Gallagher, Charles P.

English

University of Denver

Denver Law Review Volume 35 Issue 2 Article 5 May 2021 Prior State Court Proceedings as Affecting the Marital Deduction Charles P. Gallagher Follow this and additional works at: https://digitalcommons.du.edu/dlr Recommended Citation Charles P. Gallagher, Prior State Court Proceedings as Affecting the Marital Deduction, 35 Dicta 99 (1958). This Article is brought to you for free and open access by the Denver Law Review at Digital Commons @ DU. It has been accepted for inclusion in Denver Law Review by an authorized editor of Digital Commons @ DU. For more information, please contact jennifer.cox@du.edu,dig-commons@du.edu. MARCH-APRIL, 1958PRIOR STATE COURT PROCEEDINGS AS AFFECTINGTHE MARITAL DEDUCTIONBy CHARLES P. GALLAGHERCharles P. Gallagher received his B.S. de-gree in Foreign Service from GeorgetownUniversity in 1949, and his LL.B. fromGeorgetown University Law Center in1952. He is a member of the bar in Colo-rado, Connecticut and the District of Co-lumbia, and has been active in the Taxa-tion as well as the Probate and TrustSection of the Colorado Bar Association.He is an attorney in the trust departmentof the Central Bank & Trust Company ofDenver.While state law determines the property rights and interests ofparties' the manner in which such rights and interests shall be subjectedto federal tax is determined by federal law.' To these principles shouldbe added an important corollary-that the determination of such rightsand interests under state law may be rejected by the Commissioner ofInternal Revenue and the federal courts.' How these principles areapplied will be shown in this article.W, a bereaved widow, is more bereaved when she is informed thatH, her deceased husband has left his entire estate to his children by aformer marriage. Her sorrow is unbounded when she is further informedthat the document she signed before her marriage to H is reputed to bean antenuptial agreement, and that by it, she may have no rights to H'sestate.' W later is advised by her attorney that she has possible groundsfor having the antenuptial agreement declared invalid.The executor of H's estate is advised of the widow's apparent dis-pleasure with the will when W files her election to take the allowablestatutory interest.5 The executor informs the children that settlementis advisable. An agreement is subsequently reached whereby, in con-sideration of W's not attempting to exercise her statutory right to elect,she is to receive one-fourth of H's estate outright. The executor in hispetition to the probate court sets forth the proposed agreement and thefact that the antenuptial agreement may be of questionable validity.The petition also says that H's children desire settlement in accordancewith the proposed agreement. No argument or evidence is otherwisepresented, and the probate court approves the agreement and issues its1Blair v. Commissioner, 300 U.S. 5, 12 (1937).' Morgan v. Commissioner, 309 U.S. 78, 80 (1940).3 Estate of Arthur Sweet, 24 T.C. 488 (1955), aff'd, 234 F.2d 401 (10th Cir.), cert.denied, 352 U.S. 878 (1956).4 Griffee v. Griffee, 108 Colo. 366, 117 P.2d 283 (1941).5 Colo. Rev. Stat. § 152-5-5 (1953).DICTAMARCH-APRIL, 1958order permitting settlement. Will the interest which W receives underthe settlement agreement qualify for the federal estate tax marital deduc-tion?6The legislative intent in such a situation as just presented was todisallow as a marital deduction any settlement received by the survivingspouse which did not reflect the surviving spouse's rights under statelaw.' Subsequent regulations relating to this point indicated that theInternal Revenue Service looked askance at such settlements. In effect,the Internal Revenue Service said that a settlement of this type wouldqualify for the marital deduction only if such settlement was a bona fiderecognition of the surviving spouse's enforceable rights. A presumptionof such recognition attached where the settlement was made pursuantto a state court decision decided upon the merits in an actual adversaryproceeding. Settlements made pursuant to decrees obtained by consent, ormade pursuant to agreements not to contest the will, or not to probate thewill would not "necessarily" be accepted as a bona fide recognition of thesurviving spouse's enforceable rights.' The proposed regulations havenot departed from this view.'Hence, it might appear in the example given that the executor ofH's estate will experience difficulty in obtaining the marital deductionfor the amount given to W. Such would not be the case, however, if theexecutor can meet the standard set forth in the Tax Court case, Estate ofGertrude P. Barrett." As long as the executor of H's estate can demon-strate that W's grounds for setting aside the antenuptial agreement pro-vided him with a reasonable belief that there was a serious and substan-tial threat to the plan of the decedent, H, part of the standard is met.Then, if the settlement was the result of arms length negotiations, thecriterion set forth in the treasury regulations, as interpreted by theBarrett case, is met, and the amount given to W will qualify for themarital deduction.The result is sound law. If, in the illustration, W's claim had beenadjudicated on its merits, and if she had succeeded, the property interestshe would have received through her election would have qualified forthe marital deduction." Thus, if the executor has reasonable basis forbelieving that the widow W's claim is valid, the settlement given her forabandoning her claim is clearly in bona fide recognition of her rightsunder state law. To have held that there must be an actual contest onthe merits would be to make the executor of H's estate defend a posi-tion he reasonably believes untenable. Such an unreasonable require-ment could very well result in a greater loss to the beneficiaries underH's will.It should be mentioned that the settlement which the survivingspouse receives must be an interest which meets the other requirementsof section 2056 of the 1954 code in order to qualify for the marital deduc-tion. 1 2 In our illustration, if the agreement had been that W would not6 Int. Rev. Code of 1954, § 2056.7 U.S. Code Cong. Serv., 80th Cong. 2d Sess. 12,6 (1948).8 U.S. Treas. Reg. 105, § 81.47(g) (1949).9 Proposed U.S. Treas. Reg. § 20.2056(e)-2(d) (1956). The language used in theproposed regulation is the same as that used in U.S. Treas. Reg. 105, § 81.47(g) (1949).10 Estate of Gertrude P. Barrett, 22 T.C. 606 (1954), acq., 1954-2 Cum. Bull. 3.11 Id. at 611: U.S. Treas. Reg. 105, § 81.47(f) (1949); Proposed U.S. Treas. Reg.§ 20.2056(e)-2(c) (1956).12 Int. Rev. Code of 1954, § 2056(b) which states that a life estate or any othersimilar interest which will terminate upon the occurrence of some event or lapse oftime will not qualify.DICTAMIARcH-APRIL, 1958receive the property outright, but would take it in trust and receive allthe income for life, with a remainder to H's children, the settlementwould not qualify.' Similarly, if widow W ostensibly receives the prop-erty outright, but with the understanding that she immediately createan irrevocable trust reserving to herself the income for life, with aremainder to H's children, that settlement would not qualify. 4Estate of Arthur Sweet1" is an example of the kind of a state courtproceeding which is not binding on the Commissioner and the federalcourts. In that case, the decedent had created a revocable trust. In 1948,he amended the trust in an attempt to qualify it for the marital deduc-tion. After his death and upon revaluation of the trust assets, it appearedthat the decedent's wife would not receive the full marital deductionunless some portion of the revocable trust qualified. The Commissionerrefused to allow any portion of the trust to qualify because the generalpower to appoint, given to the wife by the 1948 trust amendment, didnot extend to the whole trust. The Commissioner rejected the trustee'scontention that there were two trusts.'The trustee brought suit in the Utah state court against the dece-dent's wife and remaindermen, seeking construction of the trust instru-mnents and instructions as to its duties thereunder. In its complaint thetrustee suggested that two trusts had been created by the 1948 amend-ment to the trust. At the hearing the trustee presented arguments andother evidence, but the defendants, having failed to answer or otherwiseplead, did not appear. Default judgments were rendered against thedefendants that same day, and the court immediately rendered itsopinion (which followed much of the language in the trustee's com-plaint) and ordered the trustee to separate the trust estate into twotrusts.In its decision the Tax Court noted the following sequence ofevents. The state court proceeding was instituted after the Commissionerrefused to recognize the two trusts. The trustee's complaint suggested13 Ibid.; Estate of Hyman Kleinman, 25 T.C. 1245 (1956), aff'd per curiam, 245F.2d 235 (6th Cir. 1957).14 Cf. Estate of Thomas W. Tebb, 27 T.C. 671 (1957); Comment. 43 Va. L. Rev.740 (1957).15 See note 3 supra.16 The case arose under Int. Rev. Code of 1939, § 812 as amended by 62 Stat. 117(1948) which permitted such a trust to qualify for the marital deduction only if the sur-viving spouse could exercise the general power to appoint the whole trust. Under thepresent law, Int. Rev. Code of 1954, § 2056, a general power to appoint just a specificportion of a trust would qualify."The store with personality"Serving the needs of men, women and boysfor quality apparel for over 75 years16th St. at Stout andWriters' Manor-DenverBroadmoor Hotel--Colorado SpringsDICTAMARCH-APRIL, 1958that two trusts were created. Default judgments were rendered againstthe defendants after they failed to answer, plead, or appear. The statecourt's opinion was rendered the same day as the hearing in almost thesame language as the trustee's complaint. Finally, the trustee had notcomplied with the state court's order regarding the separation of thetrust estate into two trusts. The state court's decree was rejected by theTax Court as not being determinative of interests in property understate law.17 The Court of Appeals for the Tenth Circuit, in affirmingthe Tax Court decision, concluded that the state court proceeding hadbeen brought with the concurrence of the trustee and the trust bene-ficiaries solely to circumvent the Commissioner's contention. "The(state) court decree," the court of appeals said, "was obtained by col-lusion for the purpose of maintaining the claim for marital deduction.And it therefore is not binding in this proceeding.""5 Once collusion orfraud is found in cases involving state determination of property rights,the Commissioner and the federal courts will find that they are not boundby the state court proceeding.Whether or when a state court proceeding is binding on the Com-missioner and the federal courts seems to be a continuing problem. It hasarisen in other types of cases affecting the marital deduction. Thus,should the widow's portion under the will bear the proportionate shareof taxes attributable to that share under state law?1" Can the widowelect to take her statutory interest in lieu of the interest given to herunder a joint and mutual will?2' Do certain insurance policies qualifyfor the marital deduction?21Moreover, that there is variance of opinion as to the effect of someof these state court proceedings may be gathered by the following lan-guage in the case of Merchants Nat'l Bank and Trust Co. v. UnitedStates:22"it is apparent that both sides agree, that if the probate courtfinal decree was entered by consent of the parties or in a non-adversary proceeding, it is not binding upon defendants in thisFederal estate tax litigation. It is, therefore, unnecessary forus to pass upon the validity of that proposition of law andwe are relieved of any obligation to consider and reconcile anumber of seemingly conflicting Federal courts of appealscases."'Although this article does not attempt to reconcile the seemingconflict in the circuit courts, certain conclusions may be gleaned from17 Estate of Arthur Sweet, 24 T.C. 488, 495 (1955).18 Estate of Arthur Sweet, 234 F.2d 401, 404 (10th Cir. 1956) (parenthetical matteradded).19 Merchants Nat'l Bank and Trust Co. v. United States, 246 F.2d 410 (6th Cir),cert. denied, 78 Sup. Ct. 148 (1957), in which the circuit court found the Indianastate court's decision permitting the widow to take her portion under the will freefrom taxes was not binding. But see Pitts v. Hamrick, 228 F.2d 486 (4th Cir. 1955).2 Estate of Charles Elson, 28 T.C. No. 48 (May 24, 1957). The court held thatthe Iowa state court's order approving the widow's election against the joint andmutual will was not binding. Compare with Awtry v. Commissioner, 221 F.2d 749(8th Cir. 1955), reversing 22 T.C. 167 (1954).21 Estate of William Walker Wynekoop, 24 T.C. 167 (1955), which held that theIllinois state court's decision regarding insurance policies was a binding one, and thepolicies qualified for the marital deduction.22 Merchants Nat'l Bank and Trust Co. v. United States, 246 F.2d 410 (6th Cir.1957).23 Id. at 417DICTAMIVIARCH-APRIL, 1958the cases involving the determination of property rights in a prior statecourt proceeding. These conclusions may be of some help in analyzingsimilar situations affecting areas of federal taxation, including the mari-tal deduction.It would seem that where there has been a determination of prop-erty rights under state law, which is binding on the parties, the statecourt proceeding should be binding on the Commissioner and the federalcourts as long as the state court determination was not tainted with fraudor collusion. Even though the proceeding may be nonadversary, theparties friendly, and a tax saving effected, these factors alone should notbe enough to permit the Commissioner and the federal courts to rejectthe state court's determination and substitute his or their own finding.21If state law, as interpreted by the state court proceedings, is to determineproperty rights and interests of the parties, those proceedings should bebinding on the Commissioner and federal courts.A different conclusion is reached where the federal government hasestablished a criterion as to the taxability of a property right, or thequalifying of such property right for a deduction under federal law.In this case, the state court proceedings should be binding on the Com-missioner and the federal courts only if the criterion as established bythe federal government is met. Hence, whether a property right receivedin settlement of a will controversy will qualify for the marital deductionwill be determined by the criteria set forth in Treasury Regulation 105,§ 81.47 (f), and Proposed Treasury Regulation § 20.2056 (e) -2 (c).Whether or not the criteria are met, of course, will be determinedby the Commissioner. It is in cases involving some federally establishedcriterion that variable factors become very important. These factors maybe the relationship of the parties, the reasonableness of the issues orclaims, how the issues or claims are adjudicated or settled, and the taxconsequences. The attorney may feel that he can take little solace incases involving this problem since the Commissioner will determinewhether the criterion has been met in the state court proceeding. How-ever, as long as the claims or issues involved are bona fide and reason-able, and as long as the settlement or adjudication in the state courtproceeding is bona fide and reasonable, the Commissioner should bebound. This proposition was affirmed in the case of Estate of Gertrude P.Barrett and to this extent, should give attorneys some consolation.'4 Gallagher v. Smith. 223 F.2d 218, 226 (3rd Cir. 1955).YOUR OFFICE SAFEmay be safe enough for ordinary purposes but your importantdocuments should be a SAFE DEPOSIT BOX in our new modernvault, designed for both safety and convenience.A whole year for as little as $5 plus tax.COLORADO STATE BANKOF DENVER-SIXTEENTH AT BROADWAYMember Federal Deposit Insurance CorporationDICTA

Prior State Court Proceedings as Affecting the Marital Deduction

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Prior State Court Proceedings as Affecting the Marital Deduction

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