ESTATE OF BURGESS v. C. I. R., 622 F.2d 700 (4th Cir. 1980)

ESTATE OF GRAFTON G. BURGESS, DECEASED, AND KENNETH D. THOMAS, EXECUTOR, APPELLANTS, v. COMMISSIONER OF INTERNAL REVENUE, APPELLEE.

No. 79-1368.United States Court of Appeals, Fourth Circuit.Argued February 4, 1980.
Decided May 14, 1980.

Page 701

Kenneth D. Thomas, Hickory, N.C., for appellants.

Anthony Ilardi, Jr., Tax Division, Dept. of Justice, Washington, D.C. (M. Carr Ferguson, Asst. Atty. Gen., Gilbert E. Andrews and Richard W. Perkins, Tax Division, Dept. of Justice, Washington, D.C., on brief), for appellee.

Appeal from the United States Tax Court.

Before BRYAN, Senior Circuit Judge, and RUSSELL and PHILLIPS, Circuit Judges.

ALBERT V. BRYAN, Senior Circuit Judge.

[1] This is an appeal by Kenneth D. Thomas, executor of the estate of Grafton G. Burgess of North Carolina, from a decision of March 12, 1979, by the United States Tax Court, upholding a deficiency of $43,775.85 determined by the Commissioner of Internal Revenue in assessment of the Federal estate tax upon the Burgess estate. The determination was the result of the disallowance of a charitable deduction claimed by the executor under section 2055
of the Internal Revenue Code of 1954, as amended in 1969 and as in effect at the time of decedent’s death.[1]

Page 702

[2] The bulk of the estate consisted of 11 tracts of real property which had been conveyed to Grafton by his mother. Although she conveyed a full interest in fee simple in eight of the tracts, she retained a life estate in the other three — 18 acres surrounding her home and two one-acre tracts of business property. On June 23, 1973, Grafton died, and by his will made a few specific bequests and devises. Among them he devised two small parcels to his brother, Ralph, for life. The rest of his property, passed into a residuary trust created for the benefit of his mother for her lifetime. The trustees were instructed to be generous and were given the power to invade the corpus for her support. At the mother’s death, the trust would terminate and the remainder interest in the entire property, after paying five specific bequests, would pass in fee simple to two Lutheran churches in North Carolina.

[3] Soon after Grafton’s death, Ralph initiated suit against the executor of Grafton’s estate in the Superior Court of Alexander County, North Carolina, the court probating the will, to set aside his mother’s conveyances to Grafton. He charged that Grafton had obtained the real estate from their mother through the imposition of undue influence. Before this litigation came on for trial, all parties in interest, including the mother, by her guardian ad litem, and the churches, reached an agreement in compromise of the claims in suit. The agreement was effectuated by the court’s final decree on July 31, 1974.

[4] Specifically, the decree provided: that the mother’s life interest in the trust be dissolved; that she continue to hold a life interest in her business properties and residence, but with a diminished amount of acreage surrounding her house; that a tract of 42.5 acres be allotted to Ralph in fee, with the understanding that he would support his mother for the rest of her life; and that the estate continue to be liable on a $30,000 note secured by real estate involved in the litigation. The effect was that the fee title to all of the remaining property was at once invested in the two churches. However, the will was never revoked or set aside in any respect whatsoever.

Page 703

[5] In the tax return for Grafton’s estate, the executor claimed a charitable deduction under I.R.C. § 2055 in the amount of $158,237.15, the value of the property received by the churches. On the Commissioner’s adverse ruling, the executor petitioned the Tax Court for a redetermination. After reviewing the facts (as to which the parties were in complete accord), the Court sustained the determination of the Commissioner. The executor appeals.

[6] The ground of the Tax Court’s decision was that the churches’ fee simple interest in the residue of the estate was obtained by purchase, not inheritance. Under the will, to repeat, the residue passed first in trust to Grafton’s mother for life, and upon her death to the churches in fee. Had this testamentary scheme eventuated, the churches would have received their interest as an inheritance. The estate, however, would not have been able to take a charitable deduction under I.R.C. § 2055(a) because the will created non-deductible “split interests” by investing a life estate in decedent’s mother and the remainder in the churches. I.R.C. § 2055(e)(2). Instead of adhering to the testamentary plan, however, the beneficiaries redistributed the property of the deceased when they settled the suit aimed at striking down the questioned conveyances. As a result, the churches received the immediate enjoyment of the fee simple interest in the residue of Grafton’s estate but, of course, not through inheritance. In addition, as more particularly explained in a moment, the deductions which the executor claimed under the exceptions to the “split interest” rule, stated in subsection (e)(2) (for property in which Grafton had only a remainder interest), were not allowed because these exceptions do not apply to property passing through a nonqualifying trust, such as that before us.

[7] Despite the fact that the redistribution of decedent’s property was directed by a State court order, presumably under State law, we think we must apply Federal law in determining Federal tax questions. Lyeth v. Hoey, 305 U.S. 188, 193-94, 59 S.Ct. 155, 158-59, 83 L.Ed. 119 (1938). In this application, we, like the Tax Court, cannot accept the argument of the executor tha Lyeth permits the churches to take their interest by inheritance. That decision permitted the benefits of a compromise settlement agreement to be treated as property acquired by inheritance, but the circumstances there were altogether diverse from those presently. To begin with, the case involved an heir in a will contest, and, thus, was framed from the beginning to end in a testamentary setting. Here, unlike in Lyeth, the agreement and the decree settled a suit challenging the validity of deeds
signed, sealed and delivered before death and without reference to a testamentary environment or context. The character of that law suit determines the tax treatment.

[8] Alternatively, as previously noted, the executor claims that the exceptions in § 2055(e)(2), permitting deductions for “split interests” where the property passing is “a remainder in a personal residence or farm or an undivided portion of the decedent’s entire interest in property . . .,” would, nevertheless, allow the deductions claimed for property in which Grafton owned only the remainder interest (the three tracts in which his mother retained a life estate). This property included the residence he shared with his mother, land said to be farm land adjacent thereto, and additional business property. He left his entire remainder interest in these properties in undivided portions to his mother in the residuary trust. That which the churches could have obtained under the will thus had to pass first through the trust. Since the devises were, therefore, neither outright nor via a qualifying trust, we accept the Tax Court’s construction placed on the statute, as clarified by the regulations, and conclude that the deductions claimed under the exceptions created by subsection (e)(2) were properly disallowed. 26 C.F.R. § 20.2055(e)(2)(i)-(iii).[2]

Page 704

[9] While those persons mentioned in the will had the power to divide the property by agreement inter se, they could not maneuver their interests so as to rewrite the will and, thereby, achieve a tax savings. The State court order did not free the estate, as shaped in the will, from the Federal tax laws. Hence, the dispositions under the will stand subject to the Internal Revenue Act; the estate has not been discharged of the inheritance taxes assessed by the United States.

[10] With the Tax Court’s penetrating analysis of the facts and complete exposition of its conclusions, a further statement of them would be but an unproductive reiteration. Accordingly, the judgment on appeal is affirmed upon the opinion of the Tax Court.

[11] Affirmed.