Opinion ID: 382100
Heading Depth: 1
Heading Rank: 1

Heading: the gilchrist case

Text: 2 In 1960, Anna Gilchrist's husband, having made several specific bequests to others, left to his wife the income the use and benefits with full rights to sell or transferall (sic) the remainder of (his) property, both real and personal, so long as she may live.... This remainder was to be divided among named remaindermen should Mrs. Gilchrist not have exercised her power over it. 3 In 1971, a Texas court declared Mrs. Gilchrist to be of unsound mind and appointed guardians of her person and estate. Two years after Mrs. Gilchrist's death in 1973, the Commissioner declared in a notice of estate-tax deficiency that Mrs. Gilchrist had received a general power of appointment under her husband's will and that the value of the property subject to this power should be included in her gross taxable estate. The Tax Court held otherwise and this appeal followed. 4 The foremost question on appeal is whether Mrs. Gilchrist, contrary to the Tax Court's holding at 69 T.C. 5, 19 (1977), at the time of her death had a general power of appointment within the meaning of that term in the Revenue Code. The Code provides in pertinent part that a decedent's gross estate shall include the value of all property with respect to which the decedent has at the time of his death a general power of appointment created after October 21, 1942, or with respect to which the decedent has at any time exercised or released such a power of appointment.... I.R.C. § 2041(a)(2). A general power of appointment is defined as a power which is exercisable in favor of the decedent, his estate, his creditors, or the creditors of his estate.... Id. § 2041(b)(1). 1 A general power of appointment under § 2041 must be exercisable. This appeal is mainly a dispute over the meaning of that work in estate-tax argot. The Commissioner contends that § 2041 embraces all powers which are exercisable by the terms of the instruments creating them. Mrs. Gilchrist's executor prefers a more everyday construction of the word, arguing that a power which a decedent is personally unable to exercise cannot be an exercisable one. 5 Construing § 2041 requires a balancing of considerations of fairness and utility. Equitable considerations weigh against including property in a decedent's estate, when that decedent held only the most attenuated incidents of ownership of the property. Yet to require the Commissioner and the courts to determine whether in every case decedents personally had the legal capacity to exercise powers of appointment would seriously complicate an area where Congress has sought a test of taxability which is simple, clear-cut, and easy to apply. Senate Rep. No. 82-382 (on Powers of Appointment Act of 1951) reprinted (1951) U.S.Code Cong. & Admin.Serv. at 1530, 1531. 6 The history of Congressional treatment of taxation of powers of appointment does not support exempting from taxation powers held by incompetents. See generally Note, Federal Estate Tax: A Possible Exception in the Application of I.R.C. Section 2041 to Testamentary Powers of Appointment Held by Incompetent Decedents, (1977) B.Y.U.L.Rev. 644, 650-51. Originally, appointive property was taxed only if subject to a general power which had been exercised. Revenue Act of 1918, § 402, 40 Stat. 1057, 1097. Amendments made in 1942 included property subject to unexercised pre-1942 powers in the taxable estate unless the donee of such power is under a legal disability to release such power.... Revenue Act of 1942, § 403(d)(2), 56 Stat. 798, 944. It is clear from the language of these amendments that a power could be exercisable under the Revenue Act even though such a disability existed. See Pennsylvania Bank & Trust Co. v. United States, 451 F.Supp. 1296, 1300 n. 6 (W.D.Pa.1978), aff'd, 597 F.2d 382 (3d Cir.), cert. denied, 444 U.S. 980, 100 S.Ct. 483, 62 L.Ed.2d 407 (1979). 7 The present § 2041 of the Code was born with the Powers of Appointment Act of 1951, 65 Stat. 91. This Act further limited the retroactive application of the 1942 amendments, but did not distinguish between competent and incompetent holders of post-1942 powers. The 1942 amendments had shown Congress's awareness of the problem of the incompetent holder of a taxable power; Congress's silence was eloquent when it declined to create an express dispensation for holders of post-1942 powers. See Alperstein v. Commissioner, 613 F.2d 1213, 1217 (2d Cir. 1979), cert. denied sub nom. Greenberg v. Commissioner, --- U.S. ----, 100 S.Ct. 1852, 64 L.Ed.2d 272 (1980). 8 Parallel usage of the term exercisable in § 2056 of the Revenue Code also shows that the word was not used by Congress in its quotidian sense. Section 2056 defines the property which qualifies for the marital deduction-an exemption from estate tax of certain property passing between spouses. Property subject to a life estate with a testamentary power of appointment in a surviving spouse is excluded from the decedent spouse's estate if the power in the surviving spouse ... is exercisable by such spouse alone and in all events. I.R.C. § 2056(b) (5). Since eligibility for the martial deduction must be determined at the time of the donor spouse's death, 2 exercisable in this context must mean exercisable under the terms of the instrument creating the interest. See Pennsylvania Bank, supra, 451 F.Supp. at 1300-01, adopted 597 F.2d 383-84. 9 Decisions of this and other circuits of the Court of Appeals have established that a decedent's actual inability (as distinguished from legal incapacity) to exercise a power of appointment at the time of death is irrelevant to the application of § 2041. In Estate of Bagley v. United States, 443 F.2d 1266 (5th Cir. 1971) the decedent had possessed a testamentary power of appointment for only a theoretical instant during the auto crash in which she was presumed to have survived her husband, the grantor of the power. This Court held the power was in that instant legally exercisable by the decedent wife; the property subject to the power was therefore reckoned part of the decedent's estate. 10 In Fish v. United States, 432 F.2d 1278 (9th Cir. 1970) the Ninth Circuit held that the annual lapse of a power of appointment was a taxable release of the power, even though the lapse resulted from the holder's actual mental incapacity. The Court in Fish noted in the margin of its opinion that the decedent had never been adjudicated an incompetent prior to her death, 432 F.2d at 1280 n. 3, but that fact had little relevance to the body of the court's opinion, which stressed that the incidence of estate tax should not depend on the circumstances surrounding the exercise or release of powers of appointment. See id. at 1280. 11 The utilitarian grounds for limiting non-statutory estate-tax exemptions have been recognized and relied on by the Supreme Court. Commissioner v. Estate of Noel, 380 U.S. 678, 85 S.Ct. 1238, 14 L.Ed.2d 159 (1965), arose under § 2042 of the Code; this section requires inclusion in the gross estate of the proceeds of life insurance, if a decedent possessed at death exercisable incidents of ownership over the policy. Mr. Noel had taken two flight insurance policies at an airport. These documents were given to Mrs. Noel before her husband boarded a plane which crashed three hours after take-off. There was no practical opportunity for Mr. Noel to assign the policies or change their beneficiaries at the time of his death, yet the Court held that the proceeds of the policies must be included in Mr. Noel's gross estate, declaring that 12 It would stretch the imagination to think that Congress intended to measure estate tax liability by an individual's fluctuating, day-by-day, hour-by-hour capacity to dispose of property which he owns. We hold that estate tax liability for policies with respect to which the decedent possessed at his death any of the incidents of ownership depends on a general, legal power to exercise ownership, without regard to the owner's ability to exercise it at a particular moment. 13 380 U.S. at 684, 85 S.Ct. at 1241. 14 The root issue of this case is whether the adjudication of the incompetence of a holder of a power of appointment should be classed among the legally irrelevant fluctuations in the holder's day-by-day, hour-by-hour capacity to dispose of property, or whether such an adjudication destroys the holder's general, legal power to exercise incidents of ownership. While sympathy inclines to the latter view, reason counsels that simplicity and utility should prevail wherever possible in the administration of estate-tax laws. Simplicity is best served by a rule under which the adjudication of a holder's incompetence is irrelevant to estate-tax liability, unless the holder's estate can show that all exercise of a power on the holder's behalf, by any person in any capacity, is barred by the adjudication. 15 The Tax Court held that Mrs. Gilchrist's power was no longer taxable, because her legal incompetence affected the manner in which the power could be exercised. This holding followed a survey of Texas law to determine whether Mrs. Gilchrist's guardians could substitute their judgment for hers in exercising the power. Concluding that they could not, the Tax Court held that Mrs. Gilchrist's general power of appointment had been transmuted by the declaration of her legal incapacity into one limited by the ascertainable standards imposed on her guardians by Texas law. 69 T.C. at 18-19. 16 It is not beyond cavil that the prudent man standard of action imposed on guardians by Texas law is, as the Tax Court concluded, an ascertainable standard in the everyday sense; more importantly, the Tax Court erred in its interpretation of this statutory phrase. Under Treasury Regulation § 20.2041-1(c)(2), 23 Fed.Reg. 4529, 4560 (1958), as amended, 26 Fed.Reg. 11861 (1961), (a) power is limited by such a standard if the extent of the holder's duty to exercise and not to exercise the power is reasonably measurable in items of his needs for health, education, or support.... The statute and the regulation 3 both refer to ascertainable standards imposed on the holder's exercise of the power by the terms of the instrument creating the power-not to standards imposed on guardians by local law. A contrary interpretation would make § 2041 what Justice Frankfurter has termed the victim of conflicting state decisions on matters relating to local concerns and quite unrelated to the single uniform purpose of federal taxation. See Estate of Rogers v. Helvering, 320 U.S. 410, 414, 64 S.Ct. 172, 174, 88 L.Ed. 134 (1943). 17 The rule that state law defines the type of property interest held by a decedent is well established. See, e. g., Keeter v. United States, 461 F.2d 714, 717 (5th Cir. 1972); Estate of Vardell v. Commissioner, 307 F.2d 688, 692 (5th Cir. 1962). This case does not call that rule into question. State law creates property interests but federal law determines which incidents of ownership are taxable. See Morgan v. Commissioner, 309 U.S. 78, 80-81, 60 S.Ct. 424, 425-26, 84 L.Ed. 585 (1940); Keeter, supra. A federal rule should determine which state-created powers of appointment are general and taxable. Cf. Estate of Rogers, supra, 320 U.S. at 414-15, 64 S.Ct. at 174 (decided under 1932 Revenue Act). 18 Not surprisingly, the Service's own interpretations of § 2041 favor taxation of an incompetent's appointive powers. Revenue Ruling 55-518, (1955-2) C.B. 384, 385 noted a distinction between existence of a power and the capacity to exercise it, and held that possession of a power at death, rather than its exercise before death, is what is cumbrously styled the taxable event. Under this ruling, the continuing existence of an incompetent's power is shown by the possibility of its exercise by a court or guardian. Id. The service later harmonized § 2041 with § 2056 (martial estate-tax deductions) of the Code by declaring that a surviving spouse's legal incapacity to exercise a testamentary power of appointment was irrelevant to the application of either section, unless legal capacity is by the terms of the power a condition of its exercise. Revenue Ruling 75-350 (1975-2) C.B. 367, 368. 19 Treasury Regulation § 20-2041-3(b), 23 Fed.Reg. 4529, 4562 (1958), echoes this emphasis on the terms of the grant of a power: 20 (A) power which by its terms is exercisable only upon the occurrence of an event or a contingency which did not in fact take place ... is not a power in existence on the date of decedent's death. 21 In light of the clear legislative intent to tax the existence and not the exercise of post-1942 powers, these rulings and regulations seem reasonable and persuasive. 22 Against the weight of judicial and executive precedent urging a clear-cut test of taxability of powers held by incompetents stand the recent cases of Finley v. United States, 404 F.Supp. 200 (S.D.Fla.1975), vacated on jurisdictional grounds, 612 F.2d 166 (5th Cir. 1980) and Williams v. United States, 43 A.F.T.R.2d 1254 (W.D.Tex.1978), on appeal, No. 78-3797 (5th Cir.) (decision pending). Finley, cited by the Tax Court in its decision in the present case, now lacks precedential force; Williams follows rather than supports the Tax Court's reasoning in the present case. 23 Lest reversal of the Tax Court's judgment seem inequitable, it is noted that under what it terms the Texas-style construction given Mr. Gilchrist's will by the Tax Court, Mrs. Gilchrist held an unrestricted power to consume or sell her husband's property. 69 T.C. at 10-11. This power was unimpaired from the time of Mr. Gilchrist's death in 1960 until the declaration of Mrs. Gilchrist's incompetence in 1971. From 1971 until Mrs. Gilchrist's death in 1973, the power, although somewhat limited by Texas law, was held by Mrs. Gilchrist's guardian. It was the nonexercise of this power which resulted in the inclusion of the property subject to it in Mrs. Gilchrist's estate. Under the Revenue Code whether this nonexercise was purposeful or neglectful is irrelevant. This power lay with Mrs. Gilchrist's guardians at the time of her death, and is therefore taxable. 24 Reversed and remanded.