McAlpine v. C.I.R.

IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
No. 91-4699
ESTATE OF MALCOLM McALPINE, JR., Deceased,
GERALDINE McALPINE, Independent
Executrix and JOCELYN McALPINE
GREEMAN, Independent Executrix,
Petitioners-Appellees,
versus
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellant.
Appeal from the Decision of the United States Tax Court
( August 4, 1992 )
Before HIGGINBOTHAM and DUHÉ, Circuit Judges, and HARMON, District
Judge.*
HIGGINBOTHAM, Circuit Judge:
This case involves the special use valuation provision for
family farms and businesses under the federal estate tax. The
estate elected special use valuation for a qualified family ranch,
but failed to obtain the signatures of trust beneficiaries who had
an interest in the property. The Tax Court held that the estate
nevertheless "substantially complied" with Treasury regulations
governing the election of special use valuation, and was therefore
*
District Judge of the Southern District of Texas, sitting
by designation.
entitled to perfect its election under 26 U.S.C. § 2032A(d)(3).1
We affirm.
I.
The federal government generally imposes estate taxes on real
property according to its fair market value, as measured by its
highest and best use. § 2031(a). Congress has created an exception
to the rule, however, for family farms and businesses. The purpose
of the exception is to grant relief to heirs of such properties who
might otherwise find the financial burden imposed by the estate tax
so great that it would be necessary to sell the farm or business to
pay the tax. Estate of Thompson v. Commissioner, 864 F.2d 1128,
1133 (4th Cir. 1989); Mangels v. United States, 828 F.2d 1324, 1326
(8th Cir. 1987); H.R. Rep. No. 94-1380, 94th Cong., 2d Sess., 21-22
(1976). Under § 2032A, estates that include qualified real
property may elect to value the property on the basis of its actual
use instead of its most profitable use. The provision thus allows
heirs of qualified farms and businesses to write down the property
they inherit and escape higher taxation based on actual market
values. There are strings attached, however. The heirs must
continue to use the property as a family farm or business for at
least ten years following the decedent's death to avoid recapture
of part of the tax savings resulting from special use valuation.
Section 2032A(c); Bartlett v. Commissioner, 937 F.2d 316, 320 (7th
Cir. 1991).
1
All statutory references in this opinion are to the
Internal Revenue Code, codified at chapter 26 of the U.S. Code.
2
Electing special use valuation under § 2032A is a fairly
laborious process. The Secretary has prescribed regulations
governing the substantive qualifications for special use valuation
as well as the procedures for making an election. See 26 C.F.R.
§ 20.2032A-3 -- A-8 (1991). As a procedural matter, a qualified
estate must attach to its estate tax return a notice of election
including, inter alia, the decedent's name and taxpayer
identification number, the relevant qualified use, the items of
real property to be specially valued, the fair market value of this
real property and its value based on the qualified use, the methods
used in determining the special value based on qualified use, and
the names, addresses and relationship to the decedent of each
person taking an interest in specially valued property. 26 C.F.R.
§ 20.2032A-8(a)(3). The estate must also attach a recapture
agreement expressing consent to personal liability for or
collection of any additional estate tax which may later be imposed
if the property is put to uses other than the qualified ones. See
§ 2032A(c); 26 C.F.R. § 20.2032A-8(c)(1); Prussner v. United
States, 896 F.2d 218, 221 (7th Cir. 1990). The recapture agreement
must be signed and executed by all parties in being who have any
interest in the property designated in the agreement for special
use valuation. § 2032A(d); 26 C.F.R. § 20.2032A-8(c)(1). An
interest in the property is an interest which, as of the date of
the decedent's death, can be asserted under applicable local law so
as to affect the disposition of the specially valued property by
the estate. 26 C.F.R. § 20.2032A-8(c)(2). Such persons as owners
3
of remainder and executory interests, joint tenants and holders of
other undivided interests in the property, and trustees of trusts
holding an interest in the property are specifically included among
those who must sign and execute the recapture agreement. Id.
In 1984, Congress amended § 2032A to permit correction of
certain defects in notices of election of special use valuation and
the accompanying recapture agreements. The purpose of the
amendment was to prevent the Commissioner from using slight
technical defects in these documents to prevent otherwise qualified
taxpayers from taking advantage of the special use valuation
provided in the statute. McDonald v. Commissioner, 853 F.2d 1494,
1498 (8th Cir. 1988); 130 Cong. Rec. S4318 (1984). Section
2032A(d)(3) therefore provides that:
The Secretary shall prescribe procedures which provide
that in any case in which --
(A) the executor makes an election under paragraph
(1) [the special use valuation election] within the time
prescribed for filing such election, and
(B) substantially complies with the regulations
prescribed by the Secretary with respect to such
election, but --
(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 agreement described in paragraph (2)
[the recapture agreement] are not included on the
agreement as filed, or the agreement does not contain all
required information,
the executor will have a reasonable period of time (not
exceeding 90 days) after notification of such failures to
provide such information or agreements.
"Substantial compliance" is not defined in the Code, and the
Secretary has yet to prescribe procedures governing this matter.
It is left to the courts to determine whether a taxpayer has
4
substantially complied with the applicable regulations such that
perfection of an election is allowed.
Malcolm McAlpine left his interest in a family ranch to three
discretionary spendthrift trusts for the benefit of his three
grandchildren, ages 22, 20 and 9 at the time of his death. Their
mother was designated trustee and was given the power to distribute
income and corpus to the beneficiaries for their health,
maintenance, support, and education as she saw fit. The trusts
contained "spendthrift clauses" prohibiting the beneficiaries from
transferring their interests in the trusts by assignment, sale,
pledge, encumbrance or charge, and preventing the beneficiaries'
share of trust income or principal from being subjected to or
applied to the payment of their debts. The trusts were to
terminate and all undistributed corpus was to be distributed to the
beneficiaries when they reached age thirty-five. The trustee was
to hold and manage the trust property with all the powers given to
trustees under the Texas Trust Act.
On its estate tax return, McAlpine's estate elected to value
the decedent's share of the family ranch according to the special
use valuation provision of § 2032A.2 It is undisputed that the
ranch is qualified real property within the meaning of this
statute. It is also undisputed that a properly documented and
completed notice of election was timely filed along with the estate
2
As a result of the election, the decedent's share of
the ranch would be valued for estate tax purposes at $
577,602.25, rather than at its fair market value of $
1,327,602.25.
5
tax return. A recapture agreement was attached, signed by
McAlpine's daughter as trustee of the three spendthrift trusts
holding an interest in the property. The names and addresses of
the three beneficiaries were listed on the agreement, as well as on
the notice of election. The beneficiaries of the trusts did not
sign the recapture agreement, however.
The Internal Revenue Service notified the estate that the
recapture agreement was invalid because it had not been executed by
the beneficiaries of the trusts. Within ninety days, the estate
filed an amended notice of election and an amended recapture
agreement signed by all the trust beneficiaries, except for the
nine-year-old, whose signature was made by her mother as guardian
ad litem. The Service nevertheless asserted that the election
could not be perfected under § 2032A(d)(3) because substantial
compliance with applicable regulations requiring all parties with
an interest in the qualified property to execute the recapture
agreement required the beneficiaries' signatures. It accordingly
found a deficiency in the federal estate tax of $333,363.24. The
estate petitioned for a redetermination in the Tax Court, which
found the estate in substantial compliance despite the omission of
the signatures. Perfection was therefore proper. The Commissioner
appeals.
We agree with the Tax Court that McAlpine's estate was
entitled to perfect its election of special use valuation under
§ 2032A(d)(3). By the statute's explicit terms, omitting required
signatures from a recapture agreement is the kind of defect that
6
can be cured by the estate within ninety days of notification of
the error. Here the trustee of the spendthrift trusts that
inherited the qualified property signed the agreement, as
explicitly required in 26 C.F.R. § 20.2032A-8(c)(2), but the
beneficiaries of the trusts did not. As long as the estate
"substantially complied" with the Secretary's regulations, the
statute allows correction of the oversight.
As the Seventh Circuit has noted, the decisions of the Tax
Court regarding the substantial compliance rule are not
particularly enlightening. See Prussner, 896 F.2d at 224.
Distinctions between "essential" requirements and "procedural or
directory" requirements, see, e.g., Estate of Strickland v.
Commissioner, 92 T.C. 16, 29 (1989), do not provide us with much
guidance as to when the omission of signatures can be excused.
Without attempting to announce a rule applicable in all cases, we
think substantial compliance is achieved where the regulatory
requirement at issue is unclear and a reasonable taxpayer acting in
good faith and exercising due diligence nevertheless fails to meet
it. See Prussner, 896 F.2d at 224-25 (substantial compliance
doctrine applies where requirement is unclearly or confusingly
stated). Congress did not intend that estates be denied special
use valuation when despite their best efforts, they fail to achieve
perfect compliance with regulations that are subject to conflicting
interpretations.
The Tax Court's decision was based largely on the idea that
the purposes of § 2032A(d)(3) would not be fulfilled by precluding
7
perfection here, where it is not plain in the regulations whether
the signatures of the trust beneficiaries are in fact required. We
agree. The beneficiaries are qualified heirs who have an interest
in the property for the purposes of special use valuation, see
§ 2032A(e)&(g), but it is not entirely clear whether their
signatures are required on the recapture agreement under
§ 2032A(d)(2). The Secretary's regulations say that an interest in
the property for the purposes of signing the recapture agreement
"is an interest which, as of the date of the decedent's death, can
be asserted under applicable local law so as to affect the
disposition of the specially valued property by the estate." 26
C.F.R. § 20.2032A-8(c)(2). Trustees are explicitly mentioned, but
trust beneficiaries are not.
The beneficiaries of a trust have the ability to affect the
disposition of the assets of the trust only insofar as they have
the right to sue to force the trustee to fulfill its fiduciary
obligations. The signatures of trust beneficiaries are arguably
required on this basis. This result is hardly obvious from the
plain language of the regulations, however. Trustees are generally
empowered to take such actions as are necessary or appropriate to
carry out the purposes of the trust, including leasing or selling
the trust property. See Restatement (Second) of Trusts §§ 186-90
(1959). Under the terms of the trust agreement in this case, the
trustee has all powers given to trustees under Texas law, and may
manage, handle, invest, reinvest, exchange, lease, dispose of,
develop, operate, use, mortgage or pledge all or any part of the
8
property in the trust. See McAlpine Will § (h); Tex. Prop. Code
§ 113.001-.024. The trustee thus has the power to decide whether
the trust should continue to put the property to a qualified use--
that is, whether it would remain a family operated ranch. It is
also significant that these were spendthrift trusts, so that the
beneficiaries could not alienate their interests in the trusts by
assigning, selling, or pledging them. The trusts would not
terminate until after the expiration of the ten year period during
which the property was required to maintain its character as a
family ranch to avoid recapture taxes. In sum, although the
beneficiaries are qualified heirs, they have little control over
how the qualified property is used and could not transfer or
dispose of their interests in the property within the relevant ten
year period. There is at least a good faith argument that the
signature of the trustee was sufficient and the beneficiaries'
signatures were not required. Under these circumstances, we think
Congress intended to allow the estate to perfect its election by
supplying the beneficiaries' signatures within ninety days of
notification that the Service considered them necessary.
The Commissioner urges that Congress was not so generous to
estates that omit required signatures as the plain language of
§ 2032A(d)(3) might suggest. He relies heavily on a passage in the
legislative history of the provision which says that
[t]o be eligible for perfection, the 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
9
where, for example, a parent of a minor remainderman,
rather than a guardian ad litem as required under State
law, signs the agreement.
H.R.Conf.Rep. No. 861, 98th Cong., 2d Sess. 1241,
reprinted in 1984 U.S.Code Cong. & Admin. News 1445,
1929.
The argument is that because the interests of the trust
beneficiaries here cannot be characterized as being of "relatively
small value," the omission of their signatures indicates that the
recapture agreement is not eligible for perfection.
We concede that this passage lends some support to the
Commissioner's position. But it is, after all, a statute that we
are interpreting, not a conference report. See Prussner, 896 F.2d
at 228. Had Congress intended to limit the addition of signatures
to those of individuals who have only interests of a relatively
small value, it could have said so in the statute. It did not.
Furthermore, the example provided in the conference report does not
jibe with the "small value" theory. A minor remainderman may have
a large financial interest in qualified property. The failure to
obtain the signature of a guardian ad litem on behalf of the minor
is excused because it is a good faith error, not because the
interest of the minor is of small value. See Cong. Rec. S4318
(daily ed. Apr. 11, 1984) (remarks of Senator Dixon). In fact, we
think the error provided as an example of what may be excused is
the same type of error that the Commissioner argues is inexcusable
in this case--a reasonable misunderstanding as to who has the legal
authority to sign on behalf of others in a fiduciary relationship.
Because the conference report itself offers contradictory bases for
10
determining when an estate has substantially complied despite the
omission of signatures, we accord it less weight.
The Commissioner also refers to the General Explanation of the
Revenue Provisions of the Deficit Reduction Act of 1984, 98th
Cong., 2d Sess. (Jt. Committee Prt. 1984). This document indicates
that perfection is proper only for "mistakes that were reasonable
in light of the circumstances existing at the time the elections
were made." Id. at 1123. As we have explained, we think the
mistake by McAlpine's estate falls into this category, so this
citation is of little help to the Commissioner. Other examples of
curable signature mistakes are provided in this document--when the
existence of an heir is unknown at the time the estate tax return
is filed, and when a tenant-in-common with the decedent fails to
sign the recapture agreement. Id. at 1124. The Commissioner does
not explain why obtaining the signature of a trustee but omitting
the signatures of the beneficiaries is different in kind from these
others.
We recognize that the courts have on several occasions refused
to allow estates to take advantage of § 2032A(d)(3) on the ground
that the estate had not substantially complied with the applicable
regulations. See, e.g., McDonald, 853 F.2d at 1498 (omission of
signatures of all persons with an interest in the property is not
substantial compliance); Prussner, 896 F.2d at 223-24 (failure to
attach a recapture agreement at all is not substantial compliance),
Strickland, 92 T.C. 17 (failure to substantiate method used for
determining special value based on qualified use is not substantial
11
compliance); Estate of Doherty v. Commissioner, 95 T.C. 446 (1990)
(failure to obtain appraisal before filing return is not
substantial compliance). We think this case is different. In the
cases where courts have found that an error precluded a finding of
substantial compliance, the taxpayers did not have reasonable, good
faith arguments that the regulations did not require what was
omitted. Furthermore, the degree to which the taxpayers satisfied
the regulatory requirements was not as great in the other cases as
it is here. McAlpine's estate supplied all the necessary
information, and the trustee signed the recapture agreement,
binding the trusts. The beneficiaries' names and addresses were
included. The only thing missing was their signatures. There is
no evidence of fraud or dilatory or slipshod preparation of the
necessary documentation. We must give the statute a common sense
interpretation, with an eye towards protecting the family farm and
business as Congress intended. Estate of Thompson, 864 F.2d at
1134. On the facts of this case, it was not an unreasonable
mistake for the estate to fail to obtain the signatures of the
trust beneficiaries.
We do not think our holding jeopardizes the Commissioner's
ability to recapture taxes when specially valued property is put to
non-qualifying uses after an election.3 The signing trustee
3
Of course, the estate added the signatures of the
beneficiaries in this case, so the government is fully protected.
The Commissioner's argument is that allowing perfection in this
situation will encourage others to omit the signatures of trust
beneficiaries, reap the advantages of special use valuation, and
then devote the property to non-qualifying uses without fear of
recapture tax liability.
12
assumed personal liability for any recapture taxes later imposed.
The government may therefore sue the trustee for recapture taxes if
necessary. See Restatement (Second) of Trusts § 262 (1959). The
government can also reach trust property directly by a proceeding
in equity to the extent it has benefited the estate, or if the
trustee is insolvent or absent. Id. §§ 268, 269. Furthermore, the
act of filing an election under § 2032A gives the United States a
lien on the qualified real property that continues until the
recapture tax liability is satisfied or has become unenforceable
through lapse of time. § 6324B. The recapture agreement is not a
prerequisite to the lien. The Commissioner's fears that he will be
unable to recapture taxes from trust beneficiaries whose failure to
sign recapture agreements goes undetected seem groundless.
In sum, we are persuaded that McAlpine's estate was entitled
to perfect its election of substantial use valuation under
§ 2032A(d)(3). In light of our conclusion, it is unnecessary to
consider the applicability of § 1421.
AFFIRMED.
13