Estate A. Tamulis v. CIR

In the
United States Court of Appeals
For the Seventh Circuit
____________
No. 06-4141
ESTATE OF ANTHONY J. TAMULIS,
Petitioner-Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.
____________
Appeal from the United States Tax Court.
No. 20721-03.
____________
ARGUED OCTOBER 26, 2007—DECIDED NOVEMBER 29, 2007
____________
Before POSNER, FLAUM, and ROVNER, Circuit Judges.
POSNER, Circuit Judge. This appeal involves the tax
treatment of a charitable remainder trust—a trust in which
the income goes to individuals during their lifetime (or
some other period) but what remains after their rights
expire goes to charity. Until 1969 the estimated present
value of the remainder was what was deductible from the
federal estate tax. But that year, concerned that the
trustee might invest the trust’s assets in a way calculated
to maximize current income, with the result that when
finally received by the charity the remainder would be
worth less than the estimated actuarial value on which
2 No. 06-4141
the deduction from estate tax had been based, Congress
provided (so far as bears on the present case) that to obtain
the deduction the settlor would have to create the trust
in the form of a “charitable remainder unitrust.” This is
a trust in which no more than a specified percentage
of the fair market value of the trust’s assets (as deter-
mined each year), for a specified period, can go to the
noncharitable beneficiaries; the rest belongs to a charity or
charities designated in the trust. 26 U.S.C. § 664(d)(2).
Congress later created a safety valve by providing that a
charitable remainder trust that was not in the unitrust
form could, if changed to that form, qualify for the deduc-
tion. But if the change that would be required to do this
would not just be the correction of some merely technical
error in the original trust instrument, then “a judicial
proceeding [must be] commenced to change [into the
unitrust form any interest for which the charitable de-
duction would be allowable were the trust a unitrust] not
later than the 90th day after—(1) if an estate tax return
is required to be filed, the last date (including extensions)
for filing such return.” 26 U.S.C. § 2055(e)(3)(C)(iii).
Father Tamulis, a Catholic priest, died in 2000, leaving
an estate of $3.4 million. His will left the bulk of his estate
to a living trust that he had created. The trust was to
continue for the longer of 10 years or the joint lives of
Tamulis’s brother and the brother’s wife. During that
period they would have a life estate in a house owned by
the trust and the trust would pay the real estate taxes on
the house. The net income of the trust, as “determined in
accordance with normal accounting principles,” would go
to two of the brother’s and sister-in-law’s grandchildren
(that is, Tamulis’s grandnieces), minus $10,000 a year,
which would go to their third child until she graduated
No. 06-4141 3
from medical school. Upon the termination of the trust
the assets would pass to a Catholic diocese.
The estate tax return, filed in 2001, claimed a charitable
deduction of $1.5 million, represented to be the present
value of the charitable remainder, which was described
on the return as the “residue following 10 year term cer-
tain charitable remainder unitrust at 5% quarterly pay-
ments to two grand nieces.” In each of the years 2001
through 2004, the trust distributed no more than 5 percent
of the fair market value of the trust’s assets, as valued
at the beginning of each year, to the grandnieces and
for the payment of the real estate taxes on their parents’
home. The Internal Revenue Service refused to allow
the charitable deduction. The charitable remainder, as
defined in the trust instrument, was not a charitable
remainder unitrust as defined in the Internal Revenue
Code. In particular, the trust instrument did not specify
either a fixed dollar amount, or the percentage of the trust’s
fair market value, that would go to the income beneficia-
ries—to the grandnieces in cash and to their parents in
the form of a life estate in the house and payment of the
real estate taxes on it, which would be paid out of the
trust’s income. This was a fundamental defect, corrigible
only by a judicial proceeding to reform the trust, filed
within 90 days after the estate tax return was due.
The trustee (who was also the executor of Father
Tamulis’s will) and the diocese realized that there was a
problem. But more than eight months elapsed before the
executor prepared a complaint to file in an Illinois
state court (the trust is governed by Illinois law) to reform
the trust. And for unexplained reasons the complaint
was never filed. Instead, in 2003 the executor circulated
to the income beneficiaries a proposed reformation of the
4 No. 06-4141
trust to bring it into compliance with the Code. But the
third grandniece did not sign it, and so the trust has never
been reformed, with or without a judicial proceeding,
although the trustee continues to administer it in accor-
dance with the requirements of the Code, as her predeces-
sor (the original trustee, who has died) had said in the
estate tax return that he was doing. Her argument, re-
jected by the Tax Court and renewed before us, is that
the statement in the return, coupled with the trustee’s
continued administration of the trust as if it were a quali-
fied unitrust, should be deemed substantial compliance
with the Code, although she concedes that it is not literal
compliance.
There is a doctrine of substantial compliance with the
often intricate and obscure provisions of the Internal
Revenue Code. We have criticized the Tax Court’s articula-
tion of the doctrine for formlessness, and, noting that
the courts of appeals do not defer to the legal rulings
of that court any more than they do to the rulings of a
district court, have ruled that the “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 confus-
ingly stated in the regulations or the statute.” Prussner v.
United States, 896 F.2d 218, 224 (7th Cir. 1990) (en banc);
see also Volvo Trucks of North America, Inc. v. United States,
367 F.3d 204, 209-10 (4th Cir. 2004); Estate of Hudgins v.
Commissioner, 57 F.3d 1393, 1404-05 (5th Cir. 1995).
Tamulis’s charitable remainder trust flunks this test. The
executor-trustee, represented by counsel, as he was, and
well aware that a substantial tax deduction was at stake,
had no excuse for failing to bring the required judicial
No. 06-4141 5
proceeding to reform the trust. The requirement is not
unimportant; it protects against efforts to bend trust law
to get a tax benefit. Nor is the requirement stated unclear-
ly or confusingly in the Code or in any regulation—it is
perfectly clear. Until the trust was reformed, compliance
with the spirit of the Code’s provisions dealing with
charitable remainder trusts had depended largely on the
good faith of the trustee; had Congress thought this
enough it would not have amended the Code as it did
in 1969.
Nor can the trustee get mileage from the fact that the
deduction for a charitable remainder unitrust is made to
depend on the taxpayer’s being able to obtain a remedy
from a state court (in this case, an Illinois state court). It
is true that in all likelihood she could not have not obtained
the remedy from a federal court. The “probate exception”
to federal jurisdiction, on which see, e.g., Marshall
v. Marshall, 547 U.S. 293 (2006); Struck v. Cook County
Public Guardian, No. 07-2420, 2007 WL 4145845 (7th Cir.
Nov. 26, 2007); Jones v. Brennan, 465 F.3d 304 (7th Cir.
2006), would doubtless bar the way; perhaps Article III of
the Constitution, as well. For under Illinois law the
reformation of a trust to take advantage of the charitable
remainder deduction requires unanimous consent of the
beneficiaries, Charitable Trust Tax Law Conformance
Act, 760 ILCS 60/1(2); In re Estate of Bishop, 468 N.E.2d
506 (Ill. App. 1984), and the trustee who seeks reformation
in a judicial proceeding is thus not suing anyone. So there
would be no case or controversy within the meaning
of Article III unless the Internal Revenue Service inter-
vened to oppose the reformation in order to thwart the
charitable deduction and by doing so converted the
proceeding to an adversary one and thus a case or contro-
6 No. 06-4141
versy. (The Tax Court is not an Article III court, but it has
not been authorized to reform wills or trusts.)
Even if, no federal forum being available, the state
whose law governed the trust did not authorize a pro-
ceeding to convert a charitable remainder trust to a charita-
ble remainder unitrust, that omission—though closing
the only path to qualifying for the deduction—would
deprive the state’s residents of the federal tax benefit.
Congress has made the benefit dependent on state law,
and there is no doubt of its power to do so. Nothing
is more common than for tax benefits to depend on state
law; a state that does not permit 14-year-olds to marry
deprives them of access to the benefits of filing a
joint return. But Illinois law does authorize a judicial
proceeding to reform a will, e.g., Bangert v. Northern Trust
Co., 839 N.E.2d 640, 646-47 (Ill. App. 2005); In re Estate of
Bishop, supra, 468 N.E.2d at 506, as indeed, as far as we
know, every other state does. See Restatement (Second) of
Trusts § 259 and comment a (1959). So there was nothing
to prevent the trustee from bringing the trust into com-
pliance with the requirements of the Internal Revenue
Code for obtaining the charitable remainder deduc-
tion—except that, as we mentioned, Illinois does not
allow a trust to be reformed for purposes of qualifying
for the deduction unless all the beneficiaries of the trust
consent. This is a significant protection for trust beneficia-
ries (though it could give rise to high transaction costs,
given the power of holdouts in any situation in which
unanimity is required for action, not to mention com-
plications introduced when beneficiaries are minors or
unborn), especially in this case, where no judicial pro-
ceeding to reform the trust was instituted. Neither the
(federal) requirement of filing a state judicial proceeding
if the state permits, nor the (state) requirement of unani-
No. 06-4141 7
mous consent of beneficiaries, can be deemed unimportant
or unclear, and therefore the doctrine of substantial
compliance cannot be used to excuse a failure to comply
with them.
When the conditions for applying the doctrine are not
satisfied, it makes compellingly good sense to hold a
taxpayer to the requirements of the tax code, as the
courts have held in cases comparable to this one, e.g.,
Bartlett v. Commissioner, 937 F.2d 316, 321-22 (7th Cir. 1991);
Estate of Hudgins v. Commissioner, supra, 57 F.3d at 1404-05;
In re Estate of Lucas, 97 F.3d 1401, 1404-08 (11th Cir. 1996);
Credit Life Ins. Co. v. United States, 948 F.2d 723, 726-28 (Fed.
Cir. 1991), although they do not involve charitable re-
mainder trusts. The doctrine of substantial compliance
“seek[s] to preserve the need to comply strictly with
regulatory requirements that are important to the tax
collection scheme and to forgive noncompliance for
either unimportant and tangential requirements or re-
quirements that are so confusingly written that a good
faith effort at compliance should be accepted.” Volvo
Trucks of North America, Inc. v. United States, supra, 367
F.3d at 210; see generally Michael B. Lang & Colleen A.
Khoury, Federal Tax Elections § 2.26 (1991, and 1996 Cum.
Supp.). The doctrine is therefore inapplicable to this case.
AFFIRMED.
A true Copy:
Teste:
_____________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-02-C-0072—11-29-07