Supreme Court of the United States
ESTATE OF HUBERT
Decided March 18, 1997
Justice O’Connor, Concurring
|Topic: Federal Taxation*||Court vote: 7–2|
Click any Justice for detailJoining O'Connor opinion: Justice SOUTER Justice THOMAS
|Citation: 520 U.S. 93||Docket: 95–1402||Audio: Listen to this case's oral arguments at Oyez|
* As categorized by the Washington University Law Supreme Court Database
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JUSTICE O'CONNOR, with whom JUSTICE SOUTER and JUSTICE THOMAS join, concurring in the judgment.
Logic and taxation are not always the best of friends.
Sonneborn Brothers v. Cureton, 262 U. S. 506, 522 (1923) (McReynolds, J., concurring). In cases like the one before us today, they can be complete strangers. That our tax laws can at times be in such disarray is a discomforting thought. I can understand why the plurality attempts to extrapolate a generalized estate tax valuation theory from one regulation and then to apply that theory to resolve this case, perhaps with the hope of making sense out of the applicable law. But where the applicability-not to mention the validity-of that theory is far from clear, the temptation to make order out of chaos at any cost should be resisted, especially when the question presented can be resolved-albeit imperfectlyby reference to more directly applicable sources. While JUSTICE SCALIA, JUSTICE BREYER, and I agree on this point, we disagree on the result ultimately dictated by these sources. I therefore write separately to explain why in my view the plurality's result, though not its reasoning, is correct.
When a citizen or resident of the United States dies, the Federal Government imposes a tax on "all [of his] property, real or personal, tangible or intangible, wherever situated." 26 U. S. C. §§ 2001(a), 2031(a). Specifically excluded from taxation, however, is certain property devised to the decedent's spouse or to charity. Such testamentary gifts may qualify for the marital deduction, § 2056(a), or the charitable deduction, § 2055(a). If they do, they are removed from the decedent's "gross estate" and exempted from the estate tax. § 2051. Calculating the estate tax, however, takes time, as does marshaling the decedent's property and distributing it to the ultimate beneficiaries. During this process, the assets in the estate often earn income and the estate itself incurs administrative expenses. To deal with this eventuality, the Tax Code permits an estate administrator to choose between allocating these expenses to the assets in the estate at the time of death (the estate principal), or to the postmortem income earned by those assets. § 642(g). Everyone agrees that when these expenses are charged against a portion of the estate's principal devised to the spouse or charity, that portion of the principal is diverted from the spouse or charity and the marital and charitable deductions are accord ingly "reduced" by the actual amount of expenses incurred. See ante, at 104 (plurality opinion); post, at 123 (SCALIA, J., dissenting); Brief for Petitioner 19; Brief for Respondent 6. The question presented here is what becomes of these deductions when the estate chooses the second option under § 642(g) and allocates administrative expenses to the postmortem income generated by the property in the spousal or charitable devise.
The Tax Code itself supplies no guidance. Accord, post, at 127 (SCALIA, J., dissenting). The statute most relevant to this case, 26 U. S. C. § 2056(b)(4)(B), provides:"[W]here [any interest in property otherwise qualifying for the marital deduction] is encumbered in any manner, or where the surviving spouse incurs any obligation imposed by the decedent with respect to the passing of such interest, such encumbrance or obligation shall be taken into account in the same manner as if the amount of a gift to such spouse of such interest were being determined. "
Although an executor's power to burden the postmortem income of the marital bequest with the estate's administrative expenses is arguably an "encumbrance" or an "obligation imposed by the decedent with respect to the passing of such interest," the statute itself says only that the "encumbrance or obligation shall be taken into account." It does not explain how this should be done, however. In my view, it is not possible to tell from § 2056(b)(4)(B) whether allocation of administrative expenses to postmortem income reduces the marital deduction always, sometimes, or not at all.
Nor does the Code's legislative history give shape to its otherwise ambiguous language. The discussion in the Senate Report of § 2056(b)(4)(B)'s predecessor statute reads:"The interest passing to the surviving spouse from the decedent is only such interest as the decedent can give. If the decedent by his will leaves the residue of his es tate to the surviving spouse and she pays, or if the estate income is used to pay, claims against the estate so as to increase the residue, such increase in the residue is acquired by purchase and not by bequest. Accordingly, the value of any such additional part of the residue passing to the surviving spouse cannot be included in the amount of the marital deduction." S. Rep. No. 1013, 80th Cong., 2d Sess., pt. 2, p. 6 (1948) (emphasis added).
This italicized passage might be helpful if it explicitly referred to "administrative expenses" instead of "claims against the estate." But it is not at all clear from the Senate Report whether the latter term includes the former: The Report nowhere defines the term "claims against the estate," and the immediately preceding paragraph discusses § 2056(b)(4)(B)'s language with reference to mortgages. Ibid. Because mortgages differ from administrative expenses in many ways (e. g., mortgages pre-exist the decedent's death and are fixed in amount at that time), there is a reasonable argument that administrative expenses are not "claims against the estate." In sum, the Code's legislative history is not illuminating.
All that remains in this statutory vacuum are the Commissioner's regulations and Revenue Rulings, and it is on these sources that I would decide this issue. The key regulation is 26 CFR § 20.2056(b)-4(a) (1996):"The value, for the purpose of the marital deduction, of any deductible interest which passed from the decedent to his surviving spouse is to be determined as of the date of the decedent's death.... The marital deduction may be taken only with respect to the net value of any deductible interest which passed from the decedent to his surviving spouse, the same principles being applica ble as if the amount of a gift to the spouse were being determined. In determining the value of the interest in property passing to the spouse account must be taken of the effect of any material limitations upon her right to income from the property."
The text of the regulation leaves no doubt that only the "net value" of the spousal gift may be deducted. Moreover, there is little doubt that, in assessing this "net value," one should examine how the spousal devise would have been treated if it were instead an inter vivos gift. See 26 U. S. C. § 2056(b)(4)(A) (also referring to treatment of gifts).
The plurality latches onto 26 CFR § 25.2523(a)-1(e) (1996), and to the statutes and regulations to which it refers. Ante, at 101-102 (referring to 26 U. S. C. § 7520; 26 CFR § 20.2031-7 (1996)). In the plurality's view, these regulations define how to "tak[e] [account] of the effect of any material limitations upon [a spouse's] right to income from the property." 26 CFR § 20.2056(b)-4(a) (1996). The plurality frankly admits that these regulations do not speak directly to the antecedent inquiry-when an executor's right to allocate administrative expenses to income constitutes a "material limitation." Ante, at 106. The plurality nevertheless believes that these regulations bear indirectly on this inquiry by implying an underlying estate tax valuation theory that, in the plurality's view, dovetails nicely with our decision in Ithaca Trust Co. v. United States, 279 U. S. 151 (1929). Ante, at 102. It is on the basis of this valuation theory that the plurality is able to conclude that the Tax Court's analysis was wrong because that analysis did not, consistent with the plurality's theory, focus solely on anticipated administrative expenses and anticipated income. Ante, at 107-109. But, as JUSTICE SCALIA points out, the plurality's valuation theory is not universally applicable and, in fact, conflicts with the Commissioner's treatment of some other expenses. See 26 CFR § 20.2056(b)-4(c) (1996); post, at 133-136. Because § 25.2523(a)-1(e) and its accompanying provisions do no more than suggest an estate tax valuation theory that itself has questionable value in this context, these provisions do not in my view provide any meaningful guidance in this case.
The Tax Court, on the other hand, zeroed in on 26 CFR §§ 25.2523(e)-1(f)(3) and (4) (1996), the gift tax regulations which, read together, provide that a trustee's power to allocate the "trustees' commissions... and other charges" to the trust's income will not disqualify the trust from the gift tax spousal deduction as long as the donee spouse receives "substantial beneficial enjoyment" of the trust property. 101 T. C. 314, 325 (1993); see also 26 CFR § 20.2056(b)-5(f) (1996) (tracking language of § 25.2523(e)-1(f)). The Commissioner interpreted this language in Revenue Ruling 69-56, and held that a trustee's power to"charge to income or principal, executor's or trustee's commissions, legal and accounting fees, custodian fees, and similar administration expenses..."[does] not result in the disallowance or diminution of the marital deduction for estate and gift tax purposes unless the execution of such directions would or the exercise of such powers could, cause the spouse to have less than substantially full beneficial enjoyment of the particular interest transferred." Rev. Rul. 69-56, 1969-1 Cum. Bull. 224 (emphasis added).
Both the plurality and JUSTICE SCALIA argue that these gift regulations and rulings are inapposite because they address how the power to allocate expenses affects a trust's qualification for the marital deduction, and not how it affects the trust's value. Ante, at 103-104; post, at 125-126, 131-132. They further contend that the "material limitation" language in 26 CFR § 20.2056(b)-4(a) (1996) would be rendered superfluous if a "material limitation" on the spouse's right to receive income existed only when that spouse lacked "substantial beneficial enjoyment" of the income. 101 T. C., at 325-326 (adopting this argument). Under this reading, there could be no such thing as a trust that qualified for the marital deduction but imposed a material limitation on the right to income because any trust failing the "substantial beneficial enjoyment" test would not qualify for the deduction at all. Ante, at 103; post, at 132. These are potent criticisms. But no matter how poorly drafted or ill conceived the Revenue Ruling might be, the fact remains that the Commissioner issued it and its plain language is hard to ignore. In the end, the conclusion one draws regarding how the marital and charitable trusts would be treated if they were inter vivos gifts depends on whether one takes the Commissioner at her word: If one does, the gift tax provisions, Revenue Ruling 69-56 in particular, favor respondent's position; if one does not, one is left with no guidance at all. Neither result is wholly satisfying.
Fortunately, § 20.2056(b)-4(a) further directs the reader to consider a second method of determining the amount of the marital deduction:"In determining the value of the interest in property passing to the spouse account must be taken of the effect of any material limitations upon her right to income from the property."
From this we ask whether the executor's right to allocate administrative expenses to the postmortem income of the marital bequest is a material limitation upon the spouse's "right to income from the property," such that "account must be taken of the effect." Because the executor's power is undeniably a "limitation" on the spouse's right to income, the case hinges on whether that limitation is "material." Accord, post, at 128 (SCALIA, J., dissenting) ("The beginning of analysis... is to determine what, in the context of § 20.2056(b)-4(a), the word 'material' means").
We can quibble over which definition of "material"-"substantial" or "relevant"-precedes the other in the dictionary, see ibid.; American Heritage Dictionary 772 (2d ed. 1985) ("substantial" precedes "relevant"), but this debate is beside the point. The Commissioner has already interpreted the language in § 20.2056(b)-4(a). In Revenue Ruling 93-48, the Commissioner ruled that the marital deduction is not "ordinarily" reduced when an executor allocates interest payments on deferred federal estate taxes to the postmortem income of the spousal bequest. Rev. Rul. 93-48, 1993-2 Cum. Bull. 271 ("[T]he value of a residuary charitable [or marital] bequest is [not] reduced by the amount of [interest] expenses payable from the income of the residuary property"). JUSTICE SCALIA contends that Revenue Ruling 93-48 should be disregarded because it was promulgated by the Commissioner only after her attempts to prevail on the contrary position in federal court repeatedly failed. Post, at 129-130. To be sure, the Commissioner may not have whole-heartedly embraced Revenue Ruling 93-48, but the Ruling nevertheless issued and we may not totally ignore the plain language of a regulation or ruling because the entity promulgating it did not really want to have to adopt it. See Connecticut Nat. Bank v. Germain, 503 U. S. 249, 253-254 (1992) ("We have stated time and time again that courts must presume that a legislature says in a statute what it means and means in a statute what it says there"); West Virginia Univ. Hospitals, Inc. v. Casey, 499 U. S. 83, 98 (1991) (rejecting argument that "the congressional purpose in enacting [a statute] must prevail over the ordinary meaning of statutory terms").
It is, as an initial matter, difficult to reconcile the Commissioner's treatment of interest under Revenue Ruling 93-48 with her position in this case. For all intents and purposes, interest accruing on estate taxes is functionally indistinguishable from the administrative expenses at issue here. By definition, neither of these expenses can exist prior to the decedent's death; before that time, there is no estate to administer and no estate tax liability to defer. Yet both types of expenses are inevitable once the estate is open because it is virtually impossible to close an estate in a day so as to avoid the deferral of estate tax payments or the incursion of some administration expenses. Although both can theoretically be avoided if an executor donates his time or pays up front what he estimates the estate tax to be, this will not often occur. Both types of expenses are, moreover, of uncertain amount on the date of death. Because these two types of expenses are so similar in relevant ways, in my view they should be treated the same under § 20.2056(b)-4(a) and Ruling 93-48, despite the Commissioner's limitation on the applicability of Revenue Ruling 93-48 to interest on deferred estate taxes.
But more important, the Commissioner's treatment of interest on deferred estate taxes in Revenue Ruling 93-48 indicates her rejection of the notion that every financial burden on a marital bequest's postmortem income is a material limitation warranting a reduction in the marital deduction. That the Ruling purports to apply not only to income but also to principal, and may therefore deviate from the accepted rule regarding payment of expenses from principal, see supra, at 112-113, does not undercut the relevance of the Ruling's implications as to income. Post, at 130 (SCALIA, J., dissenting). Thus, some financial burdens on the spouse's right to postmortem income will reduce the marital deduction; others will not. The line between the two does not, as JUSTICE SCALIA contends, depend upon the relevance of the limitation on the spouse's right to income to the value of the marital bequest, post, at 128-129, since interest on deferred estate taxes surely reduces, and is therefore relevant to, "the value of what passes," post, at 128 (emphasis deleted). By virtue of Revenue Ruling 93-48, the Commissioner has instead created a quantitative rule for § 20.2056(b)-4(a). That a limitation affects the marital deduction only upon reaching a certain quantum of substantiality is not a concept alien to the law of taxation; such rules are quite common. See, e. g., Rev. Rul. 75-298, 1975-2 Cum. Bull. 290 (exempting from income tax the income of qualifying banks owned by foreign governments, as long as their participation in domestic commercial activity is de minimis); Rev. Rul. 90-60, 1990-2 Cum. Bull. 3 (establishing de minimis rule so that taxpayers who give up less than 33.3% of their partnership interest need not post a bond to enable them to defer payment of credit recapture taxes for low-income housing).
The Commissioner's quantitative materiality rule is consistent with the example set forth in 26 CFR § 20.2056(b)4(a) (1996):"An example of a case in which [the material limitation] rule may be applied is a bequest of property in trust for the benefit of the decedent's spouse but the income from the property from the date of the decedent's death until distribution of the property to the trustee is to be used to pay expenses incurred in the administration of the estate."
Even assuming that JUSTICE SCALIA is correct that the word "may" connotes "possibility rather than permissibility," post, at 131, the example still does not specify whether it applies when all the income, some of the income, or any of the income "from the property... is to be used to pay expenses incurred in the administration of the estate." Any of these constructions of the example's language is plausible, and the Commissioner's expressed preference for the second one is worthy of deference. National Muffler Dealers Assn., Inc. v. United States, 440 U. S. 472, 476 (1979).
That said, the proper measure of materiality has yet to be decided by the Commissioner. The Tax Court below compared the actual amount spent on administration expenses to its estimate of the income to be generated by the marital bequest during the spouse's lifetime. 101 T. C., at 325. One amicus suggests a comparison of the discounted present value of the projected income stream from the marital be quest when the actual administrative expenses are allocated to income with the projected income stream when the expenses are allocated to principal. App. to Brief for American College of Trust and Estate Counsel as Amicus Curiae 1-2. The plurality, drawing upon its valuation theory, supra, at 115, looks to whether the "date-of-death value of the expected future administration expenses chargeable to income... [is] material as compared with the date-of-death value of the expected future income." Ante, at 110. None of these tests specifies with any particularity when the threshold of materiality is crossed. Cf. 26 U. S. C. § 2503(b) (setting $10,000 annual minimum before gift tax liability attaches). The proliferation of possible tests only underscores the need for the Commissioner's guidance. In its absence, the Tax Court's approach is as consistent with the Code as any of the others, and provides no basis for reversal.
I share JUSTICE SCALIA'S reluctance to find a $1.5 million diminution in postmortem income immaterial under any standard. Post, at 128-129. Were this Court considering the question of quantitative materiality in the first instance, I would be hard pressed not to find this amount "material" given the size of Mr. Hubert's estate. But the Tax Court in this case was effectively pre-empted from making such a finding by the Commissioner's litigation strategy. It appears from the record that the Commissioner elected to marshal all her resources behind the proposition that any diversion of postmortem income was material, and never presented any evidence or argued that $1.5 million was quantitatively material. See App. 58 (Stipulation of Agreed Issues) (setting forth Commissioner's argument); Brief for Respondent 47. Because she bore the burden of proving materiality (since her challenge to administrative expenses was omitted from the original notice of deficiency), Tax Court Rule 142(a), her failure of proof left the Tax Court with little choice but to reach its carefully crafted conclusion that $1.5 million was not quantitatively material on "the facts before [it]." 101 T. C., at 325. I would resist the temptation to correct the seemingly counterintuitive result in this case by protecting the Commissioner from her own litigation strategy, especially when she continues to adhere to that strategy and does not, even now, ask us to reconsider the Tax Court's finding on this issue.
This complex case has spawned four separate opinions from this Court. The question presented is simple and its answer should have been equally straightforward. Yet we are confronted with a maze of regulations and rulings that lead at times in opposite directions. There is no reason why this labyrinth should exist, especially when the Commissioner is empowered to promulgate new regulations and make the answer clear. Indeed, nothing prevents the Commissioner from announcing by regulation the very position she advances in this litigation. Until that time, however, the relevant sources point to a test of quantitative materiality, one that is not met by the unusual factual record in this case. I would, accordingly, affirm the judgment of the Tax Court.
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