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In re Estate of Joseph E. Reilly

decided: January 8, 1957.


Author: Mclaughlin

Before MARIS, GOODRICH and McLAUGHLIN, Circuit Judges.

McLAUGHLIN, Circuit Judge.

Petitioner, administratrix of the estate of her deceased husband, seeks review of the decision of the Tax Court that all of the proceeds under certain life insurance policies payable to her as spouse are excluded from the marital deduction by Section 812(e) (1) (B) of the Internal Revenue Code of 1939, 26 U.S.C. § 812(e) (1) (B), the terminable interest rule. The facts were stipulated and so found by the Tax Court.

Included in the gross estate was the sum of $58,430.09, representing the proceeds of eight policies of insurance upon decedent's life issued by the Penn Mutual Life Insurance Company. Decedent had filed a beneficiary designation and settlement option with the insurance company in 1944 which provided that in the event his wife should survive him the proceeds of each policy were to be distributed to her in equal monthly installments for ten years certain and thereafter for life; and if his wife should die within the ten year period, the remainder of installments for the ten year period were to be paid to his surviving children or to the estate of the last survivor of his wife and children. The option was in effect at his death in 1950.

Decedent was survived by his spouse and two children. At that time the surviving spouse was 47 years of age. Each policy specified the amount payable in monthly installments under the above option to a female, age 47, for each $1,000 of proceeds. The total amount she was to receive under the eight policies was $270.85 per month. On the basis of the calculations used by the insurance company to determine the amount of the monthly installments, of the total proceeds in amount of $58,430.09, the sum of $28,149.63 was necessary to provide the stated monthly income for ten years certain and $30,280.46 was required to provide said monthly income thereafter for the life of the surviving spouse.

By all eight of the policies the installment payments during the ten year certain period, but not the installment payments thereafter, were to be increased by any surplus additions as might be awarded by the board of trustees of the insurance company. The policies provide that the right to the income payments could not be commuted, alienated, assigned, or anticipated by the beneficiary without the written permission of the insured, which in the instant case was not given.

Petitioner originally claimed a marital deduction in the estate tax return with respect to the entire proceeds of the policies in the amount of $58,430.09; but conceded prior to the hearing in the Tax Court that the portion of the proceeds required to provide the monthly payments for ten years certain, totaling $28,149.63, does not qualify for the marital deduction. Respondent disallowed the full amount of the deduction and was sustained in this by the Tax Court.

The Tax Court held that the word "property" as used in Section 812(e) (1)*fn1 of the Internal Revenue Code of 1939, as amended, 26 U.S.C. 1952 ed. § 812(e) (1), included all the proceeds payable under each of the contracts of insurance.

The purpose of the marital deduction in determining estate tax liability under the Revenue Act of 1948, is to make more nearly uniform the tax treatment of married persons in community property and non-community property states. This was accomplished by allowing a deduction up to fifty per cent of the gross estate of the spouse first to die for outright transfers of assets to the surviving spouse. The assets so removed from the tax in the estate of the spouse first to die are to be exposed to the tax at the death of the surviving spouse. Fundamentally postponement of the tax is contemplated so that if the full marital deduction is taken, the property of the marital community will be subject to the tax only once in the estate of either spouse.

In order to prevent abuse and tax avoidance through the marital deduction, the terminable interest rule was enacted. Broadly, it excepts from the marital deduction any asset of the estate transferred to the spouse which may by any event ultimately pass from the decedent to any other person for less than full consideration in money or money's worth. But not all terminable interests are barred from the marital deduction. To be excluded, the property, of which the terminable interest is a part, must under some contingency be liable to pass from the decedent to someone other than the spouse and be possessed and enjoyed by such other person after the surviving spouse. A second type of terminable property eliminated, is one which at the direction of the decedent is purchased by an executor or trustee for the spouse.

To accomplish this purpose in language of wide application was no small task. In the Senate Committee Report*fn2 the term "property" was generally defined as "used in a comprehensive sense and includes all objects or rights which are susceptible of ownership." "Interest in property" was in effect stated as anything short of "property".*fn3 Thereafter, it is pointed out that a terminable interest may be the entire "property"*fn4 and further that a terminable interest may be subdivided into interests, each of which is separate property for purposes of the terminable interest rule.*fn5 The limitation on such subdivision is that under no circumstances may any other person succeed to the property in which the surviving spouse had an interest. The committee report does not contemplate that the assets encompassed by the term "property" are to be mechanically determined in the verbiage of the overall definition, for the very example quoted below is completely inconsistent with any attempted use of the language in that definition as a rigid formula. Rather it appears that the question of where one "property" ends and a separate "property" begins must be judged in the light of the particular circumstances and their relationship to the purpose of the statute.

It is those standards which the Tax Court failed to consider in evaluating the word "property" as applied to the specific facts of the situation before us. The proceeds of one insurance policy certainly can be divided into separate properties. The fact that each single property had its genesis in the same piece of paper is without significance taxwise. Otherwise, every indicia of title would be indivisible, which is not true. Substance must prevail on this question, as in all tax matters.

The regulation issued under Section 812(e) (1) (G)*fn6 which is specifically addressed to life insurance and annuity payments contemplates the division of the proceeds from one insurance contract into two separate funds held by the insurer and different treatment under the terminable interest rule accorded to each by Section 81.47 (a) (d) (2) of Regulations 105:

"(2) If the interest of the surviving spouse under a life insurance, endowment, or annuity contract is in proceeds held by the insurer which do not, however, represent the entire amount payable under such contract, the provisions of section 812(e) (1) (G) nevertheless apply to such proceeds so held to which all five of the above conditions apply. For example, an insurance contract on the decedent's life may provide for payment of the proceeds into two funds to be held by the insurer. In such case, if all five of the above conditions are satisfied with ...

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