Estate Rose v. Commissioner IRS

Opinions of the United

1996 Decisions States Court of Appeals

for the Third Circuit

11-26-1996

Estate Rose v. Commissioner IRS

Precedential or Non-Precedential:

Docket 95-7643

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UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

No. 95-7643

ESTATE OF ROSE D'AMBROSIO, Deceased,

VITA D'AMBROSIO, Executrix,

Appellant

v.

COMMISSIONER OF INTERNAL REVENUE SERVICE

ON APPEAL FROM THE UNITED STATES TAX COURT

(Tax Court Docket No. 94-06724)

Argued June 4, 1996

Before: COWEN, NYGAARD and LEWIS, Circuit Judges.

(Opinion Filed: November 26, 1996)

HARVEY R. POE, ESQUIRE (Argued)

Poe & Rotunda

256 Columbia Turnpike

Columbia Commons, Suite 202

Florham Park, NJ 07932

Attorney for Appellant

CHARLES BRICKEN, ESQUIRE (Argued)

GARY R. ALLEN, ESQUIRE

GILBERT S. ROTHENBERG, ESQUIRE

United States Department of Justice

Tax Division

P.O. Box 502

Washington, DC 20044

Attorneys for Appellee

OPINION OF THE COURT

NYGAARD, Circuit Judge.

Vita D'Ambrosio, executrix of the estate of Rose D'Ambrosio,

appeals from a judgment of the United States Tax Court upholding

a statutory notice of deficiency filed against the estate by the

Commissioner of Internal Revenue. The tax court held that, even

though the decedent had sold her remainder interest in closely

held stock for its fair market value, 26 U.S.C. § 2036(a)(1)

brought its entire fee simple value back into her gross estate.

We will reverse and remand with the direction that the tax court

enter judgment in favor of appellant.

I.

The facts in this case have been stipulated by the parties.

Decedent owned, inter alia, one half of the preferred stock of

Vaparo, Inc.; these 470 shares had a fair market value of

$2,350,000. In 1987, at the age of 80, decedent transferred her

remainder interest in her shares to Vaparo in exchange for an

annuity which was to pay her $296,039 per year and retained her

income interest in the shares. There is no evidence in the

record to indicate that she made this transfer in contemplation

of death or with testamentary motivation. According to the

actuarial tables set forth in the Treasury Regulations, the

annuity had a fair market value of $1,324,014. The parties

stipulate that this was also the fair market value of the

remainder interest.

Decedent died in 1990, after receiving only $592,078 in

annuity payments and $23,500 in dividends. Her executrix did not

include any interest in the Vaparo stock when she computed

decedent's gross estate. The Commissioner disagreed, issuing a

notice of deficiency in which she asserted that the gross estate

included the full, fee simple value of the Vaparo shares at the

date of death, still worth an estimated $2,350,000, less the

amount of annuity payments decedent received during life. The

estate then petitioned the tax court for redetermination of the

alleged tax deficiency.

The tax court, relying largely on Gradow v. United States,

11 Cl. Ct. 808 (1987), aff'd, 897 F.2d 516 (Fed Cir. 1990), and

Estate of Gregory v. Commissioner, 39 T.C. 1012 (1963), ruled in

favor of the Commissioner. Eschewing any attempt to construe the

language of either the Code or the applicable Treasury

Regulations, the tax court reasoned that the transfer of the

remainder interest in the Vaparo stock was an abusive tax

avoidance scheme that should not be permitted:

In the instant case, we conclude that Decedent's

transfer of the remainder interest in her preferred

stock does not fall within the bona fide sale exception

of section 2036(a). Decedent's gross estate would be

depleted if the value of the preferred stock, in which

she had retained a life interest, was excluded

therefrom. Decedent's transfer of the remainder

interest was of a testamentary nature, made when she

was 80 years old to a family-owned corporation in

return for an annuity worth more than $1 million less

than the stock itself. Given our conclusion that

Decedent did not receive adequate and full

consideration under section 2036(a) for her 470 shares

of Vaparo preferred stock, we hold that her gross

estate includes the date of death value of that stock,

less the value of the annuity.

Estate of D'Ambrosio v. Commissioner, 105 T.C. 252, ___ (1995).

The executrix now appeals; we have jurisdiction under 26 U.S.C. §

7482. Both parties agree that our standard of review for this

issue of law is plenary.

II.

Our nation's tax laws have, for several generations, imposed

a tax upon decedents' estates. Under 26 U.S.C. § 2033, a

decedent's gross estate includes "[t]he value of all property to

the extent of any interest therein of the decedent at the time of

his death." In addition the Code contains, among other

provisions, § 2036(a), which provides, in pertinent part:

The value of the gross estate shall include the value

of all property to the extent of any interest therein

of which the decedent has at any time made a transfer

(except in case of a bona fide sale for adequate and

full consideration in money or money's worth), by trust

or otherwise, under which he has retained for his life

or for any period not ascertainable without reference

to his death or for any period which does not in fact

end before his death--

(1) the possession or enjoyment of, or the right to

the income from the property[.]

Section 2036(a) effectively discourages manipulative transfers of

remainder interests which are really testamentary in character by

"pulling back" the full, fee simple value of the transferred

property into the gross estate, except when the transfer was "a

bona fide sale for adequate and full consideration."

There is no dispute that Rose D'Ambrosio retained a life

interest in the Vaparo stock and sold the remainder back to the

company. The issue is whether the sale of a remainder interest

for its fair market value constitutes "adequate and full

consideration" within the meaning of § 2036(a). Appellant argues

that it does. The Commissioner takes the position that only

consideration equal to the fee simple value of the property is

sufficient. Appellant has the better argument.

A.

The tax court and the Commissioner rely principally on four

cases, Gradow v. United States, 11 Cl. Ct. 808 (1987), aff'd for

the reasons set forth by the claims court, 897 F.2d 516 (Fed.

Cir. 1990); United States v. Past, 347 F.2d 7 (9th Cir. 1965);

Estate of Gregory v. Commissioner, 39 T.C. 1012 (1963); United

States v. Allen, 293 F.2d 916 (10th Cir. 1961). We find these

cases either inapposite or unpersuasive; we will discuss them in

chronological order.

In Allen, the decedent set up an irrevocable inter vivostrust in

which she retained a partial life estate and gave the

remainder (as well as the remaining portion of the income) to her

children. Apparently realizing the tax liability she had created

for her estate under the predecessor of § 2036, she later

attempted to sell her retained life interest to her son for an

amount slightly in excess of its fair market value. After she

died, the estate took the position that, because decedent had

divested herself of her retained life interest for fair market

value, none of the trust property was includable in her gross

estate. The Court of Appeals disagreed, holding that

consideration is only "adequate" if it equals or exceeds the

value of the interest that would otherwise be included in the

gross estate absent the transfer. See 293 F.2d at 917. Although

acknowledging that the decedent owned only a life estate, which

she could not realistically hope to sell for its fee simple

value, the court nevertheless rejected the estate's argument,

opining:

It does not seem plausible, however, that Congress

intended to allow such an easy avoidance of the taxable

incidence befalling reserved life estates. This result

would allow a taxpayer to reap the benefits of property

for his lifetime and, in contemplation of death, sell

only the interest entitling him to the income, thereby

removing all of the property which he has enjoyed from

his gross estate. Giving the statute a reasonable

interpretation, we cannot believe this to be its

intendment. It seems certain that in a situation like

this, Congress meant the estate to include the corpus

of the trust or, in its stead, an amount equal in

value.

Id. at 918 (citations omitted).

Allen, however, is inapposite, as the Commissioner now

concedes, because it involved the sale of a life estate after the

remainder had already been disposed of by gift, a testamentary

transaction with a palpable tax evasion motive. This case, in

contrast, involves the sale of a remainder for its stipulated

fair market value. Nevertheless, we agree with its rationale

that consideration should be measured against the value that

would have been drawn into the gross estate absent the transfer.

As the tax court persuasively reasoned in a later case:

[W]here the transferred property is replaced by other

property of equal value received in exchange, there is

no reason to impose an estate tax in respect of the

transferred property, for it is reasonable to assume

that the property acquired in exchange will find its

way into the decedent's gross estate at his death

unless consumed or otherwise disposed of in a

nontestamentary transaction in much the same manner as

would the transferred property itself had the transfer

not taken place. . . .

In short, unless replaced by property of equal

value that could be exposed to inclusion in the

decedent's gross estate, the property transferred in a

testamentary transaction of the type described in the

statute must be included in his gross estate.

Estate of Frothingham v. Commissioner, 60 T.C. 211, 215-16 (1973)

(emphasis added).

Gregory presents a closer factual analogy to D'Ambrosio's

situation. Gregory was a "widow's election" case involving the

testamentary disposition of community property. Typically in

such cases, the husband wishes to pass the remainder interest in

all of the marital property to his children, while providing for

the lifetime needs of his surviving spouse. In a community

property state, however, half of the marital property belongs to

the wife as a matter of law, so he cannot pass it by his own

will. To circumvent this problem, the will is drafted to give

the widow a choice: take her one-half share in fee simple,

according to law, or trust over her half of the community

property in exchange for a life estate in the whole. Put another

way, she trades the remainder interest in her half of the

community property in exchange for a life estate in her husband's

half.

In Gregory, the widow exchanged property worth approximately

$66,000 for a life estate with an actuarial value of only around

$12,000; by the time she died eight years later, the property she

gave up had appreciated to approximately $102,000. The tax court

compared the $102,000 outflow to the $12,000 consideration and

concluded that the widow's election did not constitute a bona

fide sale for an adequate and full consideration. 39 T.C. at

1015-16. It also stated that "the statute excepts only those

bona fide sales where the consideration received was of a

comparable value which would be includable in the transferor's

gross estate." Id. at 1016 (emphasis added).

We believe that the Gregory court erred in its analysis,

although it reached the correct result on the particular facts of

that case. There is no way to know ex ante what the value of an

asset will be at the death of a testator; although the date of

death can be estimated through the use of actuarial tables, the

actual appreciation of the property is unknowable, as are the

prevailing interest, inflation and tax rates. Consequently,

there is no way to ever be certain in advance whether the

consideration is adequate and thus no way to know what tax

treatment a transfer will receive. This level of uncertainty all

but destroys any economic incentive to ever sell a remainder

interest; yet, Congress never said in § 2036 that all transfers

of such interests will be taxed at their fee simple value or that

those transfers are illegal. Instead, it clearly contemplated

situations in which a sale of a remainder would not cause the

full value of the property to fall into the gross estate.

Without some express indication from Congress, we will not

presume it intended to eliminate wholesale the transfers of

remainder interests. Therefore, rather than evaluate the

adequacy of the consideration at the time the decedent dies, we

will compare the value of the remainder transferred to the value

of the consideration received, measured as of the date of the

transfer. Here, we need not address that valuation issue,

because it is stipulated that the fair market value of the stock

was the same on the date of transfer as it was on the date of

death.

In Gregory, however, the $12,000 the decedent received was

grossly inadequate against the value of the property she

transferred, regardless of the valuation date. The court was

therefore correct that the transfer was not for adequate and full

consideration. Because of that gross inadequacy, however, the

holding of Gregory does not extend to the issue now before us:

whether, when a remainder is sold for its stipulated fair market

value, the consideration received is inadequate because it is

less than the fee simple value of the property.

The Past case was factually somewhat different, in that it

involved a divorce settlement, but the substance of the

transaction was the same as in Gregory: the sale of a remainder

in one-half of the marital property in exchange for a life estate

in the whole. In that case, however, the court valued the

property the divorcing spouse gave up at about $244,000 and the

life estate she received at about $143,000; as a result, it held

that the consideration was inadequate. 347 F.2d at 13-14. In

making these valuations, however, the court took the fee simple

value of the trust property and divided it in half. This was

analytically incorrect, however, because the divorcing wife never

gave up the life estate in her half of the marital property. She

contributed only her remainder interest in that half, and that is

the value that should have been used in the court's analysis.

Alternatively, the Past court could have used the fee simple

value of the wife's share, but it would then have needed to

measure that against the value of the life estate in both halves

of the property. Had the court employed this latter methodology,

it would have seen that the $287,000 value of the life estate

exceeded the $244,000 she contributed and would have found

adequate consideration. Instead, it compared "apples and

oranges" and, we believe, reached the wrong result.

B.

The facts in Gradow were similar to those in Gregory; both

are "widow's election" cases. That case is particularly

significant, however, because the court focused on the statutory

language of § 2036. The court began its analysis, however, with

a discussion of Gregory, Past and Allen. While acknowledging

that it was not bound by those three cases, the Gradow court

found them persuasive, for two reasons: 1) "the most natural

reading of § 2036(a) leads to the same result[;]" and 2) their

holding is "most consistent with the purposes of § 2036(a)." 11

Cl. Ct. at 813. We will discuss these rationales in turn.

1.

We examine first the Gradow court's construction of the

statute. It opined that

there is no question that the term "property" in the

phrase "The gross estate shall include ... all property

... of which the decedent has at any time made a

transfer" means that part of the trust corpus

attributable to plaintiff. If § 2036(a) applies, all

of Betty's former community property is brought into

her gross estate. Fundamental principles of grammar

dictate that the parenthetical exception which then

follows--"(except in case of a bona fide sale...)"--

refers to a transfer of that same property, i.e. the

one-half of the community property she placed into the

trust.

Id. (ellipses in original). We disagree; although the Gradowcourt's

rationale appears plausible, we note that the court, in

quoting the statute, left out significant portions of its

language. Below is the text of § 2036, with the omitted words

emphasized:

The value of the gross estate shall include the value

of all property to the extent of any interest thereinof which the

decedent has at any time made a transfer

(except in case of a bona fide sale for an adequate and

full consideration in money or money's worth), by trust

or otherwise, under which he has retained for his life

* * * (1) the possession or enjoyment of, or the right

to the income from, the property * * *

After parsing this language, we cannot agree with the Gradowcourt's

conclusions that "property" refers to the fee simple

interest and that adequate consideration must be measured against

that value. Rather, we believe that the clear import of the

phrase "to the extent of any interest therein" is that the gross

estate shall include the value of the remainder interest, unless

it was sold for adequate and fair consideration.

In addition to § 2036, Treas. Reg. § 20.2036-1 also

addresses this issue. It provides, in pertinent part (emphases

added):

(a) In general. A decedent's gross estate

includes under section 2036 the value of any interestin property

transferred by the decedent . . . except to

the extent that the transfer was for an adequate and

full consideration in money or money's worth if the

decedent retained or reserved (1) for his life . . .

(i) The use, possession, right to the income, or

other enjoyment of the transferred property, . . .

Appellant refers us to the emphasized words "interest" and

"transferred" in § 20.2036-1(a) and argues that "adequate and

full consideration" must be measured against the interest

transferred. The Commissioner, on the other hand, looks at the

phrase "of the transferred property" in § 20.2036-1(a)(i) and

concludes that, because one cannot retain any lifetime interest

in a remainder, "property" must refer to the fee simple interest.

The regulation, unfortunately, is not exactingly drafted and

does not parse "cleanly" under either party's interpretation.

The Commissioner is of course correct that one cannot enjoy any

sort of life interest in a remainder. On the other hand,

appellant validly asks why, if the drafters of the regulation

meant to include the full value of the property, they referred to

the value of any "interest in property transferred." On balance,

we believe that, if some words of the regulation must be

construed as surplusage, it is more reasonable and faithful to

the statutory text to render inoperative the word "transferred"

in § 20.2036-1(a)(i) than it would be to strike "interest" in the

first part of the section. We think it is likely that, although

the choice of verbiage was less than precise, the drafters meant

merely to refer to the "transferred" property so as to

distinguish it from other property owned by the estate. It

strains the judicial imagination, however, to conclude that the

drafters used the term of art "interest in property" when they

meant simply "property."

2.

The Gradow court also believed that its construction of §

2036 was "most consistent" with its purposes. 11 Cl. Ct. at 813.

The tax court in this case, although recognizing that the issue

has spawned considerable legal commentary and that scholars

dispute its resolution, 105 T.C. at ___, was persuaded that

decedent's sale of her remainder interest was testamentary in

character and designed to avoid the payment of estate tax that

otherwise would have been due. Id. at ___. It noted

particularly that the transfer was made when decedent was eighty

years old and that the value of the annuity she received was over

$1 million less than the fee simple value of the stock she gave

up. Id. Again, we disagree.

We too are cognizant that techniques for attempting to

reduce estate taxes are limited only by the imagination of estate

planners, and that new devices appear regularly. There is, to be

sure, a role for the federal courts to play in properly limiting

these techniques in accordance with the expressed intent of

Congress. Under long-standing precedent, for example, we measure

"consideration" in real economic terms, not as it might be

evaluated under the common law of contract or property. E.g.,

Commissioner v. Wemyss, 324 U.S. 303, 65 S. Ct. 652 (1945)

(promise of marriage insufficient consideration, for gift tax

purposes, for tax-free transfer of property); Merrill v. Fahs,

324 U.S. 308, 65 S. Ct. 655 (1945) (same). Likewise, when the

transfer of the remainder interest is essentially gratuitous and

testamentary in character, we focus on substance rather than form

and require that the full value of trust property be included in

the gross estate, unless "the settlor absolutely, unequivocally,

irrevocably, and without possible reservations, parts with all of

his title and all of his possession and all of his enjoyment of

the transferred property." See Commissioner v. Estate of Church,

335 U.S. 632, 645, 69 S. Ct. 322, 329 (1949) (gratuitous transfer

of remainder in trust for family members with possibility of

reverter to estate); accord Helvering v. Hallock, 309 U.S. 106,

110, 60 S. Ct. 444, 447 (consolidation of three cases involving

"dispositions of property by way of trust in which the settlement

provides for return or reversion of the corpus to the donor upon

a contingency terminable at his death").

On the other hand, it is not our role to police the

techniques of estate planning by determining, based on our own

policy views and perceptions, which transfers are abusive and

which are not. That is properly the role of Congress, whose

statutory enactments we are bound to interpret. As stated

supra, we think the statutory text better supports appellant's

argument.

Even looking at this case in policy terms, however, it is

difficult to fathom either the tax court's or the Commissioner's

concerns about the "abusiveness" of this transaction. A

hypothetical example will illustrate the point.

A fee simple interest is comprised of a life estate and a

remainder. Returning to the widow's election cases, assume that

the surviving spouse's share of the community property is valued

at $2,000,000. Assuming that she decides not to accept the

settlement and to keep that property, its whole value will be

available for inclusion in the gross estate at death, but only as

long as the widow lives entirely on the income from the property.

If she invades principal and sells some of the property in order

to meet living expenses or purchase luxury items, then at least

some of that value will not be included in the gross estate. Tax

law, of course (with the exception of the gift tax), imposes no

burdens on how a person spends her money during life.

Next, assume that same widow decides to sell her remainder

and keep a life estate. As long as she sells the remainder for

its fair market value, it makes no difference whether she

receives cash, other property, or an annuity. All can be

discounted to their respective present values and quantified. If

she continues to support herself from the income from her life

estate, the consideration she received in exchange for the

remainder, if properly invested, will still be available for

inclusion in the gross estate when she dies, as Frothingham and

Gregory require. On the other hand, if her life estate is

insufficient to meet her living expenses, the widow will have to

invade the consideration she received in exchange for her

remainder, but to no different an extent than she would under the

previous hypothetical in which she retained the fee simple

interest. In sum, there is simply no change in the date-of-death

value of the final estate, regardless of which option she

selects, at any given standard of living.

On the other hand, if the full, fee simple value of the

property at the time of death is pulled back into the gross

estate under § 2036(a), subject only to an offset for the

consideration received, then the post-sale appreciation of the

transferred asset will be taxed at death. Indeed, it will be

double-taxed, because, all things being equal, the consideration

she received will also have appreciated and will be subject to

tax on its increased value. In addition, it would appear

virtually impossible, under the tax court's reasoning, ever to

sell a remainder interest; if the adequacy of the consideration

must be measured against the fee simple value of the property at

the time of the transfer, the transferor will have to find an

arms-length buyer willing to pay a fee simple price for a future

interest. Unless a buyer is willing to speculate that the future

value of the asset will skyrocket, few if any such sales will

take place.

Another potential concern, expressed by the Gradow court, is

that, under appellant's theory, "[a] young person could sell a

remainder interest for a fraction of the property's [current, fee

simple] worth, enjoy the property for life, and then pass it

along without estate or gift tax consequences." 11 Cl. Ct. at

815. This reasoning is problematic, however, because it ignores

the time value of money. Assume that a decedent sells his son a

remainder interest in that much-debated and often-sold parcel of

land called Blackacre, which is worth $1 million in fee simple,

for its actuarial fair market value of $100,000 (an amount which

implicitly includes the market value of Blackacre's expected

appreciation). Decedent then invests the proceeds of the sale.

If the rates of return for both assets are equal and decedent

lives exactly as long as the actuarial tables predict, the

consideration that decedent received for his remainder will equal

the value of Blackacre on the date of his death. The equivalent

value will, accordingly, still be included in the gross estate.

Moreover, decedent's son will have only a $100,000 basis in

Blackacre, because that is all he paid for it. He will then be

subject to capital gains taxes on its appreciated value if he

decides to ever sell the property. Had Blackacre been passed by

decedent's will and included in the gross estate, the son would

have received a stepped-up basis at the time of his father's

death or the alternate valuation date. We therefore have great

difficulty understanding how this transaction could be abusive.

On this appeal, the Commissioner likewise argues for the

Gradow rule on the rationale that "the retained life interest is

in closely held stock whose dividend treatment is subject to the

control of decedent and her family. In such circumstances, the

amount of the dividend income that decedent was to receive from

her life income interest in the Vaparo preferred stock was

susceptible of manipulation[.]" Commissioner's Brief at 33.

There is no evidence, however, that the Vaparo dividends weremanipulated,

and the Commissioner directs us to no authority that

we should presume so. In addition, implicit in her argument is

the proposition that the life estate was overvalued by the

executor and the remainder correspondingly undervalued. Such a

position, however, is directly contrary to the Commissioner's own

stipulation regarding the values of those interests.

The Commissioner also asserts that the D'Ambrosio estate

plan is "calculated to deplete decedent's estate in the event

that she should not survive as long as her actuarially projected

life expectancy." Commissioner's Brief at 34-35. We note first

that the Commissioner does not argue that decedent transferred

her remainder in contemplation of imminent death under such

circumstances that the tables should not be applied. Leaving

aside the untimely death of Rose D'Ambrosio, any given transferor

of a remainder is equally likely to outlive the tables, in which

case she would collect more from her annuity, the gross estate

would be correspondingly larger and the Commissioner would

collect more tax revenue than if the remainder had never been

transferred.

3.

Several courts have followed the holding in Gradow, but none

of their opinions provides any cogent analysis that persuade us

it is sound. See Pittman v. United States, 878 F. Supp. 833, 835

(E.D.N.C. 1994) (applying Gradow without analysis); Wheeler v.

United States, No. SA-94-CA-964, 77 A.F.T.R.2d 96-1405, 96-1411,

1996 WL 266420, *4-*5 (W.D. Tex. Jan. 26, 1996) (similar). Two

other courts have questioned the soundness of Gradow, but have

either applied it reluctantly or decided the case on other

grounds. See Parker v. United States, 894 F. Supp. 445, 447

(N.D. Ga. 1995); Estate of McLendon v. Commissioner, Nos. 20324-

90, 20325-90, T.C. Memo. 1993-459, 66 T.C.M. (CCH) 946, T.C.M.

(P-H) ¶ 93,459, 1993 WL 391134, n.24 and accompanying text (Tax

Ct. Sept. 30, 1993), rev'd on other grounds, 77 A.F.T.R.2d 666

(5th Cir. 1995).

The holdings of Gradow and the earlier cases such as Gregoryhave

inspired considerable legal commentary, most of it critical.

See Jacques T. Schlenger et al., Cases Addressing Sale of

Remainder Wrongly Decided, 22 Estate Planning 305 (1995)

(reproducing Professor Pennell's remarks criticizing Pittman as a

"mindless" decision); 2 A. James Casner, Estate Planning §

6.15.2, at 6-146-50, 6-158 (Supp. 1995) (Professor Casner,

criticizing Gradow court as lacking understanding of future

interests, economics and time value of money); Jacques T.

Schlenger et al., Property Included in Estate Despite Sale of

Remainder Interest, 23 Estate Planning 132 (1996) (criticizing

reasoning of tax court in D'Ambrosio); Richard B. Stephens et

al., Federal Estate and Gift Taxation ¶ 4.08[1], at 4-138 (6th

ed. 1991) (stating that payment of full consideration for

remainder interest alone is sufficient under § 2036, but noting

Gregory, Past and Gradow in a footnote); Peter M. Weinbaum, Are

Sales of Remainder Interests Still Available in Light of a New

Decision?, 14 Estate Planning 258 (1987) (criticizing Gradow for

quoting and analyzing § 2036(a) out of context and for ignoring

the value of the life estate in the wife's community property as

consideration received in the transfer). As discussed supra, we

find this criticism to be well-taken.

III.

Because we conclude that the tax court erred as a matter of

law when it determined that the consideration received by Rose

D'Ambrosio for her remainder interest was not adequate and full,

we will reverse and remand for it to enter judgment in favor of

the estate.

Estate of Rose D'Ambrosio v. Commissioner of Internal Revenue

No. 95-7643

COWEN, Circuit Judge, dissenting.

Today the majority holds that a tax-avoidance approach

previously considered "too good to be true" can, at least in

limited circumstances, actually be true. I respectfully dissent.

The tax court's opinion is supported by well-established case law

and the plain language of the Internal Revenue Code. It should

be affirmed.

I.

The value of a gross estate includes the value of all

property held by the decedent on the date of death. I.R.C. §

2033. Pursuant to section 2036(a), for federal estate tax

purposes the gross estate also includes any property that is the

subject of an inter vivos transfer and in which the taxpayer

reserves an income interest in that property until death. The

sole exception authorized by section 2036(a) is a "bona fide

sale" in which the transferor receives "adequate and full

consideration" in exchange for the transferred property. I.R.C.

§ 2036(a). The majority holds that under section 2036(a),

"adequate and full consideration" must be provided merely for

that portion of the taxpayer's property interest actually

transferred, rather than for the full value of the property that

is the basis for the ongoing income interest.

The majority excludes from the computation of "full and

adequate consideration" the value of decedent's life interest in

the transferred stock, on the grounds that D'Ambrosio retained

that interest. The intended purpose of section 2036 is to

prevent decedents from avoiding estate taxes by selling their

property to a third party but retaining the benefits of ownership

during their lives. It includes in a decedent's gross estate the

date-of-death value of

all property to the extent of any interest therein of

which the decedent has at any time made a transfer

(except in the case of a bona fide sale for an adequate

and full consideration in money or money's worth), by

trust or otherwise, under which he has retained for his

life . . . the possession or enjoyment of, or the right

to the income from, the property.

I.R.C. § 2036(a). When a taxpayer makes a transfer with a

retained life interest, the powerful arm of section 2036(a) pulls

into the gross estate the full value of the transferred property,

not merely the value of the remainder interest.

The majority accepts the view of the estate that the

decedent "sold" only the remainder interest to Vaparo. This view

of section 2036 sanctions tax evasion: It enables strategic

segmentation of the property into multiple interests, with

"adequate and full consideration" now required only for a

specific transferred segment, rather than the indivisible whole.

Such an interpretation of section 2036(a) thwarts its very

purpose, enabling taxpayers to avoid paying estate taxes on

property while retaining the income benefits of ownership. I

would affirm the tax court's holding that "adequate and full

consideration" assesses whether the consideration received is

equal to the value of the property that would have remained in

the estate but for the transfer, not whether it is commensurate

with the value of the artfully separated portion of the property

technically transferred.

II.

The well-reasoned case law construing section 2036(a)

supports the ruling of the tax court. That law correctly tests

the adequacy of the consideration received by a taxpayer against

the amount that otherwise would be included in that taxpayer's

gross estate. The majority distinguishes these cases by focusing

on irrelevant distinctions, and overlooks the commanding

principle that a taxpayer who fails to convey all interests in an

asset, continuing to derive some benefit from the asset until

death, must include the entire asset in the taxpayer's estate.

In Gradow v. United States, 11 Cl. Ct. 808 (1987),

aff'd, 897 F.2d 516 (Fed. Cir. 1990), the surviving spouse

transferred her full community property interest into a trust

that held all of the couple's community property. Thereafter,

the trust paid her all of the trust income during her life, and

distributed the entire corpus of the trust to her son upon her

death. Gradow's executor asserted that decedent's retained life

interest was received in exchange for adequate and full

consideration, so that none of the trust's assets were includable

in her gross estate. The court disagreed, holding that the

consideration paid by the decedent had to cover not only the

remainder interest that was left to her son in the trust, but

also her half of the underlying community property.

Other courts have acknowledged and followed this rule.

See United States v. Past, 347 F.2d 7 (9th Cir. 1965)

(consideration decedent received from trust had to be measured

against the total value of the property she contributed to the

trust, not only against the remainder interest in the property);

United States v. Allen, 293 F.2d 916 (10th Cir. 1961) (decedent

who received most of trust's income for life but before death

sold her remainder interest to her children had to include the

value of the trust assets corresponding to the percentage of the

trust's income that she received); Estate of Gregory v.

Commissioner, 39 T.C. 1012, 1016 (1963) (decedent who received a

life estate in exchange for transferring property to a trust

failed to qualify for exception because "[t]he statute excepts

only those bona fide sales where the consideration received was

of a comparable value which would be includable in the

transferor's gross estate").

The paramount purpose of section 2036(a) is to prevent

the depletion of estate assets when individuals retain the use

and enjoyment of those assets until death. In Commissioner v.

Estate of Church, 335 U.S. 632, 69 S.Ct. 322 (1949), the Supreme

Court emphatically noted that

an estate tax cannot be avoided by any trust transfer

except by a bona fide transfer in which the settlor,

absolutely, unequivocally, irrevocably, and without

possible reservations, parts with all of his title and

all of his possession and all of his enjoyment of the

transferred property.

Id. at 645. D'Ambrosio clearly fails this requirement that all

title, enjoyment, and possession of the transferred property be

unequivocally halted. Commenting on the forerunner to section

2036(a) more than a half century ago, the Supreme Court stated

that the law

taxes not merely those interests which are deemed to

pass at death according to refined technicalities of

the law of property. It also taxes inter vivostransfers that

are too much akin to testamentary

dispositions not to be subjected to the same excise.

Helvering v. Hallock, 309 U.S. 106, 112, 60 S.Ct. 444, 448

(1940).

These cases clearly demonstrate that the concept of

"adequate and full consideration," as used in sections 2035

through 2038, must be construed with reference to the special

problems posed by trying to prevent testamentary-type transfers

from evading estate tax. The bona fide sale analysis, which

exempts property from inclusion in the gross estate pursuant to

section 2036(a), cannot focus merely on the value of the limited

property interest that is sold. It must also consider the

property that would otherwise be included in the decedent's gross

estate.

III.

The estate asserts that the tax court erred because it

misunderstood or disregarded the "economic reality" of a sale of

a remainder interest. To the contrary, it was precisely the tax

court's awareness of the economic realities of a retained

interest transaction that led it to follow well-established law.

Executrix D'Ambrosio alleges that Gradow is inapposite and, in

any event, was erroneously decided. She states that

if the Decedent had retained and invested the dividends

from the Vaparo Stock and from the annuity payments

received during her life, the potential value of her

gross estate as a result of the sale would be worth no

less on the date of her death, than if she had never

sold the remainder interest in the Vaparo Stock or if

she had sold the entire interest in the Vaparo Stock

and invested the proceeds therefrom for the rest of her

life.

Appellant's brief at 11.

This view ignores the very reason for section 2036(a).

Its purpose is precisely to prevent taxpayers from retaining the

practical benefits of asset ownership during their lifetime while

divesting themselves for estate tax purposes of a portion of that

property. As the court in Gradow correctly explained:

[The "economic reality" argument] flies squarely in the

face of the Supreme Court's analysis as to the

assumptions and purposes behind 2036(a). [T]he Court

has taught that while tax limitation is perfectly

legitimate, § 2036(a) is a reflection of Congress'

judgment that transfers with retained life estates are

generally testamentary transactions and should be

treated as such for estate tax purposes. The fond hope

that a surviving spouse would take pains to invest,

compound, and preserve inviolate all life income from

half of a trust, knowing that it would thereupon be

taxed without his having received any lifetime benefit,

is a slim basis for putting a different construction on

§ 2036(a) than the one heretofore consistently adopted.

11 Cl. Ct. at 815-816.

Even if the annuity decedent received were not an

attempt to deplete her property for estate tax purposes, courts

have consistently held that section 2036(a) does not exempt

transfers of property in which the taxpayer retains an income

interest in his or her underlying assets. As the Tenth Circuit

concluded in Allen:

It does not seem plausible . . . that Congress intended

to allow such an easy avoidance of the taxable

incidence befalling reserved life estates. This result

would allow a taxpayer to reap the benefits of property

for his lifetime and, in contemplation of death, sell

only the interest entitling him to the income, thereby

removing all of the property which he has enjoyed from

his gross estate. . . . [I]n a situation like this,

Congress meant the estate to include the corpus of the

trust or, in its stead, an amount equal in value.

293 F.2d at 918 (citations omitted).

IV.

I would affirm the decision of the tax court. I

respectfully dissent.