Opinion ID: 7103
Heading Depth: 1
Heading Rank: 2

Heading: The QTIP Deduction

Text: 4 Section 2001 of the Internal Revenue Code imposes a tax on each decedent's taxable estate. The taxable estate equals the value of the gross estate, which consists of all property owned by the taxpayer upon death, less applicable deductions. Upon Mary Jane's death in 1983, Herbert, as executor of the estate, elected to exclude from the gross estate the value of certain properties transferred to him by virtue of her will. Section 2056(a) now authorizes an unlimited (in dollars) deduction from the decedent's gross estate of property transferred to a surviving spouse. Often referred to as the Marital Deduction, this provision postpones taxation on such property until the surviving spouse disposes of the exempted property by gratuitous transfer, whether inter vivos or at death. See Estate of Clayton v. C.I.R., 976 F.2d 1486, 1492 (5th Cir.1992). 5 To ensure that none of this property escapes taxation, section 2056(b) provides an exception to subsection (a)'s grant of an unlimited Marital Deduction for terminable interests. Code section 2056(b) excludes terminable interests 1 in property from eligibility for the Marital Deduction. But a number of particular exceptions to this general terminable interest exception are recognized; among the particular types of terminable interests that are in fact deductible by virtue of being exceptions-to-the-exception is the Qualified Terminable Interest Property (QTIP) created by the Congress in 1981. Subsection 2056(b)(7)(B)(i) defines QTIP as 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 to exclude is made. An election to claim a marital deduction for qualified terminable interest property once made is irrevocable. Section 2056(b)(7)(B)(v). 6 Herbert exercised such an election on behalf of Mary Jane's estate in 1983 and accordingly excluded the properties at issue here from her gross estate. Nevertheless, Herbert's estate now claims that this election was unavailable since the transferred property was ineligible for QTIP treatment. Hence the estate attempts to circumvent Section 2044(a), which requires inclusion in Herbert's estate of the value of all property in which the decedent had a qualifying interest for life. 7 The estate advances two arguments why the initial election was defective: (1) The income interest that Herbert received could not constitute a qualifying income interest for life; (2) Mary Jane's will precluded the executor, Herbert, from exercising the necessary election. This second theory, however, collapses into the first argument since section 2044 defines petitioner's tax liability independently of the constraints of Mary Jane's will. Specifically, this section requires the inclusion of the property in Herbert's gross estate if the decedent had a qualifying income interest for life when a deduction was allowed with respect to the transfer of such property to the decedent. Since there is no dispute that such a deduction was allowed by the Commissioner, whether the property received by Herbert was a qualifying income interest for life becomes dispositive. The viability of a QTIP election, in other words, presents a question of federal, not state law, and such an election, once made and approved by IRS, is irrevocable. 8 This court reviews de novo the Tax Court's conclusion that this property did qualify. McIngvale v. Commissioner, 936 F.2d 833, 835-36 (5th Cir.1991). A qualifying income interest for life is a defined term of art for an interest 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. Estate of Clayton, 976 F.2d at 1496 (quoting Sec. 2056(b)(7)(B)(ii)(II)) (alterations in original). Consequently, the statute imposes two definitional elements: (1) Herbert must be entitled to all of the income; and (2) no person can be authorized to appoint any part of the property to anybody but Herbert. These determinations must be made as of the date of Mrs. Cavenaugh's death. Id. at 1497. Applicable regulations incorporate state law to determine whether the income distribution requirements are satisfied. Treas.Reg. Sec. 20.2056(b)-5(e). 9 Herbert received two types of interests in property. Mary Jane bequeathed him specifically defined interests in their home and other real property. 2 Her will also created a residuary trust whose net income was to be paid to Herbert during his lifetime only. Only Herbert's interest in the residuary trust is at issue in this appeal. 10 Herbert's estate and the IRS part company over the scope of his interest as a beneficiary of the residuary trust. The precise question is whether Herbert was entitled to receive all of the income during his life. Herbert's estate contends that since no provision of Mary Jane's will nor of Texas law 3 precludes the accumulation of trust income (as opposed to its distribution currently to Herbert), the possibility existed that some of this income might go to Mary Jane's descendants (the Cavenaugh children) upon Herbert's death. Thus, it urges the QTIP deduction's statutory requirement that Herbert be entitled to all of the income of the residuary trust payable at least annually might not be satisfied. Moreover, the trustee by resort to accumulation is also technically authorized to appoint part of this property to somebody other than Herbert. 11 Fortunately, this court need not enter the fray between the Ninth Circuit in Estate of Howard v. Commissioner, 910 F.2d 633 (1990), and the Tax Court in Estate of Shelfer v. Commissioner, 103 T.C. 10 (1994) (refusing to follow Estate of Howard since Shelfer resides in Eleventh Circuit), in determining whether a technical possibility that any income will not go to the surviving spouse destroys eligibility for QTIP treatment. 4 The significance petitioner derives from the lack of an express prohibition on accumulation (in either the will or under Texas law) is misplaced. Whether the surviving spouse is entitled to all the income is not measured by an abstract principle of law but merely by reference to the decedent's intent. See generally Estate of Clayton, 976 F.2d at 1488-1490 (eligibility for QTIP measured by reference to four corners of will); Perfect Union Lodge No. 10 v. Interfirst Bank, 748 S.W.2d 218 (Tex.1988) (wills are construed to give effect to the actual intention of the testator). In other words, whether Mary Jane intended that Herbert receive all of the income from these property interests and whether she did--or did not--authorize any other person to appoint part of this property to somebody other than her spouse is dispositive. 12 The cardinal rule for construing a will requires that the testator's intent be ascertained by looking to the provisions of the instrument as a whole. Id. The best evidence the estate identifies that Mary Jane did not intend for Herbert to receive all of the income in at least annual intervals is Paragraph B of Article V of her will. That paragraph requires that the net income from the trust be paid to Herbert for as long as he lives monthly or at the end of such other periods as may be necessary or desirable in the discretion of the Trustee. (emphasis added). Herbert's estate reasons that Mary Jane thus imposed on the trustee no limitations on its discretion to distribute and thereby left to the professional trustee all of the considerations and decisions about how much and when distributions of income should be made. Although this provision plainly provides the trustee with some latitude in determining when income distributions should be made, reading that clause to manifest an intent to permit the trustee to exercise absolute discretion in choosing when to pay income to Dr. Cavenaugh is unwarranted. 13 To begin, the will specifically states that the payments of income should be made periodically. Normally, a trustee is required to make payments of income at reasonable intervals. Bogert, TRUSTS AND TRUSTEES, Sec. 814 (2d ed. 1981). A reasonable interval is ordinarily semiannually or quarterly. 2A Scott, TRUSTS, Sec. 182, at 550 (4th ed. 1987). If anything, the inclusion of monthly evinces an intent to distribute the income at more frequent intervals than reasonableness requires. 14 Resort to the reading advanced by the estate would render the word monthly wholly meaningless. Texas presumes that a testator would not include useless expressions in her will. Republic National Bank v. Fredericks, 155 Tex. 79, 283 S.W.2d 39, 44 (1955). 15 Notably, no authorization in the will exists for the trustee to accumulate income during Herbert's life, and Mary Jane interestingly neglected to provide for the disposition of accumulated income. In contrast, Mary Jane did explicitly provide that after Herbert's death income could be accumulated and added to the trust corpus and that the trustee shall have sole and absolute discretion to distribute income and corpus to her children. 16 Finally, paragraph D of Article V of the will gives Herbert the express right to withdraw the greater of $5,000 or five percent of the corpus of the residuary trust in any calendar year. Presumably, the trust settlor intends that the trust income be distributed before corpus is invaded. Since Herbert is entitled to require distributions of corpus annually, it is unlikely that Mary Jane did not intend to entitle him to distributions of income as often. Taken cumulatively, it is easy to conclude that Herbert's estate was compelled to include the value of his interest in the trust, already made the subject of a QTIP election on Mary Jane's estate tax return, in its return.