Trust Didn't Qualify For Marital Deduction

[5] On * * * in * * * decedent executed his will and established a revocable trust, the "Trust * * *' Concurrent with the execution of the trust agreement, decedent executed quitclaim deeds and transferred to the trust his * * * residence and property in * * * Decedent named himself as trustee of the trust and, upon his death, his son, * * * became the sole successor trustee. * * * was also designated in decedent's will as the executor of decedent's estate.

Relevant Trust Provisions

[6] Article V of the Trust * * * provides for the administration and distribution of the trust estate, together with any additions thereto, after the death of decedent. Relevant provisions of Article V are as follows:

[9] Article VI, Section C, gives the surviving spouse a power to appoint by will the accrued but undistributed income of the Life Interest Trust. Income not so appointed was to pass to the Family Trust, along with the principal then remaining in the Life Interest Trust.

[10] The parties agree that the Family Trust does not qualify for the marital deduction. Pursuant to Article VII of the trust agreement, the Family Trust was to be held for the benefit of decedent's grandchildren and one of his sons, subject to the use of the income for the maintenance of the * * * residence during the time decedent's surviving spouse personally occupied the residence.

Relevant Will Provisions

[11] Decedent's will left certain items of tangible personal property outright to his surviving spouse. The balance of his tangible personal property was given to his children, with a request by decedent that they permit the surviving spouse to use these items so long as she lived in the * * * residence. Decedent bequeathed the residue of his estate to his revocable trust, to be administered and distributed according to the trust terms.

[12] Article Fifth of decedent's will provides for the payment of death taxes. Decedent directed that all death taxes with respect to property attributable to his probate estate be equitably prorated among the beneficiaries of such property except:

[14] Following decedent's death, the Life Interest Trust was funded with the * * * residence and other assets valued at $* * * The QTIP election was made by the executor, and the estate claimed a marital deduction for the value of the trust property. You have requested our opinion as to whether the marital deduction should be desallowed under the rationale employed by the Tax Court in Estate of Robertson v. Commissioner, 98 T.C. No. 47 (June 29, 1992), which followed the court's holding in Estate of Clayton v. Commissioner, 97 T.C. 327 (1991), appeal docketed, No. 92-4196 (5th Cir. 1992). See also Estate of Spencer v. Commissioner, T.C. Memo. 1992-579.

[15] For purposes of our analysis we have reviewed the following documents: the Trust * * * agreement, decedent's will, the supporting statement of the Appeals Officer, and the estate's argument in response to the supporting statement.

[19] We are faced in this case with conflicting provisions in the trust agreement, governed by * * * law, and in the will, governed by * * * law. Article V, Section C, of the Trust * * * agreement provides, "Any portion of the Life Interest Trust which for any reason is not qualified for the marital deduction shall be allocated to the Family Trust, subject to all of the rights, interests, powers and other terms prescribed for the Family Trust." Article Eleventh, Paragraph E, of the will provides, "Any portion of the Life Interest Trust which for any reason is not qualified for the marital deduction shall be held in a separate share of that trust, subject to all of the rights, interests, powers and other terms prescribed for the Life Interest Trust." Thus, the initial inquiry is whether the disposition of the probate property passing from the estate to the trust is governed by the terms of the trust or the will.

[20] The facts favor the conclusion that the surviving spouse's interest in the Life Interest Trust is to be determined by the terms of the trust rather than by the provisions of the will. The only property which passed from the decedent to his surviving spouse under the will consisted of "all items of household furniture, furnishings, appliances and garden equipment located at my residence." The balance of decedent's tangible personal property was bequeathed to his children. The only remaining bequest in the will was the gift of the residue. Decedent bequeathed the residue to the trustee of the Trust * * * and explicitly directed "that this gift of the residue of my estate shall be administered and distributed as part of that living trust according to its terms on the date of my death. . . ."

[21] Because * * * is both executor of the estate and trustee of the trust, his fiduciary powers and responsibilities are easily confused. This is demonstrated by the estate's response to the Appeals Case Memo. The estate makes the argument, on page 7:

[23] The taxpayer appears to be arguing that the disposition of the probate property passing to the trust pursuant to the terms of the will should be governed by the clause in the will providing that if the QTIP election was not made, the property would continue to be held in a separate share of the Life Interest Trust. That is, while the trust instrument governed the disposition of the assets held in the Trust * * * at the time of decedent's death, the terms of the will governed the disposition of the probate assets passing to the trust under the residuary clause of the will.

[24] Such an interpretation is dubious. First, the will passed the residuary assets to the trust, subject to the terms of the trust. Second, there is a good possibility, depending on the outcome of the issue involving the valuation of the * * * property, that there were sufficient assets in the Trust * * * at decedent's death to fund the Life Interest Trust. If so, the extent to which any probate assets would be used to fund the specific pecuniary amount was within the discretion of the trustee, since the trust provided for the allocation to the Life Interest Trust of property equal to $* * *

[25] If the trust agreement controls the disposition of the probate assets passing to the Life Interest Trust, the provisions of Article V of the trust agreement preclude a finding that the surviving spouse's interest was a qualifying income interest for life. Pursuant to Section A of Article V, she was entitled to all of the income of the trust only if the QTIP election was made. Pursuant to Section C of Article V, that portion of the Life Interest Trust for which QTIP treatment was not elected would be allocated to the Family Trust in which, the parties agree, she did not have a qualifying income interest for life.

[26] We therefore agree with the conclusions reached on the substantive issue by the Appeals Officer in his supporting statement. However, we wish to comment further on the hazards of litigating this issue in this particular case, since the case would be appealable to the * * * Circuit.

[27] The Tax Court has consistently interpreted the statutory and regulatory provisions of section 2056 in agreement with the Service on issues involving the QTIP marital deduction, particularly with regard to the question of whether the surviving spouse has a qualifying income interest for life. See Estate of Robertson, supra; Estate of Clayton, supra; Estate of Spencer, supra. See also Estate of Manscill v. Commissioner, 98 T.C. 413 (1992); Estate of Ellingson v. Commissioner, 96 T.C. 760 (1991), rev'd 964 F.2d 959 (9th Cir. 1992).

[28] In Estate of Ellingson, the Tax Court sustained the Commissioner's position that the surviving spouse did not have a qualifying income interest for life in a trust where the surviving spouse's right to the income of the trust was based on the following provision:

[30] The Ninth Circuit reversed the Tax Court in a poorly articulated opinion which we believe incorrectly interpreted, to the extent they were addressed, the requirements of section 2056(b) (7). The Ninth Circuit's opinion was based more on "intent" than on the statutory requirements for qualified terminable interest property. Although we did not recommend the filing of a petition for a writ of certiorari in the absence of clear inter-circuit conflict, we believe the Ninth Circuit's opinion establishes dangerous precedent for the argument that an indication in the will of the decedent's intent to qualify property for the marital deduction, coupled with the QTIP election itself, is determinative of whether the surviving spouse has a qualifying income interest for life. Indeed, in its appeal to the Fifth Circuit from the Tax Court's decision in Estate of Clavton, the taxpayer made this argument citing to the Ninth Circuit's opinion.

[31] The Ninth Circuit's reversal in Estate of Ellingson represented the second time the Tax Court was reversed on a QTIP marital deduction issue by that circuit court. See Estate of Howard v. Commissioner, 91 T.C. 329 (1988), rev'd, 910 F.2d 633 (9th Cir. 1990). The Tax Court was able to distinguish the facts before it in Estate of Ellingson from the facts of Estate of Howard. Similarly, the facts of the present case are distinguishable from the facts in Estate of Ellingson. Nevertheless, we are wary of the effect the Ninth Circuit's decision may have on the Tax Court in determining whether the surviving spouse in the present case has a qualifying income interest for life. In this vein, we note that the taxpayer, in responding to the Appeals Case Memo, has cited to the Ninth Circuit's opinion in support of the estate's position.

[32] We are presently awaiting the decision of the Fifth Circuit in Estate of Clayton. * * *

[33] This document may include confidential information subject to the attorney-client and deliberative process privileges, and may also have been prepared in anticipation of litigation. This document should not be disclosed to anyone outside the IRS, including the taxpayer involved, and its use within the IRS should be limited to those with a need to review the document in relation to the subject matter or case discussed herein. This document also is tax information of the instant taxpayer which is subject to I.R.C. section 6103.

[34] If you have any further questions or comments, please contact * * * of this office at (202) 622-* * *