REVISED May 21, 1997


                 UNITED STATES COURT OF APPEALS
                      For the Fifth Circuit



                          No. 95-60541



               ESTATE OF ALTO B. CERVIN, Deceased,
                   Bennett W. Cervin, Executor,
            & Nita-Carol Cervin Miskovitch, Executor,

                                            Petitioner-Appellant,


                             VERSUS


                COMMISSIONER OF INTERNAL REVENUE,


                                             Respondent-Appellee.



             Appeal from the United States Tax Court

                           May 9, 1997


Before POLITZ, Chief Judge, and SMITH and DUHÉ, Circuit Judges.

DUHÉ, Circuit Judge:

     The Estate of Alto B. Cervin petitioned the United States Tax

Court for a redetermination of a federal estate tax deficiency

asserted against it by the Internal Revenue Service.    The alleged

deficiency was based upon a determination by the Commissioner that

(1) the decedent’s gross estate should include one hundred percent

of the proceeds of three whole life insurance policies, and (2)
the estate was not entitled to a twenty-five percent discount with

respect to the valuation of certain real property.       The Tax Court

held that (1) the gross estate includes one hundred percent of the

proceeds of the life insurance policies, and (2) the estate was

entitled to a twenty percent discount with respect to the valuation

of   the   real   property.   The   estate   unsuccessfully   moved   for

litigation costs.       It now appeals, asserting that only fifty

percent of the proceeds of the life insurance policies should be

included in the gross estate and that it is entitled to litigation

costs pursuant to section 7430 of the Internal Revenue Code.

      We hold that the decedent’s gross estate includes only fifty

percent of the proceeds of the three life insurance policies, and

that the estate is entitled to reasonable litigation costs.           Thus

we reverse the Tax Court’s decision and remand to the Tax Court for

a determination of such costs.

                              BACKGROUND

      Alto B. Cervin (“decedent”) and Manita Cervin were husband and

wife, and both were domiciled in Texas.           The couple had two

children, Bennett W. Cervin and Nita-Carol Cervin Miskovitch, who

are the co-executors of the Estate of Alto B. Cervin.

      Alto and Manita Cervin purchased three whole life insurance

policies from Mutual Life Insurance Company of New York on the life

of Alto Cervin.     Manita Cervin and the couple’s two children were

the beneficiaries.      The policies were purchased with community

funds, and the premiums were paid, while the decedent and Manita

Cervin were alive, with community funds.


                                    2
      Manita Cervin died intestate in 1978, and one-half of the cash

surrender value of the insurance policies was included in her

estate.       Her one-half interest in the policies passed under Texas

intestacy law to the couple’s two children. The children, however,

after consultation with their father, did not exercise their right

to receive one-half of the cash surrender value of the policies,

and the insurance policies remained in effect.                     For reasons of

convenience, the three agreed that Alto Cervin would continue to

pay the premiums and deal with any other administrative matters

regarding the policies.

      Alto Cervin died in 1988, and his estate included one-half of

the proceeds of the life insurance policies ($65,462.88).                         The

estate       also   included   accounts       receivable    in     the   amount    of

$35,268.16 from the children, as reimbursement for the insurance

premiums paid by decedent on their behalf from the time of his

wife’s death to his own death.

      At the time of his death, Alto Cervin owned a fifty percent

undivided community interest in four parcels of real estate, and

his   children      owned   equal   shares     of   the    other    fifty   percent

interest.      The overall fair market value of each of the properties

is undisputed,1 but instead of valuing its share of the properties

at fifty percent of the total fair market value, the estate


         1
        The four pieces of real property, with their undisputed
overall fair market valuation, are as follows:
   (1) 657-acre farm in Ellis and Johnson Counties, TX: $650,000;
   (2) homestead at 4343 W. Lawther Dr., Dallas, TX: $625,000;
   (3) 6318 Vickery Blvd., Dallas, TX: $27,000; and
   (4) 1633 E. Main St., Grand Prairie, TX: $60,000.

                                          3
discounted the value of its ownership interest by twenty-five

percent. It reasoned that an undivided fractional interest in real

property may be valued at an amount less than the fractional share

of the value of the entire property because of the difficulty in

selling only a proportionate interest in an undivided piece of real

estate. The estate’s valuation of its ownership in the properties,

less       the   twenty-five   percent    discount,     thus   totaled   $510,750

(681,000 - 170,250), the figure that was included on Alto Cervin’s

estate tax return, filed on March 5, 1990.

           Upon audit, the Commissioner determined that all of the

proceeds of the insurance policies ($130,925.76) were includible in

Alto Cervin’s gross estate, and that the estate was not entitled to

exclude the receivables from Bennett and Nita-Carol.               In addition,

the Commissioner determined that the estate was not entitled to the

twenty-five percent discount on any of the properties.2              The estate

petitioned the Tax Court for a redetermination.

           The Tax Court held that (1) the decedent’s gross estate

includes one hundred percent of the insurance proceeds, but that

the estate could exclude the receivables owed by Bennett and Nita-

Carol, and (2) the estate was entitled to a twenty percent discount

in valuing the two pieces of property at issue.                 The estate then

sought an award of litigation costs pursuant to section 7430 of the

Internal         Revenue   Code,   and   moved   for   reconsideration    of   the

insurance proceeds issue in light of our decision in Estate of


       2
     At trial, the Commissioner accepted the estate’s valuation of
the two lesser-valued properties.

                                           4
Cavenaugh v. Commissioner, 

(5th Cir. 1995).             The Tax

Court denied both motions.      The Cervin estate now appeals, arguing

that only one-half of the insurance proceeds is includible in the

gross estate and that it is entitled to reasonable litigation

costs.

                           STANDARDS OF REVIEW

     We review the Tax Court’s findings of fact for clear error and

its legal conclusions de novo. Park v. Commissioner, 

,

1291 (5th Cir.), cert. denied, 

(1994); Harris v.

Commissioner, 

, 81 (5th Cir. 1994).               The Tax Court’s

holding that all of the proceeds of the life insurance policies are

includible    in   the   decedent’s   gross   estate   is   based   upon   an

interpretation of Texas law, and is subject to de novo review.              We

review the denial of a request for litigation costs for abuse of

discretion.    Nalle v. Commissioner, 

, 191 (5th Cir.

1995).

                                DISCUSSION

I.   THE LIFE INSURANCE PROCEEDS

     The Internal Revenue Code (the “Code”) imposes a tax on a

decedent’s taxable estate, 26 U.S.C. § 2001, which is defined as

the gross estate less allowable deductions.        26 U.S.C. § 2051.       If,

as here, a policy on a decedent’s life names beneficiaries other

than the decedent’s estate, section 2042(2) of the Code mandates

that the decedent’s gross estate include the proceeds of life

insurance policies with respect to which the decedent possessed

“incidents of ownership” at his death.        26 U.S.C. § 2042(2).    Thus,


                                      5
we must determine to what extent Alto Cervin possessed incidents of

ownership in the three life insurance policies at his death.            To

resolve this question, state law must be considered.         See Treas.

Reg. § 20.2042-1(c)(5); Broday v. United States, 

,

1099 (5th Cir. 1972).

       As an initial matter, it is necessary to define some terms at

issue in this case.     The Treasury Regulations define “incidents of

ownership” as:

       the right of the insured or his estate to the economic
       benefits of the policy. Thus, it includes the power to change
       the beneficiary, to surrender or cancel the policy, to assign
       the policy, to revoke an assignment, to pledge the policy for
       a loan, or to obtain from the insurer a loan against the
       surrender value of the policy, etc.

Treas. Reg. § 20.2042-1(c)(2). This definition is nearly identical

to what this Court has referred to as “policy rights” under Texas

law.   See Commissioner v. Chase Manhattan Bank, 

, 245-

46 (5th Cir. 1958).      Policy rights refer to the “whole bundle of

incidents of ownership of property in a policy.”            

Policy    rights   or   incidents   of   ownership,   however,   must   be

distinguished from the “proceeds rights,” which are rights to

receive the proceeds of the insurance policy at maturity. In fact,

policy rights include the entire bundle of ownership “except the

right to the proceeds.”      

rights and proceeds rights are distinct under

Texas law, if “life insurance is purchased during a marriage and

paid for with community funds, the ‘policy rights’ or incidents of

ownership and the ‘proceeds rights’ or the rights to receive the

proceeds in the future constitute community property.”           Estate of

                                     6
Cavenaugh v. Commissioner of Internal Revenue, 

, 602

(5th Cir. 1995) (quoting Freedman v. United States, 

,

745 (5th Cir. 1967) (citing Brown v. Lee, 

(Tex.

1963))).       The parties do not dispute that the life insurance

policies at issue were purchased during the Cervin marriage with

community funds, and thus they agree that Manita Cervin owned an

undivided one-half interest in both the policy rights and the

proceeds rights at her death.

      Further, at the time of Manita Cervin’s death, Texas law

provided that upon dissolution of the marriage by death, the

surviving spouse is entitled to one-half of the community property,

and the children are entitled to the other half of the community

property.      Tex. Prob. Code § 45 (West 1980).3            Therefore, upon

Manita Cervin’s death, one-half of the incidents of ownership in

the policies and one-half of the right to the future proceeds

passed to Alto Cervin, and the other one-half of the policy rights

and one-half of the proceeds rights descended to the children.

      The parties are in full agreement as to the above analysis.

It   is   at   the   next   step   in   the   analysis,   however,   that   the

disagreement begins.        The Cervin estate argues that because one-

half of the incidents of ownership in the policies passed to the

children, upon Alto Cervin’s death he also possessed only one-half

of the incidents of ownership in the insurance policies.              Because

      3
     In 1991, the Texas Legislature amended Tex. Prob. Code § 45,
and that section now requires that all community property of a
spouse who dies intestate pass to the surviving spouse when all
surviving children are also children of the surviving spouse. Tex.
Prob. Code § 45 (West Supp. 1997).

                                         7
incidents of ownership determine the percentage of proceeds to be

included in the gross estate, see 26 U.S.C. § 2042(2), and because

Alto Cervin possessed one-half of the incidents of ownership, the

estate asserts   that   only   one-half   of   the   proceeds   should     be

included in the gross estate.

     The Commissioner contends that the Cervin estate’s analysis is

incomplete because it does not consider whether Manita Cervin’s

community property interest in the insurance policies was settled

prior to Alto Cervin’s death.     Based upon the Texas Supreme Court

case of Brown v. Lee, 

(Tex. 1963), the Commissioner

argues that Manita Cervin’s interest in the policies was settled

when one-half of the cash surrender value of the policies was

allocated to her estate and reported on her federal estate tax

return. Because Manita Cervin’s interest was settled prior to Alto

Cervin’s death, the Commissioner maintains that Alto Cervin died

possessing one hundred percent of the incidents of ownership in the

insurance policies, and that section 2042(2) of the Code thus

requires the inclusion of all of the proceeds in his gross estate.

     Although we agree with the Commissioner that settlement of a

predeceased,   uninsured   spouse’s    community     interest   in   a   life

insurance policy on the life of the other spouse may extinguish the

uninsured spouse’s remaining interest in the policies, we believe

that Manita Cervin’s interest in the policies was never settled.

Thus we hold in favor of the estate.

     The Commissioner’s argument that Manita Cervin’s interest in

the policies was settled prior to Alto Cervin’s death is based upon


                                   8
the following passage from Brown v. Lee:

     Under circumstances where the uninsured spouse predeceases the
     insured spouse, settlement of the decedent’s community
     interest in the unmatured chose [i.e., the proceeds rights]
     has ordinarily been resolved by allocating one-half of the
     cash surrender value to the deceased’s estate and the other
     one-half, plus ownership of the unmatured chose, to the
     surviving spouse. Thompson v. Calvert, 

(Tex.
     Civ. App. 1957, no writ).     But in the present case, where
     settlement of the deceased wife’s community interest in the
     policies was not made prior to the death of the insured and
     her heirs were not guilty of laches in failing to seek such
     compensation, the wife’s community interest was never
     extinguished and the policies retained their community status
     up to the time of maturity. Consequently the proceeds are
     

.     Simply put, the above passage sets forth two

rules for determining the proceeds rights (the rights to the

“unmatured chose”) of an uninsured spouse who predeceases the

insured spouse.    The first rule holds that when the uninsured

spouse’s   community   interest   in    the   policies   is   settled,   the

uninsured spouse does not retain any right to the proceeds.              The

second rule holds that when such interest is not settled, the

uninsured spouse maintains a community interest in the proceeds.

     Based on no legal authority except the foregoing passage, the

Commissioner asserts that Manita Cervin’s interest in the life

insurance policies was settled when one-half of the cash surrender

value of the policies was allocated to her estate and included on

her federal estate tax return.         Thus, the Commissioner concludes

that the first rule of the quoted passage mandates that full

ownership of the proceeds rights be allocated to Alto Cervin (the

then-surviving spouse), and that all of the proceeds must therefore

be included in his gross estate pursuant to section 2042(2).


                                   9
     The Commissioner’s theory is based upon the conclusion that

reporting one’s ownership interest in a life insurance policy on a

federal estate tax return can settle one’s interest in such policy

under state community property law.   Neither the Commissioner nor

the Tax Court provides any authority for this novel proposition.

We fail to see how Manita Cervin’s estate, by adhering to federal

estate tax law and including her one-half interest in the cash

surrender value of the policies in her gross estate, has somehow

settled her interest in the policies under the laws of the State of

Texas.

     The Commissioner’s position is not only completely without

support, it is also inconsistent with Brown v. Lee itself and would

nullify the then-recent changes in the definition of “property”

that the Brown v. Lee court was analyzing.   To see why this is so,

it is necessary to consider the 1957 amendments to Texas law and

Brown v. Lee’s interpretation of those changes.

     Before 1957, the legal theory of title to insurance proceeds

in Texas was somewhat unclear.   In Warthan v. Haynes, 

, 482-84 (Tex. 1956), the Texas Supreme Court held that a wife

had no community property interest in the proceeds of a life

insurance policy on the life of her husband, even when the policy

was bought during marriage and paid for with community funds.   This

holding did not last long, however, because in 1957, the Texas

legislature enlarged the definition of property to include “life

insurance policies and the effects thereof.”   Tex. Rev. Civ. Stat.

art. 23(1) (West 1969) (current version at Tex. Gov’t Code Ann. §


                                 10
312.011(13) (West 1988)).        The Texas Supreme Court in Brown v. Lee

considered the 1957 amendments at length and noted that “the right

to receive insurance proceeds payable at a future but uncertain

date is 

.                   It referred to such

insurance proceeds as “a chose in action which matures at the death

of the insured,” and held that “[w]hen purchased with community

funds, the ownership of the unmatured chose logically belongs to

the community.”      

examining the 1957 legislative changes, the

Brown v.    Lee    court--in    the   paragraph     quoted   in   full   above--

discussed the effect that settlement of an uninsured spouse’s

interest in a life insurance policy would have on her interest in

the unmatured chose.       It is worth quoting the first sentence of the

paragraph again for emphasis:

      Under circumstances where the uninsured spouse predeceases the
      insured spouse, settlement of the decedent’s community
      interest in the unmatured chose [i.e., the proceeds rights]
      has ordinarily been resolved by allocating one-half of the
      cash surrender value to the deceased’s estate and the other
      one-half, plus ownership of the unmatured chose, to the
      surviving spouse.

asserts that this sentence sets forth the

rule that settlement of an uninsured spouse’s interest in the

proceeds of a life insurance policy occurs when one-half of the

cash surrender value of the policy is included on the federal

estate tax return of the uninsured spouse.

      We   are    unable   to   discern     where   the    Commissioner   finds

justification for her proposition.           Support is certainly not found

in the text of the quoted sentence itself, for nowhere does it


                                       11
mention    that    settlement    under   Texas   law    is   accomplished   by

including one-half of the cash surrender value on a federal estate

tax return.       Furthermore, the Commissioner’s proposed rule of law

would abrogate the 1957 enlargement of the definition of property

that the Texas legislature had promulgated shortly before Brown v.

Lee was decided.      The Brown v. Lee court recognized that the Texas

legislature defined property to include the right to receive

insurance proceeds payable at a later date.             We do not think that

the Texas Supreme Court intended to dispossess uninsured spouses

(and their heirs) of their newly-acquired property right merely

because they abided by federal law and included their share of the

asset on their federal estate tax return.

     The   sentence     at    issue   merely   states   that   settlement   is

“resolved by allocating one-half of the cash surrender value to the

deceased’s estate.”          A more plausible reading of this clause is

that settlement is effected when one-half of the cash surrender

value is actually paid to the deceased wife’s estate by the living

husband; that is what “allocate” means in this context.               And in

this case, Bennett Cervin testified that he and his sister, after

consultation with their father, decided not to seek allocation of

their one-half value and to keep the insurance policies in effect.4

     4
      At oral argument, the Commissioner’s attorney asserted that
settlement occurred when Manita Cervin’s heirs could have received
one-half of the cash surrender value of the policies. We do not
think that Brown v. Lee supports this assertion. The IRS attorney
also contended at oral argument that this is not a case in which
Alto Cervin and his children had an agreement to maintain the
children’s fifty percent ownership interest in the policies. As
evidence of this, he pointed to the fact that the parties amended
the insurance policies such that decedent possessed sole rights to

                                       12
Indeed, the second sentence of the much-quoted paragraph makes

reference to the heirs of the deceased wife seeking compensation.

This also suggests that the heirs of the deceased, uninsured spouse

must be compensated.          Because one-half of the cash surrender value

was never distributed or allocated to the children of Alto and

Manita Cervin, Manita Cervin’s interest in the insurance policies

remained unsettled, and thus the second rule of Brown v. Lee

governs.         Because Manita Cervin’s community interest was never

extinguished, under Texas law her children inherited that interest,

which       is   one-half   of   the   policy   rights   and   one-half   of   the

unmatured chose.5           The Estate of Alto Cervin therefore contains

only one-half interest in the policy rights and one-half interest

in the proceeds rights, and it should be taxed on one-half of the

value of the proceeds.

     This reading of Brown v. Lee is fully consistent with the

definition         of   “settlement”       in    Black’s       Law   Dictionary:

“‘Settlement,’ in reference to a decedent’s estate, includes the

full process of administration, distribution and closing.” Black’s

Law Dictionary 1373 (6th ed. 1990).              The cash surrender value of

the policies was never distributed to Bennett Cervin and Nita-Carol


many of the incidents of ownership. The fact that the children
were never compensated for their one-half interest in the cash
surrender value still justifies our belief that the children never
settled their interest in the policies.
        5
      The second sentence of the quoted paragraph also notes that
the heirs must not be guilty of laches in attempting to seek
compensation. The evidence shows that Manita Cervin’s heirs had an
agreement with their father not to be compensated for their one-
half interest in the policies, and the Commissioner does not argue
that they were guilty of laches.

                                          13
Cervin Miskovitch, and thus Manita Cervin’s estate was not settled.

     Furthermore, the Commissioner’s position also contradicts a

unanimous   body   of   legal   authority,    which   she   attempts   to

distinguish on the grounds that such authority involved situations

where the estate was never settled.     Take, for example, Estate of

Cavenaugh v. Commissioner, 

(5th Cir. 1995).        As in this

case, the uninsured wife predeceased the insured husband--both of

whom resided in Texas--and we held that only fifty percent of the

proceeds of a term life insurance policy should be included in the

estate of husband who survived his uninsured wife.          

     It is true, as the Commissioner asserts, that in Cavenaugh we

determined that the second rule of Brown v. Lee applies because the

uninsured wife’s estate was never settled or partitioned prior to

the death of her husband.       

   The Commissioner argues

that settlement never occurred because the wife’s executor did not

include any interest in the policies in question in the gross

estate as reported on her federal estate tax returns.           We think

that the Commissioner misstates the facts of Cavenaugh. It appears

that the wife’s estate did list a value of her interest in the

insurance policy at issue; that interest was listed as having a

zero value, however, because the life insurance was term insurance.

See 

n.9.

     Moreover, even if we ignore the fact that the wife’s ownership

interest in the insurance was included in her gross estate in

Cavenaugh, it is clear that the Cavenaugh Court did not interpret

Brown v. Lee to mean that settlement of the uninsured’s interest in


                                   14
the proceeds occurs merely by including the value of the uninsured

wife’s one-half interest on her estate tax return.      Instead we

noted that under Brown v. Lee, “the community interest of the

deceased uninsured wife in the proceeds was not extinguished sans

partition or laches.”   

n.10 (emphasis omitted).    The

Commissioner provides no support for the proposition that the

inclusion of an asset on a federal tax return effects a partition,

and there is no evidence that the Cervin heirs were guilty of

laches.   The Cavenaugh Court also cited the case of Amason v.

Franklin Life Ins. Co., 

(5th Cir. 1970), for the

proposition that “the death of [the uninsured wife] without a

partition created a tenancy-in-common between Mr. Cavenaugh and her

estate’s designated heirs vis à vis the policy.”     

. Once again, the inclusion of Manita Cervin’s one-half

interest in the cash surrender value does not negate the tenancy-

in-common between Alto Cervin and the children that was created

when Manita Cervin died intestate.6

    6
      We note that the Commissioner litigated this identical issue
in the Ninth Circuit, asserting that the only interest in insurance
policies that passed under the uninsured wife’s will “was the right
to receive one-half of the cash surrender value of the policies.”
See Scott v. Commissioner, 

, 159 (9th Cir. 1967). The
Ninth Circuit rejected this argument based on California community
property law. 

Analyzing Scott, the Cavenaugh Court
held that:
   Although the community property laws of California and Texas
   differ in many respects, neither the IRS nor the Tax Court has
   produced authority confirming a meaningful variation between
   California and Texas law on this issue [i.e., regarding
   ownership of life insurance policies]. Specifically, Scott’s
   treatment of a marital community dissolved via death--
   construction of a tenant in common relationship--accords with
   the solution to dissolution adopted by Amason in the context of
   divorce. This parallelism is not only logical, but appears

                                15
     The Commissioner also runs afoul the Treasury Regulations,

which provide an example directly on point:

     For example, assume that the decedent purchased a policy of
     insurance on his life with funds held by him and his surviving
     wife as community property, designating their son as
     beneficiary but retaining the right to surrender the policy.
     Under the local law, the proceeds upon surrender would have
     inured to the marital community. Assuming that the policy is
     not surrendered and that the son receives the proceeds on the
     decedent’s death, the wife’s transfer of her one-half interest
     in the policy was not considered absolute before the
     decedent’s death. Upon the wife’s prior death, one-half of
     the value of the policy would have been included in her gross
     estate. Under these circumstances, the power of surrender
     possessed by the decedent as agent for his wife with respect
     to one-half of the policy is not, for purposes of this
     section, an “incident of ownership,” and the decedent is,
     therefore, deemed to possess an incident of ownership in only
     one-half of the policy.

Treas. Reg. § 20-2042-1(c)(5). Again, the Commissioner attempts to

distinguish this example on the grounds that Texas law is such that

the inclusion of one-half of the value of the policy in the wife’s

gross estate settles (and extinguishes) the wife’s interest in the

proceeds.    The Commissioner continues to press this interpretation

of   Brown   v.   Lee   even   though    the   above   example   expressly

contemplates that one-half of the value would be included in the

uninsured wife’s gross estate and still holds that the decedent



compelled by the synergy of Amason and Brown v. Lee.

-04.
   Despite the foregoing paragraph, the Commissioner continues to
assert, with success in the Tax Court, that Cavenaugh’s discussion
of the similarity between Texas and California community property
law refers only to the interest of heirs of an uninsured spouse in
the proceeds of community life insurance where there was no
settlement. Therefore, the Commissioner asserts that California
and Texas community property law differ on the definition of
settlement.   We believe that Brown v. Lee does not establish a
contrary definition of settlement, and thus the rule set forth in
Scott is applicable here.

                                    16
possesses only one-half the incidents of ownership.

       Last, but not least, is the Commissioner’s own Revenue Ruling.

Rev.    Rul.    75-100,     1975-1   C.B.     303.        In   that   ruling,    the

Commissioner considered facts almost identical to those in this

case.     The Commissioner ruled that because the estate of the

predeceased, uninsured wife was not settled, the estate of the

husband included only one-half of the value of the proceeds because

the    wife’s    one-half    interest     passed     to    her   children.      The

Commissioner again attempts to distinguish this ruling on the

grounds that the uninsured wife’s interest was not settled in that

example.       The Revenue Ruling, which applied Texas law, makes it

clear, however, that settlement is an agreement that must occur

between the husband and the heirs or legatees of the wife, and not

between the wife’s estate and the federal government: “in the

instant case, there was no settlement of W’s community interest in

the life insurance policy (between H and her legatees) between the

time of her death and that of H ten days later, nor were the

legatees of W’s estate guilty of laches in failing to seek such a

settlement.”

       In conclusion, the Estate of Alto Cervin owns only one-half of

the policy rights because ownership of Manita Cervin’s one-half

interest in the policy rights passed to Bennett Cervin and Nita-

Carol Cervin Miskovitch under section 45 of the Texas Probate Code

(West   1980).      Section     2042(2)      of   the   Internal      Revenue   Code

therefore dictates that the Cervin estate need include only one-

half of the value of the proceeds ($65,462.88) in the gross estate


                                        17
because it possesses only one-half of the policy rights. 26 U.S.C.

§ 2042(2).7

II.   LITIGATION COSTS

      The Cervin estate argues that the Tax Court erred by denying

its request for litigation costs under section 7430 of the Internal

Revenue Code.      Section 7430 provides that a “prevailing party” in

a tax proceeding may recover “reasonable litigation costs incurred

in connection with such court proceeding.” 26 U.S.C. § 7430(a)(2);

accord Nalle v. Commissioner, 

, 191 (5th Cir. 1995).               As

defined in the statute, a party prevails if it establishes: (1)

that the “position of the United States” in the proceeding was not

“substantially justified”; (2) that the party has “substantially

prevailed” with respect to the amount in controversy or with

respect to the most significant issue or set of issues presented;

and   (3)   that    the   party   has    met   the    applicable    net     worth

requirements.      26 U.S.C. § 7430(c)(4)(A); 

.

      Our   decision      above   establishes        that   the    estate    has

substantially prevailed with respect to the amount in controversy

regarding the insurance proceeds, and the Commissioner concedes

that the estate substantially prevailed with respect to the amount

in controversy regarding the valuation of the four properties. The

Commissioner also does not argue that the estate has not met the

      7
      Because Bennett and Nita-Carol have owned one-half of                  the
policy rights since Manita Cervin’s death in 1978, they                      are
responsible for one-half of the post-1978 insurance premiums.                 We
therefore conclude that the Cervin estate must also include                  the
accounts   receivable  of   $35,268.16  from   the  children                  as
reimbursement for the premiums paid by the decedent on                       the
children’s behalf.

                                        18
net worth requirements. Thus, the only element at issue is whether

the “position of the United States” with respect to the insurance

proceeds and the property valuation was substantially justified.

     The term “substantially justified” means “‘justified to a

degree that   could   satisfy   a   reasonable   person’   and   having a

‘reasonable basis both in law and fact.’”        

(quoting Pierce v. Underwood, 

, 565 (1988)).               In

determining whether the Commissioner’s position was substantially

justified, it is necessary to ascertain whether the Commissioner

acted unreasonably, that is, whether she “knew or should have known

that her position was invalid at the onset of the litigation.”

(citing Bouterie v. Commissioner, 

, 1373 (5th Cir. 1994)).

     The estate maintains that the position of the Commissioner was

not substantially justified with respect to both the insurance

proceeds issue and the property valuation matter.          We agree.

     A.   The Life Insurance Proceeds

     As noted above, in arguing that one hundred percent of the

proceeds of the life insurance policies is includible in the

decedent’s gross estate, the Commissioner runs afoul of a legal

principle set forth in a Treasury Regulation, a Revenue Ruling, and

a Ninth Circuit case--each of which contains facts exceedingly

similar to the present case.        The Commissioner is not concerned

with this inconsistency, for she contends that the Texas Supreme

Court case of Brown v. Lee outlines a different rule of law in the

State of Texas.   This suggested rule of law, however--that merely


                                    19
reporting one’s ownership interest in a life insurance policy on a

federal estate tax return can settle one’s ownership interest in

the policy for purposes of state law--is nowhere to be found in

that opinion and indeed is inconsistent with the definition of

property set forth by the Texas legislature.

       The    unreasonableness           of   the    Commissioner’s          position     is

underscored by her argument that the gross estate includes both the

full one hundred percent of the life insurance proceeds and the

receivables from Bennett and Nita-Carol representing reimbursement

of insurance premiums paid by the decedent--undisputably double

taxation.         In addition, the Commissioner continued to press her

position even after Cavenaugh established that an insured wife’s

interest in an insurance policy may not be settled even when her

estate tax return lists such an asset.                     

, 603

n.9.         We   recognize      that     our      cases   require       a    finding    of

unreasonableness at the onset of litigation and that Cavenaugh was

not decided until after the Tax Court’s decision.                         See 

;    

.        Nevertheless,      the

Commissioner’s insistence in her position in the face of Cavenaugh

is   evidence        of   her   single-minded        pursuit     of    the    tax   on   the

insurance proceeds in spite of state and federal law.

       This and other circuits have held that the Commissioner’s

position was not substantially justified when she had ignored state

law that clearly supported the taxpayer’s position.                          See 

-92 (citing cases).                While the Commissioner’s position

in the instant case may not be as egregiously wrong as it was in


                                              20
the cases cited by Nalle, her legal argument is unreasonable.                The

fact that the Tax Court ruled for the Commissioner, while a factor

in favor of her position, is not dispositive.             See Pate v. United

States, 

, 459 (10th Cir. 1993); Huckaby v. United

States Dep’t of Treasury, 

, 299 (5th Cir. 1986).                 The

Commissioner is certainly free to argue that different laws of the

fifty states can have different tax consequences in each state,

just as she may litigate the same issue in different circuits in

order to create a conflict.        That does not, however, suggest that

taking    an    unsupported   legal    position      in   such    instance   is

substantially justified.        Cf. Estate of Perry v. Commissioner, 

, 1046 (5th Cir. 1991).          Where the Commissioner elects to

litigate an untenable position of state law, she “does so at the

risk of incurring the obligation to reimburse such taxpayers for

attorneys’ fees pursuant to the provisions of Section 7430.”                 

Property Valuation

     As noted above, the Commissioner initially determined that the

estate was not entitled to any discount on any of the four parcels

of   real      estate.    One     month     before   trial,      however,    the

Commissioner’s expert prepared a report stating that the estate was

entitled to a five percent discount on the two higher-valued

properties.      In addition, in the Stipulation of Facts filed on the

trial date, the Commissioner accepted the estate’s valuation of the

two lesser-valued properties.         After hearing expert testimony from

both sides at trial, the Tax Court decided that a twenty percent

discount on the two higher-valued properties was appropriate, and


                                       21
this holding has not been appealed.

     On appeal, the estate asserts that the Commissioner’s position

regarding the valuation of the property was not substantially

justified because the Commissioner relied upon the discredited

unity-of-ownership theory in disallowing the twenty-five percent

discount.     The Commissioner does not dispute the fact that this

circuit rejected the unity-of-ownership theory in Estate of Bright

v. United States, 

, 1005-07 (5th Cir. 1981) (en banc).

Instead, she argues that the unity-of-ownership theory was never

the “position of the United States” as that term is defined in

Section 7430(c)(7) of the Code.

     Section 7430(c)(7) defines “position of the United States” as

the position taken in a judicial proceeding and also as the

position taken in an administrative proceeding as of the date of

the Notice of Deficiency.      26 U.S.C. § 7430(c)(7).           Although we

must determine the Commissioner’s position as of the date of the

Notice   of   Deficiency   (filed   on   August   13,   1992),    Lennox   v.

Commissioner, 

, 248 (5th Cir. 1993), establishes that

the Commissioner’s position on that date must be viewed in the

context of what caused the IRS to issue the Notice of Deficiency.

     The record shows that the IRS first disallowed the twenty-five

percent discount in its Notice of Proposed Adjustment sent to the

estate on July 3, 1991.       Included with the Notice of Proposed

Adjustment was the Revenue Agent’s examination report, which stated

that the discount should be disallowed for two reasons. First, the

agent noted that the Cervin estate had “presented no evidence of


                                    22
sales of undivided fractional real estate interests which would

corroborate its theory that undivided interests sell on the market

for an amount less than their proportionate value.”                 Second, the

agent asserted that the unity-of-ownership theory should apply.

The Cervin estate unsuccessfully protested the Notice of Proposed

Adjustment, and the IRS, on August 13, 1992, sent the estate a

formal Notice of Deficiency. We thus conclude that issuance of the

Notice of Deficiency was based in large part upon the discredited

unity-of-ownership theory.

     It is true that the Commissioner abandoned the unity-of-

ownership    theory   at    some    point   after   issuing   the    Notice   of

Deficiency but before trial, arguing instead that the estate had

simply not presented adequate evidence to justify the twenty-five

percent discount. Relying on Minahan v. Commissioner, 

,

501 (1987), the estate maintains that the Commissioner may not

“extricate   himself   from     a   holding   of    unreasonableness     merely

because his valuation expert is also unreasonable.”                 In Minahan,

the Commissioner first espoused the unity-of-ownership theory in

support of the Notice of Deficiency, then on the date of the trial

conceded that there was no deficiency.          In arguing that litigation

costs were not appropriate, the Commissioner in Minahan maintained

that his position was not unreasonable because valuation is a

factual question and reliance upon expert opinion is reasonable.

The Tax Court rejected this argument, noting that not only was the

unity-of-ownership         theory    untenable,      but   also      that     the

Commissioner’s valuation expert was unreasonable, as evidenced by


                                       23
the fact that the Commissioner simply capitulated before trial.

See 

     In   the   present   case,   the    Commissioner   did   not   totally

capitulate at trial and instead presented expert testimony on the

valuation issue. Nevertheless, we are guided by Minahan. Until at

least the date of the Notice of Deficiency, the Commissioner relied

upon a discredited legal theory and maintained that the estate was

entitled to no discount on any of the four parcels of real estate.

Not until after the issuance of the Notice of Deficiency did the

Commissioner abandon her reliance on the unity-of-ownership theory.

Moreover, shortly before trial the Commissioner agreed that the

estate was entitled to a slight (five percent) discount on two of

the properties, and at trial the Commissioner capitulated as to the

other two properties.     Finally, the Tax Court found the estate’s

expert to be more persuasive, determining that a twenty percent

discount was appropriate on the two contested properties.               In

short, the above shows that the Commissioner’s stance on the

property valuation was unreasonable.

                              CONCLUSION

     The Cervin estate need include one-half the value of the life

insurance proceeds and the accounts receivable from the children.

The position of the Commissioner was not substantially justified,

and thus the estate is entitled to reasonable litigation costs.

     For the foregoing reasons, we REVERSE and REMAND.




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