Estate of Robertson, together with last year's holding in Estate of Clayton v. Commissioner, 97 T.C. 327(1991), may require an additional examination of testamentary provisions that provide executors with similar powers. Failure to take these precautions may result in the subsequent denial of the marital deduction.

The Facts of the Case

In October 1983, Willard Robertson died leaving a gross estate valued in excess of $31,500,000. Most of the estate was divided and funded three separate trusts, The Marlin Robertson Trust one, two, and three (MR-1, MR-2, and MR-3). The first of these three trusts (MR-1) provided Mrs. Robertson with an income interest for life and qualified for the estate tax marital deduction because it provided, inter alia, Mrs. Robertson with an unlimited testamentary power of appointment. The remaining two trusts (MR-2 and MR-3) also provided the surviving spouse with an income interest for life, and upon her death, the principal would be transferred to the Willard Robertson Trust to be held or distributed in accordance with the terms of that trust.

However, before the income interests in MR-2 and MR-3 would vest unconditionally in Robertson, the executor was required to affirmatively elect to treat the interests passing into those trusts as qualified terminable interest property. In the event the executor declined to make the QTIP election, such interests would not pass into the MR-2 and MR-3 trusts. Instead, the property would be transferred into the Willard Robertson Trust and be held or distributed in accordance with the terms of that trust. Mrs. Robertson had no interest in this trust.

The estate tax return filed claimed an estate tax marital deduction in the amount of $27.7 million. This amount reflected the values of the three trusts (MR-1, MR-2, and MR-3 approximately $9.23 million each) and the value of life insurance proceeds payable directly to the surviving spouse (approximately $1.2 million). The marital deduction, together with other deductions claimed, resulted in an estate tax of zero.

In September 1987, the IRS issued a notice of deficiency in the amount of $14.0 million. The IRS disallowed the marital deduction for the two residuary marital trusts (MR-2 and MR-3) because the interests did not satisfy the requirements for QTIP treatment.

Applicable Authority

IRC Sec. 2056(a) provides a marital deduction from a decedent's gross estate for the value of all property passing directly from the decedent to the surviving spouse. The property must pass unconditionally to the surviving spouse. The deduction will be denied if the interest passing to the surviving spouse will terminate or fail upon a) the lapse of time, b) the occurrence of an event or contingency, or c) the failure of an event or contingency to occur |IRC Sec. 2056(b)(1).

IRC Sec. 2056(b)(7) permits an estate tax marital deduction for certain interests passing to a surviving spouse that would otherwise have failed to satisfy the conditions set forth in IRC Sec. 2056(a). Such "terminable interests" will qualify for the marital deduction if a) they pass from decedent to surviving spouse, b) the surviving spouse has a qualifying income interest for life, and c) an election to treat such interests as qualified terminable interest property is made on Form 706 |IRC Sec. 2056(b)(7)(B)(i). A qualifying income interest for life requires that a) all income from the property must be payable to the spouse annually (or at more frequent intervals), and b) no person has the power to appoint such property to any person other than the surviving spouse |IRC Sec. 2056(b)(7)(S)(ii).

In short, IRC Sec. 2056(b)(7) permits a decedent to provide the surviving spouse with a life interest in the property while retaining control over the ultimate disposition of the property following the death of the surviving spouse.

Whether such an interest qualifies for the marital deduction or treatment, is determined at the time of the decedent's death. Moreover, the courts have consistently stated that it is, "The possibility, not the probability, that an interest will terminate or fail" that determines whether a spouse has been given a qualified interest |Estate of Robertson. Thus, regardless of the likelihood that the surviving spouse's interest will continue, a possibility that it could terminate or fail will suffice to deny the estate the marital deduction.

Analysis

The Tax Court agreed with the IRS's position that the mere possibility that the interests could pass to the non-marital trust prevented the bequest from satisfying the statutory requirements of IRC Sec. 2056(b)(7). The Court determined that the consequence of the executor's failure to elect treatment would prevent the surviving spouse from receiving a qualified income interest for life |IRC Sec. 2056(b)(7)(F)(ii). Specifically, the executor's ability to transfer the interests into the non-marital trust by declining to make the QTIP election created an impermissible power of appointment |IRC Sec. 2056(b)(7)(B)(ii)(ll). The failure to make the QTIP election would have prevented the interests from satisfying the even more basic requirement that they "pass" to the surviving spouse from the decedent |IRC. Sec. 2056(b)(7)(B)(i).

The Court based its conclusions on a strict reading of the terms of the decedent's will, and the resulting legal consequences. The Court was not persuaded by the decedent's express intention, clearly stated in the will, that the executor should make the QTIP election. Nor was the Court persuaded by the petitioner's argument that, under Arkansas law governing the conduct of fiduciaries, there was never any real possibility that the executor would have forgone making the election.

Qualified Income Interest For Life. The Court noted that, in analyzing the terms of the will that preceded the decedent's instructions to the executor should the QTIP election not be made, the surviving spouse had a net-income interest in the residuary trusts. Without examining the tax consequences to the estate resulting from the failure to make the QTIP election, the terms of the will would have given the surviving spouse an uncontestable legal interest in the trust income. Therefore, whether the executor made the QTIP election or not would not have altered the legal rights of the surviving spouse. The tax consequences, while certainly altering the ultimate composition of the net estate, would not alter the rights of the beneficiaries (beyond the provisions of any tax apportionment clauses).

However, beyond the initial terms and provisions of the MR-2 and MR-3 trusts, the specific instructions to the executor required him to transfer the interests into the non-marital trust if the QTIP election was not made. That specific directive created the possibility that the surviving spouse's interests would never reach the MR-2 and MR-3 trusts, but rather be transferred directly into the Willard Robertson Trust. Had the interests been transferred into the MR-2 and MR-3 trusts before the due date for the QTIP election, the possibility would have existed that the surviving spouse could have been divested of her interests as a consequence of a subsequent failure to make the election.

Neither of the two possibilities satisfy the statutory requirement that "no person has a power to appoint any part of the property to any person other than the surviving spouse" |IRC Sec. 2056(b)(7)(B)(ii)(II). While the testamentary language is not drafted as a customary power of appointment, the Court reasoned that it had such legal effect "|As we held in Estate of Clayton, the executor's ability to control the trusts' assets is tantamount to a power to appoint property and to appoint that property to someone other than the surviving spouse, which does not meet the requirements of IRC Sec. 2056(b)(7)(B)(ii)(II)".

Once the Court agreed that the contingency in effect created an impermissible power of appointment, the Court need not have proceeded further. That factor alone would have prevented the interests from satisfying the requirement for a qualified income interest for life. However, the Court also held that the possibility the interests would pass to the non-marital trust would deny the surviving spouse of any income interest in the transferred property. Mrs. Robertson had no interest in the Willard Robertson Trust, so that any interests transferred to that trust would generate income for, and provide benefits to, non-spouse beneficiaries, i.e., the decedent's children. That possibility would fail to satisfy the other requirement for a qualifying income interest for life that "the surviving spouse is entitled to all the income from the property, payable annually or at more frequent intervals" |IRC Sec. 2056(b)(7)(B)(ii)(l).

The Rights Did Not Pass From Decedent. As if to highlight the pervasive effects of the contingency created by the executor's instructions to transfer the property to the non-marital trust if the QTIP election was not made, the Court concluded that there was no passage of rights from the decedent to the surviving spouse. This is merely a restatement of the Court's position on the "power of appointment" issue discussed above. In short, the decedent's property would only "pass" to Mrs. Robertson upon the executor making the QTIP election. As the Court pointed out: "Here, the decedent's will failed to grant Mrs. Robertson any qualifying income interest for life separate and apart from the interest that would arise if the executor made a QTIP election". Absent the QTIP election, the decedent had not left anything in the MR-2 and MR-3 trusts for the surviving spouse. Accordingly, the Court concluded that the "passes from" language of IRC Sec. 2056(b)(7)(B)(i)(I) was not satisfied.

Petitioner's Arguments. The essence of the petitioner's argument was that there was never any real likelihood that the executor would have chosen not to make the QTIP election. This position was supported by the decedent's own statement in the will, and a further argument that Arkansas law governing fiduciaries would have prevented the executor from forgoing the election.

The decedent's intention is reflected in the sentence following his grant of authority to make or forgo the QTIP election: "Without limiting the discretion..., it is my expectation that my executor will make said election with respect to all of any such amount unless the timing of my wife's death and mine and the computation of the duties in our two (2) estate (sic) render such an election inappropriate". From this language, it can be surmised that unless the tax consequences dictated otherwise, the decedent wanted the executor to make the QTIP election.

Despite this language, and the intention it obviously sought to express, the Court was unpersuaded. The Court considered the above language to be "at most ... an indication that he intended that the executor lower estate taxes through the QTIP election. However, the clause explicitly states that it does not limit the executors discretion. The Court did not believe that the terms of the will, the above statement notwithstanding, limited the executor's discretion in determining whether to make the QTIP election. "To say that this means he did not have the authority not to elect is to ignore the express words in the will".

The same reasoning was applied in reviewing the applicable Arkansas law. None of the various authorities cited by petitioners to support the contention that the executor was bound by fiduciary principals to make the election, persuaded the Court. Ultimately, the Court noted: "The decedent contemplated the possibility that the executor might choose not to make the QTIP election, since the decedent included specific directions as to what was to occur in that event ...". It was those specific instructions "that created the possibility that the surviving spouse's income interest could terminate or fail".

Impact of Estate of Clayton. Most, if not all the Court's analysis of the forgoing issues was based on the reasoning of last years decision in Estate of Clayton.

That case presented an even more persuasive argument for granting the marital deduction despite the contingency, because surviving spouse also served as executor for the estate. The likelihood that the QTIP election would not be made was remote, because the consequences of that failure would have resulted in a loss of the surviving spouse's/executor's income interest in the property from the second trust. Even this significant additional factor did not alter the Tax Court's conclusion.

Helpful Suggestions

Practitioners cannot help but be sobered by the Tax Court's observation: "We grant that the decedent may not have intended the tax result that flows from the terms of his will; nevertheless, the language of his will clearly mandates this outcome". Loss of the estate tax marital deduction was certainly not expected when the Robertsons (or the Claytons) drafted their wills.

However, this should be viewed as opportunity to review and immediately correct similar problems. The Court made some helpful suggestions. For example, one possibility mentioned by the Court was to have the testator limit the non-election of QTIP status to specific circumstances rather than granting the executor blanket authority to forgo the election. This should reduce the likelihood that the testamentary directive could be viewed as a general power of appointment.

In any case, testamentary provisions should be closely examined considering the above decisions. Any suspect provision should be immediately removed and redrafted to avoid loss of the estate tax marital deduction as a consequence.

Practice Opportunity

Reviewing testamentary provisions of wills to head off the problems of Clayton and Robertson should not be viewed as a nonproductive chore. Clients will clearly see the additional value you are bringing to the practitioner/client equation. The result will be a more profitable relationship.

|Editor's Note: On November 17, 1992, the United States Court of Appeals for the Fifth Circuit reversed the Tax Court's decision in the Estate of Clayton. The Fifth Circuit's reversal does not alter the outcome in Estate of Robertson, but does seriously weaken the Court's analysis which had borrowed heavily from Estate of Clayton.

Frank G. Colella, LLM, CPA