62 A.F.T.R.2d 88-5992, 88-1 USTC P 13,766, 1988 WL 123836 (C.D.Ill.)

United States District Court, C.D. Illinois.

Mary I. CLEAVELAND, Plaintiff v. UNITED STATES of America, Defendant.

No. 87-2436.

May 6, 1988.

JUDGE:  BAKER, Chief Judge.

[*1]  On June 10, 1987, the plaintiff filed a complaint for a refund of taxes paid to the United States of America. This case is before the court on cross-motions for summary judgment. For the reasons stated below, the plaintiff’s motion for summary judgment is granted, and the defendant’s motion for summary judgment is denied.

Summary judgment “shall be rendered forthwith if the pleadings, depositions, answers to interrogatories, and the admissions on file, together with the affidavits, if any, show there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law.” Fed.R.Civ.P. 56(c). “At the summary judgment stage, the Judge’s function is not himself to weigh the evidence and determine the truth of the matter but to determine whether there is a genuine issue for trial.” Anderson v. Liberty Lobby, Inc., 477 U.S. 242 (1986). There is no genuine issue of fact to be determined at trial unless there is sufficient evidence favoring the non-moving party for a fact finder to return a verdict for that party. Anderson, 477 U.S. at 249.

FACTS

The facts in the case, which are not in dispute, are as follows: Harry H. Cleaveland (Harry) executed his will in 1976. Harry died on May 16, 1982, a resident of Rock Island, Illinois. Harry’s widow, Mary Cleaveland (Mary), the plaintiff, was appointed executor of the estate and timely filed an estate tax return on February 9, 1983.

Article IV of Harry’s will directed that the First National Bank of Moline, as trustee, hold the residue of his estate in trust. [FN1] The trust instrument directed the trustee to use the income and, if necessary, the principal, for the support and maintenance of his wife, except that the trustee could use such portion of the income and principal necessary to furnish Harry’s children with a “college or university education.” In 1982, the trustee executed a disclaimer of its power to utilize the income or principal of the trust for the college education of the children. Copies of the disclaimer were served upon Mary and Harry’s four children. None of the children objected to the disclaimer.

At the time of Harry’s death, Harry’s three oldest children had received their Bachelor of Arts degree from Knox College. The youngest child received his degree from Knox College just twenty days after Harry’s death. His college expenses had been paid in full at the time of Harry’s death.

Mary Cleaveland filed an estate tax return on behalf of Harry’s estate on February 9, 1983. The Internal Revenue Service audited the estate tax return and issued a statutory notice of deficiency. The Internal Revenue Service took the position that the trustee’s disclaimer was not effective, and, therefore, that the trust did not qualify for the marital deduction under § 2056 of the Internal Revenue Code of 1986. Mary then filed this case alleging that the trust does qualify for the marital deduction and requesting a refund of taxes paid.

DISCUSSION

[*2]  A trust qualifies for the marital deduction if all of the income is payable to the surviving spouse at least annually and no person has the power to appoint any part of the property to any person other than the surviving spouse. 26 U.S.C. § 2056(b)(7)(B)(iii)(I) and (II) (1988). Initially, the trust did not qualify for the marital deduction because the trustee had the power to divert income and principal to the children. The central issue of the controversy, therefore, is whether the disclaimer executed by the trustee qualifies the trust for the marital deduction.

The plaintiff contends that the disclaimer was effective under Illinois law and that Illinois law satisfies the requirements of 26 U.S.C. § 2518 (1979), the federal statute authorizing the disclaimer of an interest in property. The government, on the other hand, contends that state law is not relevant to this controversy [FN2] and argues that the trustee’s disclaimer was ineffective under federal law and, even if effective, was not sufficient to qualify the trust for the marital deduction.

A) THE FEDERAL STATUTORY SCHEME

As noted above, 26 U.S.C. § 2056 governs whether trust property qualifies for the marital deduction. Section 2056(b)(7)(B)(ii) (1988) provides that trust property qualifies for the marital deduction if:

(I) The surviving spouse is entitled to income from the property, payable annually or at more frequent intervals, or has a usufruct interest for life in the property, and

(II) No person has the power to appoint any part of the property to any person other than the surviving spouse.”

26 U.S.C. § 2518 (1979) authorizes the disclaimer of an interest in property. Section 2518(b) provides that:

(b) QUALIFIED DISCLAIMER DEFINED—For purposes of Section (a), the term “qualified disclaimer” means an irrevocable and unqualified refusal by a person to accept an interest in property but only if—

(1) such refusal is in writing;

(2) such writing is received by the transferor of the interest, his legal representative, or the holder of the legal title to the property to which the interest relates not later than the date which is nine months after the latter of—

(a) the date on which the transfer creating the interest in such person is made, or

(b) the date on which such person attains twenty-one;

(3) such person has not accepted the interest or any of its benefits; and

(4) as a result of such refusal, the interest passes without any direction on the part of the person making the disclaimer and passes either—

(a) to the spouse of the decedent, or

(b) to a person other than the person making the disclaimer.

Therefore, a trust that is initially not eligible for the marital deduction may become eligible for the marital deduction if all parties with an interest in the trust other than the spouse effectively disclaim their interests. [FN3]

B) THE TWO POINTS OF DISPUTE

In effect, the parties agree on all points but two. The first point of disagreement is whether the disclaimer by the trustee satisfies the requirements of § 2518. The second issue is, assuming the trustee’s disclaimer was valid, whether the trust meets the requirements of § 2056.

(1) Did the trustee’s disclaimer satisfy the requirements of § 2518?

[*3]  The government does not contend that the trustee’s disclaimer failed to meet the first three parts of a § 2518 disclaimer, but argues that the trustee’s disclaimer does not satisfy the fourth part, which requires that the interest disclaimed pass either to the surviving spouse or to a person other than the person making the disclaimer. The government says that the power the trustee attempted to disclaim did not pass to anybody and, therefore, that it does not satisfy part four of § 2518. The plaintiff, relying on Treasury Regulation § 25.2518-(2)(e)(1), says that, although the power did not pass to a separate entity or person, the disclaimer is still valid under § 2518. Regulation § 25.2518-(2)(e)(1) (1987) states:

If a power of appointment is disclaimed, the requirements of this paragraph (e)(1) are satisfied so long as there is no direction on the part of the disclaimant with respect to the transfer of the interest subject to the power or with respect to the transfer of the power to another person.

This regulation, Mary says, allows a party to satisfy the requirements of § 2518 as long as the disclaimant does not give any direction as to what should happen to the power after it is disclaimed. The court finds this argument persuasive and holds that the disclaimer by the trustee satisfies the requirements of §  2518.

(2) Does the trust now qualify for the § 2056 marital deduction?

The Internal Revenue Service argues that, regardless of the validity of the trustee’s disclaimer, the trust still fails to qualify for the §  2056 marital deduction. For a trust to qualify for the marital deduction, the surviving spouse must be entitled to all of the income from the property and no person must have the power to appoint any part of the property to any person other than the surviving spouse. 26 U.S.C. § 2056(b)(7) (1988). The government says that even if the trustee did disclaim his power, the children of the decedent still have an interest in the trust, which allowed the trustee to give the children money from the trust for their “college or university” education, because the children may go on to obtain further education.

The court does not accept the government’s contentions. Once the trustee disclaimed his discretionary power to appoint trust property to the children, the children, in effect, no longer had an interest in the trust. Estate of Ware v. C.I.R., 480 F.2d 444 (7th Cir.1973). Furthermore, all of the children received notice of the trustee’s disclaimer and did not object. [FN4] Therefore, the children of the decedent are estopped from claiming any interest in the trust because they failed to object to the trustee’s disclaimer. Jurek v. Smuczynski, 61 Ill.App.2d 426 (1st Dist.1965). [FN5] The court, therefore, rules that the trust qualifies for the § 2056 marital deduction.

CONCLUSION

In conclusion, the court holds that the trustee’s disclaimer satisfies the requirements for an effective disclaimer set out in 26 U.S.C. § 2518. Furthermore, after the trustee’s disclaimer, the trust qualifies for the 26 U.S.C. § 2056 marital deduction.

[*4]  IT IS THEREFORE ORDERED that the plaintiff’s motion for summary judgment is allowed.

IT IS FURTHER ORDERED that the defendant’s cross-motion for summary judgment is denied.

The Clerk shall enter judgment for the plaintiff and against the defendant for the refund claimed plus statutory interest.

FN1. Harry’s will also appointed Mary Cleaveland as trustee. Mary, however, declined to act as Trustee.

FN2. At oral argument on the motions for summary judgment, the government asked leave untimely to file a brief discussing Illinois law. Upon objection by the plaintiff to the late filing, the court denied leave.

FN3. The Internal Revenue Service contends that allowing a disclaimer to qualify a trust for the marital deduction would be contrary to the policy of not allowing estates to be reformed at the administration stage. However, Treasury Regulation § 20.2056(d)-1(b) provides that

“… if an interest in property passes to one other than the surviving spouse from a decedent in a taxable transfer made after December 31, 1976, and

“(1) the person other than the surviving spouse makes a qualified disclaimer with respect to such property, and

“(2) the surviving spouse is entitled to such interest in property as a result of such disclaimer, the disclaimed interest is treated as passing directly from the decedent to the surviving spouse. If the disclaimer is not a qualified disclaimer, the interest in property [is] considered as passing from the decedent to the person who made the disclaimer as if the disclaimer had not been made. See § 2518 and the corresponding regulations for rules relating to a qualified disclaimer.”

Therefore, it appears that the government contemplated disclaimers of interests qualifying trust property for the marital deduction.

FN4. Mary points out that the children would have executed a disclaimer as well except at the time of the trustee’s disclaimer there was a proposed Internal Revenue Service regulation that would have required the children to give up their remainder interest in the trust property in order to execute an effective disclaimer, something the children were not willing to do.

FN5. The court does not decide whether Illinois courts could appoint a successor trustee. Since the children have no interest in the trust, the only person a successor trustee could appoint property to would be the surviving spouse.