Commissioner of Internal Revenue v. Estate of Herman J. Bosch, Deceased, Irving Trust Company, Executor,respondent ( 1966 )

HAYS, Circuit Judge.

The Commissioner petitions for review of a decision of the Tax Court which held that the Commissioner had erroneously disallowed the sum of $70,222.04 as a marital deduction under Section 2056(b) (5) of the Internal Revenue Code of 1954, 26 U.S.C. § 2056(b) (5)¹ We affirm the Tax Court.

The facts are fairly simple and are not in dispute.

On April 9, 1930 the decedent set up a trust by the terms of which the income was to be paid to his wife during her lifetime. Upon the death of the wife the corpus was to be paid to the grantor or his estate. The trust was amendable and revocable.

On February 6,1931 decedent amended the trust instrument to grant to his wife a general power of appointment. She was empowered to appoint by her will the corpus of the trust to any “persons and/or corporations.” The amendment provided, for a disposition over in the event the wife failed to exercise her power of appointment.

On October 25, 1951, the wife executed a document by which she purported to release a portion of her general power of appointment under the trust and to convert it into a special power of appointment.²

It appears from the - document itself and it is readily conceded by the trustee, which proposed to Mr. and Mrs. Bosch the execution of the release, that the purpose of the release was to take advantage of the Powers of Appointment Act of 1951, Ch. 165, 65 Stat. 91, amending Int. Bev. Code of 1939, § 811(f) (now Int. Rev. Code of 1954, § 2041), then recently enacted, and thus “to prevent the assets of the trust being taxed as part of Margaret Bosch’s estate.”

On April 6, 1957 Herman Bosch died. His executor claimed a marital deduction for the value of the trust. The Commissioner determined that the trust did not qualify for the marital deduction and asserted a federal tax deficiency based upon the disallowances of the amount of $70,-222.04, the value of the corpus of the trust.

The executor filed a petition in the Tax Court for a redetermination of the deficiency. While the action was pending in the Tax Court, the trustee, which was also executor of the estate of Herman Bosch, brought a proceeding in the New York Supreme Court for a settlement of its account as trustee. In connection with the proceeding in the New York Supreme Court, the trustee asked for a determination of the validity of Mrs. | Bosch’s release of part of her power of (appointment. Respondent stipulated and conceded that the New York proceeding was instituted “at least in part for the purpose of affecting [the] outcome of the case before the Tax Court. The trustee’s petition in the New York court described the proceedings then pending in the Tax Court, and stated the position taken in that proceeding by the executor.

The issue in the state proceeding was whether the release executed by Mrs. Bosch on October 25, 1951 was effective. Three briefs were filed in the New York proceeding, one for Mrs. Bosch, one for the trustee, and one by a guardian ad litem in behalf of a minor interested in the trust by reason of being a possible beneficiary in the event Mrs. Bosch died without exercising her power of appointment. All three briefs argued that the release was a nullity. No argument for the validity of the release was presented to the court.

There were twenty-two persons having the same interest as the infant who was represented by the guardian ad litem. Although they received notice of the proceeding, none of them appeared.

The state court held that Mrs. Bosch’s purported release was a nullity.³

The Tax Court decided to accept the New York decision and gave the following reasons for doing so:

1. The New York court had jurisdiction over the parties and subject matter of the proceeding, and its judgment was final and conclusive as to those parties. Therefore, Mrs. Bosch now has a general power of appointment which she could exercise in favor of herself, her estate, her creditors, or the creditors of her estate.

2. Decisions of the Supreme Court of the State of New York represent legal precedent for courts throughout the state, unlike decisions of local courts with limited geographical jurisdiction whose decisions are not binding upon other courts of the state.

3. The Commissioner was fully aware of the proceeding in the New York court and could have sought the opportunity to present his views to that court. Indeed, he agreed to the continuance of the hearing before the Tax Court so that the New York proceeding might be brought to a conclusion.

4. The New York court rendered a reasoned opinion and reached a deliberate conclusion.

5. The New York court’s decision, which is binding upon Mrs. Bosch, may have certain offsetting tax' consequences in respect to her own estate tax. The New York decree establishing that she has a general power of appointment will result in the inclusion in her gross estate of any property passing under her exercise of that power, and the record indicates that it is not reasonable to assume that this power of appointment will remain unexercised.^* Thus, the state court decree was more than “a label for past events that would affect the present litigation; it authoritatively determined the nature of the power of appointment with potentially adverse tax consequences at a later date.”

The Tax Court stated that it was not necessary for it to say that it was “bound” by the New York decision. It held that it was sufficient to state, for all of the above reasons, that it would accept the New York decision “as an authoritative exposition of New York law and adjudication of the property rights involved.”

In deciding whether the Tax Court ascribed proper effect to the state decision, a few preliminary observations may be helpful. We believe that much of the confusion in the cases is caused by the failure of the courts carefully to formulate the issue. For example, it is quite clear that the state decision is not binding upon the federal courts because the situation is covered by the principle of res judicata. See Freuler v. Helvering, 291 U.S. 35, 43, 54 S.Ct. 308, 78 L.Ed. 634 (1934). Obviously the Commissioner is not bound by the state decision in a res judicata sense, since he was not a party to the litigation which resulted in the decision. It may be that it would be desirable to hold the Commissioner bound when he has received notice and an opportunity to appear as in this case, but that is clearly not the law now, and any such change in the law would no doubt require legislative action. Similarly the federal courts are not bound ih this situation by the rule of Erie R. R. Co. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188 (1938). It is for this reason that most of the Commissioner’s argument must be considered to be beside the point. The task here is not to discover the general New York law applicable to releases of powers of appointment. That may well be the subject of the required search in a case which concerns a taxpayer whose own special status under New York law has never been authoritatively determined by a New York tribunal. In the determination of the present case we are not required to take issue with our learned colleague, Judge Friendly, whose brilliant lecture In Praise of Erie — And of the New Federal Common Law, 39 N.Y.U.L.Rev. 383 (1964) is quoted in the Commissioner’s Reply Brief. We may indeed agree with him that- the correct view, that “the Erie doctrine applies, whatever the ground for federal jurisdiction, to any issue or claim which has its source in state law,” is set forth by Judge Waterman in Maternally Yours, Inc. v. Your Maternity Shop, Inc., 234 F.2d 538, 541 n. 1 (2d Cir. 1956). The reference in the quoted passage is to the great run of cases in which the federal courts are obliged to search out the general principle of state law in order to apply that principle to a case under consideration. It does not refer, and was never intended to refer, to the question of whether or not a federal court is to "accept a state determination of the rights under state law of a party to a federal action. In the latter situation, which is that in the case at bar, the party comes into the federal court with his rights already fixed by a decision of a state tribunal. There is no occasion to inquire into the general law of the state to ascertain what those rights are.

The issue is, then, strictly speaking, not whether the federal court is “bound by” the decision of the state tribunal, but whether or not a state tribunal has authoritatively determined the rights under state law of a party to the federal action.

This is clearly the effect of Sharp v. Commissioner, 303 U.S. 624, 58 S.Ct. 748, 82 L.Ed. 1087 (1938), reversing, 91 F.2d 802 (3d Cir. 1937), Blair v. Commissioner, 300 U.S. 5, 57 S.Ct. 330, 81 L.Ed. 465 (1937) and Freuler v. Helver-ing, 291 U.S. 35, 54 S.Ct. 308, 78 L.Ed. 634 (1934). In the Blair case, the issue was whether a certain trust was a spendthrift trust under the law of Illinois. The Circuit Court of Appeals, examining the general law of Illinois on the subject, held it to be a spendthrift trust. The trustees thereupon brought an action in the Illinois courts to obtain a construction of the will and the Appellate Court of Illinois, an intermediate appellate court, held that the trust was not a spendthrift trust. The United States Supreme Court ruled that the Commissioner was required to accept the Illinois decision as dispositive. The Court said:

“In this instance, it is not necessary to go beyond the obvious point that the decision was in a suit between the trustees and the beneficiary and his assignees, and the decree which was entered in pursuance of the decision determined as between these parties the validity of the particular assignments.” 300 U.S. at 10, 57 S.Ct. at 332.

In deciding whether the determination of the rights under state law of a party to a federal action has been authoritative, the majority of federal courts in which the question has been raised have refused to accept the result in cases which were non-adversary.⁴ However, there is very respectable authority for the proposition that, if the state decision is binding on the parties as tq their rights under state law (as it would not be if it resulted from fraud or collusion), it is conclusive as to those rights for purposes .of federal taxation. In Gallagher v. (Smith, 223 F.2d 218, 223 (3d Cir. 1955), the court said:

“An adjudication of such a question of title by a court.of the state must accordingly be given effect, not because it is res judicata against the United States, but because it is conclusive of the parties’ property rights which alone are to be taxed. So far as those parties are concerned the law of the state is what the state court has declared and applied in their case. If the state court’s judgment has binding final effect under the state law the rights of the parties can only be what the court has held them to be. It is for this reason that the federal court should not in a case of this kind make an independent examination and application of state law. For if it reaches a different conclusion from the state court as to what the parties’ rights should be under the state law its decision will not change those rights which will necessarily remain what the state court has declared them to be.”

See Flitcroft v. Commissioner, 328 F.2d 449 (9th Cir. 1964); Estate of Dar-lington v. Commissioner, 302 F.2d 693 (3d Cir. 1962); Eisenmenger v. Commissioner, 145 F.2d 103 (8th Cir. 1944); Sharpe v. Commissioner, 107 F.2d 13 (3d Cir. 1939), cert. denied, 309 U.S. 665, 60 S.Ct. 591, 84 L.Ed. 1013 (1940).

It may fairly be said, we think, that the question is an open one in this circuit. (However, compare Kelly’s Trust v. Commissioner, 168 F.2d 198 (2d Cir. 1948). The decision in Second National Bank v. United States, 351 F.2d 489 (2d Cir. 1965), was based, as the court makes clear,⁵ on the holding that the determination of the Connecticut Probate Court was not authoritative in Connecticut.

An able Tax Court judge quite explicitly undertook to balance several relevant factors (see pp. 2494-2495 supra) before deciding to accept the New York judgment as authoritative of the rights of parties. We, too, have considered all of the circumstances and feel that the decision below was correct. We hold that the New York judgment, rendered by a court which had jurisdiction over parties and subject matter, authoritatively settled the rights of the parties, not only for New York, but also for purposes of the application to those rights of the relevant provisions of federal tax law. Mrs. Bosch now has a general power of appointment under the trust. The corpus of the trust therefore qualifies for the marital deduction.

The decision of the Tax Court is affirmed.

1 . “(5) Life estate with power of appointment in surviving spouse.- — -In the case of an interest in property passing from the decedent, if his surviving spouse is entitled for life to all the income from the entire interest, * * * with power in the surviving spouse to appoint the entire interest, * * * (exercisable in favor of such surviving spouse, or of the estate of such surviving spouse, or in favor of either, whether or not in each case the power is exercisable in favor of others),

and with no power in any other person to appoint any part of the interest, or such specific portion, to any person other than the surviving spouse—

(A) the interest * * * thereof so passing shall, for purposes of subsection (a), be considered as passing to the surviving spouse, and

(B) no part of the interest so passing shall, for purposes of paragraph (1) (A), be considered as passing to any person other than the surviving spouse. This paragraph shall apply only if such power in the surviving spouse to appoint the entire interest, or such specific portion thereof, whether exercisable by will or during life, is exercisable by such spouse alone and in all events.”

2 . “Know All Men by These Pbesents : Whebeas I, Mabgabet Bosch, am the life beneficiary of the trust created by a certain Agreement of Trust dated April 9, 1930 between Herman J. Bosch, as Grantor, and Irving Trust Company, as Trustee, which trust is now being administered by said Irving Trust Company as such Trustee; and

Whebeas, by an amendment of said Agreement of Trust, dated February 6, 1931, made by said Grantor pursuant to the power thereby preserved to him, it is provided that in the event that said Grantor shall not survive me, the beneficiary therein named—

‘then upon the death of said Margaret Bosch the Trustee shall pay, transfer and deliver the principal of the trust fund to the persons and/or corporations appointed to receive the same by the Last Will and Testament of Said Margaret Bosch, * * * ’

and

Whebeas I desire to release in part my contingent power of appointment under said Agreement of Trust in the manner contemplated by the ‘Powers of Appointment Act of 1951’ amending Section 811 (f) and Section 1000(c) of the Internal Revenue Code of the United States of America, so that my said contingent power of appointment under said Agreement of Trust shall not be a general power of appointment,

Now, Thebeeobe, I, said Margaret Bosch, hereby renounce, relinquish, surrender and release my said contingent power to appoint all or any part of said trust fund by said Agreement of Trust dated April 9, 1930 made by Herman J. Bosch, as amended by instrument dated February 6, 1931, or any property which may hereafter form a part of said trust fund, in favor of myself, my estate, my creditors or the «editors of my estate.

Any attempted exercise of said power made by my Will which is inconsistent or in any way in conflict with this release and limitation by me of said power shall be void.

In Witness Whebeoe, I have executed this instrument in duplicate this 25 day of October, 1951.

/s/ Mabgabet Bosch (L.S.)

Margaret Bosch”

3 . “Matter of Irving Trust Co. (Bosch)— In this proceeding to judicially settle and allow the intermediate account of the trustee under an inter vivos trust, a ruling is requested respecting the validity of an instrument executed by Margaret Bosch, wife of the settlor of the trust, dated October 25, 1951, purportedly partially releasing her contingent power of appointment. On April 9, 1930, Herman J. Bosch created a trust which provided for the payment of income to his wife for her life with a reversion to the grantor if his wife should predecease him, or to his estate if he should predecease his wife, leaving a will, or to his next of kin if he should die intestate. The trust instrument reserved to the grantor the right to alter or amend the trust at any time during his life with thp consent of the trustee, and the further 'right without the consent of the trustee or any other person to revoke the trust in whole or in part. On February 6, 1931, the grantor exercised his right to amend the trust to provide that his wife, Margaret Bosch, should have a general power of appointment over the property of the trust exercisable by Will if she survived the grantor. The power in the grantor to further alter, amend or revoke the trust in his lifetime was undisturbed by this amendment. On October 25, 1951, during the lifetime of the grantor, his wife, Margaret Bosch, executed an instrument by which she purported to effect a partial release of the general power of appointment granted to her by the trust instrument as amended. The grantor, Herman Bosch, died on April 6, 1957. The applicable provision of the law is section 183, subdivision 1, of the Beal Property Law [McKinney’s Consol.Laws, c. 50], which stated: ‘Any power which is exercisable by deed, by will, by deed or will, or otherwise, whether general or special, other than a power in trust which is imperative, is releasable, either with or without consideration, by written instrument signed by the grantee and delivered as hereinafter provided.’ This section, although a part of the Beal Property Law, applies to powers of appointment over personal property as well as to powers over real property (Matter of N. Y. Title & Mortgage Co., 150 Misc. 488 [270 N.Y.S. 473]; In re Goldwitz Will, 145 Misc. 300 [259 N.Y.S. 900]; Matter of Cooksey’s Estate, 182 N.Y. 92 [74 N.E. 880]). In order that the donee of a power of appointment release any rights under that power, the donee must have the right to exercise the power at the time the purported release is made. It seems clear that the donee of power of appointment cannot exercise it prior to its creation (Matter of Piffard, 111 N.Y. 410 [18 N.E. 718, 2 L.R.A. 193]). In the instant case, Margaret Bosch, on October 25, 1951, sought to effect a partial release of the power of appointment over the property of the trust. At that time she lacked the power to exercise any rights under the trust instrument. Her power with respect to the trust instrument came into being upon the death of the grantor on April 6, 1957. A power of appointment created under a revocable deed of trust, which power shall be exercised by will, may not be exercised while the settlor of the trust is still alive. Since she could not have exercised the power of appointment on October 25, 1951, she could not have effected a valid partial release of the power on that date. Hence her purported partial release of the power of appointment on October 25, 1951, was a nullity (Matter of Piffard, supra). Accordingly, the purported partial release by Margaret Bosch on October 25, 1951, of the power of appointment granted to her by the trust instrument was a nullity. Settle order.” N. Y. L. J., November 15, 1963.

* The Tax Court said “[W]e cannot reasonably assume that she will permit that power to remain unexercised, for there are indications in the record that the immediate natural objects of her bounty do not include all of the many relatives of her husband who would take in default of her exercise of the power.”

4 . See the discussion and the cases cited in the following:

10 Mertens, Law of Federal Income Taxation, Ch. 61 (Zimet Revision 1964) ; Braverman and Gerson, The Conclusiveness of State Court Decrees in Federal Tax Litigation, 17 Tax L. Rev. 545 (1962) ; Colowiek, The Binding Effect of a State Court’s Decision in a Subsequent Federal Income Tax Case, 12 Tax L.Rev. 213 (1957) ; Holzmam, Impact of State Law upon Fed. Tax., 42 Taxes 240 (1964) ; Sacks, Binding Effect of Nontax Litigation in State Courts, N.Y.U. 21st Inst. on Fed. Tax., 277 (1963) ; Stephens & Freeland, The Role of Local Law and Local Adjudication in Federal Tax Controversies, 46 Minn.L.Rev. 223 (1961) ; Note, Binding Effect of a Nonadversary State Court Decree in a Federal Tax Determination, 33 Fordham L.Rev. 705 (1965) ; Note, Effect of State Court Decrees in Federal Tax Litigation, 30 U. of Chi.L.Rev. 569 (1963) ; Note, The Role of State Law in Federal Tax Determination, 72 Harv.L.Rev. 1350 (1959).

5 . “The trial court after carefully considering the arguments and the many relevant decisions concluded that ‘the decrees of the Connecticut Probate Court — which is not a court of record and most of the judges of which are laymen, not lawyers— under no circumstances can be construed as binding and conclusive upon a federal court in construing and applying the federal revenue laws.’ 222 F.Supp. [446,] at 457. This court is in accord with the trial court’s conclusion as to the effect of the state decree, see Estate of Peyton v. Commissioner, 323 F.2d 438 (8th Cir. 1963), since under Connecticut law the Probate Court’s decisions are not binding on the state’s higher courts, Heiser v. Morgan Guaranty Trust Co., 150 Conn. 563, 192 A.2d 44 (1963), and are even subject to collateral attack in another probate district, Culver’s Appeal from Probate, 48 Conn. 165, 172-174 (1880). Under the circumstances, it was unnecessary ‘to make a finding as to whether the proceedings in the Probate Court were collusive or nonadversary in nature’ and the court properly refrained from so doing.” 351 F.2d at 494.