus by Mrs. Gradow----rather than the zero date-of-death value of her life interest in that property----would be included in her gross estate. Id. Citing [f]undamental principles of grammar, the court concluded that the bona fide sale exception must refer to adequate and full consideration for the property placed into the trust and not the remainder interest in that property. Id. 32 Fundamental principles of grammar aside, the Gradow court rested its conclusion equally on the underlying purpose of section 2036(a), observing that: 33 The only way to preserve the integrity of the section, then, is to view the consideration moving from the surviving spouse as that property which is taken out of the gross estate. In the context of intra-family transactions which are plainly testamentary, it is not unreasonable to require that, at a minimum, the sale accomplish an equilibrium for estate tax purposes. Id. at 813-14. 34 In support of its equilibrium rule, the Gradow court cited precedent in the adequate and full consideration area, most notably United States v. Allen, 293 F.2d 916 (10th Cir.), cert. denied, 368 U.S. 944, 82 S.Ct. 378, 7 L.Ed.2d 340 (1961). 35 It is not our task to address the merits of Gradow 's analysis of how section 2036(a) operates in the widow's election context but rather to determine whether the Gradow decision supports the construction urged by the government in the sale of a remainder context. We conclude that the widow election cases present factually distinct circumstances that preclude the wholesale importation of Gradow 's rationale into the present case. 36 As noted, a widow's election mechanism generally involves an arrangement whereby the surviving spouse exchanges a remainder interest in her community property share for a life estate in that of her deceased spouse. Usually, as in Gradow, the interests are in trust. Necessarily, the receipt of an equitable life estate in the decedent-spouse's community property share does little to offset the reduction in the surviving spouse's gross estate caused by the transfer of her remainder interest. It is precisely this imbalance that the commentators cited in Gradow----and the equilibrium rule gleaned from United States v. Allen----recognized as the determinative factor in the widow's election context. Because a surviving spouse's transfer of a remainder interest depletes the gross estate, there can be no bona fide sale for an adequate and full consideration unless the gross estate is augmented commensurately. See Charles L.B. Lowndes, Consideration and the Federal Estate and Gift taxes: Transfers for Partial Consideration, Relinquishment of Marital Rights, Family Annuities, the Widow's Election, and Reciprocal Trusts, 35 Geo. Wash. L.Rev. 50, 66 (1966); Stanley M. Johanson, Revocable Trusts, Widow's Election Wills, and Community Property: The Tax Problems, 47 Tex. L.Rev. 1247, 1283-84 (1969) (But in the widow's election situation, the interest the wife receives as a result of her election-transfer is a life estate in her husband's community share----an interest which, by its nature, will not be taxed in the wife's estate at her death. It appears that the wife's estate is given a consideration offset for the receipt of an interest that did not augment her estate.). Accordingly, we need not address the issue whether the value or income derived from a life estate in the decedent-spouse's community property share can ever constitute adequate and full consideration. For our purposes it is enough to observe that, in most cases, the equitable life estate received by the surviving spouse will not sufficiently augment her gross estate to offset the depletion caused by the transfer of her remainder interest. 7 This depletion of the gross estate prevents the operation of the adequate and full consideration exception to section 2036(a). 8 Had the court in Gradow limited its discussion of section 2036(a)'s adequate and full consideration exception to the widow's election context, the nettlesome task of distinguishing its blanket rule of including the value of the full fee interest on the underlying property when a remainder interest is transferred might be somewhat easier. In dicta, however, and apparently in response to a hypothetical posed by the taxpayer, the Gradow court let loose a response that, to say the least, has since acquired a life of its own. The entire passage----and the source of much consternation----is as follows: 37 Plaintiff argues that the defendant's construction would gut the utility of the 'bona fide sales' exception and uses a hypothetical to illustrate his point. In the example a 40-year-old man contracts to put $100,000.00 into a trust, reserving the income for life but selling the remainder. Plaintiff points out that based on the seller's life expectancy, he might receive up to $30,000.00 for the remainder, but certainly no more. He argues that this demonstrates the unfairness of defendant insisting on consideration equal to the $100,000.00 put into trust before it would exempt the sale from § 2036(a). 38 There are a number of defects in plaintiff's hypothetical. First, the transaction is obviously not testamentary, unlike the actual circumstances here. In addition, plaintiff assumes his conclusion by focusing on the sale of the remainder interest as the only relevant transaction. Assuming it was not treated as a sham, the practical effect is a transfer of the entire $100,000.00, not just a remainder. More importantly, however, if plaintiff is correct that one should be able, under the 'bona fide sale' exception to remove property from the gross estate by a sale of the remainder interest, the exception would swallow the rule. A young person could sell a remainder interest for a fraction of the property's worth, enjoy the property for life, and then pass it along without estate or gift tax consequences. Gradow, 11 Cl.Ct. at 815. 39 The Claims Court went on to conclude that [t]he fond hope that a surviving spouse would take pains to invest, compound, and preserve inviolate all the life income from half of a trust, knowing that it would thereupon be taxed without his or her having received any lifetime benefit, is a slim basis for putting a different construction on § 2036(a) than the one heretofore consistently adopted. Id. at 816. 40 One can only imagine the enthusiasm with which the IRS received the news that, at least in the view of one court, it would not have to consider the time value of money when determining adequate and full consideration for a remainder interest. 9 Subsequent to the Gradow decision, the government has successfully used the above quoted language to justify inclusion in the gross estate of the value of the full fee interest in the underlying property even where the transferor sold the remainder interest for its undisputed actuarial value. See Pittman v. United States, 878 F.Supp. 833 (E.D.N.C.1994). See also D'Ambrosio v. Commissioner, 105 T.C. 252, 1995 WL 564078 (1995), rev'd, 101 F.3d 309 (3d Cir.1996), cert. denied, --- U.S. ----, 117 S.Ct. 1822, 137 L.Ed.2d 1030 (1997). 41 Pittman (and the Tax Court's decision in D'Ambrosio) presents a conscientious estate planner with quite a conundrum. If the taxpayer sells a remainder interest for its actuarial value as calculated under the Treasury Regulations, but retains a life estate, the value of the full fee interest in the underlying property will be included in his gross estate and the transferor will incur substantial estate tax liability under section 2036(a). If the taxpayer chooses instead to follow Gradow, and is somehow able to find a willing purchaser of his remainder interest for the full fee-simple value of the underlying property, he will in fact avoid estate tax liability; section 2036(a) would not be triggered. The purchaser, however, having paid the fee-simple value for the remainder interest in the estate, will have paid more for the interest than it was worth. As the adequate and full consideration for a remainder interest under section 2512(b) is its actuarial value, the purchaser will have made a gift of the amount paid in excess of its actuarial value, thereby incurring gift tax liability. 10 Surely, in the words of Professor Gilmore, this carr[ies] a good joke too far. 11