TAM 9207004, 1992 WL 801030 (IRS TAM)

Internal Revenue Service (I.R.S.)

Technical Advice Memorandum

Issue: February 14, 1992

October 21, 1991

Section 2031 — Definition

2031.00-00 Definition

2031.01-00 Valuation of Property in General

Section 2033 — Property in Which Decedent Had an Interest

2033.00-00 Property in Which Decedent Had an Interest

2033.01-00 Interest v. No Interest at Time of Death

Section 2053 — Expenses, Indebtedness, and Taxes (Deductible v. Not Deductible)

2053.00-00 Expenses, Indebtedness, and Taxes (Deductible v. Not Deductible)

2053.09-00 Claims Against the Estate

Section 2054 — Losses (Deductible v. Not Deductible)

2054.00-00 Losses (Deductible v. Not Deductible)

TR-32-191-91

Taxpayer’s Name = * * *

Taxpayer’s Address = * * *

Taxpayer’s I.D. No. = * * *

Date of death = * * *

No conference held = * * *

LEGEND:

Decedent = * * *

City = * * *

Interstate Highway = * * *

the two accomplices = * * *

ISSUES

(1) Are the drugs that were in the decedent’s possession at the time of his death includible in his gross estate under section 2033 of the Internal Revenue Code?

(2) If the drugs are includible in the decedent’s gross estate, how is the fair market value determined for purposes of section 2031 of the Code?

(3) Does the forfeiture of the drugs and cash under the drug enforcement laws result in a deduction under section 2053 or section 2054 of the Code?

FACTS

The decedent was a resident of Tennessee. The federal and local law enforcement authorities had suspected him of smuggling drugs for several years prior to his death. Although the decedent was never arrested for drug activity, he was arrested and convicted on several occasions for activities involving airplanes and airplane equipment used in drug smuggling.

On January 4, 1987, the decedent contacted his two accomplices at their homes in Tennessee. They met him in Florida and, together, they drove out to an unopened area of Interstate Highway that was under construction and deserted at night. The decedent told them that it was a good place to land an airplane and offload drugs. The decedent then told the two accomplices to be at the Interstate Highway site the next night, January 5th, between 10:00 and 10:30 p.m. with a truck. Under the plan, as later revealed by the two accomplices, the two accomplices were to offload the marijuana that the decedent was bringing in by airplane; one of the accomplices was to drive the truck, loaded with the marijuana, to City; the other accomplice and the decedent were to fly in the decedent’s airplane to City; then both of the accomplices were to be paid by the decedent.

The next night, the two accomplices drove to the landing site as they had been directed to do by the decedent. However, because there was a severe storm, they arrived late. They were in the process of setting up landing lights when the decedent’s airplane, while landing, struck a tree and power lines behind the two accomplices and crashed. The decedent died in the crash.

When the police came to the crash scene, they found bales of marijuana weighing a total of 459.5 pounds. The police also found $2,841 in cash. Shortly after the crash, the police stopped and arrested the two accomplices as they were driving in the truck on Interstate Highway. In the back of the truck were bales of marijuana weighing a total of 204.9 pounds.

According to police reports, the two accomplices said that they had been hired by the decedent to offload the drugs from the plane and that they had obtained the marijuana from the crash site. Tire impressions made at the scene of the airplane crash confirmed that the accomplices’ truck had been there.

The money and all of the marijuana found at the crash site and in the truck, totalling 662.50 pounds, was ordered forfeited and confiscated under the drug enforcement laws of Florida. The grade of the marijuana was not ascertained. Both of the accomplices were convicted of conspiracy to traffick marijuana and of possession of marijuana.

Under the laws of Florida (and Tennessee), an individual’s possession of personal property is prima facie evidence of the individual’s ownership of the property. Inman v. Rowsey, 41 So.2d 655 (1949); 73 C.J.S. Property §36. See Turner v. State, 394 S.W.2d 635 (1965). This, however, is rebuttable upon proof of ownership in another person. Nash Miami Motors, Inc. v. Bandel, 37 So.2d 366 (1948).

LAW AND ANALYSIS

ISSUE 1: SECTION 2033

Section 2033 of the Code provides that the value of the gross estate shall include the value of all property to the extent of the interest therein of the decedent at the time of death.

Section 20.2033-1 of the Estate Tax Regulations provides that the gross estate includes under section 2033 the value of all property beneficially owned by the decedent at death.

The legislative history of the predecessor statute to section 2033 of the Code indicates that the statute was intended to include in a decedent’s gross estate the estate (or property) that the decedent owned at death. See H.R. Rep. No. 922, 64th Cong., 1st Sess. 55 (1916). Compare sections 202(a) and 205 of the Revenue Act of 1916.

In determining the nature of ownership that is required for inclusion of property in a decedent’s gross estate under section 2033, we note that the estate tax inclusionary statutes, including section 2033, include property in a decedent’s gross estate based upon the decedent’s possession of the economic benefits of the property. For this reason, if a decedent possessed the economic equivalence of outright ownership of property, it is not necessary to establish that the decedent possessed the legal title to the property. Thus, for example, the Supreme Court stated in Burnet v. Wells, 289 U.S. 670 (1933):

“Taxation is . . . concerned with . . . the actual command over the property taxed-the actual benefit for which the tax is paid . . . Liability may rest upon the enjoyment by the taxpayer of privileges and benefits so substantial and important as to make it reasonable and just to deal with him as if he were the owner and to tax him on that basis. [Emphasis supplied.]

289 U.S. at 678.

Likewise, in Helvering v. Safe Deposit & Trust Co. of Baltimore, 316 U.S. 56 (1942), the Court stated, in footnote 1, “[T]he realities of the taxpayer’s economic interest . . . should determine the power to tax.” See also, Lowndes, Kramer & McCord, Federal Estate and Gift Taxes sections 4.2, 4.7 (3d ed. 1974), which, in considering the ownership requirement of section 2033, indicates that, so long as a decedent possessed the economic equivalence of ownership (of property), in that the property within the decedent’s possession and control could be transmitted by him to his heirs, the property is includible in the decedent’s gross estate under section 2033 of the Code.

Therefore, for purposes of section 2033 of the Code, if (1) a decedent had the possession and control of property, and (2) at the time of death, the decedent could transfer the property (or the proceeds of the decedent’s sale of the property) to the objects of his bounty, the decedent is regarded as the owner of the property and it is includible in the decedent’s gross estate. See Surrey, McDaniel & Gutman, Federal Wealth Transfer Taxation 108, 109 (Successor ed. to 2d ed. 1987).

In this case, the decedent, rather than an unknown third party, employed the accomplices. The role of the accomplices, in awaiting the decedent’s arrival at the makeshift landing strip, was to unload the plane and assist the decedent in transporting the marijuana to City. The evidence indicates that the two accomplices were the decedent’s employees, having no apparent interest in the marijuana. See, for example, Erickson v. Commissioner, T.C. Memo. 1989-552, aff’d 937 F.2d 1548 (10th Cir. 1991).

In Erickson, a case involving the income tax, the Tax Court noted that the taxpayer’s ownership of an airplane and his possession of a planeload of drugs (seized from the airplane) were sufficient to put the taxpayer to the burden of proof as to the ownership of the drugs. Likewise, the circuit court, in affirming the Tax Court’s finding that the taxpayer was the owner of the planeload of drugs, stated, “Considering the Byzantine ways of drug trafficking, it is . . . easy to argue that . . . marijuana in one’s possession belongs to someone else.”

For income tax purposes, the courts have consistently held that gains acquired by a taxpayer from drug smuggling are includible in the taxpayer’s gross income. Wood v. United States, 863 F.2d 417 (5th Cir. 1989); Gambina v. Commissioner, 91 T.C. 826 (1988); Vasta v. Commissioner, T.C. Memo. 1989-531. The basis for inclusion of the illicitly obtained gain in gross income is enunciated in James v. United States, 366 U.S. 213 (1961). In James, the Court considered whether cash that the taxpayer had obtained through embezzlement could be taxed as income. The Court stated:

[T]he obvious intent of . . . Congress [was] to tax income derived from both legal and illegal sources, to remove the incongruity of having the gains of the honest laborer taxed and the gains of the dishonest immune . . . [Property received] “constitutes taxable income when its recipient has such control over it that, as a practical matter, he derives readily realizable economic value from it . . .”

366 U.S. at 218 and 219. The Court thus concluded that the taxpayer’s violation of the criminal laws to obtain the gains did not affect the character of the gains as taxable income.

In this case, the decedent’s ownership of the airplane and his possession of a planeload of drugs that he was flying into Florida sufficiently establish i) the decedent’s exclusive possession and control over the drugs, and ii) that it was the decedent who was to receive the economic benefits of the drugs. See Erickson v. Commissioner, above cited. (We note that, under Florida law, the decedent’s possession of the drugs is prima facie evidence of his ownership.)

Thus, 1) at the time of the decedent’s death, he had the exclusive possession and control over the drugs, and 2) his possession and control over the drugs were to continue until the drugs were sold for cash which the decedent was to retain for himself (or transfer to his heirs). Consequently, the decedent’s possession, control, and power of disposition over the marijuana were tantamount to his ownership of it for purposes of section 2033 of the Code.

CONCLUSION ISSUE 1:

The drugs that were in the decedent’s possession are regarded as owned by him at the time of his death. Therefore, the drugs are includible in his gross estate under section 2033 of the Code.

ISSUE 2: SECTION 2031—VALUATION:

Section 2031(a) of the Code provides that the value of the gross estate shall be determined by including the value at the time of death of all property wherever situated.

Section 20.2031-1(b) of the regulations provides that the value of every item of property includible in a decedent’s gross estate is its fair market value at the time of the decedent’s death. The fair market value is the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or to sell and both having reasonable knowledge of the relevant facts.

For federal tax purposes, in determining the value of illicit drugs held by a taxpayer and subsequently destroyed pursuant to drug enforcement laws, so that the grade or quality of the drugs cannot be determined, the Service is given latitude in establishing 1) the grade of the drugs, and 2) the selling price of the drugs. See, for example, Jones v. Commissioner, T.C. Memo. 1991-28, and Graff v. Commissioner, T.C. Memo. 1986-550, in which the court stated that, in determining the value of narcotics sold by the taxpayer, in order to reconstruct the income that the taxpayer failed to report, the Commissioner is under no obligation to assume the lowest price supported by the evidence. See also Erickson v. Commissioner, above cited, in which the circuit court stated:

The problem facing the Commissioner where criminal activity of the type involved in drug trafficking is concerned, is that the activity is characterized by cash transactions and a lack of records, or concealed or deceptive records.

937 F.2d at 1554.

Thus, in applying section 2031 of the Code, to determine the fair market value of drugs that have been confiscated, the Service is entitled to use any reasonable means to establish the grade of the drugs held by the decedent at his death and the market in which the drugs would have been sold. See Petzoldt v. Commissioner, 92 T.C. 661 (1989) (an income tax case in which the taxpayer’s unreported income was reconstructed).

In Kent v. Commissioner, T.C. Memo. 1986-324, the taxpayer was arrested while smuggling marijuana into the United States. The marijuana was immediately seized and confiscated. In reconstructing the taxpayer’s unreported income from drug smuggling, since information concerning the quality of the marijuana was not available the Service predicated its case upon the value of “average-quality” marijuana.

In Caffery v. Commissioner, T.C. Memo. 1990-498, the taxpayer was engaged in the importation and distribution of marijuana. In reconstructing the taxpayer’s income earned from his drug activities, the Service computed the unreported income based on the “street value” of the marijuana. See also, Jones v. Commissioner, above cited.

In Jones, because it was known that the taxpayer sold 42 kilos of cocaine to drug dealers, the Service reconstructed the taxpayer’s income based on the “street market” and the “retail street value” of “uncut” cocaine (in the city in which the taxpayer had conducted the illegal business). See also, Costa v. Commissioner, T.C. Memo. 1990-572, in which, in reconstructing the taxpayer’s unreported income, the value of drugs, smuggled into the United States by the taxpayer’s father and found in the taxpayer’s possession, was determined based on the “estimated street value.”

In this case, because the decedent obtained the marijuana through a smuggling operation in which he expected to sell the drugs, it is reasonable to assume that the marijuana that was held by the decedent, at death, and confiscated by drug enforcement authorities was, at a minimum, of an average grade. See Kent v. Commissioner, above cited. Further, because the willing buyers of the marijuana could have included street dealers (as well as distributors to street dealers), it is reasonable to determine the fair market value of the marijuana based on the retail street value in the City area. See Caffery v. Commissioner, above cited; Jones v. Commissioner, above cited; Costa v. Commissioner, above cited. Consequently, for purposes of section 2031 of the Code, the value of the 662.5 pounds of marijuana is determined based on retail street value of average grade marijuana (in the City area at the time of the decedent’s death).

CONCLUSION ISSUE 2:

For purposes of section 2031 of the Code, the fair market value of the marijuana is determined based upon the retail street value of average grade marijuana.

ISSUE 3: SECTION 2053(a) and SECTION 2054—DEDUCTION:

Section 2053(a) of the Code provides, in part, that, for purposes of the estate tax, the value of the taxable estate shall be determined by deducting from the value of the gross estate such amounts for administration expenses and claims against the estate as are allowable by the laws of the jurisdiction under which the estate is being administered.

Section 2054 of the Code provides that the value of the taxable estate shall be determined by deducting from the value of the gross estate losses incurred during the settlement of estates arising from fires, storms, shipwrecks, or other casualties, or from theft, when such losses are not compensated by insurance or otherwise.

Fla. Stat. Ann. section 893.12(1) (West) provides that all controlled substances which may be possessed are declared to be contraband and shall be subject to seizure and confiscation. The court having jurisdiction shall order such controlled substances forfeited and destroyed.

21 U.S.C. section 881(f) provides that all controlled substances that are possessed in violation of the provisions of the subchapter shall be deemed contraband and seized and summarily forfeited to the United States.

21 U.S.C. section 881 was enacted to sanction forfeiture as a law enforcement tool in combatting drug trafficking, one of the most serious crime problems facing the United States today. The legislative history of the amended 21 U.S.C. section 881 states, in H.R. No. 98-1030, 98th Cong. 2d Sess. 191 (1984):

Profit is the motivation for this criminal activity, and it is through economic power that it is sustained and grows . . . the traditional sanctions of fine and imprisonment are inadequate to deter or punish the enormously profitable trade in drugs which, with its inevitable attendant violence, is plaguing the country. Clearly, if law enforcement efforts to combat . . . drug trafficking are to be successful, they must include an attack on the economic aspects of these crimes. Forfeiture is the mechanism through which such an attack may be made.

Is a federal estate tax deduction allowable for a seizure and forfeiture made pursuant to drug enforcement laws?

The courts, holding that the allowance of an income tax deduction for the confiscation of drugs and the proceeds of drug dealing would frustrate a sharply defined public policy against drug trafficking, have consistently denied any income tax deduction for the loss. Smith v. Commissioner, No. 90- 1143 (6th Cir. 1991). Wood v. United States 863 F.2d 417 (5th Cir. 1989); Gambina v. Commissioner, 91 T.C. 826 (1988); Holt v. Commissioner, 69 T.C. 75 (1977); Bailey v. Commissioner, T.C. Memo. 1989-674, aff’d 929 F.2d 700 (6th Cir. 1991).

In Bailey v. Commissioner, the court, in denying an income tax deduction for a forfeiture of assets derived from drug dealing, stated:

The law is clear . . . that no loss, otherwise properly allowable . . . is to be allowed where to do so would violate a clearly defined public policy . . . [T]here is a clearly defined public policy in the United States against trafficking in narcotics.

In Wood v. United States, the court held that the drug smuggling proceeds that the taxpayer had forfeited (under drug enforcement laws) constituted taxable income. The court denied an income tax deduction for the forfeiture and stated:

It is obvious . . . that the public policy embodied in this nation’s drug laws is not enhanced by allowing a tax deduction to offset a forfeiture . . . Forfeiture cannot seriously be considered anything other than an economic penalty for drug trafficking . . . The legislative history of 21 U.S.C. section 881 reveals that the forfeiture provision was designed to reach druc traffickers “where it hurst the most,” . . . and to augment “the traditional criminal sanctions of fines and imprisonment.” [Emphasis supplied.]

863 F.2d at 421.

The court, in Wood v. United States, further stated that, “Allowing a loss deduction would certainly “take the sting” out of a penalty intended to deter drug dealing.” 863 F.2d at 422.

In Smith v. Commissioner, the Fourth Circuit adopted the rationale of Wood v. United States stating, “The Fifth Circuit has held . . . that allowing a deduction for forfeited assets would violate the ‘sharply defined national policy against’ drug trafficking . . . We agree with the reasoning of the Fifth Circuit in this regard.” See also, Bailey v. Commissioner, in which the Sixth Circuit denied the taxpayer’s appeal “based on the rationale expressed in Wood v. United States.Ƣ

Because state drug enforcement laws of forfeiture and 21 U.S.C. section 881 are based on the same principles, any forfeiture made pursuant to a state drug enforcement law is regarded as made in furtherance of the same public policy that underlies 21 U.S.C. section 881. Therefore, in considering whether a tax deduction is allowable for a forfeiture under drug enforcement laws, and in denying a tax deduction for public policy reasons, it does not matter whether the forfeiture was made pursuant to a state law or federal laws.

As with the income tax, the sharply defined public policy against drug trafficking (as particularly expressed in the legislative history of 21 U.S.C. section 881 and by Congress’ enactment of forfeiture statutes to attack the economic power of drug trafficking) likewise overrides any deduction that might otherwise be allowable under the federal estate tax statutes for a forfeiture (of a decedent’s property) made pursuant to drug enforcement laws.

In this case, the decedent held cash and drugs at his death that were included in his gross estate. The cash and drugs were forfeited under the drug enforcement laws of Florida. Because the allowance of any estate tax deduction for the forfeiture would violate the sharply defined public policy against drug trafficking, no deduction is allowable under section 2053 or section 2054 of the Code for the value of any of the property that was forfeited. Wood v. United States, above cited; Smith v. Commissioner, above cited; Bailey v. Commissioner, above cited. See Rev. Rul. 81-154, 1981-1 C.B. 470; Estate of Bahr v. Commissioner, 68 T.C. 74 (1977).

CONCLUSION ISSUE 3:

No deduction is allowable under section 2053 or section 2054 of the Code for the confiscated property.

A copy of this Technical

Advice Memorandum should be given to the Taxpayer. Section 6110(j) of the Code provides that it may not be used or cited as precedent.

This document may not be used or cited as precedent. Section 6110(j)(3) of the Internal Revenue Code.