Estate of Robertson is the second major Court of Appeals decision to reverse the Tax Court position on this important estate planning issue. In Estate of Clayton v. Commissioner, 976 F.2d 1486 (5th Cir. 1992), the Fifth Circuit also reversed the Tax Court's decision 97 T.C. 327 (1991), on facts that were indistinguishable from those in Estate of Robertson.

Factual Background

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 Martin Robertson Trusts 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 Mrs. Robertson, the executor was required to affirmatively elect to treat the interests funding those trusts as qualified terminable interest property. In the event the executor declined to make the QTIP election, those 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 claimed a 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 $8.83 million each) and the value of life insurance proceeds payable directly to the surviving spouse (approximately $1.2 million). This marital deduction, together with other deductions claimed, resulted in an estate tax due 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 interests passing to a surviving spouse that would otherwise fail to satisfy the conditions set forth in IRC Sec. 2056(a). The "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)(B)(ii). Whether an interest qualifies for QTIP treatment is determined at the time of the decedent's death.

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

Tax Court Decision

The Tax Court agreed with the IRS that the executor's ability to shift property into nonmarital trusts by forgoing the QTIP election prevented the bequest from satisfying the statutory requirements of IRC Sec. 2056(b)(7).

Qualified Income Interest for Life. Without examining the tax consequences to the estate resulting from the failure to make the QTIP election, the decedent's will provided the surviving spouse an uncontestable legal interest in the trust income. However, specific testamentary instructions required the executor to transfer the property into the nonmarital trust if he did not make the QTIP election. That specific directive created the possibility, however remote, that the assets would never reach the MR-2 and MR-3 trusts but, rather, be transferred directly into the Willard Robertson Trust. Had the assets been transferred into the MR-2 and MR-3 trusts before the due date for the QTIP election, the surviving spouse would have been divested of her interests as a consequence of the executor's failure to make the QTIP election.

The Tax Court held that such a contingency could not 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 the legal effect of one. 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)." The Tax Court also held that the possibility the interests would pass to the nonmarital trust would deny the surviving spouse of any income interest at all. 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, nonspouse beneficiaries. 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)(I).

As if to highlight the pervasive effects of the executor's discretion, the Tax Court further concluded that there was no passage of rights from the decedent to the surviving spouse. The 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.

Likelihood of Forgoing the QTIP Election. The Tax Court was not persuaded that either the decedent's express intention that the QTIP election be made, or that Arkansas law would have prevented the executor from forgoing the election, required a different outcome.

The Tax Court considered the testamentary directions to be "at most...an indication that he intended that the executor lower estate taxes through the QTIP election; the clause, however, explicitly states that it does not limit the executor's discretion." The Tax Court did not believe that the will limited the executor's ability to make or forgo 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 applied to the review of Arkansas law. None of the authorities cited supported the contention that the executor was required by fiduciary principles to make the election. The Tax 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...." Those specific instructions "created the possibility that the surviving spouse's income interest could terminate or fail."

Reliance upon Estate of Clayton. The Tax Court's statutory analysis of the elements of a QTIP election relied heavily upon the reasoning in Estate of Clayton. The facts of Estate of Clayton were indistinguishable from those in the present case. Similarly, the Tax Court held that the executor had a power to appoint that permitted the transfer of property into the nonmarital trust and, therefore, did not meet the requirements of IRC Sec. 2056(b)(7).

Following the Tax Court's decision in Estate of Robertson, the Court of Appeals, Fifth Circuit, in a strongly worded opinion, reversed the Tax Court's decision in Estate of Clayton.

Court of Appeals Decision

The Eighth Circuit Court of Appeals, in Estate of Robertson, adopted the analysis of the Fifth Circuit, and reversed the Tax Court. "We follow the decision of the Fifth Circuit..., a case which all the parties regard as indistinguishable from this one" 15 F.3d at 781.

Power to Appoint. The decisive question was framed as "whether or not the right of the executor to make the QTIP election or refrain from making the QTIP election is a prohibited 'power to appoint' under IRC Sec. 2056(b)(7)(B)(ii)(II)." The Court of Appeals answered this question in the negative: "The right to make or refrain from making a QTIP election is not a prohibited 'power to appoint.'" By concluding that the executor's discretion was not a prohibited power to appoint, the interest would satisfy the requirements for a qualified income interest for life and IRC Sec. 2056(b)(7).

Conversely, the IRS once again argued that the executor's discretion to forgo the QTIP election was a power to appoint because his failure to make that election would leave the surviving spouse with no interest in the property. In holding that a power to appoint was not created, the Court specifically rejected the IRS position that "the failure to make the election would 'effect the beneficial enjoyment of trust property or its income...by testing the trust.'" Quoting from Estate Tax Regulations, 26 C.F.R. Sec. 20.2041-1(b).

The Court of Appeals found that both the IRS and Tax Court misunderstood the plain meaning of the statute. The question of whether property was eligible for QTIP treatment was to be determined by reference to the property for which the election has been made. Thus it is irrelevant to inquire what would have happened had the election not been made." What happens to the property if the executor forgoes the QTIP election is irrelevant. "'Congress could not have cared less whether the portion of the... property for which the QTIP election is not made goes to the surviving spouse, to the children, or to a stranger. Obviously, that is why Congress placed the election in the definition of QTIP property.'" quoting Estate of Clayton, 976 F.2d at 1498

The critical inquiry is whether the property for which a QTIP election is made satisfies the requirements for qualified terminal interest property. "QTIP is by statutorily explicit definition property for which the election has been made." In other words, does the property transferred into the MR-2 and MR-3 trusts qualify for QTIP treatment (does it pass from decedent to surviving spouse; does the surviving spouse have a qualified income interest for life; and, has a timely QTIP election been made)?

Having noted that a timely QTIP election was made on Form 706, one must decide whether the surviving spouse received a "qualified income interest for life." By the very terms of the MR-2 and MR-3 trusts, Mrs. Robertson would receive all the income generated from the trust corpus for the remainder of her life. Following her death, the corpus would be transferred to the Willard Robertson Trust and be administered in accordance with the terms of that trust. Based upon these facts, Mrs. Robertson received a classic life estate - the very interest contemplated by the statute.

Remaining Tax Court Conclusions. The Court of Appeals disposed of the additional conclusions reached by the Tax Court in a one sentence footnote to the decision: "We also reject the tax court's alternative conclusions - that the spouse's rights did not 'pass' from the decedent ... and the executor's power created the possibility that the spouse would not be entitled to all the income from the property... - because these conclusions are based upon the same faulty reading of the statutory definition of QTIP."

In addition, by holding that the executor's discretion in and of itself did not create a power to appoint, the actual likelihood the executor would forgo the QTIP election is irrelevant. In other words, it's no longer necessary to determine whether the decedent's testamentary instructions require that the QTIP election be made, or whether Arkansas fiduciary principles compel the executor to make the QTIP election.

Where Are We?

Given the two significant reversals, it would seem that the IRS should acquiesce when confronted with similar facts and circumstances. However, Estate of Robertson and Estate of Clayton bind the Tax Court and IRS only in the jurisdictions of the Eighth (Arkansas, Iowa, Minnesota, Missouri, Nebraska, North Dakota, and South Dakota) and Fifth (Alabama, Florida, Georgia, Louisiana, Mississippi, and Texas) Circuits, respectively. Taxpayers in the remaining jurisdictions can rely on the Eighth and Fifth Circuit decisions as persuasive authority.