Under IRC section 2056(a), an estate may claim a marital deduction for property passing to the surviving spouse. As a general rule, the law denies a deduction for “terminal interests” (those that will terminate or fail “on the lapse of time, on the occurrence of an event or contingency or on the failure of an event or contingency to occur”). This includes life estates. The Economic Recovery Act of 1981 modified the marital deduction rules by adding section 2056(b)(7), which allows a deduction for qualified terminable interest property (QTIP). In a QTIP a decedent passes to the surviving spouse a “qualifying income interest for life.” Generally, when the surviving spouse has such an interest, he or she is entitled to all income from the property, payable annually or at more frequent intervals.
The nature of the interest that passes to the surviving spouse depends on the laws of the state under which the interest passes. However, the IRS is not bound to consider a state court order that modifies a trust interest. In interpreting a will, the decedent’s intention is the prime consideration based on a sympathetic reading of the entire document in view of all applicable facts and circumstances. Extrinsic evidence should not be considered in the absence of ambiguity in the will.
At the time of his death on December 20, 1996, Charles N. Aronson resided in Cattaraugus County, New York. He was survived by his wife, Josephine R. Aronson (Jo), and his grandson, Barney P. Aronson (Bar), among others. Bar was the estate’s executor. Charles and his wife lived on property referred to as Hundred Acres in a home called the Big House. Bar and his wife also lived on Hundred Acres in the Little House, taking care of Charles, Jo and the land.
The decedent’s will was probated on January 9, 1997. Drafted by him and executed in 1993, it was the culmination of wills and codicils written and revoked dating to 1980. Under the 1993 will, Jo was to receive all real property including Hundred Acres and the Big House. Bar would inherit the remainder of the estate, with Jo to receive “as much income from such assets as she needs, for as long as she lives.” Charles was concerned about the maintenance of Hundred Acres after his death. His will stipulated “no changes or alteration in the structure or the general makeup of the Big House shall ever be made.”
The decedent structured his bequest to assure preservation of Hundred Acres over the long term. As written, the will did not seek to minimize federal estate taxes. A review of extrinsic evidence, correspondence between the decedent and his attorney and the succession of earlier wills indicated Charles was knowledgeable about estate tax laws, had created and revoked QTIPs under earlier wills, had not wished to relinquish control of assets to minimize estate taxes and was aware of the value of his estate after taxes as structured in the 1993 will.
On February 5, 1998, Bar filed a petition in the surrogate’s court to reform and construe the 1993 will as requiring all trust income to be paid to Jo and to split the trust holding the rest of the decedent’s estate into three parts—a credit shelter trust, a reverse QTIP trust and a residuary trust. The 1998 petition said the sole purpose of the changes was to “insure that decedent’s estate receives a full marital deduction, fully utilizes the decedent’s credit shelter amount and reduces substantially the GST [generation-skipping transfer] tax that will be payable by reason of distributions from the trust.” The petition said Charles always had intended to minimize estate and GST taxes. On March 5, 1998, Bar filed an amended petition to add Scott Haley Aronson, the decedent’s great-grandson, as a beneficiary if Bar predeceased Jo. The beneficiaries of the 1993 will did not contest the relief the amended 1998 petition requested.
On March 16, 1998, the surrogate’s court entered a decree granting the relief. It construed the 1993 will as requiring all trust income be paid to Jo at least semiannually.
On May 14, 1998, Bar, as executor, timely filed a federal estate tax return on the estate’s behalf. The return reported the estate as construed under the surrogate court decree. It listed Bar as the sole person, other than the surviving spouse, benefiting from the estate. The tax return also reported $1,065,420 as qualified joint interest property. The estate did not elect out of QTIP treatment on the return.
Although the surrogate court granted relief, the IRS questioned whether the trust interest the decedent’s will created was eligible for the estate tax marital deduction as qualified terminable interest property within the meaning of section 2056(b)(7).
In Estate of Charles N. Aronson v. Commissioner, TC Memo 2003-189, the court ruled the trust interest the 1993 will created did not qualify for the marital deduction under section 2056(b)(7). While local law prevails in determining the nature of the interest passing to the surviving spouse, the federal government is not bound to give effect to a local court order that modifies a document after the IRS has acquired rights to tax revenues under that document’s terms.
Under the 1993 will Jo was not “entitled to all the income from the property, payable annually or at more frequent intervals” as section 2056
(b)(7) requires. The unambiguous language of the 1993 will allowed her only “as much income from such assets as she needs, for as long as she lives.” The document did not mention the marital deduction, nor was there any evidence the decedent intended the trust property to qualify for it. The will revealed the decedent’s intention that Jo have neither the obligation, nor the right, to demand all of the income or any particular amount of income from the trust.
The estate contended the language of the 1993 will was ambiguous. The Tax Court held that the extrinsic evidence did not support that contention.
The estate argued that after giving proper regard to the surrogate court decree, the trust qualified as a QTIP. The Tax Court disagreed, arguing the surrogate’s court decree was not a mere clarification but a substantial change in the 1993 will. Additionally, the Tax Court argued the decree was not a bona fide evaluation of Jo’s rights because there was not a “genuine and active contest.” The Tax Court held that the estate filed the petition specifically to affect federal income taxes by engaging in creative postdeath estate tax planning.
Observation. Taxpayers have the right to minimize their estate taxes by taking advantage of provisions the law allows, such as a QTIP. However, if a decedent deliberately relinquishes this right, his or her heirs may not “rewrite” the will. Since the federal government is not bound to recognize a local court order changing a will’s terms, CPAs should remind clients that effective estate tax planning takes place before death and should include a will that clearly conveys the taxpayer’s wishes to minimize tax or otherwise.
Prepared by Claire Y. Nash, CPA, PhD, associate professor of accounting, Christian Brothers University, Memphis, and Tina Quinn, CPA, PhD, associate professor of accountancy, Arkansas State University, Jonesboro.