Opposition Brief — Ferman v. United States

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No. 93-569

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In the Supreme Court of the United States

OCTOBER TERM, 1993

BERTHA PAGLIN FERMAN, EXECUTRIX OF THE ESTATE OF

JULES J. PAGLIN, DECEASED. PETITIONER

Vv.

UNITED STATES OF AMERICA

ON PETITION FOR A WRIT OF CERTIORARI

10 THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT!

BRIEF FOR THE UNITED STATES

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MICH L. PAU]

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GILBERT S. ROTHENBEI

PERI KE. MCLAUGHLI

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QUESTION PRESENTED

Whether curative legislation enacted in December

1987 retroactively to avert the potential abuse of an

estate tax provision enacted in October 1986 violates due

process when applied to transactions entered into by an

estate in February 1987.

(1)

TABLE OF CONTENTS

Page

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TABLE OF AUTHORITIES

Cases:

Carlton v. United States, 972 F.2d 1051 (9th Cir. 1992),

Cart. granted, 114 B. Ct. GG ...cccccccccccocccccsccsccosscccocecccosees 8,9

Constitution and statutes:

U.S. Const. Amend. V (Due Process Clause) .................+ 6

Omnibus Budget Reconciliation Act of 1987, Pub. L. No.

EE BOE BRE, BODO covrecercevereereceveeevsesccocceseve 3

Omnibus Budget Reconciliation Act of 1989, Pub. L. No.

101-239, § 7304(a), 103 Stat. 2106 .................scccceeeereeeeees 2

Internal Revenue Code (26 U.S.C.):

aa ca ennncnpnorversovoceverecoees 2, 3, 4, 6, 8, 9

§$ 2057(b)(1) (Supp. TV 1986) ..........cccccscccssosssseereecsoees 2

§ 2057(c)(1) (Supp. 1V 1986) ..........csccccseeseceereeeeeeees 2

Tax Reform Act of 1986, Pub. L. No. 99-514, § 1172(a),

es cassceascunewnreneresaevers 2

Miscellaneous:

133 Cong. Rec. (1987):

Sy EE anncewseseresesoecenevsecerevercooessvecscoseusweccesscescceeseoeseece 3

SiN seisuctsubccteensesoceneretovoeeeseserevsecesensevoecevsvseetersoereoes 3

H.R. Rep. No. 391, 100th Cong., Ist Sess. Pt. II (1987) .... 4

I.R.S. Notice 87-13, 1987-1 C.B. 482 .........cccccseseeeeeeeeeeeeeees 2-3, 4, 7

(IIT)

In the Supreme Court of the Giuted States

OCTOBER TERM, 1993

No. 93-569

BERTHA PAGLIN FERMAN, EXECUTRIX OF THE ESTATE

OF JULES J. PAGLIN, DECEASED, PETITIONER

v.

UNITED STATES OF AMERICA

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

BRIEF FOR THE UNITED STATES

OPINIONS BELOW

The opinion of the court of appeals (Pet. App. la-

20a) is reported at 993 F.2d 485. The opinion of the

district court (Pet. App. 1b-18b) is reported at 790 F.

Supp. 656.

JURISDICTION

The judgment of the court of appeals was entered on

June 18, 1993. A petition for rehearing was denied on

July 15, 1993. The petition for a writ of certiorari was

filed on October 12, 1993. The jurisdiction of this

Court is invoked pursuant to 28 U.S.C. 1254(1).

(1)

STATEMENT

1. Petitioner is executrix of the estate of Jules J.

Paglin, who died on October 27, 1986 (Pet. App. 6a).

This case concerns whether decedent’s estate is enti-

tled to a deduction for estate tax purposes under

Section 2057 of the Internal Revenue Code, 26 U.S.C.

2057.

a. Section 2057 was enacted on October 22, 1986, as

part of the Tax Reform Act of 1986, Pub. L. No. 99-

514, § 1172(a), 100 Stat. 2085. As originally enacted,

Section 2057 allowed a deduction from the gross

estate of fifty percent of the “qualified proceeds” of a

“qualified sale” of any employer securities to an

Employee Stock Ownership Plan (ESOP). The term

“qualified sale” was defined as “any sale of employer

securities by the executor of an estate to *** an

employee stock ownership plan” (26 U.S.C. 2057(b)(1)

(Supp. IV 1986)). “Qualified proceeds” was defined as

“the amount received by the estate from the sale of

employer securities at any time before the date on

which the return of the tax imposed by section 2001 is

required to be filed.” 26 U.S.C. 2057(c)(1) (Supp. IV

1986).' As originally enacted, Section 2057 did not

explicitly require a decedent to have owned the

securities in question to permit his estate to qualify

for the deduction.

b. On January 5, 1987, the Internal Revenue Ser-

vice issued a news release addressing a number of

statutory changes affecting employee plans. The

news release was formally published as Notice 87-13

' Section 2057 has been repealed for estates of persons dying

after July 12, 1989. See Omnibus Budget Reconciliation Act of

1989, Pub. L. No. 101-239, § 7304(a), 103 Stat. 2352-2354.

3

on January 25, 1987. 1987-1 C.B. 432. The Notice stat-

ed that “(pjending the enactment of clarifying leg-

islation,” the IRS would not recognize the deduction

permitted under Section 2057 unless the decedent

“directly owned” the securities in question before

death. 1987-1 C.B. at 442.

Legislation incorporating this decedent-ownership

requirement was introduced in both houses of Con-

gress on February 26, 1987. In introducing the 1987

amendment, Representative Rostenkowski, Chairman

of the House Ways and Means Committee, noted that

when Section 2057 was originally enacted in 1986,

Jongress anticipated that the resulting revenue loss

would be approximately $300 million. 133 Cong. Rec.

4145 (1987). Shortly after the bill’s passage, however,

the Joint Committee estimated a possible revenue

loss of as much as $7 billion—more than 20 times the

amount originally anticipated—due to the fact that

the statute did not explicitly limit the deduction to

sales of securities owned by the decedent at death.

The amendment proposed in 1987 embodied “an

accurate statement of congressional intent in enact-

ing the [original] provision.” /bid. Senator Bentsen,

then Chairman of the Senate Finance Committee,

observed that “Congress did not intend for estates to

be able to claim the deduction by virtue of purchasing

stock in the market and simply reselling the stock to

an ESOP” (133 Cong. Rec. 4294 (1987)), for the

provision had not been intended to permit a deduction

for “essentially sham transactions” (ibid.).

ce. On December 22, 1987, Congress enacted the

Omnibus Budget Reconciliation Act of 1987, Pub. L.

No. 100-185, 101 Stat. 1330. Section 10411 of that Act

amended Section 2057 of the Internal Revenue Code

4

expressly to impose the requirement that the dece-

dent own the stock at the time of death for the ESOP

transaction to qualify for the estate tax deduction.

That amendment was made effective as of the date of

the original enactment of Section 2057 in October

1986. The Conference Report accompanying enact-

ment of the 1987 amendment stated that, “[wlJhile

Congress intended to encourage transfers of em-

ployer securities to ESOPs by providing for partial

elimination of estate tax liability, it was not intended

that estates be able to eliminate all estate tax liability

through use of the deduction.” H.R. Rep. No. 391,

100th Cong., Ist Sess., Pt. II, at 1045 (1987). The

Report concludes that “(t]he provision would not have

been adopted in its [original] form had the full extent

of the revenue impact and the effect of the provision

been recognized” (ibid.). The Report explains that

“(t]he modifications contained in the bill are designed

to bring the revenue loss in line with the original

estimate and Congressional intent” (ibid.).

2. Petitioner sought to obtain an estate tax

deduction under Section 2057 by engaging in the

following transactions: On February 20, 1987, after

the promulgation of Notice 87-13, but before the cura-

tive legislation was introduced in Congress, peti-

tioner purchased 12,300 shares of ALZA Corporation

stock at a total cost of $348,960 on behalf of the

decedent’s estate. That same day, she entered into a

Stock Purchase Agreement with the trustees of the

ALZA Corporation Employee Stock Ownership Plan

(ESOP) and sold the 12,300 shares to the ESOP for

$329,175, or a discount of $17,325. Three days later, on

February 23, 1987, petitioner purchased an additional

5

12,2002 shares of ALZA stock for $329,090 and sold

them to the trustees of the ALZA ESOP for

$310,317.50, or a discount of $16,332.50. And, on Feb-

ruary 24, 1987, petitioner purchased 11,200 shares of

ALZA Corporation stock for $310,100 and sold them to

the ALZA ESOP on that same day for $292,600, or a

discount of $15,400. The total purchase price for the

35,700 shares of ALZA Corporation stock, including

commissions, was $981,150.25 The aggregate sales

price of the stock to the ALZA Corporation ESOP

was $932,092.50. These purchases resulted in an ag-

gregate discount to the ESOP of $49,057.50 (Pet. App.

6a-7a, 5b).4

Petitioner entered into these transactions on the

advice of her attorneys. The parties stipulated that

her “decision to purchase these shares of ALZA

stock, pay the commissions due on the purchases, and

resell the stock to the ALZA ESOP at a discount, was

purely tax motivated” (Pet. App. 7a). The parties fur-

ther stipulated that “(t]he only reason that [peti-

tioner] purchased ALZA stock, as opposed to the

2 A typographical error in the court of appeals’ opinion

describes this as a purchase of 112,200 shares (Pet. App. 6a).

The district court’s opinion correctly states that the purchases

engaged in by petitioner in the three transactions were for a

total of 35,700 shares (Pet. App. 5b).

3 Petitioner executed these transactions with an account at

Dean, Witter, Reynolds, Inc., in which she had deposited

$350,000 (Pet. App. 5b). Since each stock purchase that she

made amounted to less than $350,000, and since the stock was

sold each time on the same day to the ALZA ESOP, petitioner

needed no more than her initial $350,000 deposit to generate

the $932,092.50 in aggregate sales proceeds.

4 The record does not disclose whether the estate ciaimed

this amount as a deduction on any fiduciary income tax return.

6

stock of another company, was the fact that the ALZA

ESOP had by prior agreement agreed to purchase at a

discount the entire quantity of ALZA Corporation

stock directly from the estate, and the ALZA ESOP

agreed to make the purchase from the estate over the

three-day period” (ibid.). Petitioner also chose the

ALZA ESOP because it had agreed to purchase the

shares at a smaller discount than other ESOPs she

contacted (7bid.).

3. On or about July 17, 1987, petitioner filed a

timely federal estate tax return. No Section 2057 de-

duction was claimed on the return (Pet. App. 6b). On

December 15, 1987, petitioner filed a claim for refund

uf $177,362.03 in federal estate taxes, plus interest.

Petitioner asserted that the estate was entitled to a

deduction under Section 2057 in the amount of

$466,046.25, which was one-half of the $932,092.50 total

sales proceeds received from sales of the ALZA

Corporation stock to the ALZA Corporation ESOP.

Petitioner calculated that the Section 2057 deduction

reduced the taxable estate from $1,869,839.03 to

$1,403,792.78, and that the estate’s tax liability was

thereby reduced from $511,097.55 to $333,735.52 (Pet.

App. 8a).

4. When the IRS denied the claim for refund,

petitioner commenced this refund suit in district

court. Petitioner contended that the estate was

entitled to the deduction under the provisions of

Section 2057 as they existed at the time the sales

were consummated. Petitioner contended that retro-

active application of the 1987 amendments to Section

2057 violated the Due Process Clause of the Con-

stitution (Pet. App. 8a).

7

The district court rejected petitioner’s claim. At

the outset, the court noted that there was “strong,

indeed virtually unanimous, support for retroactive

application of tax statutes” (Pet. App. 12b). The court

rejected petitioner’s argument that “she could not

have foreseen Congress’ retroactive amendment of

section 2057 because no legislative action took place

until after she completed the stock transfers at

issue” (id. at 13b). In the district court’s view,

“Notice 87-13 forewarned what the future could and

ultimately did bring” (ibid.):

It would seem abundantly clear that, given the

IRS’ position, Congress would enact corrective

and retroactive legislation at the earliest possible

time.

The district court noted that, “[wJhile the net effect

of the 1987 amendments to section 2057 clearly denied

the * * * estate the benefits of the fifty percent

deduction, such denial did not amount to a ‘new tax’ as

contemplated by the relevant law” (id. at 14b). The

court concluded that “Congress may surely correct

any error or inadvertence it may have created” (id. at

17b).

5. The court of appeals affirmed. The court stated

that “[e]valuating the government’s retroactive

amendment of section 2057 in the context of the facts

before us, we conclude that the government did not

inflict a ‘harsh and oppressive’ change in tax law upon

[the] estate” (Pet. App. 15a). The court found it

significant that Notice 87-13 was formally published

“nearly a month before Ferman entered into the

series of transactions at issue in this case” (ibid.).

The court distinguished the Ninth Circuit’s decision

8

in Carlton v. United States, 972 F.2d 1051 (1992), cert.

granted, (1993), which had held application of the 1987

amendment to Section 2057 to a transaction engaged

in by an estate in December 1986 to be uncon-

stitutional. The court of appeals stated in the present

case that, “although Carlton also involved an

executor’s reliance on section 2057, the executor in

that case entered the transaction at issue nearly one

month before the IRS issued Notice 87-13” (Pet. App.

A15). The court concluded that, “[aJlthough Notice

87-13 did not carry the authority of binding law, it did

notify taxpayers of the possibility that section 2057

would be amended, how section 2057 might be

amended, and the fact that there was risk associated

with entering into transactions solely out of reliance

upon section 2057” (id. at A16).

ARGUMENT

On October 4, 1993, the Court granted certiorari to

review the judgment in Carlton v. United States, No.

92-1241. In Carlton, the Ninth Circuit held the 1987

amendments to Section 2057 to be unconstitutional as

applied to a transaction completed by an estate in

December 1986. The court of appeals stated in Carl-

ton, however, that “[wJe do not doubt the power of

Congress to apply legislation retroactively to the

time such legislation was introduced, or even to the

time such legislation was proposed by the executive

branch. * * * During this time period, the taxpayer is

on notice that a change in law is forthcoming.” 972

F.2d at 1062.

In the present case, by contrast with Carlton, the

executor engaged in her stock transactions well after

the Service had given public notice of its intent to

9

seek the curative change to Section 2057 that Con-

gress enacted in December 1987. See pages 2-5,

supra. In upholding application of the 1987 amend-

ments to Section 2057 under the specific circum-

stances of this case, the court of appeals found it un-

necessary to decide whether the estate tax deficiency

would also be sustained under the circumstances that

existed in Carlton (Pet. App. 15a-16a).

The decisions of the courts of appeals in these two

cases are thus plainly not in direct conflict. Indeed,

the Ninth Circuit in Carlton cited the decision of the

district court in this case with seeming approval. 972

F.2d at 1062. Although the Court may wish to hold

the petition in the present case pending its decision in

Carlton, the two decisions do not conflict. Since the

decision in the present case is correct, further review

in this case is not warranted.

CONCLUSION

The petition for a writ of certiorari should be

denied or should be held in abeyance pending this

Court’s decision in Carlton v. United States, No. 92-

1941.

Respectfully submitted.

Drew S. DAYS, III

Solicitor General

MICHAEL L. PAUP

Acting Assistant Attorney General

GILBERT S. ROTHENBERG

TERESA E. MCLAUGHLIN

Attorneys

DECEMBER 1993