Estate of Dorothy Walsh, Charles E. Walsh, Personal Respresentative v. Commissioner

110 T.C. No. 29

UNITED STATES TAX COURT

ESTATE OF DOROTHY M. WALSH, DECEASED,

CHARLES E. WALSH, PERSONAL REPRESENTATIVE, Petitioner

v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 15150-97. Filed June 15, 1998.

H and W formed a trust to hold their property

during their lives. The trust agreement provided that

the property would pass to two trusts (A and B) upon

the death of the first spouse, and that the surviving

spouse, while competent, was entitled during life to

A's income and corpus. The trust agreement provided

that, upon the death or incompetency of the surviving

spouse, A's property would be distributed to the

persons chosen by the surviving spouse, and, if no such

persons were chosen, in six equal shares to the

children of H and W. W died before H, and W's estate

claimed the marital deduction with respect to the

assets passing to A. B was funded with assets having

an aggregate value of $600,000, and A was funded with

the remaining assets.

Held: The incompetency provisions in the trust

agreement take the property passing to A outside the

requirements for the marital deduction; the surviving

spouse's power of appointment is not exercisable by the

surviving spouse alone and in all events, as is

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required by sec. 2056(b)(5), I.R.C., and the

regulations thereunder.

Thomas J. Shroyer, Robert B. Firing, Nicky R. Hay, and

Steven Z. Kaplan,1 for petitioner.

John C. Schmittdiel, for respondent.

OPINION

LARO, Judge: This case was submitted to the Court without

trial. See Rule 122. The Estate of Dorothy M. Walsh, Deceased,

Charles E. Walsh, Personal Representative, petitioned the Court

to redetermine respondent's determination of a $291,651

deficiency in Federal estate tax. We must decide whether certain

property is eligible for the marital deduction under section

2056(a). We hold it is not.

Unless otherwise indicated, section references are to the

applicable provisions of the Internal Revenue Code. Rule

references are to the Tax Court Rules of Practice and Procedure.

Decedent references are to Dorothy M. Walsh. Estate references

are to the decedent's estate.

Background

All facts have been stipulated and are so found. The

stipulation of facts and the exhibits submitted therewith are

incorporated herein by this reference. The decedent was a U.S.

1

Mr. Kaplan, who prepared the subject petition, withdrew as

counsel of record on Mar. 4, 1998.

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citizen who resided in Ramsey County, Minnesota, when she died

testate on July 30, 1993. Charles E. Walsh, her surviving spouse

and the estate's personal representative, is a U.S. citizen who

resided in St. Paul, Minnesota, when the petition was filed.

On October 30, 1992, Mr. Walsh and the decedent established

a revocable trust named the Dorchar Trust Agreement (the Trust),

and they transferred most of their assets to the Trust. Also on

that date, the decedent executed her last will and testament,

bequeathing to the Trust the residue of her estate.

Under the terms of the Trust agreement (the Agreement), each

spouse could independently alter, amend, or revoke the Trust if

competent, and both spouses served as cotrustees during their

joint lives. Upon the incompetence or death of either spouse,

the remaining spouse would serve as sole trustee until the need

for a successor arose.

The Agreement also provided that, upon the death of the

first spouse, the Trust's assets would be placed in Trust A and

Trust B. After the payment of all expenses, Trust B would be

funded with assets having an aggregate value of $600,000, and

Trust A would be funded with the remaining assets. The Agreement

provided:

The Trustee shall try to allocate to TRUST A only

property that will qualify for the marital deduction

* * * [and] it is our intention that TRUST A shall

qualify for the marital deduction under the federal

estate tax provisions of the Internal Revenue Code in

effect at the time of the death of the first one of us.

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The provisions shall be so construed and questions

pertaining to TRUST A shall be resolved accordingly.

With respect to the administration and distribution of the

assets in Trust A, Article VII of the Agreement provided:

1. During the life of the surviving

spouse who remains competent as set

forth in Article XXIII[2] * * *

a. The net income, beginning

as of the date of the

first to die, may be paid

to said spouse in

quarterly or other

convenient installments

during the life of said

spouse.

b. The Trustee may pay to

said spouse or apply for

the benefit of said

spouse such amounts of

principal as the Trustee

deems necessary or

advisable for the proper

care, comfort, support,

maintenance, and welfare

of said spouse, including

reasonable luxuries.

c. Said spouse shall

withdraw any amount or

all of this Trust by

written request to the

Trustee.

2

Article XXIII provides that: "Incompetency * * * simply

means 'unable to handle ones [sic] affairs with adequate

competence'". Article XXIII also provides that successor

trustees are directed "to sign * * * [a form declaring the

surviving spouse incompetent] if, in each Successor Trustee's

complete discretion it will preserve the assets of this Trust."

Article XXIII further provides that the surviving spouse, if

incompetent, is "barred from receiving any of the benefits of

this Trust."

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d. If said spouse should at

any time be determined as

incompetent * * *, said

spouse shall take no

benefits hereunder and

this Trust shall be

treated and distributed

as if said spouse had

died.

2. After the death of the surviving

spouse or after the incompetency of

the surviving spouse * * *

a. All property in TRUST A,

including income, shall

be distributed to such

appointee or appointees

in the manner and

proportions as the

surviving spouse may

designate by Will

expressly referring to

this general power of

appointment, including

the power in said spouse

to appoint all thereof to

said spouse's estate,

free of any Trust

hereunder. Such general

power of appointment

shall exist immediately

upon the death of the

first one of us to die

and shall be exercisable

by the surviving spouse

exclusively and in all

events.

b. Any portion of TRUST A

which is not effectively

disposed of by the above

provision shall be

divided into six (6)

equal shares so as to be

disposed of in cash or

property, in kind, as the

Trustee deems best in the

Trustee's complete

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discretion as * * * [a

distribution to or in

trust for the settlors'

children].

Mr. Walsh has not executed the power of appointment mentioned in

the Agreement, and neither his will nor the decedent's will

provided for the exercise of this power.

The decedent's Federal estate tax return reported a gross

estate of $1,533,805, deductions of $933,805, a taxable estate of

$600,000, and no tax liability. The reported deductions included

funeral and administrative expenses of $13,198 and a marital

deduction of $920,607. The estate claimed the marital deduction

with respect to the assets passing to Trust A under the

Agreement.

Discussion

We must decide whether the property passing to Trust A

qualifies for the marital deduction under section 2056. Section

2056 provides in part:

SEC. 2056. BEQUESTS, ETC., TO SURVIVING SPOUSE.

(a) Allowance of Marital Deduction.--* * * the

value of the taxable estate shall, except as limited by

subsection (b), be determined by deducting from the

value of the gross estate an amount equal to the value

of any interest in property which passes or has passed

from the decedent to his surviving spouse, but only to

the extent that such interest is included in

determining the value of the gross estate.

(b) Limitation in the Case of Life Estate or Other

Terminable Interest.--

(1) General rule.--Where, on the lapse

of time, on the occurrence of an event or

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contingency, or on the failure of an event or

contingency to occur, an interest passing to

the surviving spouse will terminate or fail,

no deduction shall be allowed under this

section with respect to such interest—-

(A) if an interest in such

property passes or has passed (for

less than an adequate and full

consideration in money or money's

worth) from the decedent to any

person other than such surviving

spouse (or the estate of such

spouse); and

(B) if by reason of such

passing such person (or his heirs

or assigns) may possess or enjoy

any part of such property after

such termination or failure of the

interest so passing to the

surviving spouse;

and no deduction shall be allowed with

respect to such interest (even if such

deduction is not disallowed under

subparagraphs (A) and (B))—-

* * * * * * *

(5) Life estate with power of

appointment in surviving spouse.--In the case

of an interest in property passing from the

decedent, if his surviving spouse is entitled

for life to all the income from the entire

interest, or all the income from a specific

portion thereof, payable annually or at more

frequent intervals, with power in the

surviving spouse to appoint the entire

interest, or such specific portion

(exercisable in favor of such surviving

spouse, or of the estate of such surviving

spouse, or in favor of either, whether or not

in each case the power is exercisable in

favor of others), and with no power in any

other person to appoint any part of the

interest, or such specific portion, to any

person other than the surviving spouse—

(A) the interest or such

portion thereof so passing shall,

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for purposes of subsection (a), be

considered as passing to the

surviving spouse, and

(B) no part of the interest so

passing shall, for purposes of

paragraph (1)(A), be considered as

passing to any person other than

the surviving spouse.

This paragraph shall apply only if such power

in the surviving spouse to appoint the entire

interest, or such specific portion thereof,

whether exercisable by will or during life,

is exercisable by such spouse alone and in

all events.

Respondent determined and argues that the property passing

to Trust A does not qualify for the marital deduction because the

property is a terminable interest. Respondent reaches this

result mainly because, in respondent's view, the Agreement

revokes the surviving spouses's right to receive income from the

Trust, or to appoint the Trust's property, upon incompetency.

The estate argues primarily that the property is not a terminable

interest because the surviving spouse has a general power of

appointment over the Trust's assets that allows the surviving

spouse to dispose of these assets any time before the Trust

terminates on account of the surviving spouse's death or

incompetency. The estate asserts that the Agreement states

clearly that the intent of the Trust's settlors was to qualify

Trust A for the marital deduction. If the property is a

terminable interest, the estate argues alternatively, the

decedent's estate tax liability must be computed as if no

completed gift of property was made to the Trust before the

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decedent died.3 The estate asserts that the Trust fails because

its settlors never relinquished control over the property

transferred to it. The estate asserts that the Trust is revoked

if the settlors' intent to qualify Trust A for the marital

deduction is thwarted.

We agree with respondent that the property passing to

Trust A does not qualify for the marital deduction. Property

interests included in a decedent's gross estate generally meet a

threshold requirement for the marital deduction if the interests

pass to the decedent's surviving spouse. Sec. 2056(a). An

interest will not qualify for this deduction, however, if it is

terminable within the meaning of section 2056(b). Jackson v.

United States, 376 U.S. 503, 508 (1964) (citing Starrett v.

Commissioner, 223 F.2d 163 (1st Cir. 1955), affg. Estate of

Tingley v. Commissioner, 22 T.C. 402 (1954)); Hansen v. Vinal,

413 F.2d 882, 886 (8th Cir. 1969); Allen v. United States,

359 F.2d 151, 154 (2d Cir. 1966); United States v. First Natl.

Trust & Sav. Bank, 335 F.2d 107, 113 (9th Cir. 1964); Bookwalter

v. Lamar, 323 F.2d 664 (8th Cir. 1963). An interest is

terminable if: (1) It will terminate or fail on the lapse of

time, on the occurrence of an event or contingency, or on the

failure of an event or contingency to occur, (2) it passes for

less than adequate and full consideration from the decedent to a

3

The estate requests that it be allowed to recompute its

Federal estate tax liability by reference to only those assets in

the Trust which the decedent had contributed to the Trust.

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person other than the surviving spouse or his or her estate, and

(3) the person to whom the interest passes may possess or enjoy

any part of the property after the interest passing to the

surviving spouse terminates or fails. Sec. 2056(b)(1); Estate of

Abely v. Commissioner, 60 T.C. 120, 122 (1973), affd. 489 F.2d

1327 (1st Cir. 1974); see also Estate of Cunha v. Commissioner,

279 F.2d 292, 296 (9th Cir. 1960), affg. 30 T.C. 812 (1958).

An interest is usually not terminable when the surviving

spouse receives a life estate and a general power of appointment

over it. Sec. 2056(b)(5); Estate of Meeske v. Commissioner,

72 T.C. 73, 77 (1979), affd. sub nom. Estate of Laurin v.

Commissioner, 645 F.2d 8 (6th Cir. 1981). An interest passing

from a decedent to his or her surviving spouse may qualify for

the marital deduction when the surviving spouse: (1) Is entitled

for life to all income from that interest, payable at least

annually and (2) has a general power of appointment over the

interest which is exercisable in all events by the surviving

spouse alone, either by will or during life. Estate of Meeske v.

Commissioner, supra at 77; see sec. 20.2056(b)-5(a), Estate Tax

Regs. A spouse has the right to income for life if, under the

terms of the trust, the spouse has a right, exercisable at least

annually, to receive distributions of income, or the income must

be accumulated and added to corpus over which the spouse has a

power of appointment. Sec. 20.2056(b)-5(f)(8), Estate Tax Regs.

A surviving spouse does not have the right to all income if:

(1) The income must be accumulated, in whole or in part, or may

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be accumulated in the discretion of any person other than the

surviving spouse, or (2) the consent of any person other than the

surviving spouse is required to distribute the income. Sec.

20.2056(b)-5(f)(7), Estate Tax Regs. The power of appointment,

if exercisable during life, must be fully exercisable during

life. If exercisable by will, the power must be fully

exercisable regardless of the time of death. A power of

appointment is not exercisable in all events if it may terminate

during the life of the surviving spouse without his or her

complete exercise or release of it. Sec. 20.2056(b)-5(g)(3),

Estate Tax Regs.

The incompetency provisions in Article VII of the Agreement

take the property passing to Trust A outside the statutory and

regulatory requirements for the marital deduction. In Estate of

Tingley v. Commissioner, 22 T.C. 402 (1954), the surviving spouse

received an income interest and an inter vivos right to withdraw

corpus. Under the terms of the trust, this right terminated upon

the surviving spouse's legal incapacity or upon the appointment

of a guardian; upon legal incapacity or the appointment of a

guardian, the trustee was given the discretion to use and apply

this part of the net income and corpus for the surviving spouse's

benefit. The Court in Estate of Tingley held that the estate was

not entitled to the marital deduction mainly because the income

interest and power of appointment were outside the scope of the

predecessor to section 2056(b)(5). This was so even though the

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surviving spouse could invade corpus and actually did so shortly

after the decedent died. The Court noted that the surviving

spouse could not invade corpus in all events because the trust

would terminate that right upon legal incapacity or upon the

appointment of a guardian. The Court noted that the surviving

spouse's right to receive income would terminate at the same

time.

The estate argues that the facts of Estate of Tingley are

distinguishable from the facts at hand. The estate contends that

the power of appointment in Estate of Tingley, which terminated

upon the surviving spouse's legal incapacity or the appointment

of a guardian, is different from the power of appointment in this

case, which, the estate asserts, is activated by incompetency.

The estate claims that the surviving spouse in Estate of Tingley

could lose the power to appoint the property for reasons other

than legal incapacity, whereas the Agreement here terminates the

Trust only on death or incompetency. The estate concludes that

these differences in fact warrant a result in the instant case

different from the result in Estate of Tingley.

We disagree with the estate that Estate of Tingley is

inapposite to our decision herein. Although there may be

differences between the facts of Estate of Tingley and the facts

of this case,4 the critical fact that appears in both cases is

4

We do not agree with the estate that one of these

(continued...)

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that the surviving spouse could lose power over the corpus upon

the happening of a contingent event; namely, incompetency (in the

instant case) and incapacity or the appointment of a guardian (in

the case of Estate of Tingley). In Estate of Tingley, the

surviving spouse would lose any power over the corpus if the

contingent event occurred before the surviving spouse withdrew

the corpus. Although the surviving spouse in Estate of Tingley

did actually withdraw the corpus before the happening of this

contingent event, the Court held that, when viewed at the time of

the decedent's death, the surviving spouse's power was not

exercisable in all events. Estate of Tingley v. Commissioner,

22 T.C. at 404, 406.5 The same is true here. When viewed at the

time of the decedent's death, the surviving spouse would lose

4

(...continued)

differences concerns the contingent events that would cause the

surviving spouse in each case to lose his or her power to appoint

the property. We read the definition of "incompetency" as set

forth in Article XXIII of the Agreement to be essentially similar

to the conditions in Estate of Tingley v. Commissioner, 22 T.C.

402 (1954), affd. sub nom. Starrett v. Commissioner, 223 F.2d 163

(1st Cir. 1955), that would have caused the surviving spouse

there to have lost the right to appoint the property.

5

In affirming our decision, the Court of Appeals for the

First Circuit stated:

We agree with the Tax Court that the marital

deduction was properly disallowed in this case, because

the power in the surviving spouse to invade the corpus

was not exercisable by her "in all events", in view of

the terminating condition, as specified in the will,

"in case of her legal incapacity from any cause or upon

the appointment of a guardian, conservator, or other

custodian of her person or estate". [Starrett v.

Commissioner, 223 F.2d at 166-167.]

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power over the corpus if the contingent event occurred before the

surviving spouse either withdrew the corpus or provided in his

will for the corpus' disposition. Given this possible loss of

power, we are unable to conclude that the surviving spouse's

power of appointment was exercisable by the surviving spouse

alone, see sec. 20.2056(b)-5(g)(1), Estate Tax Regs., and that it

was exercisable by the surviving spouse in all events, see sec.

20.2056(b)-5(g)(3), Estate Tax Regs.;6 see also S. Rept. 1013,

80th Cong., 2d Sess. 17 (1948), 1948-1 C.B. 285, 343 ("An example

of a power which * * * [is not exercisable alone and in all

events] is a power which (unless sooner exercised or released)

will terminate on * * * [a given date], or on the date of death

of the surviving spouse, whichever occurs first.").7

Section 20.2056(b)-5(g)(1) and (3), Estate Tax Regs.,

provides:

(g) Power of appointment in surviving spouse.--

(1) The conditions * * * that the surviving spouse must

have a power of appointment exercisable in favor of

herself or her estate and exercisable alone and in all

events, are not met unless the power of the surviving

spouse to appoint the entire interest or a specific

portion of it falls within one of the following

categories:

6

We are also unable to conclude that the Trust meets the

requirements of sec. 2056(b)(5) in that the Agreement provides

that the surviving spouse is not entitled to any trust income

upon incompetency.

7

This report accompanied H.R. 4790, 80th Cong., 2d Sess.

(1948), which was enacted as the Revenue Act of 1948, ch. 168,

62 Stat. 110. Sec. 2056(b) had its origin in sec. 361 of the

Revenue Act of 1948, 62 Stat. 117.

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(i) A power so to appoint fully

exercisable in her own favor at any time

following the decedent's death (as, for

example, an unlimited power to invade); or

(ii) A power so to appoint exercisable

in favor of her estate. Such a power, if

exercisable during life, must be fully

exercisable at any time during life, or, if

exercisable by will, must be fully

exercisable irrespective of the time of her

death * * *; or

(iii) A combination of the powers

described under subparagraphs (i) and (ii) of

this subparagraph. * * * However, the

condition that the spouse's power must be

exercisable in all events is not satisfied

unless irrespective of when the surviving

spouse may die the entire interest or a

specific portion of it will at the time of

her death be subject to one power or the

other * * *.

* * * * * * *

(3) A power is not considered to be a power

exercisable by a surviving spouse alone and in all

events * * * if the exercise of the power in the

surviving spouse to appoint the entire interest or a

specific portion of it to herself or to her estate

requires the joinder or consent of any other person.

The power is not "exercisable in all events", if it can

be terminated during the life of the surviving spouse

by any event other than her complete exercise or

release of it. * * *

From this text, we discern that the surviving spouse must have

the ability during life to exercise or release the power of

appointment in all events. A power of appointment that may

terminate upon the happening of an event does not meet this

requirement, unless the event is the voluntary exercise or

release of the power by the surviving spouse. See Eckel v.

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United States, 259 F. Supp. 184 (S.D.N.Y. 1966) (surviving spouse

not entitled to income for life when spouse's right to income is

terminated upon remarriage); see also Starrett v. Commissioner,

223 F.2d at 166. A power of appointment that lapses on the

happening of a contingent event such as incompetency is outside

the reach of section 2056(b)(5). This is especially true in the

instant case where applicable State law requires that an exercise

or release of a power of appointment must adhere to the same

formalities as those that must be followed to create a power of

appointment or to transfer property in general, e.g., by a

written instrument. Minn. Stat. Ann. sec. 502.64, 502.79 Subd. 2

(West 1990).

We also disagree with the estate's alternative argument.

The estate has set forth no good reason why we should disregard

the validity of the Trust, and we decline to do so. Although the

estate states correctly that we must (and do) interpret the

language of the Agreement in accordance with the settlors'

intent, see, e.g., In re Trust Created Under Agreement with

McLaughlin, 361 N.W.2d 43, 44 (Minn. 1985), the mere fact that

the settlors meant for Trust A to qualify for the marital

deduction does not mean that it does so qualify, United States v.

First Natl. Trust & Sav. Bank, 335 F.2d at 113-114. In order for

the estate to avail itself of the marital deduction, the Trust

must fall within the statutory and regulatory requirements for

that deduction. Id. As discussed above, it does not.

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We note that the Trust serves more than just the settlors'

stated intent to avail themselves of the marital deduction. The

Agreement indicates that a principal purpose for the Trust was to

provide subsistence for the surviving spouse during his or her

competency and, thereafter, to allow the spouse to qualify for

medical assistance at minimal family expense. The Agreement

states that the Trust's assets shall be distributed to the

settlors' children upon the surviving spouse's incompetency, or,

in other words, when the surviving spouse may potentially incur

increased medical expenses for physician care and/or the need for

a nursing home. Because the Trust's assets would be outside the

Trust, they would not be counted as an asset of the surviving

spouse for purposes of ascertaining the amount that he or she

would have to pay for these expenses. Thus, more of the

settlors' assets would pass to the settlors' children.

For the foregoing reasons, we sustain respondent's

disallowance of the estate's marital deduction. In so doing, we

have considered all arguments made by the parties, and, to the

extent not discussed above, find them to be irrelevant or without

merit.

To reflect respondent's concessions,

Decision will be entered

under Rule 155.