Magazine article The CPA Journal

Court of Appeals Reverses Tax Court on Marital Deduction for Contingent QTIP

Magazine article The CPA Journal

Court of Appeals Reverses Tax Court on Marital Deduction for Contingent QTIP

Article excerpt

In Estate of Spencer v. Commissioner, 43 F.3d 226 (6th Cir. 1995) (Spencer II), the U.S. Court of Appeals, Sixth Circuit, reversed the Tax Court, T.C. Memo 1992-579 (1992) (Spencer I) and held the estate was entitled to a marital deduction for the surviving spouse's interest in the marital trust because the executor's qualified terminable interest property (QTIP) election satisfied the requirements of IRC Sec. 2056(b)(7). Spencer I had held that the possibility property that could fund a nonmarital trust (because of the executor's discretion to forgo a QTIP election) was tantamount to a power to appoint that property. As a result, the requirements for a qualified income interest for life (QIIL) and, therefore, QTIP treatment and the marital deduction were not met.

Spencer 11 is the third consecutive Court of Appeals decision to reverse the Tax Court and the position of the IRS Commissioner on this important estate planning issue-contingent QTIP elections. In Estate of Robertson v. Commissioner, 15 F.3d 779 (8th Cir. 1994) (Robertson II) rvsg, 98 T.C. 678 (1992) and Estate of Clayton v. Commissioner, 976 F.2d 1486 (5th Cir. 1992) (Clayton II) rvsg, 97 T.C. 327 (1991), the Eighth and Fifth Circuits, respectively, reversed Tax Court decisions on facts that were indistiguishable from Spencer II.

Spencer 11 is, perhaps, even more significant than Clayton II and Robertson II because it is the first judicial decision rendered after the commissioner finalize regulations on the marital deduction that specifically rejected the analysis of Clayton II and Robertson II. The commissioner may now reconsider the treatment of contingent QTIP elections.

Factual Background

On March 6, 1982, John D. Spencer died, leaving a gross estate valued in excess of $1,875,000. Ernestine Spencer, his wife, was the executrix for the estate. Most of the estate was divided and funded two separate trusts, Trust A and Trust B. Trust A, provided that Mrs. Spencer would receive all trust income for life, payable at quarterly or more frequent intervals. Trust B, was to be administered for the benefit of Mr. Spencer's wife, children, and grandchildren of any of his deceased children.

Before Trust A could be funded and the income interest vested unconditionally in Mrs. Spencer, however, the executor had to affirmatively elect to treat the interests funding that trust as qualified terminable interest property. The executor was not legally bound to make the QTIP election. In the event the executor declined to make the QTIP election, those interests would, instead, fund Trust B.

The estate claimed a marital deduction in the amount of $1.175 million. This amount represented the value of the property transferred to Trust A. The balance of the estate was transferred to Trust B. In November 1990, the IRS issued a notice of deficiency which disallowed the marital deduction to the extent the deduction was attributable to property transferred to Trust A 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 fall 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). These otherwise nondeductible "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. …

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