Court Opinion

ID: 8596391
Source: CourtListenerOpinion
Date Created: 2022-11-23 16:03:38.529236+00
Date Added: 2024-06-11T16:54:58.092537
License: Public Domain

Kashiwa, Judge,
concurring in part and dissenting in part:
I concur in part III of the majority opinion, but disagree with part II of the opinion wherein the majority holds I.R.C. § 691 inapplicable to the installment payments received by plaintiff after the death of Jeanette Andersen. Although I find the statutes involved in this case conceptually difficult,1 I am of the opinion that an integrated reading of the various provisions involved in this case require that plaintiff prevail under its section 691 argument.
The parties concede that the peculiar facts of this case present the court with a question of statutory interpretation which no other court has faced. As such there is little to guide the court as it attempts to navigate the murky waters surrounding the interrelationships among the grantor trust, income in respect of decedent, estate taxation, and death basis rules.2 We are left largely with the bare words of the provisions (I.R.C. §§ 677, 691, 2036, and 1014), the legislative and judicial history behind the sections, and the general rules of statutory construction.
The revenue provision, which the court is specifically requested to construe in this case, is section 691 (the pertinent portions of which are set forth in footnotes 3 and 4 of the majority opinion). The majority opinion as well as this court’s opinion in Estate of Davison v. United States, *358155 Ct. Cl. 290, 292 F. 2d 937, cert. denied, 368 U. S. 939 (1961), adequately elaborate the judicial and legislative history behind the predecessor provision to section 691 (section 42 of the Revenue Act of 1942);3 therefore, I will stress only two points about the predecessor provision. First, it was enacted to eliminate loopholes in the income taxation scheme created by judicial decision, Nichols v. United States, 64 Ct. Cl. 241 (1927), cert. denied, 277 U. S. 584 (1928), which resulted in favorable tax treatment to cash basis decedents. Second, once effective the predecessor provision did eliminate the loophole it was designed to plug by switching a cash basis taxpayer to the accrual method of tax accounting at death, but it was rather neanderthal in its tax effect upon taxpayers due to the pyramiding of income it caused in the final return of a decedent.
Section 691 was first enacted in 1942 (as section 126 of the 1939 Internal Revenue Code) and represents a congressional fine tuning of the predecessor provision. As the majority opinion indicates, section 691 was designed to eliminate the neanderthal tax effect caused by the income pyramiding under the predecessor provision, while at the same time continuing the basic policy of subjecting earned income of a cash basis taxpayer to the income tax despite the fact of death. See H. R. Rep. No. 2333, 77th Cong., 2d Sess. 48, 83-84, reprinted in 1942-2 Cum.Bull. 372, 411, 435-436; S. Rep. No. 1631, 77th Cong., 2d Sess. 100, reprinted in 1942-2 Cum. Bull. 504, 579-580; Estate of Davison v. United States, supra; Commissioner v. Linde, 213 F. 2d 1 (9th Cir.), cert. denied, 348 U. S. 871 (1954). The concept employed by Congress to achieve this fine tuning was that of income in respect of a decedent.4 Under this concept the earned, but not properly includible, income of a cash basis decedent is subject to income taxation, not on the decedent’s final return but on the return of the successor in interest who eventually receives the income. I.R.C. § 691(a)(1). In changing the incidence of the income *359tax from the decedent to the successor in interest (thus eliminating the pyramiding problem), Congress necessarily laid down certain other rules concerning the taxation of these items to the successor in interest. First, it provided that the amount of the income to the successor in interest would be the same as if the decedent had received the income and reported it (i.e., despite the fact that these amounts would be includible in the decedent’s gross estate, there would be no stepped-up basis for items which were income in respect of a decendent). I.R.C. § 1014(c). The characterization of the items of income as either exempt, ordinary, or capital would also be the same as if the decedent had received and reported the income, rather than the successor in interest. I.R.C. § 691(a)(3). When it reenacted section 691 into the 1954 Code, Congress specifically expanded the coverage of the section to cover installment obligations owned by a decedent at death. I.R.C. § 691(a)(4). And in so doing, Congress specifically exempted the transmission of installment obligations at death from the immediate recognition requirement of I.R.C. § 453(d)(1). I.R.C. § 453(d)(3); see also H. R. Rep. No. 1337, 83d Cong., 2d Sess. A219 (1954). Also, in adopting the income in respect of a decedent approach in 1942, Congress recognized that to an extent dual taxation would occur under the new approach. See H. R. Rep. No. 2333, 77th Cong., 2d Sess. at 86-87, reprinted in 1942-2 Cum. Bull, at 438; S. Rep. No. 1631, 77th Cong., 2d Sess. at 103-104, reprinted in 1942-2 Cum. Bull, at 582. Since the earned income not properly includible on the decedent’s last return was no longer taxed in the decedent’s final income tax return, the income tax liability on these items of income no longer reduced the decedent’s gross estate as had been the case under the predecessor provision. Instead, the income in respect of a decedent items became unique in being both (1) subject to the estate tax due to their inclusion in the gross estate without adjustment for the income tax liability they inherently carried with them, and (2) subject to the income tax in the hands of the successor in interest without a basis adjustment for the estate tax paid. To compensate for this dual taxation, Congress enacted I.R.C. § 691(c). Subsection (c) in effect gives the ultimate recipient (successor in interest) of the income in *360respect of a decedent a deduction against income for a pro rata portion of the estate tax liability incurred by the decedent’s estate due to the inclusion of the income in respect of a decedent items in the gross estate. Ferguson, Income and Deductions in Respect of Decedents and Related Problems, 25 Tax L. R. 5, 146 (1969).
The facts surrounding the installment obligations remaining after Jeanette Andersen’s death in 1968 are unique in the very same sense as set out above. And if section 691(c) were viewed as an independent deduction generating provision (i.e., absent the income in respect of a decedent requirement), plaintiff would fall within the very purpose of the provision and the reason for its enactment. I note further that section 691(c) was expressly intended to be available to estates and trusts and that specific provision was made for the allocation of the deduction between a trust, like plaintiff, and its beneficiary(ies). I.R.C. § 691(c)(1)(B).
Plaintiff, in its administrative refund claim, asserted that it was entitled to the deduction provided by section 691(c). The refund claim was disallowed on the grounds that the installment obligations remaining after the death of Jeanette Andersen do not come within the ambit of what Congress intended in the term income in respect of a decedent as that term is hazily defined in section 691(a). And that is the defendant’s position before this court.
It is indisputable that, but for the 1941 inter vivos transfer by Jeanette Andersen of the reversionary interest in the trust corpus, the installment obligations payable after her death would fall directly within the meaning of section 691(a)(4); thus qualifying as income in respect of a decedent. Indeed, the defendant admits even more in footnote 2 of its supplemental reply brief. There defendant states that had Jeanette Andersen retained ownership of the Orlando Daily Newspapers stock for one day after the date on which it was sold, thus making her actual owner of the installment obligations received from the sale for a short time under state law, and then transferred the installments to a trust identical to plaintiff, defendant would also consider the installment obligations involved herein income in respect of a decedent under section 691(a)(4). And the Commissioner has published a ruling *361holding that the transfer of installment obligations to a grantor trust will not prevent the income represented by the installment obligations from being treated as income in respect of a decedent; thus, denying these obligations a stepped-up basis under I.R.C. § 1014(c). Rev. Rui. 76-100, 1976-1 Cum. Bull. 123. Defendant, in footnote 2 of its Supplemental Memorandum, distinguishes plaintiffs situation from the facts of Rev. Rui. 76-100 on the grounds:
* * * that Jeanette Andersen did not own the notes in question and Section 691(a)(4) operates only in the case of "installment notes received by a decedent on the sale * * * (of property) * * * if such obligation is acquired * * * from the decedent”.) * * * [Emphasis in original.]
Since under state law the plaintiff (trust) did not receive the installment obligations involved herein from the decedent, but instead from the sale of stock received in an inter vivos transfer of the decedent, Government counsel argues the installment obligations involved herein are not income in respect of a decedent under section 691(a)(4). Therefore, counsel argues it follows that plaintiff is not entitled to the deduction granted by section 691(c) and the asserted refund of taxes paid. The majority apparently agreed with the defendant’s formalistic and, in my mind, hair-splitting analysis. I do not.
I start with the established principle that the incidence of the federal taxation statutes depends upon the substance, not the form, of the transaction. This basic tenet is well founded in case law. Commissioner v. Court Holding Co., 324 U. S. 331 (1945). It is also partially codified in two of the provisions involved in this case.
Section 2036 is a congressional reaction to holdings of the Supreme Court in which the court paid little heed to the substance-over-form rule. In May v. Heiner, 281 U. S. 238 (1930), and Burnet v. Northern Trust Co., 283 U. S. 782 (1931), the Supreme Court held that the retention of a life estate (primary or secondary) in property transferred to a trust did not require the inclusion of the trust corpus in decedent’s gross estate under the then-existing estate tax provisions. These decisions were apparently founded on the property law notion that the decedent retained no interest which passed to another at death5 for a life estate simply *362expired upon the decedent’s death.6 Stephens, Maxfield & Lind, Federal Estate and Gift Taxation, jf 4.08[9] (4th ed. 1978). The Supreme Court’s ignoring that an inter vivos transfer of a reversionary interest in property coupled with the settlor’s retention of a life estate or right to possess and enjoy the property for life is substantively the equivalent of a testamentary transfer of property led Congress to immediately pass Public Resolution No. 131, 46 Stat. 1516 (1931). The resolution amended the Revenue Act of 1926 to legislatively overturn the result of the Supreme Court holdings and thus subject future substantively testamentary transfers to the federal estate tax despite the nuances of state property law.7
Unlike section 2036, the grantor trust provisions (I.R.C. §§ 671-678) are a congressional attempt to codify the holding in Helvering v. Clifford, 309 U. S. 331 (1940) (that where a settlor transfers property to a trust but retains certain powers over the trust such as in effect give the settlor dominion and control over the trust corpus, the settlor will be deemed owner of the income from the trust for income taxation purposes) and to provide some exclusive, concrete rules for the income taxation of grantor trusts; thus overcoming the confusion and litigation that flowed from the Helvering v. Clifford decision. The provisions deal with the question of which taxpayer is taxable on the income of a grantor trust (the grantor, the trust, or in some cases a third party). Section 677 is quite similar to section 2036 in that it ignores the fact that a trust is a separate taxable entity under the Code when the settlor of the trust transfers property to the trust and retains the right to receive the income from the trust. In effect section 677, like section 2036, ignores the inter vivos transfer of the reversionary interest in property to the trust under state law and, instead, requires the settlor of the trust who retained the right to income to be treated as owner of the trust corpus for income tax purposes.8
*363Both section 2036 and section 677 are applicable to the facts of this case. The United States Tax Court has held that section 2036 required the inclusion of the corpus of the trust in Jeanette Andersen’s gross estate for estate taxation purposes, Estate of Andersen v. Commissioner, 32 T.C.M. (CCH) 1164 (1973), and we are bound by that decision.9 Plaintiff contends and defendant implicitly concedes in its supplemental reply brief that section 677 was the applicable provision to govern the taxation of the income stream generated by the trust during the period of years prior to Jeanette Andersen’s demise in 1968. And I believe it indisputable, as a matter of law, that section 677 was the applicable income tax provision.10
In endeavoring to overcome defendant’s argument that the installment obligations involved herein are not income in respect of a decedent, plaintiff initially contended that since Jeanette Andersen was substantively considered to have made a testamentary transfer of the corpus of the trust under section 2036, thus requiring the inclusion of the corpus in her gross estate for federal estate taxation purposes, she should also be treated as remaining, in substance, the owner of the corpus of the trust until her death for purposes of the income in respect of a decedent provision. At oral argument and in a supplemental brief on the point filed at the request of the court, plaintiff contended that under section 677 Jeanette Andersen was statutorily deemed the substantive owner of the trust corpus for federal income taxation purposes as well during *364her life. This, in plaintiffs mind, strongly buttresses its original position.
I would not be willing to hold, merely because under federal estate taxation law Jeanette Andersen was substantively deemed to have made a testamentary transfer of property to the plaintiff (trust), the installment obligations remaining after her death should be considered income in respect of a decedent. However, when one adds to plaintiffs initial contention its section 677 argument, I find the conclusion inescapable that the installment obligations remaining at the time of Jeanette Andersen’s death were income in respect of a decedent within the meaning of section 691(a)(4).
Under section 677 Jeanette Andersen was deemed the owner of the entire corpus of the trust until her death in 1968. There is no question that the gain on the sale of the Orlando Daily Newspapers stock was realized (earned) and the amount of the gain fixed in 196411 — a point in time during which Jeanette Andersen was owner of the stock for income tax purposes. As owner of the stock, Jeanette Andersen would also have been deemed to have made the sale of the stock under section 677 and would have been liable for the income tax due on the entire gain from the sale in the year of the sale, but for the structuring of the sale so that the recognition of the gain from the sale was deferred over a period of years under section 453. The characterization of the gain from the sale as either exempt income, ordinary income, or capital gain would also be fixed by viewing it as received by Jeanette Andersen. Further, if the installment obligations had been disposed of *365by the trust prior to Jeanette Andersen’s death in any of the proscribed ways under I.R.C. § 453(d)(1), Jeanette Andersen would have had to immediately recognize the remaining gain represented by the installment obligations under the provisions of section 677. Because section 677 made Jeanette Andersen the deemed owner of the stock for purposes of all the above income taxation purposes, I find it inescapable that it made her owner of the stock and resultant installment obligations for the income taxation purposes of section 691(a)(4), too.
As stated earlier in this opinion, the facts of this case make it one of first impression; thus leaving the court with no prior case law to guide it. I find one commentator, who is learned on the workings of section 691, who seems to agree with my conclusion. In a rather detailed and exhaustive article on the section, he states in discussing its applicability to trust income that:
If trust income had been taxable to the decedent under the grantor trust provisions of sections 671 to 678, the trust would have no independent taxable year, and the income would have been regarded as the decedent’s to the extent realized before death. Hence, the accounting problems in a trust taxable under subchapter J are generally avoided, and the section 691 rules applicable to income generated outright by the decedent will apply. Thus, if the trust contains rights to income generated by the decedent’s services or predeath sales, or rights to income from investments attributable to predeath holding periods, the receipts may constitute income in respect of the decedent independently of subchapter J. [Ferguson, Income and Deductions in Respect of Decedents and Related Problems, 25 Tax L. R. 1, 132-133 (1969).] [Emphasis supplied; footnote omitted.]
My conclusion is also supported by Rev. Rui. 76-100, 1976-1 Cum. Bull. 123, I believe. In that ruling the Commissioner was faced with the task of construing how revenue provisions, which are almost synonymous with the ones in this case, interacted. There in a community property context he held that the transfer of a decedent’s one-half interest in installment obligations to a grantor trust (revocable trust) did not require immediate recognition to the transferor for under the grantor trust rules there had been no change of ownership for income taxation *366purposes; that the transfer of the decedent’s half interest in the installment obligations which occured at death did not trigger immediate recognition of the gain under section 453(d)(1) because the death transfer fell within the exception stated in section. 453(d)(3); and that the installment obligations would not receive a stepped-up basis under I.R.C. § 1014(a) because the installment obligations represented income in respect of a decedent within the meaning of section 691(a)(4); thus falling within the exception stated in section 1014(c). The majority opinion distinguishes this ruling on the grounds that the ruling dealt with community property — -particularly community property passing under section 1014(b)(6). I agree that that was the question addressed in the third part of the ruling. The second portion of the ruling (the part set out above) did not deal with community property passing under section 1014(b)(6) and it is that portion of the ruling which I find very pertinent to this case. The defendant attempts to distinguish the pertinent portion of Rev. Rui. 76-100 on the grounds that the installment obligations involved there had been actually owned, under state law, prior to the transfer to the grantor trust. As I stated earlier, I find no merit in this distinction. I do not find ownership of the obligations critical to the holding in the second portion of the ruling. The factor that I find controlling in the ruling is the presence of the grantor trust and the tax ramifications it had on the income that flowed from such a trust.
For the foregoing reason, I would hold that the installment obligations remaining after the death of Jeanette Andersen are income in respect of a decedent under section 691(a)(4); that plaintiff is therefore entitled to a deduction under section 691(c); and that the proper amount of the deduction and resultant refunds for the years in issue should be determined in further proceedings pursuant to Rule 131(c) of this court.
I have heretofore twice referred to Ferguson’s Income and Deductions in Respect of Decedents and Related Problems, 25 Tax L. R. 1, in the dissenting portion of this opinion. The majority does not refer to this learned writing at all. Yet, I find this article highly pertinent in this case. The writer of the article is now Assistant Attorney General *367in charge of the Tax Division, United States Department of Justice.

 Indeed, the statutes involved in this case bring to mind words of Judge Learned Hand, expressing the plight of a generalized federal judge faced with a complicated problem of tax law:
"* * * the words of such an act as the Income Tax * * * merely dance before my eyes in a meaningless procession: cross-reference to cross-reference, exception upon exception — couched in abstract terms that offer no handle to seize hold of — leave in my mind only a confused sense of some vitally important, but successfully concealed, purport, which it is my duty to extract, but which is within my power, if at all, only after the most inordinate expenditure of time. I know that these monsters are the result of fabulous industry and ingenuity, plugging up this hole and casting out that net, against all possible evasion; yet at times I cannot help recalling a saying of William James about certain passages of Hegel: that they were, no doubt, written with a passion of rationality; but that one cannot help wondering whether to the reader they have any significance save that the words are strung together with syntactical correctness.” [Hand, Thomas Walter Swan, 57 Yale L. J. 167,169 (1947).]

 I note that new § 1023, placed in the Code by the Tax Reform Act of 1976, substantially changed the death tax basis rules. However, section 1023 does not affect this case.

 Hereinafter I will use the term "predecessor provision” to refer to the provision in effect from 1934 to 1942 and "section 691” to refer to the provision in effect after 1942.

 I note, as did the majority opinion, that Congress has never attempted to define the term "income in respect of a decedent.” Thus, the task of giving this term meaning has fallen upon the courts and this is the task we face in this case.

 Since the federal estate tax is an excise imposed upon the transfer of property at death, it would not be applicable if nothing was transferred at death.

 It is notable that this same argument is advanced in the case at bar (that Jeanette Andersen only had a right to income for life which automatically expired at her death under state law) by the Government in arguing that the installment obligations remaining after Jeanette Andersen’s death are not income in respect of a decedent.

 This quirk of judicial and legislative history partially explains the dates which now appear in I.R.C. § 2036(b).

 The extent of ownership under the grantor trust rules of section 677, as the *363Government points out in its supplemental reply brief, depends upon the extent of the retained right to income. See Treas. Reg. §§ 1.671-3(a)(l); 1.677(a)-l(g) Example 1. On the facts of this case, Jeanette Andersen had, under the Florida court decree, Martin Andersen, as Trustee, No. 67-1052 (August 8, 1967), the right to receive both ordinary and capital gain income of the trust. As such under section 677 Jeanette Andersen would be treated as constructive owner of the entire trust corpus for federal income tax purposes. Treas. Reg. § 1.671 — S(a)( 1).

 Not that we need to be bound, for I agree with the Tax Court’s holding.

 In part II-C of the majority opinion, the majority outlines the method followed in reporting the income generated by the trust during the time period prior to Jeanette Andersen’s death (i.e., as a simple trust under the regular subchapter J rules). It appears that that is how the income was reported. However, merely because that was the method used does not stamp it with the indicia of correctness or make it binding on the taxpayer or the Government. As indicated above, the correct method by which the income of the trust should have been reported prior to Jeanette Andersen’s death was under the grantor trust rules. See Treas. Reg. § 1.671-4. On the facts of this case it does not appear that the difference in method of reporting caused any loss of revenue to the Government or overpayment by the taxpayers.

 In part II-B of the majority opinion, the majority states that Jeanette Andersen did not “earn nor accrue the right to the income” from the installment obligations remaining at her death during her life. I am puzzled by that statement. It is not disputed that the realization of the income occurred in 1964 when the stock was sold. The gain from the sale was determined in 1964 also. In fact, everything was completed prior to 1968 which gave the plaintiff (trust) the right to receive the payments. In my mind the gain on the sale had most certainly been earned by the time of Jeanette Andersen’s demise in 1968. The only event of significance which had not occurred prior to her death is the date of recognition under section 453. It is clear that the later date of recognition was specifically dealt with in section 691(a)(4). Inferable from section 691(a)(4) is the concept that Congress did not want installment obligations deleted from income in respect of a decedent treatment merely because of the delayed income recognition date. Yet, this is the very effect which the majority’s holding has.