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Estate of Ludwig Neugass v. Commissioner of Internal Revenue

May 9, 1977


Appeal by the Executors of a will from a decision of the United States Tax Court which held decedent's bequest to his surviving spouse was, for the purpose of the federal estate taxes, a non-deductible terminable interest under § 2056(b)(1) of the Internal Revenue Code of 1954. Reversed.

Anderson, Oakes and Gurfein, Circuit Judges.

Author: Anderson

ANDERSON, Circuit Judge:

This is an appeal from a decision, filed October 29, 1975, by the Tax Court (65 T.C. 188 (1975)), affirming the disallowance of a marital deduction by the Commissioner of Internal Revenue and determining a deficiency in federal estate taxes due from the estate of Ludwig Neugass, deceased, in the amount of $109,079.42.

Mr. Neugass died February 24, 1969 leaving a will which was admitted to probate on April 23, 1969 in New York Surrogate's Court. On July 2, 1969, pursuant to Article FIFTH*fn1 of the will, his widow executed and filed in Surrogate's Court an instrument*fn2 pursuant to the terms of which she elected to take absolute ownership over certain specified items. Remaining items under Article FIFTH, over which Mrs. Neugass did not elect to exercise the option for absolute ownership, then devolved to Nancy Carouso, whose life estate in them commenced by virtue of Mrs. Neugass' partial renunciation. Mrs. Carouso thereafter executed an instrument, pursuant to Article FIFTH, whereby she elected to take absolute ownership of the remaining works of art.

Ludwig Neugass' executors claimed a marital deduction in the amount of $682,605.12 including $383,495.00 for the value of the works of art of which decedent's widow elected to take absolute ownership. From this amount the Commissioner disallowed $337,329.88 on the ground that Mrs. Neugass' interest in the art works was a "terminable interest" under 26 U.S.C. § 2056(b)(1)*fn3 and therefore not an allowable marital deduction.

The appellants petitioned for a redetermination of the deficiency, alleging that the value of the art collection qualified for the marital deduction, inasmuch as it passed to the surviving spouse in fee, pursuant to the "election" provision under Article FIFTH. The appellants argued here and in the Tax Court that such an election of a fee interest within a period of six months after the testator's death did not constitute an "event or contingency" under 26 U.S.C. § 2056(b)(1) sufficient to make the value of the bequest ineligible for the marital deduction. The Commissioner's position at the trial was that the correct reading of Article FIFTH was not that of an election between a life estate, fee, or any other interest in the collection, but a straightforward gift of a life estate in the works of art, vesting at the moment of the testator's death, together with a general power of appointment over the whole, exercisable within six months after that date. The election, therefore, was not available throughout Mrs. Neugass' lifetime and as a result the bequest was subject to contingencies or events pursuant to 26 U.S.C. § 2056(b)(1), and classified as a terminable interest not qualifying for the marital deduction.

At trial, the executors presented the testimony of Mr. Neugass' attorneys in order to explain the wording and structure of Article FIFTH and Mr. Neugass' expectations as to whether the will provided his spouse with the full benefits of the marital deduction. On the first issue, the uncontroverted testimony presented by the appellants showed that Article FIFTH was drafted with the intent of providing Mrs. Neugass with "as much flexibility with respect to this art collection as possible." The testator was concerned with his wife's frail health and the possibility that estate taxes on the art collection could deplete other assets in the estate. One of Mr. Neugass' attorneys testified that to achieve this flexibility, the will enabled the surviving spouse to keep the collection for herself or give it to her daughter; if neither one wanted it, it would go to a charitable foundation free of taxes. In short, Article FIFTH constituted an alternative and open-ended bequest to Mrs. Neugass, provided the choice was made within six months of the testator's death.

The attorney further explained that the reason why Mrs. Neugass was not granted an outright bequest of the collection with a right to renounce all or part of it (an arrangement which presumably would have not caused any federal estate tax problems had she merely kept the entire collection) was that there existed, at the time of drafting the will, legal uncertainty under New York law as to the validity of a partial testamentary renunciation from a greater to a lesser estate (i.e. ownership in fee to a life estate). This uncertainty was primarily attributable to Matter of Waring, 293 N.Y. 186, 189, 56 N.E.2d 543 (1944), where the New York Court of Appeals failed to pass on the issue. As a result, Article FIFTH was drafted to provide the converse of a testamentary renunciation from a fee to a life estate; a life estate which could be renounced or, more accurately, enlarged to a fee at Mrs. Neugass' election after her husband's death. The provision for a six months period within which Mrs. Neugass could make an election was used in the Article because it was the same time-period as that used in N.Y.E.P.T.L. § 4-1.3 (McKinney), which allowed total or partial renunciation of intestate shares within six months of the issuance of letters of administration, and in 26 U.S.C. § 2056(b)(3), which permitted the conditioning of an interest passing to a surviving spouse upon the six months survival of that spouse.*fn4 It was only in 1971, two years after Mr. Neugass' death, that New York approved N.Y.E.P.T.L. § 3-3.10 (McKinney), explicitly sanctioning partial or complete renunciations by testamentary beneficiaries within one year after the admission of a will to probate.

On the second issue concerning Mr. Neugass' tax intentions and expectations in executing the will as drafted, one of the attorneys testified that he had advised Mr. Neugass that the will had been drafted "with the intention of minimizing the taxes to give the widow the full marital deduction . . .," and that he had explicitly told Mr. Neugass that, in his opinion, the will carried out the testator's objectives and qualified for the marital deduction. There was also testimony that Mr. Neugass was "extremely tax conscious" and had had "a considerable amount of tax-oriented planning" done before the drafting of his 1967 will.

In spite of this uncontroverted testimony, the Tax Court agreed with the Commissioner that Article FIFTH created a grant of successive life estates to Mrs. Neugass and her daughter, effective upon Mr. Neugass' death, along with a general power of appointment in the surviving spouse exercisable within six months. 65 T.C. at 193. The court was persuaded that Article FIFTH, as so interpreted, constituted a terminable interest because 26 U.S.C. § 2056(b) (5) only exempts, from the terminable interest rule, a life estate with a general power of appointment in the surviving spouse where the power "is exercisable by such spouse alone and in all events." (Emphasis added.) It concluded that inasmuch as Mrs. Neugass' "'power' was required to be exercised within a period of 6 months after decedent's death . . .," it was not, therefore, exercisable "in all events." 65 T.C. at 194.

The Tax Court went on to distinguish, on its facts, Estate of Mackie, 64 T.C. 308 (1975), affirmed, 545 F.2d 833 (4th Cir. 1976), in which the surviving spouse was allowed by the will to select from the testator's estate properties up to the value of the full marital deduction with, however, the right to accept the devise or "appointment" in whole or in part. The surviving spouse's election was required to be effected by a statement in writing delivered to the executrix within four months of the testator's death. The Commissioner there also argued that the bequest was conditional and a terminable interest under 26 U.S.C. § 2056(b), based on the contingencies that Mrs. Mackie might not accept, in which case the properties would have gone into a residuary trust. 64 T.C. at 310. The Tax Court ruled that "the mere presence of a right of election against a will is not a disqualification so long as the interest which passes to the surviving spouse is nonterminable." 64 T.C. at 311 (citations omitted). Because the will essentially bequeathed nothing to Mrs. Mackie until she did elect, she was substantively in the same position as a disinherited surviving spouse, given a statutory right of election under state law, whose elective share would be subject to the marital deduction if it constituted a non-terminable interest, Dougherty v. United States, 292 F.2d 331, 337 (6th Cir. 1961); United States v. Crosby, 257 F.2d 515 (5th Cir. 1958). The difference between a statute created right of election and an election granted in a will was perceived by the court as "a difference without a distinction." 64 T.C. at 312. In the instant case, the Tax Court ruled that Mrs. Neugass was "not faced with a choice between alternatives, as was Mrs. Mackie." 65 T.C. at 195.

On this appeal, appellants seek a determination by this court that the interest acquired by Mrs. Neugass pursuant to Article FIFTH was an alternative or elective bequest and, as such was a non-terminable interest which qualified for the marital deduction. The Commissioner, however, argues that the Tax Court was correct in interpreting the will as a grant of an immediate life interest in the art collection to Mrs. Neugass, subject to a terminable and non-deductible general power of appointment in herself for a six month period. He further asserts that, even if this court were to disagree with the Tax Court's holding, Mackie is contrary to controlling legal principles and should not be followed.

As to the preliminary question of this court's scope of review, it is clear that we may re-examine the Tax Court's reading of Article FIFTH of the Neugass will, because it is essentially "a legal interpretation, not a finding of fact." Estate of Mittleman v. Commissioner, 173 U.S. App. D.C. 26, 522 F.2d 132, 141, n. 63 (1975); Commissioner v. Buck, 120 F.2d 775, 779 (2d Cir. 1941). The rule that findings of fact by the Tax Court should not be set aside unless clearly erroneous, Commissioner v. Duberstein, 363 U.S. 278, 290-91 n.13, 4 L. Ed. 2d 1218, 80 S. Ct. 1190 ...

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