UNITED STATES TAX COURT

T.C. Memo. 1997-470

UNITED STATES TAX COURT

ROSALYN DEUTSCH, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 21845-93.

Filed October 15, 1997.

Decedent (D), who died in 1988, bequeathed his

spouse (P) minimal assets from a net estate of

$3,361,683. In 1989, P elected against D's will to

take the Florida elective share of 30 percent of the

net estate, or $1,008,504. The estate reported 1989

distributable net income (DNI) of $707,095, including

$176,432 of capital gains that D's personal

representative treated as estate income, and $377,753

of distributions to the estate from D's individual

retirement accounts. Pursuant to order of the Florida

Probate Court, D's personal representative paid P the

elective share in 1989, but made no distributions to

the residuary beneficiaries until 1990. The personal

representative claimed a distribution deduction of

$707,095 for 1989 under sec. 661(a), I.R.C., on the

ground that all the estate's DNI had been included in

the payments to P in satisfaction of her elective

share. P did not include in her gross income any part

of the elective share.

- 2 Held: Payments to P in satisfaction of her Florida

elective share are not distributions of income or

amounts properly paid or credited or required to be

distributed to beneficiaries within the meaning of

secs. 661(a), 662(a), I.R.C., and sec. 1.661(a)-2(e),

Income Tax Regs. P’s Florida elective share is

excluded from her gross income.

Kenneth M. Hart and Stephen G. Vogelsang, for petitioner.

Sergio Garcia-Pages and Kenneth A. Hochman, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

BEGHE, Judge:

Respondent determined a deficiency of

$201,825 in petitioner's 1989 income tax.1

The issue for

decision is whether distributable net income (DNI) of the estate

of petitioner's deceased husband is included in her gross income

by reason of the payment to her during 1989 of her elective share

of the estate under Florida law.

We hold that petitioner is not

required to include any part of the payment of her elective share

in gross income.

1

All section references are to the Internal Revenue Code in

effect for the year in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure, unless otherwise

indicated.

- 3 FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

The stipulation of facts and the attached exhibits are

incorporated herein by reference.

Petitioner resided in Lake

Worth, Florida, when she filed the petition.

Petitioner and

Seymour Deutsch (decedent) had been married for approximately 9

years when he died on September 22, 1988, at age 67.

Decedent

was survived by three children from his first marriage, Jay R.

Deutsch (Mr. Deutsch) and his two sisters.

Decedent’s sister and

her children, among them Richard L. Braunstein (Mr. Braunstein),

also survived decedent.

Decedent died testate, leaving a net estate of $3,361,683.

Decedent left petitioner substantially less than the statutory

30-percent elective share of $1,008,504 that she was entitled to

under Fla. Stat. Ann. sec. 732.201 (West 1995).

Under the will,

petitioner would have taken no more than decedent's interests in

two country clubs (the Woodcrest and Fountain bonds), and

furnishings and other tangible personal property located at his

residence, a Lake Worth, Florida, condominium.

The will also

purported to devise2 to petitioner the condominium, which

2

Terminology in this area has become quite confusing. In a

distinction dating from the 19th century, a testator devises real

property to a devisee and bequeaths personal property to a

legatee. Dukeminier, Wills, Trusts, and Estates 36 (1984). In

recent years, the terms have become synonymous in some

jurisdictions. The Florida Probate Code, for example, uses

(continued...)

- 4 actually passed to her outside the probate estate as surviving

tenant by the entirety.

The will devised the residuary estate in

equal shares to Mr. Deutsch and his sisters.

Decedent's will designated Mr. Deutsch, a certified public

accountant, and Mr. Braunstein, an attorney, as executors, or

personal representatives, of his estate.3

In January 1989, Mr.

Braunstein informed petitioner that he believed decedent had

intended to increase the amounts left to her under his will.

Mr.

Braunstein also informed petitioner that, regardless of the

provisions of the will, she was entitled to elect to take the

Florida elective share.

He further told her that he would

apprise decedent's children of his understanding of decedent's

intention to change his will.

Shortly thereafter, Mr. Braunstein

disclaimed his bequest under the will.

On February 14, 1989, petitioner filed an “Election to Take

Elective Share” with the probate division of the Circuit Court

for the 15th Judicial Circuit for Palm Beach County, Florida

(Probate Court).

Petitioner's election resulted in more than 2

2

(...continued)

“devise” to describe the transfer at death of personal property

as well as real property. Fla. Stat. Ann. sec. 731.201(8) (West

1995).

3

The terms “executor” and “personal representative” are

synonymous. Fla. Stat. Ann. sec. 731.201(25) (West 1995) defines

“personal representative” as a court appointed fiduciary who

administers a decedent’s estate. For purposes of the Florida

Probate Code, the definition supersedes “executor” and other

synonymous terms. Id.

- 5 years of acrimonious litigation between her and Mr. Deutsch in 2

divisions of the Palm Beach County Circuit Court over the amount

of petitioner's elective share, the timing of its payments, and,

ultimately, whether such payment would cause petitioner to suffer

the entire Federal income tax impact of the estate's 1989 DNI.

On May 26, 1989, the personal representatives filed a

“Petition for Determination of Elective Share” with the Probate

Court.

The personal representatives asked the Probate Court to

defer payment of petitioner's elective share, pursuant to Fla.

Stat. Ann. sec. 732.214 (West 1995), until after they had filed

the estate tax return, which was due upon the expiration of

extension on December 22, 1989.

an

Petitioner's answer of June 16,

1989, requested the Probate Court to compel immediate payment.

Several concerns, some based on incomplete and erroneous

information, impelled petitioner and her attorneys to request

prompt payment of her elective share.

Petitioner's attorneys

correctly advised her that the elective share was not entitled to

participate in income of the estate and that, until the Probate

Court ordered payment of the elective share, she would not be

entitled to receive interest on the fund.

But petitioner's

attorneys mistakenly believed that the estate was already liquid

at the time of petitioner's election, and thus could easily pay

the elective share without delay.

- 6 Until September 15, 1989, consistent with their mistaken

belief in the estate's liquidity, petitioner and her attorneys

also mistakenly believed that the estate's 1989 DNI would not

exceed $100,000.

Notwithstanding that the Florida elective share

is not entitled to participate in estate income, petitioner's

attorneys believed that petitioner's elective share would attract

the estate’s DNI in the year of payment.

As early as summer

1989, petitioner's attorneys were trying to minimize the impact

of the estate’s DNI on petitioner's income tax liability, well

before they learned in late September how much DNI there would

be.

In a July 6, 1989, letter to Mr. Deutsch's attorneys,

petitioner's attorneys asked the estate to make an immediate

distribution to the residuary beneficiaries, which would have

required them to include their proportionate shares of DNI in

their taxable income.

In subsequent telephone conversations with

Mr. Deutsch's attorneys at the end of August, petitioner's

attorneys again asked the estate to make concurrent distributions

to the residuary beneficiaries.

When Mr. Deutsch refused to do

so, petitioner's attorneys asked him to postpone payment of the

elective share until a later year.

On September 6, 1989, petitioner filed with the Probate

Court a Motion for Appointment of Administrator Ad Litem,

alleging that Mr. Deutsch's dual role as estate fiduciary and

beneficiary created a conflict of interest.

On September 15,

- 7 1989, petitioner and her attorneys were informed by one of Mr.

Deutsch's attorneys that the estate income for 1989 would exceed

$250,000.

At a hearing on the motion before the Probate Court on

September 25, 1989, the parties discussed amounts and components

of estimated estate income.

Based upon Mr. Deutsch's work

papers, which were presented to the Probate Court in support of

the estate's plan to satisfy petitioner's elective share, the

parties stipulated that estate income was projected to be

$650,000 in 1989 and $50,000 in 1990.

Petitioner asked the

Probate Court to synchronize payment of the elective share with

distributions to the residuary beneficiaries.

The parties entered into a settlement, stipulating the

projected 1989 income, the size of the net estate, $3,361,683,

and the elective share, $1,008,504, and the assets to be used to

satisfy the elective share.

The Probate Court ratified this

settlement in an Agreed Order, dated September 25, 1989, the day

of the hearing.

The Order also provided for the transfer to

petitioner, as part of the elective share, of the specific assets

that would have passed to her under the will, with the balance to

be paid in cash.

The Probate Court's order directed the personal

representatives to pay petitioner the elective share in its

entirety in 1989, and not to make any distributions to the

residuary beneficiaries until 1990 or thereafter.

In the same

- 8 Order, the Probate Court denied petitioner's motion for

appointment of an administrator ad litem.

On October 30, 1989,

in response to petitioner's motion for rehearing, the Probate

Court amended its order to permit but not require the personal

representatives to make distributions to the residuary

beneficiaries during 1989.

modified order.

Petitioner promptly appealed the

In January 1990, the Florida Fourth District

Court of Appeals dismissed the appeal.

On November 3, 1989,

during pendency of the appeal, Mr. Deutsch tendered, and

petitioner accepted payment of the elective share, less amounts

left in escrow to pay various State tax liabilities.

The estate

paid petitioner the amount that had been fixed by the Agreed

Order of September 25, 1989.

It did not include interest from

the date of the Agreed Order to the date of payment.

In the 1989 calendar year fiduciary income tax return for

decedent's estate, filed August 15, 1990, pursuant to extensions,

Mr. Deutsch reported DNI of $707,095, net of tax-exempt interest,

and claimed a distribution deduction for that amount pursuant to

section 661(a) for the payment to petitioner in satisfaction of

her elective share.

Mr. Braunstein did not sign the estate’s

fiduciary income tax return.

The $707,095 of 1989 DNI reported by the estate was divided

into three major categories:

Dividend and interest income of

$152,910, some of which the estate received after petitioner

- 9 received her elective share on November 3, 1989; $377,753 of

income from 2 individual retirement accounts (IRA's), including

post mortem interest and other income paid to the estate in 1989;

and capital gains of $176,432 that, pursuant to advice from the

attorney who drafted decedent’s will, Mr. Deutsch treated as

estate income in their entirety.

The capital gains consisted

entirely of post mortem asset appreciation that the estate

realized when Mr. Deutsch liquidated estate assets in

anticipation of paying the elective share to petitioner.

On September 13, 1990, petitioner filed her 1989 income tax

return, pursuant to extensions.

Petitioner's return did not

include the DNI shown by the estate’s fiduciary income tax return

as having been distributed to her.

Petitioner's return included

a Form 8275 (Disclosure Statement under Section 6661) with a

rider that disclosed receipt of the elective share and its

noninclusion in her gross income and also disagreed with

inclusion of the capital gains in estate DNI.

Following dismissal, in March 1990, of her appeal of the

Probate Court Order, petitioner sued Mr. Deutsch in the Civil

Division of the Circuit Court for the 15th Judicial Circuit for

Palm Beach County, Florida.

Petitioner alleged that Mr. Deutsch

had violated his fiduciary duty to her by “intentionally

plac[ing] 100% of the income tax burden on [petitioner] and

- 10 diverted from himself and his relatives their share of the income

tax burden”.

The complaint did not name Mr. Braunstein.

On January 31, 1991, petitioner proposed settling her suit

against Mr. Deutsch.

She asked the estate to place $124,000 in

escrow until expiration of the 3-year period of limitations on

petitioner's 1989 Federal income tax return, to be paid only if

respondent determined an income tax deficiency against petitioner

by reason of her receipt of the elective share.

In the same

letter, petitioner asserted that “no case law, statutory law or

IRS ruling * * * holds that the Florida elective share carries

out distributable net income”.

Mr. Deutsch responded that he did

not wish to play “audit roulette”, and counter-offered to pay

petitioner $50,000 to settle all her claims and serve as a “warchest” for any controversy with respondent.

In April 1991,

petitioner accepted that offer and settled her suit against Mr.

Deutsch for a payment of $50,000.

On August 13, 1993, prior to the August 15, 1993, expiration

of the period of limitations on assessment of a 1989 income tax

deficiency against the estate, respondent determined that

petitioner had received a distribution of income of $707,095 from

the estate during 1989 and sent her a notice of a deficiency of

$201,825 in her income tax for that year.

timely petition with this Court.

Petitioner filed a

- 11 The personal representatives had made distributions from the

estate to the residuary beneficiaries in 1990 and 1991.

As of

the time of trial, the personal representatives had not made

final distributions from the estate.

OPINION

The question for decision is whether payments in

satisfaction of a surviving spouse’s elective share under Florida

law (the Florida elective share) are distributions of income or

other amounts properly paid or credited or required to be

distributed, secs. 661(a), 662(a); sec. 1.661(a)-2(e), Income Tax

Regs., that carry out the estate’s DNI to the recipient.4

We begin our inquiry by summarizing the issues that bear on

the question, as framed and argued by petitioner and respondent.

Petitioner argues, citing and quoting Ferguson, Freeland, &

Ascher, Federal Income Taxation of Estates, Trusts, and

Beneficiaries, sec. 1.3 at 1:17 (2d ed. 1993 & Supp. 1997)

(Ferguson et al.), that the Florida elective share is not

“subchapter J property”; in petitioner’s view, the Florida

4

By not issuing a timely protective notice of deficiency to

the estate, respondent lost the opportunity for a comprehensive

resolution of the issues in this case in a consolidated

proceeding that would have avoided any potential whipsaw. But

see the provisions for statutory mitigation, secs. 1311-1314,

particularly, sec. 1312(5); see also sec. 1.1312-5(a)(3), Income

Tax Regs., and transferee liability, sec. 6901(h). As to

petitioner's status as a nontransferee, see John Ownbey Co. v.

Commissioner, 645 F.2d 540, 546 (6th Cir. 1981), revg. T.C. Memo.

1978-482; Stokes v. Commissioner, 22 T.C. 415, 427 (1954).

- 12 elective share passes from a decedent to a surviving spouse

outside “the subchapter J estate,” so that “the distribution

rules of subchapter J simply do not apply”.5

See also Zaritsky &

Lane, Federal Income Taxation of Estates and Trusts, sec. 1.06 at

1-12 (2d ed. 1993 & Supp. 1996).

Petitioner also relies on Rev.

Rul. 64-101, 1964-1 C.B. (Part 1) 77, modified by Rev. Rul. 71167, 1971-1 C.B. 163, in which the Commissioner ruled that

payment of the statutory predecessor of the elective share,

Florida statutory dower, did not carry out the estate’s DNI to

the surviving spouse.6

Respondent argues that petitioner is an estate beneficiary

whose elective share interest is qualitatively indistinguishable

from the interests of the estate’s residuary beneficiaries.

In

response to petitioner’s argument that any differences between

the Florida elective share and statutory dower amount to “a

5

The terms “subchapter J estate” and “subchapter J

property” were introduced in Ferguson, Freeland, & Stephens,

Federal Income Taxation of Estates and Beneficiaries, 13-14

(1970), to describe property of decedent that, for whatever

reason, becomes subject to the subchapter J distribution rules.

See also Ferguson, Freeland, & Ascher, Federal Income Taxation of

Estates, Trusts, and Beneficiaries, sec. 1.31, at 1:19 (2d ed.

1993 & Supp. 1997) (Ferguson et al.).

6

Petitioner raised alternative arguments if we were to hold

that petitioner’s elective share is subchapter J property: (1)

Petitioner was a creditor of the estate and not a sec. 643(c)

beneficiary; (2) payment in satisfaction of the Florida elective

share qualified as a specific bequest under sec. 663(a)(1); and

(3) capital gains were not properly includable in estate DNI.

Because we decide the main issue as we do, we need not address

petitioner’s alternative arguments.

- 13 distinction without a difference”, respondent argues that any

comparison between them is “inapposite”.

Inasmuch as State law is the source of legal rights and

interests in property and income, we first ascertain the legal

and economic characteristics of the Florida elective share under

the Florida Probate Code as compared with Florida statutory

dower.

In so doing, we are bound and guided by the relevant

rulings of the Florida Supreme Court, Commissioner v. Estate of

Bosch, 387 U.S. 456, 465 (1967), and give “proper regard” to

rulings of the lower Florida courts, id.

We then determine the

effect of those legal rights and interests for Federal income tax

purposes in accordance with Federal income tax principles and

rules.

Morgan v. Commissioner, 309 U.S. 78, 81 (1940); Lyeth v.

Hoey, 305 U.S. 188, 193-194 (1938); Jones v. Whittington, 194

F.2d 812, 815 (10th Cir. 1952).

We agree with petitioner and conclude that the distribution

rules of subchapter J do not apply to her Florida elective share.

The legal and economic differences between petitioner's interest

in the Florida elective share and the interests of the residuary

beneficiaries are so significant that their respective interests

must be treated differently for Federal income tax purposes.

The

Florida elective share, which replaced statutory dower in 1975,

should be accorded the same Federal income tax treatment as

statutory dower because they have common legal and economic

- 14 characteristics that justify their exclusion from the subchapter

J estate.

The exclusion of the Florida elective share from the

subchapter J distribution rules is confirmed by its lack of any

legal or economic participation in estate income, which, under

Florida law, accrues in this case for the ultimate benefit of the

estate’s residuary beneficiaries.

1.

Comparison of Elective Share with Statutory Dower

Florida statutory dower,7 from 1933 until its replacement in

1975 by the Florida elective share, was a widow's (changed to

“surviving spouse” in 1973) one-third interest in “fee simple of

the real property which was owned by her husband at the time of

his death” and an absolute one-third interest in all “personal

property owned by her husband at the time of his death”.

Stat. Ann. sec. 731.34 (West 1964) (repealed 1974).

Fla.

The widow

was also entitled to “mesne profits” on statutory dower, or

income earned by the dower interest from the date of the election

to take dower until the date of actual payment.

sec. 733.12 (West 1964) (repealed 1974).

Fla. Stat. Ann.

Statutory dower was

originally “free from all liability for the debts of the decedent

and all costs, charges and expenses of administration”.

Fla. Laws ch. 16103, sec. 35.

7

1933

However, it was modified in 1939

Our analysis of Florida statutory dower refers to the 1964

version, which was contemporaneous with Rev. Rul. 64-101, 1964-1

C.B.(Part 1) 77, modified by Rev. Rul. 71-167, 1971-1 C.B. 163.

The Florida legislature modified statutory dower from time to

time throughout the entire period that it was in force.

- 15 to render the widow's dower interest in personal property liable

for secured debts, liens, mortgages, and other encumbrances.

1939 Fla. Laws ch. 18999, sec 1.

In 1975, the Florida legislature enacted the Florida Probate

Code, which abolished statutory dower and replaced it with the

Florida elective share, Fla. Stat. Ann. sec. 732.201 (West 1995),

in its present form:

30 percent, Fla. Stat. Ann. sec. 732.207

(West 1995), of “all property of the decedent wherever located

that is subject to administration except real property not

located in Florida”, Fla. Stat. Ann. sec. 732.206 (West 1995),

valued “on the date of death”, Fla. Stat. Ann. sec. 732.207 (West

1995).

The new elective share differed from statutory dower in 2

major respects.

Unlike dower, as to which only personal property

was liable for secured debts, the elective share is calculated

net of all liens, mortgages, and unsecured claims, Fla. Stat.

Ann. sec. 732.207 (West 1995), including funeral expenses, Fla.

Stat. Ann. sec. 731.201(4) (West 1995); Paredes v. McLucas, 561

So. 2d 439, 441 (Fla. Dist. Ct. App. 1990).

Second, the elective

share does not accrue mesne profits; it does not participate in

post mortem economic gains and losses and estate income, Price v.

Florida Natl. Bank, 419 So. 2d 389, 390-391 (Fla. Dist. Ct. App.

1982), although the electing spouse is entitled to interest on

- 16 the share from the date of the order directing the personal

representative to pay, id.

The elective share retains many fundamental attributes of

statutory dower.

See Hanley, Elective Share, in Basic Practice

Under Florida Probate Code, sec. 7.1, at 275 (3d ed. 1987);

Redfearn, Wills and Administration in Florida, sec. 19.3 (6th ed.

1986 & Supp. 1996).

The Florida statutes governing the current

elective share and statutory dower provide a virtually absolute

right to the surviving spouse to elect to take the respective

shares,

Fla. Stat. Ann. sec. 732.201 (West 1995); Fla. Stat.

Ann. sec. 731.34 (West 1964) (repealed 1974); Catlett v. Chesnut,

131 So. 120, 122 (Fla. 1930), both of which vest at death, In re

Estate of Donner, 364 So. 2d 742, 751 (Fla. Dist. Ct. App. 1978)

(dower vests at death); Fla. Stat. Ann. sec. 732.201 (West 1995)

(“The surviving spouse of a person who dies domiciled in Florida

shall have the right” to take her elective share).

Like

statutory dower, the elective share becomes a fixed claim against

the estate as of the date of decedent’s death, Wax v. Wilson, 101

So. 2d 54, 57 (Fla. Ct. App. 1958) (citing Catlett v. Chesnut,

supra), of the amount determined by the Probate Court, Fla. Stat.

Ann. sec. 732.214 (West 1995).

Under Florida law, payment of the elective share takes

precedence over distributions to all other beneficiaries,

including those receiving specific bequests, Fla. Stat. Ann. sec.

- 17 733.805(1) (West 1995), just as statutory dower took such

precedence.

In re Malone’s Estate, 54 So. 2d 248, 249 (Fla.

1951); Murphy v. Murphy, 170 So. 856, 874 (Fla. 1936); Catlett v.

Chesnut, supra at 121.

Under Fla. Stat. Ann. sec. 733.805(1)

(West 1995), “payment of debts, estate and inheritance taxes,

family allowances, exempt property, elective share charges,

expenses of administration, and devises” are to be paid, in the

absence of specific provision in decedent’s will, or designation

of funds or property to be used, first from property not disposed

of by the will and then, in turn, by residuary devises, “Property

not specifically or demonstratively devised”, and last by

specific or demonstrative devises.8

Consistent with Fla. Stat. Ann. sec. 733.805(1) (West 1995),

and the substantively identical legal characteristics of the

Florida elective share and its predecessor, statutory dower, the

Florida Supreme Court has interpreted the Florida elective share

as effectively entitling the surviving spouse to the same

longstanding legislative favor and senior status relative to

8

Fla. Stat. Ann. sec. 733.805(1) (West 1995) honors

provisions in a will for payments or transfers of assets in

satisfaction of an elective share prior to the scheme described

in the text. Respondent concedes that property passing pursuant

to such provisions would be excluded from the subchapter J

distribution rules as a sec. 663(a)(1) specific bequest.

Decedent made no such provisions in his will for payment of the

elective share, although the Probate Court, in its Agreed Order,

did include in petitioner’s elective share the assets purportedly

devised to petitioner under the will.

- 18 beneficiaries under the decedent’s will that statutory dower

enjoyed prior to 1974.

Via v. Putnam, 656 So. 2d 460, 466 (Fla.

1995) (elective share); In re Estate of Donner, supra at 751-752

(dower); see also Pawley v. Pawley, 46 So. 2d 464, 472-473 n.2

(Fla. 1950).

In Via v. Putnam, supra, the Florida Supreme Court

recently concluded that the elective share and pretermitted

spouse statutes give priority to the surviving spouse of a

subsequent marriage over the contractual rights of the children

of the decedent’s prior marriage who are beneficiaries of their

parents’ mutual wills.

The Court justified its holding as

protecting the “`institution of marriage [that] has been a

cornerstone of western civilization * * * and * * * the most

important type of contract ever formed’”.

Via v. Putnam, supra

at 465 (quoting In re Estate of Yohn, 238 So. 2d 290, 296 (Fla.

1970) (Boyd, J., concurring)).9

9

The confirmation by Via v. Putnam, 656 So. 2d 460, 465

(Fla. 1995), of the continued favored status of the surviving

spouse's interest in the elective share undercuts respondent’s

reliance on the Florida intermediate appellate decision in

Williams v. Harrington, 460 So. 2d 533, 537 (Fla. Dist. Ct. App.

1984), for the proposition that payment of the Florida elective

share is a sec. 662(a) distribution. The appellate court had

held that the surviving spouse, having paid income tax upon

receipt of her elective share, was not entitled to contribution

from the estate’s residuary beneficiaries. That decision was

based upon the assumption that, since subchapter J was in effect

when the Florida legislature enacted the current Probate Code,

the Florida legislature must have intended that payments in

satisfaction of the elective share would be treated as sec.

662(a) distributions. But see Cooper v. Parkinson, 186 So. 2d

844 (Fla. Dist. Ct. App. 1966) (enforced contract between

(continued...)

- 19 2.

Subchapter J Income Attribution Rules

The income attribution rules of subchapter J give effect to

the distinction made by section 102 between gifts and

inheritances of property, which are excluded from a recipient's

gross income, sec. 102(a), and the income derived therefrom, sec.

102(b)(1), and gifts of income from property, sec. 102(b)(2);

Irwin v. Gavit, 268 U.S. 161 (1925), which are included in a

recipient’s gross income.

Subchapter J retains the conduit

principle of the 1939 Code to pass income from an estate or trust

to its beneficiaries, see H. Rept. 1337, 83d Cong., 2d Sess. 61

(1954); Kitch v. Commissioner, 104 T.C. 1, 11 (1995), affd. on

other grounds 103 F.3d 104 (10th Cir. 1996), while introducing

the mechanism of DNI to determine the amount and character of

that income “to avoid both the necessity of ‘tracing’ and an

inquiry into the subjective intention of executors”.

United States,

Harkness v.

199 Ct. Cl. 721, 727, 469 F.2d 310, 316 (1973);

see also H. Rept. 1337, supra; Kitch v. Commissioner, supra.

A

distribution included in the gross income of a beneficiary under

subchapter J is “treated * * * as a gift, bequest, devise, or

inheritance of income from property.”

9

Sec. 102(b).

(...continued)

recipient of Florida statutory dower and estate beneficiaries

that those beneficiaries would reimburse her for Federal income

tax paid by her on receipt of an advance payment of statutory

dower).

- 20 a.

Estates

Application of Subchapter J Distribution Rules to

Estates, which are not required to distribute currently all

income received, are taxed only on income not actually

distributed or required to be distributed to beneficiaries, secs.

641(a), 661, with a deduction for distributions included in

beneficiaries' gross income under section 662, sec. 661(a).

Beneficiaries must include section 662 distributions in

their gross income in 2 tiers:

First, “income * * * required to

be distributed currently”, sec. 662(a)(1); and, second, all

“other amounts properly paid, credited, or required to be

distributed”, sec. 662(a)(2)(B).

DNI is ratably allocated among

all first tier distributions, sec. 662(a)(1), and the balance is

then ratably allocated among all second tier distributions, sec.

662(a)(2)(B).

Amounts distributed in excess of DNI are deemed to

be distributions of corpus, passing to the beneficiary tax-free.

Id.

In most cases, distributions by estates during

administration are in the second tier.10

Section 663(a)(1) excludes payments of specific sums of

money or specific property from the subchapter J estate, thus

giving effect to the distinction made by State law between

10

Payments in satisfaction of the Florida elective share

are not first tier distributions inasmuch as the Florida Probate

Code does not require that such transfers be made as

distributions of current income. Fla. Stat. Ann. sec. 732.207

(West 1995); see also Fla. Stat. Ann. sec. 731.34 (West 1964)

(repealed 1974) (dower is one-third share in property).

- 21 specific bequests of property and bequests from the residuary

estate, see, e.g., Park Lake Presbyterian Church v. Estate of

Henry, 106 So. 2d 215, 217 (Fla. Dist. Ct. App. 1958).

Although

the Code does not expressly state that section 663(a)(1) gifts or

bequests are excluded from a recipient's gross income under

section 102(a), the regulations, section 1.102-1(d), Income Tax

Regs., “acknowledge that they enjoy this status”.

3 Bittker &

Lokken, Federal Taxation of Income, Estates and Gifts, sec.

81.4.7 at 81-46 (2d ed. 1991 & Supp. No. 4 1996).11

b.

Section 662(a)(2)(B) Not All-Inclusive

The distribution rules of sections 661 and 662, and the

exclusion for specific bequests provided by section 663(a)(1) do

not exclusively govern the section 102 differentiation between

nontaxable gifts and inheritances of property and taxable income

from property.

11

Because sections 661-663, found in subpart C of

At the inception of the 1954 Code, the architects of

subchapter J recognized that the statutory framework of secs. 661

through 663 could result in misattributions of estate income

among estate beneficiaries. See Kamin, Surrey, & Warren

“The Internal Revenue Code of 1954: Trusts, Estates and

Beneficiaries”, 54 Colum. L. Rev. 1237, 1258-1259 (1954); see

also Fillman, “Selections from Subchapter J”, 10 Tax L. Rev. 453,

454-455 (1955). Not long after enactment of subchapter J,

statutory modifications were proposed in H.R. 9662, 86th Cong.,

2d Sess. (1960), incorporating recommendations of a report by the

Advisory Group on Subchapter J of the Internal Revenue Code of

1954, Final Report on Estates, Trusts, Beneficiaries, and

Decedents (Comm. Print 1958), which would, among other things,

have expanded the scope of the sec. 663(a)(1) exclusion of

specific bequests and applied the separate share rule of sec.

663(c) to estates. However, the bill was never enacted.

- 22 subchapter J, do not expressly claim the attribute of

exclusiveness, they are not regarded as having that attribute.12

Under various judicial, regulatory, and administrative

exceptions, certain assets in which a decedent had an interest

are excluded from the subchapter J estate.

As a result, the

subchapter J distribution rules do not apply to their transfer or

receipt.13

In Petersen v. Commissioner, 35 T.C. 962 (1961), we held

that subchapter J distributions do not include income generated

by property held in joint and survivorship tenancies because the

decedent’s interest ceases to exist at death, supplanted by the

surviving joint tenant’s interest, leaving nothing for the estate

to administer.

Id. at 967-968; see also Lang v. Commissioner,

289 U.S. 109, 110 (1933) (tenancy by the entirety); Edmonds v.

12

This is in contrast to secs. 671-679, found in subpart E

of subchapter J (concerning the income tax treatment of grantor

trusts), which are expressly granted the attribute of

exclusiveness by the last sentence of sec. 671. See H. Rept.

1337 83d Cong., 2d Sess. A212 (1954); sec. 1.671-1(c), Income Tax

Regs.

13

Secs. 661 and 662 also do not govern situations in which

those sections conflict with more specific Code sections in

subchapter J, such as section 691, concerning income in respect

of a decedent, Rollert Residuary Trust v. Commissioner, 80 T.C.

619 (1983), affd. 752 F.2d 1128 (6th Cir. 1985), section 682,

concerning income of an estate in cases of divorce, Kitch v.

Commissioner, 104 T.C. 1 (1995), affd. on other grounds 103 F.3d

104 (10th Cir. 1996), and section 642(c), concerning the

charitable deduction for estates and trusts, Mott v. United

States, 199 Ct. Cl. 127, 462 F.2d 512 (1972).

- 23 Commissioner, 90 F.2d 14, 16 (9th Cir. 1937), affg. 31 B.T.A. 962

(1934) (joint and survivorship tenancy).14

Similarly, funds deposited in joint and survivorship bank

accounts, title to which passes to the survivor under State law,

while included in a decedent’s gross estate for Federal transfer

tax purposes, sec. 2040; sec. 20.2040-1(b), Estate Tax Regs.,

pass outside the subchapter J estate because the funds are not

subject to estate administration.

supra.

Petersen v. Commissioner,

Proceeds of life insurance policies, sec. 101(a); sec.

1.101-1(a), Income Tax Regs., Totten trusts, or savings bank

account trusts, property held in revocable trusts that terminate

at death whose corpus is transferred to named beneficiaries, and

property held in irrevocable trusts over which decedent retained

a life interest are other instances of property includable in a

decedent’s gross estate for estate tax purposes, see secs. 2036

(transfers with retained life estates); 2037 (transfers taking

effect at death); 2038 (revocable transfers); 2042 (proceeds of

life insurance), none of the payments or distributions of which

are included in section 661 and 662 distributions.

14

See Zaritsky

Citing Petersen v. Commissioner, 35 T.C. 962 (1961), the

Commissioner later published Rev. Rul. 62-116, 1962-2 C.B. 207,

208, under which the exclusion of income derived from property

from the subchapter J estate was based upon whether the property

was subject to estate administration and possession by the estate

administrator. See also Ferguson et al., supra secs. 1.3.2.2-1

to 1.3.2.3, at 1:22-23.

- 24 & Lane, supra sec. 1.06 at 1-12 to 1-13.15

In each of these

preceding instances, Federal income tax treatment takes into

account the legal and economic characteristics of the property

interest under State law by excluding the transfer of such

property from the subchapter J distribution rules.

Section 1.661(a)-2(e), Income Tax Regs., limits the scope of

section 662(a)(2)(B) by excluding from second tier distributions

all transfers of a decedent’s fee simple interest in real

property to heirs, legatees, or devisees when title passes

directly under State law upon decedent’s death.

Specific devises

by a decedent of real property the title to which passes directly

at his death, which might otherwise be excluded from subchapter J

property under an expansive reading of section 663(a)(1), are

instead excluded from second tier distributions because they do

“not constitute an amount paid, credited, or required to be

distributed under section 661”.

Sec. 1.663(a)-1(c)(1)(ii),

Income Tax Regs.

The Commissioner has also ruled that a transfer of real

property, which would otherwise be part of the residuary estate,

15

The Code also provides for other exclusions from the

subchapter J distribution rules such as lump-sum rollovers of a

decedent’s IRA assets to the IRA of a surviving spouse, secs.

401(a)(9)(B)(iv), 408(a)(6), and the “successor in interest”

regulations of sec. 1.706-1(c)(3)(iii), Income Tax Regs. Sec.

706(c)(2)(A), as amended by Taxpayer Relief Act of 1997, Pub. L.

105-34, sec. 1246(a), 111 Stat. 788, 1030, has been modified to

end the tax year of a partnership year with respect to the death

of a partner for tax years beginning after Dec. 31, 1997.

- 25 is also excluded from the subchapter J estate when title to such

property passes directly to an heir or devisee.

“[E]ven though

the real property is in the possession of the executor or

administrator during the period of administration”, such

transfers are subject only “to the general provisions of section

102 of the Code.”

Rev. Rul. 68-49, 1968-1 C.B. 304, 305; cf.

Rev. Rul. 62-116, 1962-2 C.B. 207.

In Rev. Rul. 64-101, 1964-1 C.B. (Part 1) 77, relied upon by

petitioner, the Commissioner advanced the broad exclusion of real

property as the primary ground for similarly excluding payment of

Florida statutory dower from section 662(a)(2)(B) distributions.

The Commissioner primarily justified the exclusion of dower by

its similarities in “legal characteristics to the real property

exception provided in” section 1.661(a)-2(e), Income Tax Regs.

Rev. Rul. 64-101, 1964-1 C.B. (Part 1) at 79.

The Commissioner

went on to declare that the statutory “dower interest might be

even more absolute than real property * * * since real property *

* * might be liable for debts of the estate.”16

16

Id.

In 1964, the personal property portion of Florida

statutory dower was liable for secured debts of the estate, while

real property was not so liable. Fla. Stat. Ann. sec. 731.34

(West 1964) (repealed 1974); 1939 Fla. Laws ch. 18999, sec. 1.

In contrast, the entire Florida elective share, both real and

personal property, is reduced by both secured and unsecured

claims. Fla. Stat. Ann. sec. 732.207 (West 1995). Rev. Rul. 64101, 1964-1 C.B. (Part 1) 77, to the extent that it reflects an

assumption that none of the statutory dower interest could be

subject to secured debts, misreads Florida law. However, it

(continued...)

- 26 Rev. Rul. 64-101, 1964-1 C.B. (Part 1) at 78, also cited

similarities in “purpose and effect” between statutory dower and

temporary family support allowances payable from corpus, which

were excluded from the subchapter J estate under section

1.661(a)-2(e), Income Tax Regs., at the time Rev. Rul. 64-101,

1964-1 C.B. (Part 1) 77, was published.

However, Estate of McCoy

v. Commissioner, 50 T.C. 562 (1968), held invalid that portion of

section 1.661(a)-2(e), Income Tax Regs., and the regulation was

accordingly modified.17

Nevertheless, in modifying the portion

of the regulation dealing with family support allowances, the

Commissioner did not retract support for the exclusion of

statutory dower from the subchapter J estate on the ground of its

legal similarity to real property whose title directly vests in a

16

(...continued)

obviously does not rely upon that reading inasmuch as it relies

upon the similarity of statutory dower to real property, passage

of title to which is subject to debts secured by mortgages and

other liens.

17

Under sec. 1.661(a)-2(e), Income Tax Regs., as it

currently reads, temporary family and surviving spouse support

allowances, whether payable from income or corpus under local

law, are included in a beneficiary's gross income as second tier

distributions. Secs. 1.662(a)-2(e), 1.662(a)-3(b), Income Tax

Regs. But see Ferguson et al., supra sec. 6.10 at 6:19, which

distinguishes between statutory nonvested family support

allowances, which may be awarded at the discretion of the

presiding court, Estate of Cunha v. Commissioner, 279 F.2d 292,

297 (9th Cir. 1960), affg. 30 T.C. 812 (1958), and are included

in subchapter J distributions, and vested family support

allowances, which are excluded.

- 27 devisee.18

Thus, Rev. Rul. 64-101, 1964-1 C.B. (Part 1) 77,

continued to have vitality insofar as it relied upon the real

property exception of section 1.661(a)-2(e), Income Tax Regs., to

justify the exclusion of Florida statutory dower from subchapter

J distributions.

3. Exclusion of Statutory Dower From Surviving Spouse’s Gross

Income Requires Exclusion of Elective Share

Several legal and economic characteristics of statutory

dower virtually replicate the characteristics of transfers of

decedents’ real property.

Both are rights to property, Fla.

Stat. Ann. sec. 731.34 (West 1964) (repealed 1974), that vest in

the recipient at decedent’s death, Emmerson v. Merritt, 94 N.E.

955, 956 (Ill. 1911) (real property vests at death); Jones v.

Federal Farm Mortgage Corp., 182 So. 226, 227 (Fla. 1938) (same);

In re Estate of Donner, 364 So. 2d at 751 (dower vests at death).

While both rights of succession share antecedents rooted in the

common law, they have both evolved into transfers at death whose

rights and limitations now are a matter of legislative

discretion.

Irving Trust Co. v. Day, 314 U.S. 556, 562 (1942);

Coral Gables First Natl. Bank v. Hart, 20 So. 2d 647, 649 (Fla.

1945) (devolution is a matter of legislative discretion).

The

most significant limitation on both interests is liability for

18

See T.D. 7287, 1973-2 C.B. 210 (transmittal memorandum

for proposed change to sec. 1.661(a)-2(e), Income Tax Regs., from

IRS to Assistant Secretary of Treasury for Tax Policy).

- 28 decedent’s debts.

See, e.g., Fla. Stat. Ann. sec. 733.613 (West

1995) (power of sale over real property to pay debts); Fla. Stat.

Ann. sec. 731.34 (West 1964) (repealed 1974) (personalty liable

for decedent’s secured debts after 1939).

The Commissioner’s ruling in Rev. Rul. 64-101, 1964-1 C.B.

(Part 1) 77, confirmed that the longstanding practice of

excluding dower from a widow’s gross income under the 1939 Code

and earlier revenue acts would be continued under the 1954 Code.

6 Merten's Law of Federal Income Taxation, sec. 36.81 at 390

(1949) (“Amounts received as dower by a widow are not taxable”

under the 1939 Code).

There is no evidence in the legislative

history of the 1954 Code that Congress intended to reverse the

exclusion when it enacted subchapter J.19

That exclusion ensures

that the surviving spouse will incur no income tax liability by

19

In Lemle v. United States, 419 F. Supp. 68, 71 (S.D.N.Y.

1976), affd. on another ground 579 F.2d 185 (2d Cir. 1978), the

District Court expressed the view that payment of a former

version of the New York elective share, which was entitled to

share in estate income, resulted in sec. 662 distributions to the

surviving spouse, is distinguishable. The Court of Appeals for

the Second Circuit framed the issue in Lemle as “whether, having

already received payments out of estate income, * * * [the

taxpayer, a surviving spouse] can, by subsequent compromise

agreement, recharacterize them as payments of principal” Lemle v.

United States, 579 F.2d at 188, when she and her husband’s estate

subsequently settled her right to the New York elective share.

The Court of Appeals decided that the taxpayer could not do so.

Id.; cf. Delmar v. Commissioner, 25 T.C. 1015, 1021-1022 (1956)

(income received as part of settlement in lieu of a statutory

forced share, which was entitled to share in estate income under

Illinois law, was taxable to the surviving spouse under sec.

162(c) of the 1939 Code).

- 29 reason of the transfer to her of property in satisfaction of

statutory dower in excess of any tax liability incurred by reason

of her receipt of mesne profits.

The exclusion is also

consistent with the longstanding solicitude of the Florida

legislature towards the economic interests of the surviving

spouse that has been repeatedly implemented by the Florida

See, e.g., Via v. Putnam, 656 So. 2d 460 (Fla.

Supreme Court.

1995); In re Malone’s Estate, 54 So. 2d at 249; Pawley v. Pawley,

46 So. 2d 464 (Fla. 1950); Catlett v. Chesnut, 131 So. at 121; In

re Estate of Donner, 364 So. 2d 742 (Fla. Dist. Ct. App. 1978).20

The Florida elective share possesses the same legal and

economic characteristics as statutory dower and real property.

A

surviving spouse's right to her elective share arises from local

law, vests at decedent's death, Fla. Stat. Ann. sec. 732.201

(West 1995), and is similarly subject to certain limitations, see

e.g., Fla. Stat. Ann. sec. 732.207 (West 1995) (elective share

calculated net of decedent's debts).

The surviving spouse who

elects to take her Florida elective share enjoys, for purposes of

payment of her share, the same precedence over other estate

beneficiaries as was enjoyed by a widow who elected to take

statutory dower.

20

Via v. Putnam, supra at 466.

See G.C.M. 32485 (Jan. 15, 1963) (referring to the

solicitude of State legislatures for the rights of surviving

spouses and expressing the view that exclusion of statutory dower

under 1954 Code is consistent with the exclusion in practice

under the 1939 Code).

- 30 Moreover, the Florida elective share, unlike statutory

dower, does not share in income of the estate, or mesne profits,

nor is it entitled to interest from the estate prior to the date

distribution is ordered by the Probate Court, Price v. Florida

Natl. Bank, 419 So. 2d at 390-391.

This is because Fla. Stat.

Ann. sec. 732.207 (West 1995), fixes the amount as of the date of

decedent's death without any other express statutory provision

for income to accrue.

A transfer of statutory dower to a

surviving spouse included both property and mesne profits and the

surviving spouse incurred an income tax liability under section

102(b) to the extent of the mesne profits.21

The fact that the

surviving spouse who elects the Florida elective share incurs no

similar income tax liability because she is not entitled to enjoy

21

In Rev. Rul. 71-167, 1971-1 C.B. 163, the Commissioner

modified Rev. Rul. 64-101, 1964-1 C.B. (Part 1) at 78 which had

included mesne profits in the widow’s income as a “gift, bequest,

devise, or inheritance * * * of income from property” under

section 102(b), to express the view that mesne profits are

instead included in the estate’s gross income and that payments

of mesne profits earned by dower assets are includable in the

gross income of the widow under sec. 662(a), and deductible by

the estate under sec. 661(a). Inasmuch as the Florida elective

share does not have any income component, we express no view on

the correctness of Rev. Rul. 71-167, 1971-1 C.B. 163, with

respect to the transfer to a surviving spouse of income earned by

a statutory forced share. We also express no view on whether the

calculus of factors leading to our holding that the Florida

elective share is excluded from second tier distributions would

change were the share to have an income component, other than to

observe that the lack of entitlement to income means that the

Florida elective share consists entirely of property for estate

accounting purposes.

- 31 any portion of estate income only confirms that the payment of

the Florida elective share is not a subchapter J distribution.

The dissociation of the Florida elective share from estate

income is illustrated in the case at hand by the following

catalog of the respective interests of the surviving spouse and

the residuary beneficiaries of the Deutsch estate in various

categories of 1989 estate income.

In 1989, the estate received $152,910 in interest and

dividends.

Petitioner had no right to receive, participate in,

or enjoy any of these items because the estate received them

after decedent's death; the Probate Court fixed the value and

amount of the elective share as of the date of decedent’s death.

Fla. Stat. Ann. secs. 732.207, 732.214 (West 1995).

Furthermore,

the estate received some of those items of income after it had

paid petitioner on November 3, 1989, bearing in mind that the

estate's taxable year was the entire calendar year 1989.

The estate also realized $176,432 in net capital gains that,

because decedent's assets received a step-up in basis at his

death to fair market value, sec. 1014(a), measured appreciation

in estate assets only from the date of death until sale.

Petitioner enjoyed no benefits from that post mortem appreciation

because her share was valued as of the date of decedent’s death.

Fla. Stat. Ann. sec. 732.207 (West 1995).

Although the assets

whose sale generated the gains were realized in order to enable

- 32 the estate to pay petitioner’s elective share, the economic

benefit of those gains inured solely to the estate and its

residuary beneficiaries, Mr. Deutsch and his sisters.

Mr.

Deutsch’s purported allocation of capital gains to income,

whatever its effect for estate accounting purposes, had no

practical consequence whatsoever with respect to the relative

entitlements of petitioner and the residuary beneficiaries.

The largest components of the estate's 1989 DNI, totaling

$377,753, were the distributions to the estate from decedent's

IRA's.

The bulk of the income from the IRA's represented the

proceeds of decedent's lifetime accumulations of deferred

compensation and were included in estate principal under Florida

law.

Fla. Stat. Ann. sec. 738.04(c) (West 1995).

Although

petitioner had an economic interest equal to 30 percent of the

value of the IRA’s reflected in the amount of the elective share,

the remaining 70 percent redounded to the benefit of the

residuary beneficiaries.

Neither subchapter J, nor the income

tax law generally, provides for allocating income between

petitioner on the one hand, and the estate and its beneficiaries

on the other, on the basis of their proportionate economic

interests therein.

Because the quantitative interest of the

estate and its residuary beneficiaries in the income from the

IRA’s is more than twice as large as petitioner’s interest

- 33 therein, the entire amount of that income should remain with the

estate.22

Section 662(a)(2)(B) does not exclusively govern all

transfers by a decedent’s estate that are not otherwise governed

by section 662(a)(1) and section 662(a)(2)(A) as income required

to be distributed currently.

Second tier distributions do not

include interests in joint tenancies, income derived therefrom,

transfers at decedent’s death of title to real property, or

payments in satisfaction of statutory dower, all of which share a

number of legal and economic characteristics.

In Rev. Rul. 64-

101, 1964-1 C.B.(Part 1) 77, the Commissioner has conceded that

statutory dower is properly excluded from second tier

distributions under the 1954 Code, just as payments for statutory

forced shares were excluded from distributions of estate income

under the 1939 Code and earlier revenue acts.23

The same must

hold true of petitioner’s Florida elective share.

22

When more than one person has dealings or interests with

respect to an item of income, the relative interests must be

weighed, and the item attributed to the person whose relationship

thereto is most significant for income tax purposes. The Code

does not allocate income between such persons on some ratio

derived from the importance of their various interests. This

basic principle was first articulated in American Law Institute

Tentative Draft No. 1, 8-11, Apr. 15, 1949, a major departure

point for what eventually was enacted as the 1954 Code. See also

Surrey & Warren, Federal Income Taxation 956 (1960).

23

See supra note 20 and accompanying text.

- 34 We conclude that payment to the surviving spouse in

satisfaction of the Florida elective share is not a distribution

within the meaning of sections 661(a) and 662(a)(2)(B).

Petitioner is not required to include any part of the payment of

her Florida elective share in gross income.

Decision will be entered

for petitioner.