Estate of Hudgins v. C.I.R. ( 1995 )

IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
No. 94-40211
ESTATE OF HARRY M. HUDGINS,
Deceased, LEE C. HUDGINS and
HARRY HUDGINS II, Co-Independent
Executors,
Petitioners-Appellees,
versus
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellant.
Appeal from the United States Tax Court
(No. 5506-91)
(June 28, 1995)
Before JOLLY and WIENER, Circuit Judges.*
WIENER, Circuit Judge.
In this federal estate tax case, implicating "special use
valuation" of several tracts of farm or ranch property owned by
Harry M. Hudgins (Decedent) at the time of his death, the
*
Judge Irving L. Goldberg was a member of this panel when
counsel presented arguments to the court, but he died before the
opinion was written and circulated. The case is therefore being
decided by a quorum. 28 U.S.C. § 46(d).
Commissioner of Internal Revenue (Commissioner) appeals the adverse
decision of the United States Tax Court (Tax Court). The
Commissioner questions the Tax Court's holding that, when filing
Decedent's federal estate tax return (706), the independent co-
executors of Decedent's estate (Estate) "substantially complied"
with the requirements of the Internal Revenue Code (Code) and
applicable Treasury Regulations (Regs.) for electing a special use
valuation of the Estate property, thereby entitling the Estate to
perfect its election within ninety days following notice from the
IRS that the Estate's election was defective. Concluding that the
Tax Court's substantial compliance ruling was erroneous, we reverse
and remand for further proceedings consistent with this opinion.
I
FACTS AND PROCEEDINGS
Decedent was a Texas rancher who died testate in 1987.1 In
his Last Will and Testament (the Will), Decedent left several
tracts of ranch property to various combinations of five grandsons.
The Will's SECTION 5., which applied to each legacy of ranch
property that resulted in two or more of Decedent's grandsons
becoming "joint owners," imposed several ten year restrictions on
the legatees and the property thus bequeathed: (1) No such jointly
owned tract could be mortgaged or partitioned; (2) any joint owner
of an interest in one tract could sell his interest to another
1
As Decedent died after December 31, 1981, the issue of
special use valuation in his estate is governed by the provisions
of the Economic Recovery Tax Act of 1981. Economic Recovery Tax
Act of 1981, Pub. L. No. 97-34, § 421(k)(3), 95 Stat. 172, 313
(1981).
2
joint owner of that tract but not to any other person; and (3) any
joint owner could rent or lease his interest to another joint owner
but not to any other person. [Neither SECTION 5. nor any other
provision of the Will expressly required that the land actively be
used for ranch purposes, expressly prohibited any other use of the
property, expressly required the grandsons to participate in
qualifying activities, or expressly imposed any penalties, such as
reversion, revocation, forfeiture or other loss of ownership
interests, in the event of an actual or attempted alienation in
violation of the restriction.]2
The Will appointed Decedent's son, Lee C. Hudgins, grandson,
Harry Hudgins II, and long-time attorney and scrivener of the Will,
Joe A. Keith, to serve as Independent Co-Executors (Executors).
The Will specified that Mr. Keith's service as a co-executor would
not preclude his being compensated "for also being attorney for my
estate." Although not expressed in the Will, Mr. Hudgins
apparently expected the Estate to retain Mr. Keith as its attorney,
which it did.
Mr. Keith was an experienced attorney who had represented Mr.
Hudgins for over forty years, had also represented other prominent
ranching families in that part of North Texas, and had prepared and
filed a number of federal estate tax returns, including some in
2
SECTION 9. directed that in each business in which Decedent
may be engaged at his death "whether in individual, partnership,
corporate or other form, shall be discontinued and liquidated as
soon as reasonably possible" following the death of Decedent.
Neither the Tax Court nor any of the parties contend that the
provisions of SECTION 9. affect the use of the subject property.
3
which special use valuation elections were made. The record
reflects that Mr. Keith was incapacitated at the time this action
was commenced in the Tax Court and has since died.
Mr. Keith prepared and timely filed the 706 for the Estate.
In the portion of the 706 that asks if the estate intends to elect
special use valuation on any of its property, the "Yes" box was
checked. In compliance with instructions in the 706, the Estate
completed and affixed a Schedule N, together with required
attachments to that schedule. A "Notice of Election" was also
attached to the 706, but it contained only nine of the fourteen
items required by the instructions and the Regs. The Notice of
Election contains a statement, presumably affixed by Mr. Keith, to
the effect that "[i]t is considered that all requirements exist for
special valuation of the qualified real property." Although the
Notice of Election contains signature lines for all five grandsons,
only three of the five had signed that instrument by the time it
was filed with the 706. This is at least partially explained in a
"Memorandum" typed at the bottom of the Notice of Election and
signed by Mr. Keith, which states that one of the grandsons had not
signed "because he is in military service" and that another had not
signed because he was "not presently available." The Memorandum
concludes with the following statement:
"To remedy that situation, the undersigned preparer of
this Form 706 will undertake to obtain the signatures of
[the two grandsons who had not signed] on a counterpart
hereof, which when available will be transmitted to the
office of the Internal Revenue Service at Austin, Texas."
The record does not reflect that any steps were taken to effectuate
4
the promised "remedy" until after the IRS audited the 706 and
notified the Estate that its special use valuation election was
defective due to the incomplete Notice of Election and the failure
to attach an executed Recapture Agreement.
Within ninety days after receiving that notice from the IRS,
the Estate submitted all previously missing information,
documentation, and signatures. The Commissioner nevertheless
denied the special use valuation claimed by the Estate, contending
that, as the Estate's initial election was not "in substantial
compliance" with the requirements of the Regs., the Estate was
precluded from perfecting its election post hoc. The Commissioner
assessed the subject properties at their fair market values,
thereby increasing the value of the gross estate by $487,790SQthe
excess of the aggregate fair market value of the subject tracts
over their aggregate special use valuations.3 As a result of this
adjustment the Commissioner issued a deficiency notice to the
Estate for underpayment of taxes in the amount of $149,622.
The Estate petitioned the Tax Court for a redetermination of
the deficiency. Following a trial on mostly stipulated facts, the
Tax Court held that the Estate was indeed entitled to the special
use valuation, thus there was no deficiency in estate taxes. The
court's conclusion that the Estate was entitled to special use
valuation was grounded in its determination that the Estate's
initial election substantially complied with the election
3
The parties stipulated at the redetermination hearing that
the appropriate increase to the gross estate was $403,345, not
$487,790.
5
requirements, entitling the Estate to perfect its election within
the statutory period following notice of the defective election.
This review followed the Commissioner's timely filing of a notice
of appeal.
II
ANALYSIS
The Tax Court's holding for the Estate apparently served as a
wake-up call for the Commissioner, for his brief to this court
presents both a comprehensive explanation of the law applicable to
special use valuation elections and an application of that legal
framework to the pertinent facts. We therefore borrow extensively
from the Commissioner's brief in the analysis that follows.
A. Standard of Review
In reviewing decisions of the Tax Court we apply the same
standards used in reviewing a decision of the district court:
Questions of law are reviewed de novo; findings of fact are
reviewed for clear error.4 We will not find a ruling to be clearly
erroneous unless we are left with the definite and firm conviction
that a mistake has been made.5
In the instant case the discrete facts, as noted, are
stipulated for the most part and otherwise are essentially
undisputed. That the belated efforts of the Estate to perfect the
4
Park v. Commissioner, 25 F.3d 1289, 1291 (5th Cir. 1994)
(citing McKnight v. Commissioner, 7 F.3d 447, 450 (5th Cir. 1993)),
cert. denied, 115 S.Ct. 673 (1994).
5
United States v. United States Gypsum Co., 333 U.S. 364, 395
(1948).
6
election were substantively adequate is not disputed; thus the sole
issue presented is whether the Estate's initial effort was
sufficient to constitute "substantial compliance," thereby
entitling the Estate to perfect its election within ninety days
following notice from the IRS that the original election was
defective. Even though the parties assumed that this issue
presented a factual question, i.e., whether the facts of the case
constitute "substantial compliance"SQa term of art in Code
§ 2032A(d)(3)SQwe believe that, despite the fact that in other
contexts issues of substantial compliance, like substantial
completion, are indeed questions of fact, the question here
presented is one of law. Resolution of this fact/law dichotomy is
not important in this appeal, however, as we conclude that,
irrespective of whether we review the issue de novo or for clear
error, the Tax Court erred reversibly in determining that the
Estate's initial filing was in substantial compliance with the
requirements for a valid special use election.
B. Special Use Valuation
Generally, property subject to federal estate tax is returned
at its fair market value.6 One limited exception to that
generality is found in § 2032A of the Code, which provides an
alternative, more "taxpayer friendly" method for valuing some
family farms and closely held businesses.7 Courts have recognized
6
United States v. Cartwright, 411 U.S. 546, 550-51 (1973);
Treas. Reg. § 20.2031-1(b).
7
See Tax Reform Act of 1976, Pub. L. No. 94-455, § 2003(a),
90 Stat. 1520, 1856 (1976); I.R.C. § 2032A.
7
that, in enacting § 2032A, Congress sought to provide relief to
those who, when inheriting family farms, might otherwise be forced
to sell them to pay estate taxes calculated on "highest and best
use" values, which often exceed significantly the land's value for
farming purposes.8 In the hope of avoiding such a result and
helping to preserve family farms and other closely held businesses,
Congress allows qualifying property to be returned for estate tax
purposes at its actual (farm) use value rather than its fair market
value based on its highest and best use.9 As permission to elect
this so-called "special use valuation" constitutes an act of grace
or a special dispensation by Congress, the courts have strictly
construed § 2032A and its requirements.10
Briefly summarized, the conditions that must be met to qualify
for special use valuation are: The decedent must have been a
citizen or resident of the United States at the time of his death;
the property must be located in the United States; the value of the
8
See, e.g., McAlpine v. Commissioner, 968 F.2d 459, 460
(5th Cir. 1992) (noting that purpose of exception is to grant
relief to heirs); Estate of Thompson v. Commissioner, 864 F.2d
1128, 1133 (4th Cir. 1989) (same); see H.R. Conf. Rep. No. 94-1380,
94th Cong., 2d Sess. 21-22 (1976).
9
McAlpine, 968 F.2d at 460.
10
See, e.g., Martin v. Commissioner, 783 F.2d 81, 83-84 (7th
Cir. 1986) (construing strictly "qualified use" provision of
§ 2032A); Estate of Sherrod v. Commissioner, 774 F.2d 1057, 1062-67
(11th Cir. 1985) (construing strictly "material participation" and
"qualified use" tests of § 2032A), cert. denied, 479 U.S. 814(1986); Estate of Cowser v. Commissioner, 736 F.2d 1168, 1171 (7th
Cir. 1984) (adhering to precise language of § 2032A defining
"qualified heir"). Cf. Corn Products Ref. Co. v. Commissioner, 350
U.S. 46, 52 (1955) (construing narrowly term "capital assets" in
§ 117).
8
property must exceed specified percentages of the decedent's gross
estate and adjusted estate; the property must devolve to a
"qualified heir," who must be a member of the decedent's family;
and the decedent or a member of the decedent's family must have
been materially participating in the operation of the farm or
business at the time of the decedent's death and for five of the
eight years preceding his death.11
Although not as initial eligibility requirements, the Code
imposes two continuing conditions if the estate is to avoid
subsequent recapture of the tax savings produced by special use
valuation: The property's ownership must remain in the family and
must be used for the qualified use for at least ten years following
the decedent's death.12 The qualified successors must agree
contractually, at the time that the special use valuation election
is made, to keep the property in the family and to operate it for
the qualified use for the specified period.13 That contract must
be executed and filed with the estate tax return; and to ensure the
Commissioner's ability to accomplish recapture if necessary, the
heirs must bind themselves therein to be responsible personally for
11
Whalen v. United States, 826 F.2d 668, 669 (7th Cir. 1987);
Schuneman v. United States, 783 F.2d 694, 697 (7th Cir. 1986).
12
I.R.C. § 2032A(c).
13
I.R.C. § 2032A(c) and (d)(2). See, e.g., McAlpine,
968 F.2d at 460 (noting that heirs must continue to use property as
family farm or business for ten year period to avoid recapture of
tax savings); Bartlett v. Commissioner, 937 F.2d 316, 320 (7th Cir.
1991) (same); Prussner v. United States, 896 F.2d 218, 221 (7th
Cir. 1990) (discussing requirement that recapture agreement must be
filed for valid election).
9
additional tax in the event of premature disposition of the
property or cessation of qualified use. This contract, which must
be enforceable by the Commissioner under state law, is generally
referred to as a "Recapture Agreement."
The benefits of § 2032A do not appertain automatically just
because all prerequisites happen to coalesce: The estate must act
affirmatively to elect such treatment. Important to the instant
case are the mechanics of electing special use valuation, principal
among which are (1) checking the appropriate box or blank on the
estate tax return and completing Schedule N, thereby evidencing the
intention to make such an election, (2) completing and attaching to
the return a Notice of Election containing the information
specified in § 2032A and the applicable Regs.,14 and (3) as just
discussed, attaching a Recapture Agreement that has been signed by
all parties with interests in the property to be specially valued,
expressly consenting to the imposition of the additional tax and to
be personally liable to pay it in the event of a premature
disposition of the property or cessation of its qualified use.15
Thus a Notice of Election and a Recapture Agreement, validly and
completely executed and filed contemporaneously with the estate tax
return, are essential prerequisites if an estate that elects
special use valuation is to be in full compliance with § 2032A.
Not even the Executors contend that the Estate was in full
14
I.R.C. § 2032A(d)(1); Treas. Reg. § 20.2032A-8(a)(3).
15
I.R.C. § 2032A(a)(1)(B) and (d); Treas. Reg. § 20.2032A-
8(a)(3) and (c).
10
compliance when the 706 was filed; thus the need to determine if
the Estate was in substantial compliance.
Recapture Agreement
The 706 was not accompanied by any instrument labeled or
purporting to be a Recapture Agreement. Yet § 2032A(b)(1)(B) of
the Code makes abundantly clear that the Recapture Agreement, i.e.,
"the agreement described in subsection (d)(2)" is an integral and
indispensable element of a special use valuation election. The
legislative history of § 2032A confirms the essential nature of the
Recapture Agreement:
One of the requirements for making a valid
election is the filing with the estate tax
return [of] a written [recapture] agreement
signed by each person in being who has an
interest in any qualified real property with
respect to which the special use valuation is
elected. The [recapture] agreement must
evidence the consent of each of those parties
to the application of the recapture tax
provisions to the property.16
That the filing of a valid Recapture Agreement is indispensable has
also been recognized by the courts and in the Regs.17
The contents required for a valid Recapture Agreement are
specified in § 2032A(d)(2):
The agreement referred to in this paragraph is
a written agreement signed by each person in
being who has an interest (whether or not in
possession) in any property designated in such
16
H. R. Conf. Rep. No. 94-1380, 94th Cong., 2d Sess. 27
(1976).
17
See Bartlett, 937 F.2d at 320; Prussner, 896 F.2d at 222;
McDonald v. Commissioner, 853 F.2d 1494, 1495 (8th Cir. 1988),
cert. denied sub nom. Cornelius v. Commissioner, 490 U.S. 1005(1989); Treas. Reg. §§ 20.2032A-8(a)(3) and (c)(1).
11
agreement consenting to the application of
subsection (c) [imposition of the additional
estate tax] with respect to such property.18
By making the heirs personally responsible for any additional tax,
which is triggered either by a disposition of the property or
cessation of its qualified use within the statutory period, the
Recapture Agreement provides considerable assurance to the
Commissioner of collectibility. Treas. Reg. § 20.2032A-8(c) sets
forth the required contents of the Recapture Agreement in greater
detail than does the Code. Indeed, a model form of such an
agreement is available for those who care to avail themselves of
it.19 Among other things, the Recapture Agreement (1) must express
the consent of the heirs to be liable personally under Code
§ 2032A(c) in the event of early disposition of the property or
early cessation of qualified use; (2) must be binding under local
law on all parties with an interest in the property; and (3) must
designate an agent for the parties and endow such agent with
authority to act for all parties to the agreement in dealing with
the IRS.20
In addition to the in personam security obtained by the
Commissioner through the Recapture Agreement, in rem security is
garnered through the provisions of § 6324B of the Code, which
create a statutory lien on the subject property. This lien
attaches automatically at the time an election is filed under
18
I.R.C. § 2032A(d)(2).
19
Rev. Proc. 81-14, 1981-1 C.B. 669.
20
Treas. Reg. § 20.2032A-8(c).
12
§ 2032A, regardless of the enforceability or timeliness of filing
the Recapture Agreement.21
Obviously, the comprehensive statutory and regulatory scheme
just described envisions the combination of in personam of the
heirs and in rem responsibility of the property, not merely as
security for the collection of additional taxes but also to
constrain at least ten years of qualified ownership and qualified
use of the property. Personal liability of the heirs enhances the
likelihood that the property will be kept in the family and used
for qualified purposes, and that the Commissioner would be able to
recover the defaulted tax benefit if, by the time recapture is
triggered, the value of the property shall have so declined that
the § 6324B lien is then wholly or partially worthless. It is
beyond the authority of the courts, then, to say that alone the
lien would suffice: The heirs' agreement to be personally liable
for the tax consequences is equally indispensable, for "without the
heirs' signatures, the election on the original return may not
effectively bind the heirs."22
Notice of Election
The Notice of Election is the other document that must
accompany a timely filed estate tax return in which a special use
valuation election is made. Unlike the Recapture Agreement, which
here was omitted entirely, a Notice of Election did accompany
21
I.R.C.§ 6324B; McAlpine, 968 F.2d at 464.
22
McDonald v. Commissioner, 89 T.C. 293, 305 n. 31 (1987),
aff'd in part and rev'd in part, 853 F.2d 1494 (8th Cir.), cert.
denied sub nom. Cornelius v. Commissioner, 490 U.S. 1005 (1989).
13
Decedent's 706. All concede, however, that several of the required
contents of and attachments to this document were missing SQfive
out of fourteen, to be more precise.
Schedule N of the estate tax returnSQyet another document
required to be completed and included in connection with a special
use valuation electionSQcontains instructions which provide, inter
alia, that the return preparer must complete and attach the Notice
of Election. Those instructions are derived from Reg. § 20.2032A-
8(a)(3), which lists the fourteen specific items required for a
valid Notice of Election. The five items omitted from the instant
Notice of Election are: (1) information supporting the special
use values listed in the return, (2) written appraisals of the fair
market values of the properties, (3) the name, address, taxpayer
identification number, and relationship to the Decedent of each
person succeeding to an interest in the subject properties,
(4) value of the property interests being received by each such
successor, based on both fair market value and qualified use, and
(5) affidavits setting forth the activities constituting material
participation and identity of the participants in the qualified use
of the properties.
The Estate's Notice of Election was also deficient in regard
to the requirement that the signatures of all successors be
affixed: As noted earlier, only three of the five grandsons signed
the Notice; one did not sign by virtue of military service and
another simply did not sign, the Estate offering no explanation
other than that he was "not presently available." As a matter of
14
law, the Estate's cryptic, conclusionary statement on its Notice of
Election that "All requirements exist for special valuation of
qualified real property" adds nothing to the substantialitySQor
lack thereofSQof the Estate's compliance with the requirements for
making a valid election. Neither does Mr. Keith's signed statement
that he would undertake to obtain the missing signatures,
particularly given the fact that neither of the missing signatures
nor any of the other items missing from the Notice of Election were
submitted to the IRS between the time that the return was filed and
the time that the notice of deficiency disallowing special use
valuation was sent by the IRS and received by the Estate.
The record does not reflect the reason or reasons for the
Estate's omissions of so many of the substantive requirements23 for
a complete Notice of Election. Beyond the statement "explaining"
the missing signatures, the Estate offers nothing to justify the
omission of appraisals, affidavits, and other supporting
documentation in addition to the omitted Recapture Agreement;
neither does the Estate explain why nothing was done to supply the
missing pieces of the puzzle, as promised, until after the notice
of disallowance was received from the IRS. Whatever the
explanation for the omissions might be, it matters not; we deal
only with the facts directly affecting less-than-full compliance
with the election requirements, not with the excuses therefor,
particularly when, as here, none have been proffered except as to
23
We respectfully but firmly disagree with the Tax Court's
characterization of these omissions as "technicalities."
15
the signature of the grandson who was serving in the military at
the timeSQfor whatever that might be worth.
Substantial Compliance
It is undisputed that here the Notice of Election filed with
the 706 was incomplete, both as to content and signature, and that
no separate Recapture Agreement was filed with the 706. Clearly,
then, the Estate did not initially comply fully with the
requirements for electing special use valuation. As there was no
full compliance, then, whatever compliance was made must be found
to have been "substantial" under the applicable Regs. when the 706
was filed if the Estate is to be held entitled to perfect its
defective election.24 This case thus turns on the issue of
substantial compliance.
We have noted that when Congress adopted § 2032(A) as part of
the Tax Reform Act of 1976, it provided a special dispensation or
act of grace to a defined class of heirs and legatees who
gratuitously acquire family farms and some other closely-held
businesses under specified conditions and circumstances. In a
further act of grace Congress added subsection (d)(3) to Code
§ 2032(A) (effective retroactively to estates of decedents dying
after December 31, 1976) when it adopted the Deficit Reduction Act
(DEFRA) in 1984.25 Labeled "Modification of Election and Agreement
to be Permitted," subsection (d)(3) requires the Secretary of the
24
I.R.C. § 2032A(d)(3).
25
Deficit Reduction Act of 1984, Pub. L. No. 98-369,
§ 1025(a), 98 Stat. 494 (1984).
16
Treasury to promulgate procedures that would allow executors and
administrators a reasonable timeSQnot to exceed ninety daysSQto
bring flawed special use valuation elections into full compliance
if a timely election has been made and if it
substantially complies with the regulations
prescribed by the Secretary with respect to
such election, butSQ
(i) the notice of election, as filed, does not
contain all required information, or
(ii) signatures of 1 or more persons required
to enter into the [recapture] agreement
. . . . are not included on the agreement as
filed, or the agreement does not contain all
required information [.]26
As thus modified, the Code section itself, at least by strong
implication, requires that a Notice of Election and a Recapture
Agreement signed by at least one of the parties acquiring an
interest in the property must have been filed with the estate tax
return, and that a considerable amount of the required information
must have been included in or with those instruments.
"Substantial compliance" is not a defined term in § 2032A;
indeed, defining that term with precision would be a tall order for
the legislative draftsmen. We are, however, the beneficiaries of
some congressional guidance in the relevant legislative history
that accompanied DEFRA, reflecting the sense of Congress that any
permissible deficiencies in compliance with the requirements of a
valid election had to be minor:
The conferees wish to reiterate that, as under
the Senate amendment, perfection of notices of
election and of [recapture] agreements to
26
I.R.C. § 2032(A)(d)(3).
17
current use valuation elections is to be
permitted only in cases where the estate tax
return, as filed, evidences substantial
compliance with the requirements of the
Treasury Regulations. For example, merely
checking the applicable box on the federal
estate tax return that an election is being
made is not sufficient action by the estate to
secure the benefits of the current use
valuation provision. Both a notice of
election and [a recapture] agreement that
themselves evidence substantial compliance
with the requirements of the Regulations must
be included with the estate tax return, as
filed, if the estate is to be permitted to
perfect its election.27
That same conference report goes on to explain by example just how
minor the deficiencies must be to permit subsequent correction:
Illustrations of the type of information that
may be supplied after the initial filing of
the notice of election are omitted Social
Security numbers and addresses of qualified
heirs and copies of written appraisals of the
property to be specially valued . . . . To be
eligible for perfection, the [recapture]
agreement as originally filed must at a
minimum be valid under state law and must
include the signatures of all parties having a
present interest or a remainder interest other
than an interest having a relatively small
value. The right to perfect agreements is
intended to be limited to cases where, for
example, a parent of a minor remainderman,
rather than a guardian ad litem as required
under State law, signs the agreement.
Similarly, failure to designate an agent in
the agreement as filed may be corrected under
this provision.28
The significance of the quoted language, expressing the intent
of Congress to allow correction only for such hypertechnical
27
H.R. Conf. Rep. No. 98-861, 98 Cong., 2d Sess. 1240-41
(1984). (emphasis added).
28
Id. at 1241 (emphasis added).
18
glitches as the signing of the Recapture Agreement for a minor by
a parent when a guardian ad litem was required, is discussed below
when we address the "common sense" approach that we advocated under
similar circumstances in McAlpine v. Commissioner.29 More
significant to the present discussion, however, is the emphasized
portion of the foregoing quotation, explaining what is required if
a Recapture Agreement is to be susceptible of perfection under the
substantial compliance rubric: (1) validity and enforceability
under state law, and (2) signatures of all parties with a present
or remainder interest other than those of relatively small value.
Implicit beyond cavil is the obvious requirement that the original,
timely filed estate tax return in which the election is made must
be accompanied by an instrumentSQany instrument, regardless of
labelSQthat constitutes an enforceable contract under state law,
executed by those successors in interest who must be bound.
Demonstrating an admirable but unavailing bit of ingenuity,
counsel for the Estate would have us deem the agglomeration of
(1) a few designated provisions of the Will, (2) the incomplete
Notice of Election, and (3) his proffered interpretation of Texas
law, to be the legal equivalent of a Recapture Agreement sufficient
for purposes of substantial compliance. We must, however, reject
out of hand that specious bit of legal legerdemain. Neither in
form nor in substance, singly or in combination with the Will and
the Estate's (and the Tax Court's) version of the Texas law of
descent and distribution, can the instant Notice of Election be
29
968 F.2d 459 (5th Cir. 1992).
19
stretched to constitute an "agreement . . . valid under state law
. . . ." And if that were not enough, the Notice of Election,
which was filed with the 706, does not even bear the signatures of
"all parties having a present interest or remainder interest
. . ."SQa requirement for a Recapture Agreement to be eligible for
post hoc perfection. Assuming, arguendo, that the absence of the
signature of the grandson who was in military service were excused,
there still remains the unexcused omission of the signature of
another of the five grandsons.
Even if we could agree with the Tax Court's overly generous
characterization of the subject omissions as "technicalities," we
perceive them to be far more substantial than the "slightest
technicality" referred to by Senator Dixon of Illinois,30 which he
illustrated with two hypothetical examples: One featured a mother
who signed a Recapture Agreement for her minor children without
first having been appointed their guardian by a court; the second
featured a Recapture Agreement that had been signed by the mother
of a newly born infant but had not been signed by a duly appointed
legal guardian for that infantSQwho also had an interest in the
propertySQfor the simple reason that the executors were unaware of
the birth of that child. These were examples of defects that
Senator Dixon characterized as the kind of "simple technical flaws"
that should not destroy the election.31 Similar explanations and
examples of "technical" defects were provided by the staff of the
30
130 Cong. Rec. S8,700 (1984).
31
Id.20
Joint Committee on Taxation.32
Presupposed in the legislative history of § 2032A(d)(3) was
the timely filing of some agreement, binding under state law,
actually signed by or on behalf of all parties at interest (albeit
possibly by someone without technically sufficient credentials),
purporting to bind those parties personally to liability for
additional tax in the event of the occurrence of a disqualifying
event. In stark contrast, the only supporting document (other than
the Schedule N which was filed by the Estate with the 706) was the
Notice of Election, itself signed by only sixty percent in number
of the qualified heirs, lacking significantly in required (although
possibly curable) contents, but in no way implicating recapture and
in no way constituting a contract enforceable under state law.
In addition to the legislative history and the plain wording
of the Code and the Regs., the applicable jurisprudence strongly
supports the Commissioner's position while furnishing no
justifiable comfort to the Estate. We find three federal appellate
decisions especially instructive.
In the first of these, McDonald v. Commissioner,33 a widow's
state law disclaimers of farm land, one relating back to her
husband's death and another relating to property that would pass to
her children if she were to have predeceased her husband, made her
32
See Staff of Joint Comm. on Taxation, 98th Cong., 2d Sess.,
General Explanation of the Revenue Provisions of the Deficit
Reduction Act of 1984 1123-25. (Jt. Comm. Print 1984).
33
853 F.2d 1494 (8th Cir. 1988), cert. denied sub nom.
Cornelius v. Commissioner, 490 U.S. 1005 (1989).
21
children's participation in the election necessary as a matter of
law. But in the Notice of Election and the Recapture AgreementSQ
both filed timely with the Estate Tax ReturnSQthe widow was
erroneously identified as being the sole heir; and she alone signed
as such. Thus, despite the timely filed and properly executed
estate tax return, and despite the accompaniment of an otherwise
complete and legally sufficient Notice of Election and a similarly
qualified Recapture Agreement, the election was flawed by the
omission of the names and signatures of the widow's children.
Under circumstances considerably less blatant than those we
consider today, the attempt of the estate in McDonald to cure its
defective election under a claim of substantial compliance was
disallowed by the Eighth Circuit which held that, under the
statutory language, signatures could not subsequently be added to
an agreement that did not already bind "all parties taking an
interest in the property."34 The McDonald court, relying on the
language of the statute as well as the above noted legislative
history, found no substantial compliance, as neither the name nor
the signature of anyone with an interest in the property, was
affixed. The court concluded that "[t]he omission from the
recapture agreement of the signatures of all persons with an
interest in the property is not the type of slight technicality
envisioned by Congress when the 1984 amendment was enacted."35 We
are satisfied that the Eighth Circuit would have needed even less
34
Id. at 1497-98.
35
Id. at 1498.
22
time and fewer words to reach that conclusion under the facts
before us today: In McDonald, there was at least an otherwise
complete and timely filed Recapture Agreement that the court
nevertheless found to be ineligible for retroactive perfection
because none of the persons with an interest in the property had
signed it. Here, no Recapture Agreement (or any combination of
instruments and legal principles that could, by any stretch, be
deemed to suffice for a Recapture Agreement) was filed
contemporaneously with the 706 in which the election was made.36
The second special use valuation "substantial compliance" case
of recent vintage that we find instructive is our own McAlpine v.
Commissioner.37 The Estate urges us to apply the kind of "common
sense" flexibility here that we enunciated in McAlpine.38 Although
that "dog won't hunt" under the instant circumstances, which are so
distinguishable from those in McAlpine that they constitute a
material difference and are thus inapposite, McAlpine presents a
36
This is not mere speculation on our part: Shortly after
deciding McDonald, the Eight Circuit decided Foss v. United States,
865 F.2d 178 (8th Cir. 1989) and considered a situation almost
identical to that before us: The estate tax return reflected a
special use valuation election but was filed without either a
recapture agreement or a notice of election. In denying the estate
the right to correct these deficiencies under the "substantial
compliance" provisions of I.R.C. § 2032A(d)(3), the Foss court
concluded that there was no eligibility for perfection when
"nothing was filed with the return containing the substance of the
recapture agreement or the principal beneficiary's consent to be
personally liable for the recapture tax." Id. at 181.
37
968 F.2d 459 (5th Cir. 1992).
38
See id. at 464 ("We must give the statute a common sense
interpretation, with an eye towards protecting the family farm and
business as Congress intended.") (citing Estate of Thompson v.
Commissioner, 864 F.2d 1128, 1134 (4th Cir. 1989)).
23
case of life imitating art, in the incarnation of one of the
hypothetical illustrations described by Senator Dixon in the
legislative history of subsection (d)(3). The testator in McAlpine
bequeathed all of his interest in the eligible property to three
separate trusts, one for the benefit of each of three
grandchildren, one of whom was a minor. The mother of those
grandchildren was the trustee, and in each trust she was vested
with the discretionary power to distribute both income and
principal. In making a timely special use valuation election, the
return preparer dutifully attached a Recapture Agreement which was
binding under state law but was signed only by the beneficiaries'
mother as trustee. The Commissioner asserted the legal
positionSQlater proved to be correctSQthat the two major
beneficiaries and a court-appointed representative of the minor
beneficiary, not the mother as trustee, should have signed the
Recapture Agreement. Within ninety days following notice of these
defects, an amended Recapture Agreement was filed, signed by the
two major trust beneficiaries and by the minor beneficiary's
motherSQnot as trustee this time but as the minor's duly appointed
guardian ad litem.
In rejecting the Commissioner's continued disallowance of the
election after it was timely perfected, we factually and legally
distinguished the McAlpine situation from the facts considered in
prior jurisprudence in which compliance was not found to be
substantial because the timely filed Recapture Agreements had not
been signed by the right persons. In those earlier cases the
24
courts had reasoned that, as the taxpayers "did not have
reasonable, good faith arguments that the regulations did not
require what was omitted, their compliance with the Regs. was not
substantial and thus could not be perfected."39 In contrast, we
concluded that under the trust situation of McAlpine the law was
less than pellucid that the major beneficiaries and the legally
appointed representative of the minor beneficiarySQrather than the
trusteeSQwere the parties who were required to sign the Recapture
Agreement. We emphasized that the Regs. mentioned "trustees" when
referring to persons with interests in the property who were
required to sign, but did not mention trust beneficiaries. We
recognized the existence of a good faith argument under state law
that the signatures of beneficiaries were not required and that the
signature of the trustee alone would be sufficient. Even though we
held that the legal misunderstanding in McAlpine presented a
reasonable basis for permitting perfection under the substantial
compliance exception, we cautioned that we were also relying on the
absence of "evidence of fraud or dilatory or slipshod preparation
of the necessary documentation."40
We clearly viewed the McAlpine facts as presenting a close
call, yet the facts we analyzed under the good faith or "common
sense" approach there were much more favorable to the taxpayer than
39
Id. (distinguishing Prussner v. United States, 896 F.2d 218(7th Cir. 1990), McDonald v. Commissioner, 853 F.2d 1494 (8th Cir.
1988), Estate of Doherty v. Commissioner, 95 T.C. 446 (1990) rev'd
by 982 F.2d 450 (10th Cir. 1992), and Estate of Strickland v.
Commissioner, 92 T.C. 16 (1989)).
40
Id.25
those now before us: The McAlpine Recapture Agreement was timely
filed as an attachment to the estate tax return; classic per se
fiduciary relationships were involved; a party with legal authority
over all qualified property executed the Recapture Agreement,
thereby both assuming personal liability and signing de facto for
the beneficial owners of the property; and a serious, good faith
legal disagreement existed as to the identity of the party or
parties who were required to sign the Recapture Agreement. When
those characteristics are compared to the facts of instant case,
the distinguishing differences are obvious. Indeed, McAlpine's
"common sense" approach to statutory interpretation (not to factual
analysis) cuts against rather than in favor of a conclusion of
substantial compliance in the instant case. Furthermore, even
though there is not the first hint of fraud or intentional delay
here, the same cannot be said about "slipshod preparation of the
necessary documentation." Far from substantial compliance, the
documentation supporting the election in the instant case was at
most a lick and a promise; and even the "promise" remained
unfulfilled until after the Estate's hand was called by the IRS's
deficiency notice disallowing the election.
The third opinion we find persuasive was rendered by our
colleagues on the Seventh Circuit, sitting en banc. It provides
perhaps the best analysis of the instant problem under facts
closely analogous to those we are now considering. In Prussner v.
United States,41 post hoc perfection of a defective special use
41
896 F.2d 218 (7th Cir. 1990) (en banc).
26
valuation election was sought under the "substantial compliance"
provisions of § 2032A(d)(3). A duly executed estate tax return had
been timely filed; it was accompanied by a Notice of Election but,
as here, was devoid of a Recapture Agreement. Not unlike the
statement affixed to the Hudgins' 706 by Mr. Keith, a cover letter
accompanying the estate tax return in Prussner advised that a
Recapture Agreement would be submitted subsequently when signed by
the geographically scattered heirs. Unlike the "promise" in the
case sub judice, the Prussner promise was fulfilled a mere four
months later by the supplemental filing of a fully executed,
legally binding Recapture Agreement before the estate tax return
was ever audited. Construing the facts liberally in favor of the
taxpayer, the trial court treated the cover letter as a Recapture
Agreement, a holding reversed on appeal when the en banc Seventh
Circuit determined that the estate was ineligible for post-filing
perfection, irrespective of the cover letter. The Prussner court
treated the date of filing the timely estate tax return as the
"deadline" for filing a Schedule N, a Notice of Election, and a
Recapture Agreement, observing that courts have no authority to
vary deadlines fixed by Congress or by agencies exercising
delegated legislative powers.42 The court cautioned against
expansive, loose treatment of substantial compliance in the context
of § 2032A. After noting that little comfort or guidance could be
gained from prior Tax Court decisions on the subject of substantial
compliance, the Seventh Circuit admonished that:
42
Id. at 223.
27
The common law doctrine of substantial
compliance should not be allowed to spread
beyond cases in which the taxpayer had a good
excuse (though not a legal justification) for
failing to comply with either an unimportant
requirement or one unclearly or confusingly
stated in the regulations or the statute. So
conceived the doctrine is broader in scope,
but less forgiving, than section 2032A(d)(3).
It is not limited to the specific requirements
made curable by subsection (B)(i) and (B)(ii),
but there must be a showing that the
requirement is either unimportant or unclearly
or confusingly stated; no such showing is
required by those subsections . . . .
In this case a regulation the validity of
which is not challenged unequivocally required
the filing of a recapture agreement with the
return. The taxpayer's lawyer made no effort
to comply, and given his alternative remedies
SQmost simply, a request for an extension of
time in which to file the returnSQhe had no
excuse for the failure . . . . The Internal
Revenue Service cannot allow qualified-use
valuation until a recapture agreement is filed
because . . . the statute makes the filing of
such an agreement a condition of a valid
election. Until it is filed, the return is in
limbo. Failure to comply with the regulations
may also create confusion about the
irrevocability of the election. "Such an
election, once made, shall be irrevocable."
26 U.S.C. § 2032A(d)(1). When is it made, if
no recapture agreement is filed?43
We discern an obvious lesson from McDonald, Prussner and
McAlpine. During the decade since subsection (d)(3) was added to
§ 2032A by DEFRA, in not one case in which no Recapture Agreement
(or other contractually sufficient substitute, personally binding
the qualified heirs and enforceable under state law) had been
submitted contemporaneously with the estate tax return has
substantial compliance been found and post-filing perfection
43
Id. at 224-25. (emphasis added).
28
permitted. At least no such case has been cited to us by the
parties and we have found none independently. Consistent with that
history, we hold today that a special use valuation election can
never be in substantial compliance with the requirements of § 2032A
if the estate tax return in which the election is made is not
accompanied by a Recapture Agreement or some reasonable facsimile
thereof, signed by the holders of all interests (other than de
minimis) in the qualified assets, and personally binding the
interest holders under state law to be liable for tax deficiencies
in the event of disqualifying use or disposition of the property
during the statutory period.
C. The Tax Court Opinion
The Tax Court, in its "speaking opinion" from the bench, may
well have had in mind our admonition in McAlpine that "[w]e must
give the statute a common sense interpretation, with an eye towards
protecting the family farm and business as Congress intended."44
If so, the court read that admonition far too expansively. For
whether we here review the Tax Court's handling of the substantial
compliance issue de novo as an issue of law or for clear error as
a question of fact, we are "left with a firm and definite
conviction that a mistake has been committed."45 The Tax Court's
approach may best be analogized to a bankruptcy court's fashioning
44
McAlpine, 968 F.2d at 464 (citing Estate of Thompson v.
Commissioner, 864 F.2d 1128, 1134 (4th Cir. 1989)).
45
Anderson v. City of Bessemer City, N.C., 470 U.S. 564, 573
(1985) (quoting United States v. United States Gypsum Co, 333 U.S.
364, 395 (1948)).
29
unauthorized remedies under the banner of equity.46 Confronted here
with a McAlpine-proscribed "slipshod preparation of the necessary
documentation," the Tax Court faced what we have now demonstrated
to have been an impossible task if it were to find substantial
compliance despite the total absence of a Recapture Agreement.
For, as recognized by consistent jurisprudence, failure timely to
file a Recapture Agreement bars a finding of substantial
compliance. That bar looms even more impenetrable here in light of
the Estate's additional omissions of such proportion as appraisals
of the property and substantiation of the method used for
determining special value based on qualified use.47
Neither can the Tax Court's holding be sustained by its
reliance on those portions of the Will to which that court adverts.
The Tax Court's conclusion that particular Will provisions "provide
adequate assurances" to the Commissioner is simply wrong. Indeed,
they provide the Commissioner no legal assurance whatsoever. In
the total absence of a Recapture Agreement and in the face of an
otherwise substantially defective election, we can conceive of no
way for the Will to afford the Commissioner the ability to recover
from the heirs personally in the event of a breach. Equally
unavailing is the Tax Court's expressed but unsupported,
46
See, e.g., Matter of Oxford Management, Inc., 4 F.3d 1329,
1334 (5th Cir. 1993) ("The ``statute does not authorize the
bankruptcy courts to create substantive rights that are otherwise
unavailable under applicable law, or constitute a roving commission
to do equity.'") (quoting United States v. Sutton, 786 F.2d 1305,
1308 (5th Cir. 1986)).
47
See Estate of Strickland v. Commissioner, 92 T.C. 16, 28
(1989).
30
conclusional "belief" that:
Texas law would recognize the testator's intent in that
regard [non-alienation and affirmative ranch use for ten
years] and hold and bind the beneficiaries to those
provisions . . . and on the totality of the evidence in
this case, establishes effectively a constructive
agreement and legally binding commitment among the
beneficiaries that they will comply with the requirements
of the special-use valuation statutes . . . .
We are not convinced; and neither the Estate nor the Tax Court has
cited us to Texas authority in support of such a proposition.
III
CONCLUSION
We follow constant jurisprudence, as reflected by the
decisions of every court that has directly addressed the issue, in
holding that there can be no substantial compliance with the
requirements of Code § 2032A without, inter alia, the
contemporaneous filing of a Recapture Agreement or its equivalent.48
Thus we hold that the Tax Court reversibly erred in finding that
the Estate's special use value election was in substantial
compliance with the requirements of the Code and the Regs. and
allowing perfection of the flawed election. We therefore reverse
the Tax Court and remand this case to it for the limited purpose of
entering a judgment in favor of the Commissioner, rejecting the
Estate's petition for redetermination, and reinstating the
deficiency assessed by the Commissioner, modified to any extent
48
We do not imply that there must be a separate, free-
standing contract, labeled "Recapture Agreement"; indeed, we can
envision inter alia a single instrument serving as both the Notice
of Election and the Recapture Agreement, as long as the substantive
contents and legal requirements for both are present.
31
necessary to reflect precisely the correct values and the
appropriate estate taxes and interest due.
REVERSED and REMANDED.
32