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Wheeler v. United States, 96-50144 (1997)

Court: Court of Appeals for the Fifth Circuit Number: 96-50144 Visitors: 11
Filed: Jun. 30, 1997
Latest Update: Mar. 02, 2020
Summary: REVISED JUNE 25, 1997 IN THE UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT _ No. 96-50144 JOHN MICHAEL WHEELER, Independent Executor of the Estate of Elmore K. Melton, Jr., Plaintiff-Appellant, versus UNITED STATES OF AMERICA, Defendant-Appellee. _ Appeal from the United States District Court for the Western District of Texas _ June 19, 1997 Before GARWOOD, BARKSDALE and DENNIS, Circuit Judges. GARWOOD, Circuit Judge: This case involves the determination of the federal estate tax due from
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                 REVISED JUNE 25, 1997


              IN THE UNITED STATES COURT OF APPEALS

                      FOR THE FIFTH CIRCUIT


                          ___________________

                             No. 96-50144




JOHN MICHAEL WHEELER, Independent
Executor of the Estate of Elmore
K. Melton, Jr.,
                                            Plaintiff-Appellant,

     versus

UNITED STATES OF AMERICA,
                                            Defendant-Appellee.


        ________________________________________________

      Appeal from the United States District Court for the
                    Western District of Texas
        ________________________________________________
                          June 19, 1997

Before GARWOOD, BARKSDALE and DENNIS, Circuit Judges.

GARWOOD, Circuit Judge:

     This case involves the determination of the federal estate tax

due from the estate of Elmore K. Melton, Jr. (Melton).    On July 13,

1984, Melton, then age sixty, sold to his two adopted sons, John

Wheeler and David Wheeler, the remainder interest in his ranch

located in Bexar County, Texas.    Melton retained a life estate in

the ranch and used the actuarial tables set forth in the Treasury

Regulations to determine the price to be paid by the Wheelers for
the remainder interest.      On May 25, 1991, Melton, then age sixty-

seven, died.      Melton’s federal estate tax return did not include

any value for the ranch. The Internal Revenue Service (IRS) issued

a notice of deficiency, claiming that the sale of the remainder

interest in the ranch to the Wheelers for its actuarial value did

not    constitute    adequate    and       full     consideration,     and   that

accordingly the fair market value of the full fee simple interest

in the ranch, less the consideration paid by the sons, should have

been included in Melton’s gross estate.               The court below agreed

and, following a line of cases stating that the sale of a remainder

interest for less than the value of the full fee simple interest in

the property does not constitute adequate consideration for the

purposes    of    section   2036(a)    of     the    Internal   Revenue      Code,

determined that Melton’s estate had been properly assessed an

additional $320,831 in federal estate tax.               We reverse.

                       Facts and Proceedings Below

                                       I.

       In the mid-1970s, Melton, who was born April 16, 1924, and

never married, adopted two children, John Wheeler (John), who was

born in 1956, and David Wheeler (David), who was born in 1958.

Following their graduation from college, both sons——John in 1979,

David in 1981——were employed by The Melton Company, a corporation

of which Melton was then sole shareholder, president, and chairman

of the board.

       From 1983 until his death in 1991, Melton engaged in a series

of    financial   transactions   with       his   sons   that   the   government


                                       2
contends had significant estate tax ramifications.               On May 19,

1983, Melton gave John and David each 195 shares of The Melton

Company common stock, representing approximately 16.2 percent of

the 1204 shares outstanding. On June 30, 1984, The Melton Company,

pursuant to a recapitalization plan, converted each share of

existing common stock into one share of voting stock and three

shares of nonvoting stock, denominated Class A and Class B shares

respectively.    On July 13, 1984, some three months after he turned

60, Melton gave John and David each 223 shares of Class B stock of

The Melton Company.

     Also   on   July   13,   1984,   Melton   executed   a   warranty   deed

conveying to John and David his 376-acre ranch, located in Bexar

County, Texas.    The deed reserved to Melton a life estate in the

ranch.1   For many years prior to the sale, and until the time of

his death, Melton used the ranch as his personal residence.              John

and David paid for the remainder interest with a personal liability

real estate lien note in the amount of $337,790.18, secured by a

vendor’s lien expressly retained in the deed and additionally by

a deed of trust on the ranch.          The deed and deed of trust were

promptly recorded.      The purchase price for the remainder interest

in the ranch was determined by multiplying the sum of the appraised


1
         The deed conveyed to the Wheelers, “subject to the
reservations hereinafter made,” the fee simple interest in the
described 376 acres, and then provided: “Except, however, that the
grantor herein [Melton] reserves, and it is hereby expressly agreed
that he shall have, for himself and his assigns, the full
possession, benefit and use of the above-described premises, as
well as all of the rents, issues and profits thereof, for and
during his natural life.”

                                      3
fair market value of the ranch’s fee simple interest, $1,314,200,

plus $10,000, by 0.25509, the factor set forth in the appropriate

actuarial table in the Treasury Regulations for valuing future

interests in property where the measuring life was that of a person

of Melton’s age.   See Treas. Reg. § 25.2512-5(A).

     On February 12, 1985, the initial note, which bore interest at

the rate of 7 percent and called for annual payments of at least

$10,000 principal plus accrued interest, was revised to provide for

monthly payments of $833.33 principal plus accrued interest, which

remained at 7 percent.2    On that date, John and David paid the

amount due under the revised terms.

     On October 18, 1985, Melton gave John and David each an

additional 344 shares of Class B stock of The Melton Company.

     In December 1986, Melton gave $10,000 each to John and David

by forgiving that amount of each son’s indebtedness under the note.

On December 23, 1986, John and David received bonuses from The

Melton Company of $50,000 and $55,000, respectively. Each son used

$35,000 of his bonus to reduce the principal owed on the note to

Melton.   John and David each paid income taxes on their bonus.   On

December 29, 1986, Melton assigned the note to The Melton Company

in partial payment of an existing debt that he owed the company.

     One year later, on December 24, 1987, Melton gave John and

David each forty more shares of Class B stock of The Melton


2
      The note was not nonrecourse and it expressly provided that
each maker was personally responsible for the full amount of the
note and for attorney’s fees, and that matured unpaid principal and
interest bore 18 percent per annum interest.

                                 4
Company.   On December 26, 1987, Melton gave each son another 106

shares of Class A stock and 299 shares of Class B stock.

     On January 28, 1988, both John and David received a 1987 year-

end bonus of $250,000 from The Melton Company.      They each paid

income taxes on their bonus.   On January 29, 1988, Melton sold to

John and David each 280 shares of Class B stock of The Melton

Company. John and David paid the remaining balance due on the note

the same day.   Throughout the course of the indebtedness under the

note, John and David had continued to make monthly payments.   The

Melton Company continued to make annual, year-end bonuses to both

John and David long after the note was retired.

     On December 25, 1989, nearly two years after the note had been

paid in full, Melton gave John and David each thirty-five shares of

Class B stock of The Melton Company.   As a result of these gifts,

on December 26, 1989, Melton owned fifty percent of the Class A

stock of The Melton Company and no Class B stock.   John and David

each owned twenty-five percent of the Class A stock and fifty

percent of the Class B stock.    The ownership structure remained

fixed at these levels until Melton’s death.

     Melton died testate on May 25, 1991, at the age of sixty-

seven, more than six years after the sale of the remainder interest

to the Wheelers and more than three years after the note had been

paid in full.   The cause of death was heart failure.   Melton had

suffered from coronary artery disease and arteriosclerosis for

approximately ten years.    The undisputed evidence, however, was

that Melton’s death was not (and was not thought to be) imminent in


                                 5
July 1984 when he sold the remainder interest to the Wheelers (nor

is there any evidence that it was ever imminent before 1991).

     Melton’s will and codicil were admitted to probate and John

was appointed the independent executor of the estate.                  John timely

filed an estate tax return reporting a gross estate of $581,106,

and an estate tax liability of $199,936 (which was tendered with

the return).     The gross estate, as reported on the return, did not

include any amount for the ranch, thus reflecting the estate’s

position that Melton had no interest in the ranch at his death.

     The   IRS    subsequently      issued    its   “Report       of   Estate      Tax

Examination Changes,” taking the position that, under sections

2036(a) and 2043(a) of the Internal Revenue Code (IRC or Code),3

the Melton estate should have included in the gross estate the

difference     between       the   date-of-death      value    of      the     ranch,

$1,074,200,4     and   the    consideration    paid    by   the     sons     for   the

remainder interest, $337,790.18 (treated by the IRS as $338,000).

Accordingly,     the   IRS    determined     that   an   additional          $736,200

($1,074,200 less $338,000) should have been included in the gross

estate for the ranch.         As a result, the IRS issued an estate tax

notice of deficiency in the amount of $320,831.               The Melton estate

paid the asserted deficiency and filed a timely claim for refund.

When the IRS did not allow the refund within the prescribed six

3
     See note 6 infra and accompanying text.
4
      The value of the ranch had declined by $240,000 since the
date of the sale of the remainder interest to John and David.
     The IRS has never questioned that the fair market value of the
ranch was $1,314,200 immediately before the July 13, 1984, deed to
the Wheelers.

                                        6
months, the Melton estate commenced the instant action in the

United States District Court for the Western District of Texas, San

Antonio Division, seeking a refund of the additional estate tax

assessed and paid, plus interest.

                                  II.

     Before the district court, the parties stipulated to the facts

as set forth above and agreed to resolution of the issues by cross-

motions for summary judgment.          In its motion, the government

contended that the series of transactions between Melton and his

sons were part of a testamentary plan designed to shield most of

the estate from taxation.    The Melton estate argued that a sale of

a remainder interest for its actuarial value comes within the “bona

fide sale for an adequate and full consideration” exception to

section 2036(a) and therefore the ranch was properly excluded from

the gross estate.

     The magistrate judge issued a report recommending that the

government’s motion be granted.        The district court, without any

discussion or explanation, overruled the estate’s objections to the

magistrate judge’s report, accepted, approved, and adopted all the

magistrate judge’s findings and conclusions, and entered judgment

for the government.

     The   magistrate   judge,   observing   that   the   “classic   case”

envisioned by section 2036(a) was “a purported gift with a retained

life estate in the donor,” rejected the Melton estate’s contention

that the sale of the remainder interest in the ranch for its

actuarial value constituted a “bona fide sale for adequate and full


                                   7
consideration,” and opined that the date-of-death value of the

ranch——less the consideration paid by the sons——must be included in

the gross estate.      The magistrate judge’s conclusion was premised

on   two   principal   bases.   First,   the   magistrate   judge   found

persuasive the United States Claims Court’s decision in Gradow v.

United States, 
11 Cl. Ct. 808
(1987), aff’d, 
897 F.2d 516
(Fed.

Cir. 1990), and embraced its determination that, for the purposes

of section 2036(a), the value received by the decedent must be

compared to the value of the entire underlying property rather than

the present value of the future interest transferred.       Second, the

magistrate judge concluded that the sale of the remainder interest

was not a “bona fide sale” as envisioned by the exception to

section 2036(a), noting that “[a]lthough death was not imminent in

1984, it is reasonable to assume that Melton contemplated his own

death and the disposition of his estate at the time of the transfer

of his homestead to his sons in July, 1984.”          Accordingly, the

magistrate judge, viewing the evidence “as a whole,” concluded that

the series of transactions between Melton and his sons constituted

“a single transaction intended to avoid the payment of estate

taxes,” tainting the sale of the remainder interest in the ranch

and precluding the transaction from being “bona fide” under section

2036(a).5

      Melton’s estate appeals.


5
     The magistrate judge and district court ruled in favor of the
estate on a wholly unrelated issue concerning the valuation of the
estate’s stock in The Melton Company. That issue is not involved
in this appeal.

                                    8
                             Discussion

                                  I.

     The case below was decided on cross-motions for summary

judgment and on stipulated facts.      A grant of summary judgment is

subject to de novo review.     Browning v. City of Odessa, 
990 F.2d 842
, 844 (5th Cir. 1993).    Where, as here, the essential facts are

not in dispute, our review is limited to whether the government or

the Melton estate is entitled to judgment as a matter of law.

Arkwright-Boston Mfrs. Mut. Ins. Co. v. Aries Marine Corp., 
932 F.2d 442
, 444 (5th Cir. 1991).

     Central to this case is section 2036(a) of the Code, which

provides:

          “The value of the gross estate shall include the
     value of all property to the extent of any interest
     therein of which the decedent has at any time made a
     transfer (except in case of a bona fide sale for an
     adequate and full consideration in money or money’s
     worth), by trust or otherwise, under which he has
     retained for his life or for any period not ascertainable
     without reference to his death or for any period which
     does not in fact end before his death——
          (1) the possession or enjoyment of, or the right to
          the income from, the property, or
          (2) the right, either alone or in conjunction with
          any person, to designate the persons who shall
          possess or enjoy the property or the income
          therefrom.” (Emphasis added).6

6
     See also I.R.C. § 2043(a), which provides:

          “If any one of the transfers, trusts, interests,
     rights, or powers enumerated and described in sections
     2035 to 2038, inclusive, and section 2041 is made,
     created, exercised, or relinquished for a consideration
     in money or money’s worth, but is not a bona fide sale
     for an adequate and full consideration in money or
     money’s worth, there shall be included in the gross
     estate only the excess of the fair market value at the
     time of death of the property otherwise to be included on

                                  9
      The estate concedes that the fee simple value of the ranch

would have to have been brought back into the estate had the

remainder been transferred to the Wheelers without consideration or

for an inadequate consideration. However, the Wheelers paid Melton

for   the    remainder      interest   transferred     an     amount     which    the

government concedes is equal to (indeed slightly in excess of) the

then fair market value of the fee simple interest in the ranch

multiplied by the fraction listed in the Treasury Regulations for

valuing a remainder following an estate for the life of a person of

Melton’s age.        See 26 C.F.R. § 25.2512-5(A).          The estate contends

that accordingly under the parenthetical clause of section 2036(a)

the ranch is not brought back into the estate, as Melton was paid

full value for the transferred remainder.                   Indeed, there is no

evidence to the contrary.          The government, however, contends that

because Melton was paid for the remainder interest an amount

indisputably less than the value of the full fee interest, that

therefore the parenthetical clause of section 2036(a) cannot apply,

and hence the ranch must be brought back into the estate.

      This    case    thus    ultimately     turns   on     whether     the   phrase

“adequate     and    full    consideration”    as    used    in   the   italicized

parenthetical       clause    of   section   2036(a)   is    to   be    applied    in

reference to the value of the remainder interest transferred, as

the estate contends, or in reference to the value of the full fee

simple interest which the transferor had immediately before the



      account of such transaction, over the value of the
      consideration received therefor by the decedent.”

                                        10
transfer, as the government contends.        We note that for this

purpose the language of section 2036(a) makes no distinction

between transfers of remainders following retained life estates and

transfers of remainders following retained estates for a specified

term of years (or other period ascertainable without reference to

the transferor’s death) where the transferor dies before the end of

the term. Similarly, no such distinction is made between transfers

to natural objects of the transferor’s bounty and transfers to

those who are strangers to the transferor.

     That the proper construction of section 2036(a)’s    “adequate

and full consideration” has presented taxpayers, the IRS, and the

courts with such persistent conceptual difficulty can be explained,

in large part, by the absence of a statutory definition of the

phrase combined with the consistently competing interests of all

tax litigants——the government and the taxpayer.     The crux of the

problem has been stated as follows:

     “Because the actuarial value of a remainder interest is
     substantially less than the fair market value of the
     underlying property, the sale of a remainder interest for
     its actuarial value is viewed by many as allowing the
     taxpayer to transfer property to the remainderman for
     less consideration than is required in an outright sale.
     Consequently, the sale of a remainder interest for its
     actuarial value, although such value represents the fair
     market value of the remainder interest, raises the
     question of whether the seller has been adequately
     compensated for the transfer of the underlying property
     to the remainderman.     If the actuarial value of the
     remainder   interest    does   not   represent   adequate
     compensation for the transfer of the underlying property
     to the remainderman, the taxpayer may be subject to both
     the gift tax and the estate tax. . . . If the taxpayer
     holds the retained interest until death, section 2036(a)
     of the [Code] pulls the underlying property back into the
     taxpayer’s gross estate, unless the transfer is a bona
     fide sale for adequate and full consideration.” Martha

                                11
       W. Jordan, Sales of Remainder Interests: Reconciling
       Gradow v. United States and Section 2702, 14 Va. Tax Rev.
       671, 673 (1995).

       Both parties agree that, for the purposes of the gift tax

(section 2512 of the Code), consideration equal to the actuarial

value of the remainder interest constitutes adequate consideration.

See also Treas. Reg. § 25.2512-5(A).             For estate tax purposes,

however, authorities are split.         Commentators have generally urged

the same construction should apply, see, e.g., 
Jordan, supra
;

Steven A. Horowitz, Economic Reality In Estate Planning: The Case

for Remainder Interest Sales, 73 Taxes 386 (1995); Jeffrey N.

Pennell, Cases Addressing Sale of Remainder Wrongly Decided, 22

Est.   Plan.    305    (1995),   and   the   Third   Circuit   has    held     that

“adequate      and    full   consideration”    under    section      2036(a)    is

determined in reference to the value of the remainder interest

transferred, not the value of the full fee simple interest in the

underlying property.         D’Ambrosio v. Commissioner, 
101 F.3d 309
(3d

Cir. 1996), cert. denied, 117 S.Ct. ___, 
1997 WL 134397
(U.S.) (May

19, 1997).     On the other hand, Gradow v. United States, 
11 Cl. Ct. 808
(1987), aff’d, 
897 F.2d 516
(Fed. Cir. 1990), and its faithful

progeny Pittman v. United States, 
878 F. Supp. 833
(E.D.N.C. 1994),

and D’Ambrosio v. Commissioner, 
105 T.C. 252
(1995), rev’d 
101 F.3d 309
(3d Cir. 1996), cert. denied, 117 S.Ct. ___, 
1997 WL 134397
(U.S.) (May 19, 1997), have stated that a remainder interest must

be sold for an amount equal to the value of the full fee simple

interest in the underlying property in order to come within the

parenthetical exception clause of section 2036(a).             This Court has


                                        12
yet to address the precise issue.

                                   II.

A.   Gradow v. United States and the Widow’s Election Cases

     As the government’s position rests principally on an analogy

offered by the Claims Court in Gradow, a preliminary summary of the

widow’s election mechanism in the community property context is

appropriate.

     In a community property state, a husband and wife generally

each have an undivided, one-half interest in the property owned in

common by virtue of their marital status, with each spouse having

the power to dispose, by testamentary instrument, of his or her

share of the community property.         Under a widow’s election will,

the decedent spouse purports to dispose of the entire community

property, the surviving spouse being left with the choice of either

taking under the scheme of the will or waiving any right under the

will and taking his or her community share outright.            One common

widow’s election plan provides for the surviving spouse to in

effect exchange a remainder interest in his or her community

property share   for    an   equitable   life   estate   in   the   decedent

spouse’s community property share.

     In Gradow, Mrs. Gradow, the surviving spouse, was put to a

similar election.      If she rejected the will, she was to receive

only her share of the community property.         
Id. 11 Cl. Ct.
at 809.

If she chose instead to take under her husband’s will, she was

required to transfer her share of the community property to a trust

whose assets would consist of the community property of both


                                   13
spouses, with Mrs. Gradow receiving all the trust income for life

and, upon her death, the trust corpus being distributed to the

Gradows’ son.      
Id. Mrs. Gradow
chose to take under her husband’s

will and, upon her death, the executor of her estate did not

include any of the trust assets within her gross estate.             
Id. The executor
asserted that the life estate received by Mrs. Gradow was

full and adequate consideration under section 2036(a) for the

transfer of her community property share to the trust, but the IRS

disagreed.     
Id. Before the
Claims Court, the parties stipulated

that the value of Mrs. Gradow’s share of the community property

exceeded the actuarial value of an estate for her life in her

husband’s share.      
Id. However, the
estate contended that the value

of the life estate in the husband’s share equaled or exceeded the

value of the remainder interest in Mrs. Gradow’s share. The Claims

Court did not clearly resolve that contention because it determined

that the consideration flowing from Mrs. Gradow was “the entire

value of the property she placed in the trust, i.e., her half of

the   community      property,”   and   that   thus   the   life   estate   was

inadequate consideration, so the exception to section 2036(a) was

unavailable.      
Id. at 810.
      The court in Gradow concluded that the term “property” in

section 2036(a) referred to the entirety of that part of the trust

corpus attributable to Mrs. Gradow.              
Id. at 813.
      Therefore,

according to the court, if the general rule of section 2036(a) were

to apply, the date-of-death value of the property transferred to

the trust corpus by Mrs. Gradow——rather than the zero date-of-death


                                        14
value of her life interest in that property——would be included in

her    gross    estate.       
Id. Citing “[f]undamental
    principles    of

grammar,” the court concluded that the bona fide sale exception

must refer to adequate and full consideration for the property

placed into the trust and not the remainder interest in that

property.       
Id. Fundamental principles
of grammar aside, the Gradow court

rested its conclusion equally on the underlying purpose of section

2036(a), observing that:

       “The only way to preserve the integrity of the section,
       then, is to view the consideration moving from the
       surviving spouse as that property which is taken out of
       the gross estate.     In the context of intra-family
       transactions which are plainly testamentary, it is not
       unreasonable to require that, at a minimum, the sale
       accomplish an equilibrium for estate tax purposes.” 
Id. at 813-14.
In    support    of    its   equilibrium      rule,    the   Gradow   court   cited

precedent in the adequate and full consideration area, most notably

United States v. Allen, 
293 F.2d 916
(10th Cir.), cert. denied, 
82 S. Ct. 378
(1961).

       It is not our task to address the merits of Gradow’s analysis

of how section 2036(a) operates in the widow’s election context but

rather to determine whether the Gradow decision supports the

construction urged by the government in the sale of a remainder

context.        We    conclude   that   the    widow   election   cases   present

factually       distinct     circumstances     that    preclude   the   wholesale

importation of Gradow’s rationale into the present case.

       As noted, a widow’s election mechanism generally involves an

arrangement whereby the surviving spouse exchanges a remainder

                                         15
interest in her community property share for a life estate in that

of her deceased spouse.       Usually, as in Gradow, the interests are

in trust.    Necessarily, the receipt of an equitable life estate in

the decedent-spouse’s community property share does little to

offset the reduction in the surviving spouse’s gross estate caused

by the transfer of her remainder interest.            It is precisely this

imbalance    that    the   commentators      cited    in   Gradow——and        the

“equilibrium rule” gleaned from United States v. Allen——recognized

as the determinative factor in the widow’s election context.

Because a surviving spouse’s transfer of a remainder interest

depletes the gross estate, there can be no “bona fide sale for an

adequate    and   full   consideration”     unless   the   gross     estate   is

augmented commensurately. See Charles L. B. Lowndes, Consideration

and the Federal Estate and Gift taxes: Transfers for Partial

Consideration, Relinquishment of Marital Rights, Family Annuities,

the Widow’s Election, and Reciprocal Trusts, 35 Geo. Wash. L. Rev.

50, 66 (1966); Stanley M. Johanson, Revocable Trusts, Widow’s

Election Wills, and Community Property: The Tax Problems, 
47 Tex. L
.   Rev.   1247,   1283-84   (1969)    (“But   in   the   widow’s    election

situation, the interest the wife receives as a result of her

election-transfer is a life estate in her husband’s community

share——an interest which, by its nature, will not be taxed in the

wife’s estate at her death.      It appears that the wife’s estate is

given a consideration offset for the receipt of an interest that

did not augment her estate.”).          Accordingly, we need not address

the issue whether the value or income derived from a life estate in


                                       16
the decedent-spouse’s community property share can ever constitute

adequate and full consideration.          For our purposes it is enough to

observe that, in most cases, the equitable life estate received by

the surviving spouse will not sufficiently augment her gross estate

to offset the depletion caused by the transfer of her remainder

interest.7   This   depletion   of    the     gross   estate   prevents   the

7
          Commentators have disagreed about the wisdom of a
“consideration offset” in the widow’s election context.         See
Lowndes, supra
; 
Johanson, supra
. This Court’s Vardell decision has
been described as mandating the inclusion of all of the surviving
spouse’s transferred property in her gross estate, subject only to
such credits, if any, as may be due under section 2043(a) (quoted
in note 
6, supra
).    See Lowndes, Consideration and the Federal
Estate and Gift Taxes, at 67-68 (discussing Estate of Vardell v.
Commissioner, 
307 F.2d 688
, 692-94 (5th Cir. 1962)). Accordingly,
the amount of the surviving spouse’s subsequent gross estate
enhancement under section 2036(a) caused by her retained life
estate would be “offset” pursuant to section 2043(a). 
Vardell, 307 F.2d at 693
. However, it is the date-of-death value of the (now-
dead) surviving spouse’s remainder interest that is offset by the
actuarial (date-of-election) value of her life estate in the
decedent spouse’s community property share under section 2043(a).
Id. at 693-94.
     Vardell did not address the date-of-election value of the
surviving spouse’s remainder interest, although there are
indications that the life estate in the husband’s community
property share was worth less than the transferred remainder.
Vardell, 307 F.2d at 692
(“Nor are we concerned with a valuation of
the property interest transferred by Mrs. Vardell since the very
purpose of § 2036 and the related sections is to include all of
such property in her gross estate subject to such credits, if any,
as may be due.”). The Vardell court, therefore, does not appear to
have been confronted with a situation where the life estate
received by the surviving spouse was equal or greater in value than
the remainder interest transferred. Id.; see also United States v.
Gordon, 
406 F.2d 332
(5th Cir. 1969) (involving the transfer of a
wife’s remainder interest for a life estate in a trust worth less
than the transferred remainder). Gradow, however, apparently did
present such a situation, but the Claims Court chose not to address
valuation of the transferred interest at the date of election.
Other courts, however, have followed approaches that call for just
such a valuation.
     The Ninth Circuit, for example, embraced a construct in the
widow’s election context that calculates adequate consideration
under section 2036(a) by comparing the actuarial (date-of-election)

                                     17
operation of the adequate and full consideration exception to

section 2036(a).8   Had the court in Gradow limited its discussion

of section 2036(a)’s adequate and full consideration exception to

the widow’s election context, the nettlesome task of distinguishing

its blanket rule of including the value of the full fee interest on

the underlying property when a remainder interest is transferred



value of the remainder interest in the surviving spouse’s share of
her community property with the actuarial (date-of-election) value
of the life estate in the decedent spouse’s community property
share. Estate of Christ v. Commissioner, 
480 F.2d 171
, 172 (9th
Cir. 1973). If, at the date of election, the life estate in the
decedent spouse’s community property share received by the
surviving spouse is worth less than the then actuarial value of her
remainder interest, then the amount of her subsequent gross estate
enhancement under section 2036(a) caused by her retained life
estate is “offset” pursuant to section 2043(a). 
Id. If this
point
is reached, then the analysis necessarily follows Vardell: under
section 2043(a) the date-of-death value of the (now-dead) surviving
spouse’s remainder interest which is included in the estate is
offset by the actuarial (date-of-election) value of her life estate
in the decedent spouse’s community property share. 
Id. But see
United States v. Past, 
347 F.2d 7
, 13-14 (9th Cir. 1965) (stating
that the date-of-election value of the amount the surviving spouse
receives under a trust must be measured against the entire
underlying fee amount she transferred to the trust and not the
remainder interest therein); Estate of Gregory v. Commissioner, 
39 T.C. 1012
, 1022 (1963) (same).
     The Third Circuit in D’Ambrosio found no reason why a court’s
analysis of a widow’s election transaction should not compare the
actuarial (date-of-election) value of the remainder interest
transferred to the actuarial (date-of-election) value of the life
estate 
received. 101 F.3d at 313-14
.     Accordingly, the Third
Circuit found both Gregory and Past wrongly decided. Although we
find the Third Circuit’s analysis persuasive, we see little utility
in revisiting the federal estate tax ramifications of the widow’s
election device in light of the post-1981 unlimited marital
deduction (for which the typical election devise would not
qualify). See IRC § 2056.
8
        In the widow’s election context, the remaindermen are,
essentially, third-party beneficiaries of the widow’s election
transaction.    We also need not, and do not, address the
significance of this configuration on the operation of the
“adequate and full consideration” exception to section 2036(a).

                                18
might be somewhat easier.        In dicta, however, and apparently in

response to a hypothetical posed by the taxpayer, the Gradow court

let loose a response that, to say the least, has since acquired a

life of its own.       The entire passage——and the source of much

consternation——is as follows:

          “Plaintiff argues that the defendant’s construction
     would gut the utility of the ‘bona fide sales’ exception
     and uses a hypothetical to illustrate his point. In the
     example a 40-year-old man contracts to put $100,000.00
     into a trust, reserving the income for life but selling
     the remainder. Plaintiff points out that based on the
     seller’s life expectancy, he might receive up to
     $30,000.00 for the remainder, but certainly no more. He
     argues that this demonstrates the unfairness of defendant
     insisting on consideration equal to the $100,000.00 put
     into trust before it would exempt the sale from §
     2036(a).
          There are a number of defects in plaintiff’s
     hypothetical. First, the transaction is obviously not
     testamentary, unlike the actual circumstances here. In
     addition, plaintiff assumes his conclusion by focusing on
     the sale of the remainder interest as the only relevant
     transaction. Assuming it was not treated as a sham, the
     practical effect is a transfer of the entire $100,000.00,
     not just a remainder.     More importantly, however, if
     plaintiff is correct that one should be able, under the
     ‘bona fide sale’ exception to remove property from the
     gross estate by a sale of the remainder interest, the
     exception would swallow the rule. A young person could
     sell a remainder interest for a fraction of the
     property’s worth, enjoy the property for life, and then
     pass it along without estate or gift tax consequences.”
     
Gradow, 11 Cl. Ct. at 815
.

The Claims Court went on to conclude that “[t]he fond hope that a

surviving spouse would take pains to invest, compound, and preserve

inviolate all the life income from half of a trust, knowing that it

would thereupon be taxed without his or her having received any

lifetime    benefit,   is   a   slim   basis   for   putting   a   different

construction on § 2036(a) than the one heretofore consistently

adopted.”    
Id. at 816.
                                       19
     One   can   only   imagine   the   enthusiasm   with   which   the   IRS

received the news that, at least in the view of one court, it would

not have to consider the time value of money when determining

adequate   and   full    consideration     for   a   remainder   interest.9

Subsequent to the Gradow decision, the government has successfully

used the above quoted language to justify inclusion in the gross

estate of the value of the full fee interest in the underlying

property even where the transferor sold the remainder interest for

its undisputed actuarial value.         See Pittman v. United States, 
878 F. Supp. 833
(E.D.N.C. 1994). See also D’Ambrosio v. Commissioner,

105 T.C. 252
(1995), rev’d, 
101 F.3d 309
(3d Cir. 1996), cert.

denied, 117 S.Ct. ___, 
1997 WL 134397
(U.S.) (May 19, 1997).

     Pittman (and the Tax Court’s decision in D’Ambrosio) presents

a conscientious estate planner with quite a conundrum.               If the

9
      Actually, one need leave little to the imagination. Within
a year of the Federal Circuit’s affirmance of Gradow, 
897 F.2d 516
(Fed. Cir. 1990), the IRS reversed its consistent practice of
calculating adequate and full consideration for the sale of
remainder interests under section 2036(a) by using the actuarial
factors set forth in the Treasury Regulations——see, e.g., Rev. Rul.
80-80, 1980-12 I.R.C. 10 (“[T]he current actuarial tables in the
regulations shall be applied if valuation of an individual’s life
interest is required for purposes of the federal estate or gift
taxes unless the individual is known to have been afflicted, at the
time of transfer, with an incurable physical condition that is in
such an advanced stage that death is clearly imminent.”); Priv.
Ltr. Rul. 78-06-001 (Oct. 31, 1977); Priv. Ltr. Rul. 80-41-098
(Jul. 21, 1980); Tech. Adv. Mem. 81-45-012 (Jul. 20, 1981)——and
began to cite the Gradow dicta as controlling, see, e.g., Priv.
Ltr. Rul. 91-33-001 (Jan. 31, 1991) (“For purposes of section
2036(a), in determining whether an adequate and full consideration
was received by a decedent upon transferring an interest in
property, the consideration received by the decedent is compared to
the value of the underlying property rather than the value of the
transferred interest; the consideration thus being a replacement of
the property otherwise includible in the decedent’s gross estate.”)
(citing Gradow, 
11 Cl. Ct. 808
).

                                    20
taxpayer sells a remainder interest for its actuarial value as

calculated under the Treasury Regulations, but retains a life

estate, the value of the full fee interest in the underlying

property will be included in his gross estate and the transferor

will incur substantial estate tax liability under section 2036(a).

If the taxpayer chooses instead to follow Gradow, and is somehow

able to find a willing purchaser of his remainder interest for the

full fee-simple value of the underlying property, he will in fact

avoid estate tax liability; section 2036(a) would not be triggered.

The purchaser, however, having paid the fee-simple value for the

remainder interest in the estate, will have paid more for the

interest   than   it   was   worth.        As   the   “adequate   and   full

consideration” for a remainder interest under section 2512(b) is

its actuarial value, the purchaser will have made a gift of the

amount paid in excess of its actuarial value, thereby incurring

gift tax liability.10    Surely, in the words of Professor Gilmore,

this “carr[ies] a good joke too far.”11

B.   United States v. Allen

      The problem with the Gradow dicta is that, in its effort to

escape the hypothetical posed by the taxpayer, it lost sight of the


10
        See Jordan, Sales of Remainder Interests, at 682.       The
special valuation rules of the subsequently-enacted section 2702(a)
do not operate to frustrate this unfortunate result.        Section
2702(a)’s special valuation rules address whether a gift has been
made by the transferor, not the purchaser. 
Jordan, supra
.
11
        Grant Gilmore, The Uniform Commercial Code:    A Reply to
Professor Beutel, 61 Yale L.J. 364, 375-76 (1952) (characterizing,
in an entirely different context, the same type of heads-I-win-
tails-you-lose scheme).

                                      21
very principle the court was trying to apply; namely, the notion

that adequate and full consideration under the exception to section

2036(a) requires only that the sale not deplete the gross estate.

Gradow was correct in observing that “it is not unreasonable to

require that, at a minimum, the sale accomplish an equilibrium for

estate tax purposes.”         
Gradow, 11 Cl. Ct. at 813-14
.            Indeed,

United States v. Allen, 
293 F.2d 916
, when properly construed,

stands simply for that proposition.

     In Allen, the decedent had created, and made a donative

transfer of assets to, an irrevocable inter vivos trust, reserving

a three-fifth interest in the income for life, her two children to

receive the remainder in the entire corpus and the other two-fifths

of the income.       
Id. at 916.
    Thereafter, being advised that her

retention of the three-fifths of the life estate would result in

the inclusion of three-fifths of the trust corpus in her gross

estate at her death, the decedent sold her life estate to one of

her children for a little over its actuarial value.                   She died

shortly thereafter.       
Id. at 916-17.
        The trial court, although

finding   that   the   transfer      of   the   life   estate   was   made    in

contemplation of death, found that the consideration paid for it

was “adequate and full,” thereby removing the property from the

taxpayer’s estate. The Tenth Circuit reversed. Using the language

that Gradow later quoted, the Tenth Circuit determined that the

adequacy of the consideration paid for the life estate should be

measured not against the interest received by the purchaser, but

rather    by   the   amount   that    would     prevent   depletion    of    the


                                      22
transferor’s gross estate.         
Id. at 918
& n.2.

       “It does not seem plausible, however, that Congress
       intended to allow such an easy avoidance of the taxable
       incidence befalling reserved life estates. This result
       would allow a taxpayer to reap the benefits of property
       for his lifetime and, in contemplation of death, sell
       only the interest entitling him to the income, thereby
       removing all of the property which he has enjoyed from
       his gross estate.      Giving the statute a reasonable
       interpretation, we cannot believe this to be its
       intendment. It seems certain that in a situation like
       this, Congress meant the estate to include the corpus of
       the trust or, in its stead, an amount equal in value.”
       
Id. at 918
; but cf. 5 Boris I. Bittker & Lawrence Lokken,
       Federal Taxation of Income, Estates and Gifts ¶ 126.3.5,
       at 126-27 (1993) (noting that Allen may have “stretch[ed]
       the statutory language in a good cause”).

       Crucial to a proper reading of Allen is the factual basis of

the Tenth Circuit’s holding.              The decedent, Maria Allen, had

gratuitously transferred a remainder interest in an irrevocable

trust to her two children, reserving a life estate in three-fifths

for herself.    Under section 811 of the 1939 Internal Revenue Code

(the   precursor     to    sections   2035    and   2036),   this   transaction

retained the value of the full fee interest in three-fifths of the

trust corpus in Maria Allen’s gross estate for estate tax purposes.

For    this   very   reason,     Maria     Allen,    at   age   seventy-eight,

subsequently sold to one of her children her three-fifths life

estate for an amount ($140,000) slightly in excess of its actuarial

value ($135,000).         The intended result of this sale was to remove

the value of the entire fee interest in three-fifths of the trust

corpus from Maria Allen’s gross estate; as long as she retained the

life estate, section 811 would pull the date-of-death value of her

three-fifths remainder interest ($900,000) into her gross estate.

Therefore, unlike the hypothetical addressed in Gradow or the facts

                                         23
of the case here presented, the actuarial value of the transferred

interest, the life estate, would not have prevented depletion of

the   gross    estate     in   Allen.   See   Jordan,    Sales    of    Remainder

Interests,     at   699    (“The    conclusion   in     Allen    that   adequate

consideration for the sale of a retained life estate equals the

value of the trust corpus includible in the gross estate derives

from the special punitive nature of section 2035 of the Code . . .

, and not from the proposition that the transfer of a split-

interest removes the entire underlying property from the gross

estate.”).12

12
      Allen can only properly be understood as a “contemplation of
death” case. As noted, the trial court found the life estate was
transferred in contemplation of death, and this finding was not
disturbed on appeal. See 
D’Ambrosio, 101 F.3d at 312
(transfer of
life estate in Allen “a testamentary transaction with palpable tax
evasion motive”); 5 Bittker & Lokken, Federal Taxation of Income,
Estates and Gifts, 126-97 n.105 (2d ed. 1993) (describing Allen as
situation where the life estate transfer was “in contemplation of
death”).     Treating the Allen life estate transfer as in
“contemplation-of-death” under the predecessor to section 2035 (IRC
1939, § 811(c)(1)(A)) resulted in the life estate being brought
back into Maria Allen’s estate; that, in turn, made the entire fee
in the three-fifths of the corpus subject to the predecessor to
section 2036(a), and hence within Maria Allen’s estate, just as if
Maria Allen had never disposed of the life estate that she retained
when she created the trust (and donated to it the assets forming
its corpus) in a transaction concededly covered by the predecessor
to section 2036(a) and not subject to any exception thereto. In
determining whether the transfer of the life estate was for an
adequate and full consideration, so as to thereby be within the
exception to the “contemplation-of-death” provision, comparison was
made between the consideration ($140,000) for that transfer and the
amount by which the estate would have been depleted ($900,000 as
the value of the full fee interest in three-fifths of the corpus or
$765,000 as the value of the remainder interest in three-fifths of
the corpus) had the life estate not been transferred; and this
comparison demonstrated that the consideration was not adequate and
full. Here, by contrast, the deed from Melton to the Wheelers,
unlike Maria Allen’s transfer to the trust, was for an adequate and
full consideration, because immediately thereafter Wheeler owned
assets having a value equal to what he owned immediately before.

                                        24
Thus the Melton deed was not within section 2036(a). Moreover,
here there is no transaction subject to section 2035 (the successor
to the contemplation-of-death provision of IRC 1939 § 811(c)(1)(A))
as the Melton deed was executed (and the consideration fully paid)
more than three years before Melton’s death.
     Judge Breitenstein’s opinion concurring in the result in Allen
appears to suggest that Allen does not depend on the transfer of
the life estate having been made in contemplation of death, but
rather on the proposition that no transfer of the life estate could
ever “undo” the estate tax consequences of the earlier donative
transfer to the trust with a life estate retained, which was
concededly within the predecessor to section 2036(a) and not within
the exception thereto. 
Id. at 918
(“As I read the statute the tax
liability arises at the time of the inter vivos transfer under
which there was a retention of the right to income for life. The
disposition thereafter of that retained right does not eliminate
the tax liability.”). The correctness of this view is of perhaps
only tenuous relevance here, as here the deed from Melton to the
Wheelers is within the section 2036(a) exception. In any event, we
note that neither the Allen majority nor, so far as we are aware,
any other authority, has embraced Judge Breitenstein’s view as thus
broadly stated. See, for example, 5 Bittker & 
Lokken, supra, at 126-27
:

     “. . . if the decedent transferred property subject to a
     retained life estate but later (more than three years
     before death) relinquished the life estate, §2036(a)(1)
     does not apply, even though the decedent “retained” the
     right to the income “for life.”104        An unqualified
     transfer of property during life——even though effected in
     two or more steps——has long been recognized as being
     exclusively within the jurisdiction of the gift tax
     unless the final step was taken in contemplation of death
     or within three years of death.105
     . . . .
     104
          Cuddihy’s Est. v. CIR, 32 TC 1171, 1177 (1959)
     (retained right to trust income relinquished during
     decedent’s life; alternative ground). See Ware’s Est. v.
     CIR, 480 F2d 444 (7th Cir. 1973) (decedent-grantor was
     trustee with power to accumulate or distribute trust
     income, but resigned as trustee many years before dying;
     no inclusion under §2036).
     105
          If a §2036(a) right was relinquished within three
     years of death, the property is included in the gross
     estate, apparently as though the right has not been
     relinquished. IRC §2035(d)(2), 
discussed supra
¶126.4.2.
     For the result under prior law where an otherwise taxable
     right was relinquished in contemplation of death, see US
     v. Allen, 293 F2d 916 (10th Cir.), cert. denied, 
368 U.S. 944
(1961) (sale of life estate for inadequate

                                25
C.   In Pari Materia

      As alluded to above, significant problems arise when “adequate

and full consideration” is given one meaning under section 2512 and

quite another for the purposes of section 2036(a).             In a pair of

companion cases in 1945, the Supreme Court set forth the general

principle that, because the gift and estate taxes complement each

other, the phrase “adequate and full consideration” must mean the

same thing in both statutes.     See Merrill v. Fahs, 65 S.Ct 655, 656

(1945) (“‘The gift tax was supplementary to the estate tax.             The

two are in pari materia and must be construed together.’”) (quoting

Estate of   Sanford    v.   Commissioner,   
60 S. Ct. 51
,   56   (1939));

Commissioner v. Wemyss, 
65 S. Ct. 652
(1945); Estate of Friedman v.

Commissioner, 
40 T.C. 714
, 718-19 (1963) (“The phrase ‘an adequate


      consideration); Rev. Rul. 56-324, 1956-2 CB 999.”

     The current structure of section 2035 seems to confirm the
“contemplation-of-death” approach implicit in Allen. Under section
2035(a), transfers within three years of death——the substitute for
the former “contemplation-of-death” provision——are included in the
gross estate. Under section 2035(b)(1), transfers for adequate and
full consideration are exempted from section 2035(a).         Under
section 2035(d)(1), estates of decedents dying after December 31,
1981, are exempted from section 2035(a), but, by the terms of
section 2035(d)(2), that exemption “shall not apply to a transfer
of an interest in property which is included in the value of the
gross estate under sections 2036, 2037, 2038, or 2042 or would have
been included under any of such sections if such interest had been
retained by the decedent.”     See generally 5 Bittker & 
Lokken, supra, at 126-34
, 126-35.
     Thus, were the Allen facts present today——and the court again
held the life estate was not transferred for an adequate and full
consideration——there would nevertheless be no inclusion of the fee
interest in three-fifths of the trust corpus in Maria Allen’s
estate if she lived more than three years after her transfer of the
life estate; if she did not live so long, the fee interest in the
three-fifths of the trust corpus would be included in her estate by
virtue of section 2035(a) as section 2035(d)(2) would prevent
application of the section 2035(d)(1) exemption.

                                   26
and full consideration in money or money’s worth,’ common to both

the estate and gift tax statutes here pertinent, is to be given an

‘identical construction’ in regard to each of them.”) (citing 
Fahs, 65 S. Ct. at 656
).   In Fahs, the Court observed:

     “Correlation of the gift tax and the estate tax still
     requires legislative intervention. [citations] But to
     interpret the same phrases in the two taxes concerning
     the same subject matter in different ways where obvious
     reasons do not compel divergent treatment is to introduce
     another and needless complexity into this already irksome
     situation.” 
Id. at 657.
The “purpose” of gift and estate taxes was articulated clearly in

Wemyss: “The section taxing as gifts transfers that are not made

for ‘adequate and full [money] consideration’ aims to reach those

transfers which are withdrawn from the donor’s estate.” 
Wemyss, 65 S. Ct. at 655
.   In Wemyss, the donor received no consideration in

money’s worth to replenish his estate for the transfer of stock to

his bride, and therefore his estate was depleted by the amount of

the transfer.   The bride’s relinquishment of her interest in an

existing trust provided no augmentation to the donor’s estate. The

following rule emerges:     unless a transfer that depletes the

transferor’s estate is joined with a transfer that augments the

estate by a commensurate (monetary) amount, there is no “adequate

and full consideration” for the purposes of either the estate or

gift tax.   We thus come full circle to the “equilibrium rule” set

forth in United States v. Allen and cited in Gradow.

     The problem that appears to have vexed the Claims Court in

Gradow when it considered the remainder sale hypothetical posed by

the taxpayer (and the Pittman district court and the Tax Court in


                                27
D’Ambrosio who chose to follow the Gradow approach) is that,

believing themselves to be between the Scylla of estate tax evasion

and the Charybdis of misconstruction of the gift tax statute, they

looked    for    guidance        to   a   line    of    estate   tax    decisions      more

confusing than the task they faced.                In Allen, as was observed, the

amount required to prevent depletion of the gross estate caused by

the in contemplation of death sale of Maria Allen’s retained life

estate was indeed the value of the underlying estate, as that was

the amount by which Maria Allen’s gross estate was depleted.                           See

note    
12, supra
,     and    accompanying         text.      See   also     Lowndes,

Consideration and the Federal Estate and Gift Taxes, at 51 (“[T]he

estate and gift taxes limit the consideration which will prevent a

taxable transfer to an adequate and full consideration in money or

money’s worth, that is, to a consideration which will serve as a

substitute for the transferred property in the transferor’s taxable

estate.”). The actuarial value of Maria Allen’s life estate simply

would not, and did not, prevent the depletion of her estate.                           This

concern is not implicated by the sale of a remainder interest for

its actuarial value.

       The sale of a remainder interest for its actuarial value does

not deplete the seller’s estate.                       “The actuarial value of the

remainder interest equals the amount that will grow to a principal

sum    equal    to   the    value     of   the    property       that   passes    to   the

remainderman at termination of the retained interest.                            To reach

this conclusion, the tables assume that both the consideration

received for the remainder interest and the underlying property are


                                             28
invested at the table rate of interest, compounded annually.”

Jordan, Sales of Remainder Interests, at 692-93 (citing Keith E.

Morrison, The Widow’s Election: The Issue of Consideration, 
44 Tex. L
. Rev. 223, 237-38 (1965)).     In other words, the actuarial tables

are premised on the recognition that, at the end of the actuarial

period, there is no discernible difference between (1) an estate

holder retaining the full fee interest in the estate and (2) an

estate holder retaining income from the life estate and selling the

remainder interest for its actuarial value——in either case, the

estate is not depleted.     This is so because both interests, the

life estate and the remainder interest, are capable of valuation.

Recognizing this truism, the accumulated value of a decedent’s

estate is precisely the same whether she retains the fee interest

or receives the actuarial value of the remainder interest outright

by a sale prior to her actual death.         
Id. at 691-92;
Morrison, The

Issue of Consideration, at 237-38.

     Two possible objections——which are more properly directed at

the wisdom of accepting actuarial factors than at the result just

described——should be addressed.            The first, to paraphrase the

Claims Court in Gradow, is that the fee interest holder, in such a

situation,   might   squander   the    proceeds   from   the   sale   of   the

remainder interest and, therefore, deplete the estate. See 
Gradow, 11 Cl. Ct. at 816
(noting that “[t]he fond hope that a surviving

spouse would take pains to invest, compound, and preserve inviolate

all [proceeds from a sale of the remainder interest], knowing that

it would thereupon be taxed without his or her having received any


                                      29
lifetime benefit, is a slim basis” for holding the actuarial value

of a remainder interest is adequate and full consideration under

section 2036(a)).   This objection amounts to a misapprehension of

the estate tax.13   Whether an estate holder takes the “talents”

received from the sale of the remainder interest and purchases blue

chip securities, invests in highly volatile commodities futures,

funds a gambling spree, or chooses instead to bury them in the

ground, may speak to the wisdom of the estate holder, see Matthew

25:14-30, but it is of absolutely no significance to the proper

determination of whether, at the time of the transfer, the estate

holder received full and adequate consideration under section

2036(a).   If further explanation is required, we point out that

Gradow itself seems to have reached the same conclusion in an

earlier portion of the opinion.      See 
Gradow, 11 Cl. Ct. at 813
(“Even if the consideration is fungible and easily consumed, at

least theoretically the rest of the estate is protected from

encroachment for lifetime expenditures.”).   See also Jordan, Sales

of Remainder Interests, at 695-96 & n.105; Morrison, The Issue of

Consideration, at 236-44.

     The second objection is no more availing.     If a sale of a

remainder interest for its actuarial value——an amount, it is worth

noting, that is nothing more than the product of the undisputed

“fair market value” of the underlying estate multiplied by an

actuarial factor designed to adjust for the investment return over

13
           The Third Circuit likewise had “great difficulty
understanding how [such a] transaction could be abusive.”
D’Ambrosio, 101 F.3d at 316
.

                                30
the actuarial period——constitutes adequate and full consideration

under      section   2036(a),     then   the    estate     holder    successfully

“freezes” the value of the transferred remainder at its date-of-

transfer value. Accordingly, any post-transfer appreciation of the

remainder interest over and above the appreciation percentage

anticipated by the actuarial tables passes to the remainderman free

of the estate tax.          But, of course, this is a problem only if the

proceeds of the sale are not invested in assets which appreciate as

much (or depreciate as little) as the remainder.                Moreover, those

who recall the Great Depression, as well as more recent times,14

know that assets frequently do not appreciate.                 Indeed, Melton’s

ranch did not appreciate, but rather at his death was worth less

than eighty-two percent of its value when the remainder was sold.

Finally, to the extent that this “freeze” concern is legitimate, we

note, as discussed infra, that Congress, through the passage in

1987 of former section 2036(c) and, later, its 1990 repeal and the

enactment then of section 2702, has spoken to the issue.

D.   Section 2036(a)’s Bona Fide Sale Requirement

         The   magistrate    judge   below,    and   the   government    at   oral

argument, asserted that the requirement that a sale for adequate

and full consideration be “bona fide” under section 2036(a) takes

on   a    heightened   significance      in    the   context    of   intrafamily

transfers.


14
       The situation in Texas not so long ago was aptly described
by a colorful lawyer——whose name now unfortunately escapes
memory——as one in which the phrase “rich Texan” metamorphosed almost
overnight from a redundancy to an oxymoron.

                                         31
       “Although the presumption in an intrafamily transfer is that

the transfer between related parties is a gift, the presumption

that an intrafamily transaction is gratuitous ‘may be rebutted by

an affirmative showing that there existed at the time of the

transaction a real expectation of repayment and intent to enforce

the collection of the indebtedness.’” Estate of Musgrove v. United

States, 
33 Fed. Cl. 657
, 662 (1995) (citations omitted); accord

Kincaid v. United States, 
682 F.2d 1220
, 1225-26 (5th Cir. 1982);

Slappey Drive Ind. Park v. United States, 
561 F.2d 572
, 584 n.21

(5th Cir. 1977); Dillin v. United States, 
433 F.2d 1097
, 1103 (5th

Cir. 1970).

       Heightened scrutiny serves the purpose of allowing inquiry

beyond form to the substance of transactions in order to determine

the appropriate tax consequences.             But here, where the intrafamily

transaction    comports       in   substance    with    the    government’s     own

regulations,       the    government    would   have   us     take   the   opposite

approach. The government argues that we should ignore the economic

reality of a remainder interest sale and decide the tax issue based

solely on the identity of the parties.

       To the extent the “bona fide” qualifier in section 2036(a) has

any independent meaning beyond requiring that neither transfers nor

the adequate and full consideration for them be illusory or sham,

it    might   be    construed      as   permitting     legitimate,      negotiated

commercial transfers of split-interests that would not otherwise

qualify as adequate consideration using the actuarial table values

set   forth   in    the    Treasury     Regulations    to     qualify   under   the


                                         32
exception.       Such a result comports with the same construction the

term    is     given   in    the    gift    tax   regulations.       The     gift   tax

regulations prevent an “ironclad” operation of the gift tax statute

from transforming every bad bargain into a gift by the losing

party.       See Weller v. Commissioner, 
38 T.C. 790
, 805-07 (1962); 5

Bittker & Lokken, Federal Taxation, at 121-31.                      See also 
id. at 126-20.
       Accordingly, the term “bona fide” preceding “sale” in

section 2036 is not, as the government seems to suggest, an

additional wicket reserved exclusively for intrafamily transfers

that otherwise meet the Treasury Regulations’ valuation criteria.

The government implicitly asserts that the term “bona fide” in

section 2036(a) permits the IRS to declare that the same remainder

interest, sold for precisely the same (actuarial) amount but to

different       purchasers,         would     constitute       adequate    and      full

consideration for a third party but not for a family member.                        This

construction asks too much of these two small words.                      In addition

to arguing that “adequate and full consideration” means different

things for gift tax purposes than it does for estate tax purposes,

the government would also have us give “bona fide” not only a

different construction depending on whether we are applying the

gift or estate tax statute, but also different meanings depending

upon     the    identity      of    the     purchaser     in   a   section    2036(a)

transaction.       We do not believe that Congress intended, nor do we

believe the language of the statute supports, such a construction.

       Certainly an intrafamily transfer——like any other——must be a

“bona    fide    sale”      for    the    purposes   of   section    2036(a).       But


                                             33
assuming, as we must here, that a family member purports to pay the

appropriate value of the remainder interest,15 the only possible

grounds for challenging the legitimacy of the transaction are

whether the transferor actually parted with the remainder interest

and the transferee actually parted with the requisite adequate and

full consideration.      Accordingly, we do not find convincing the

government’s position that the term “bona fide” as used in section

2036(a) presents an adequate basis for imposing a dual system of

valuation under the statute.

E.    IntraFamily Transactions

      At oral argument the government pursued a line of reasoning

not   fully   anticipated   by    their    brief’s   Gradow/no-bona-fide-

transaction theory.      Stated concisely, the government asserted

that, because the purpose of section 2036(a) is to reach those

split-interest transfers that amount to testamentary substitutes

and include the underlying asset’s value in the gross estate, the

adequate and full consideration for intrafamily transfers——which

are generally testamentary in nature because the interest passes

“to    the    natural   objects    of     one’s   bounty   in   the   next

generation”——must be measured against the entire value of the

15
        The government conceded at oral argument:

      “If you accept that all that is to be valued is the
      residue [remainder interest], which is the taxpayer’s
      position here——or the estate’s position——we don’t dispute
      that, for purposes of this case, its value was accurately
      computed by application of the tables. Rather, we’re
      saying that, in this context a different property should
      be valued. . . .      We’re not suggesting that its a
      valuation question, we’re looking at it from a different
      point of view.”

                                    34
underlying asset in order to accomplish section 2036(a)’s purpose.16

This argument is necessarily at odds with Gradow’s “fundamental

principles of grammar” approach that rested on a construction of

the bona fide sale exception that did not purport to distinguish

between either   the   identity   or   the   subjective   intent   of   the

parties.17 We reject the government’s proffered construction as not

supported by the statutory language.

     Moreover, a policy-based argument to preclude intrafamily

transfers of split-interests for full actuarial value if the

transaction appears to have been undertaken in contemplation of

death embraces a concept that the Congress chose to abandon twenty

years ago——the notion that the subjective intent of an asset holder

should determine the tax consequences of his transfer.

     Given the similarity between the government’s argument and the

16
        Although stopping short of embracing a position that an
intrafamily transfer can never meet the requirements of the bona
fide sale exception, the only situation in which the government
could conceive of an intrafamily transfer qualifying was a
Friedman-type situation where the family members’ interests are
actively adverse.   See Estate of Friedman, 
40 T.C. 714
(1963)
(involving settlement of a contentious will dispute).
17
     We find no merit in the government’s contention that the only
logical way to make the government “whole” as contemplated by
section 2036(a) is to include the entire value of the underlying
asset. That which would make the estate “whole” is indeed, as the
government observed, that which puts the government in the same
position as if the transaction had never occurred. But where the
transferor’s estate receives the full actuarial value of the
transferred interest——an amount, as discussed above, that the
Treasury Regulations assume will compound to reach the full value
of the fee interest by the transferor’s death——the government is
made whole. If the entire underlying asset is also pulled back
into the estate, the government comes out ahead, for the section
2043(a) offset given for the amount paid when the remainder is
transferred fails to recognize the interest assumptions underlying
the actuarial tables.

                                  35
old   gift-in-contemplation-of-death     scheme,   a    brief   review   is

appropriate.   Recognizing that the most obvious way to defeat the

estate tax would be through inter vivos gifts, the estate tax, from

its inception, contained a provision including in the gross estate

certain   inter   vivos   transfers    “intended   to   take    effect   in

possession or enjoyment” at or after the decedent’s death and those

made “in contemplation of death.”       5 Bittker & 
Lokken, supra, at 126-30
(citing Revenue Act of 1916, Pub. L. No. 271, 39 Stat. 756).

Although the Federal Gift Tax, enacted in 1932, reduced the tax

avoidance possible through the use of inter vivos transfers, its

lower rates and separate exemptions continued the need for estate

tax treatment of gifts made in contemplation of death.          
Id. at 126-
31.   Accordingly, Congress enacted the predecessor to section 2035

“to reach inter vivos transfers of property used as substitutes for

testamentary dispositions.” Hope v. United States, 
691 F.2d 786
,

790 (5th Cir. 1982) (citing United States v. Wells, 
51 S. Ct. 446
,

451-52 (1931)).    Death was “‘contemplated’ within the meaning of

the statutory presumption if the dominant motive for the transfer

[was] the creation of a substitute for testamentary disposition

designed to avoid the imposition of estate taxes.”        
Id. (citation omitted).
   In 1976, Congress amended section 2035 to omit the

contemplation of death provision, placing in its stead an absolute

rule including in the gross estate all gifts made by the decedent

within three years of death.18    The congressional intent——relevant

18
      The 1976 amendments also unified the rate schedules between
the estate and gift taxes. Tax Reform Act of 1976, Pub. L. 94-455,
90 Stat. 1848.

                                  36
to the present case as well——was patent:

     “Congress was troubled by the inordinate number of
     lawsuits by taxpayers who attempted to establish life
     motives for transfers otherwise taxable under the
     statute. The statutory change in section 2035 bore a
     rational relationship to a legitimate congressional
     purpose: eliminating factbound determinations hinging
     upon   subjective  motive.”     Estate   of  Ekins   v.
     Commissioner, 
797 F.2d 481
, 486 (7th Cir. 1986) (citing
     H.R. Rep. No. 94-1380, 94th Cong., 2d Sess. 12 (1976),
     reprinted in 1976 U.S.C.C.A.N. 2897, 3366) (emphasis
     added)); 
Hope, 691 F.2d at 788
n.3 (same).

Section 2035 was amended again in 1981 to eliminate the three year

rule, subject to certain exceptions, for persons dying after 1981.

The Economic Recovery Act of 1981, Pub. L. 97-34, Title IV, §§

403(b)(3)(B), 424(a), 95 Stat. 301, 317; § 2035(d)(1).19

     It is safe to say that, with the possible exception of gifts

causa mortis, the present transfer tax scheme eschews subjective

intent determinations in favor of the objective requirements set

forth in the statutes.    Therefore, section 2036(a) permits the

conclusion that a split-interest transfer was testamentary when,

and if, the objective requirement that the transfer be for an


19
        Under section 2035(d), however, the three-year rule of
section 2035(a) continues to apply to a transfer of an interest
included in the gross estate under sections 2036-2038, the sections
that address transfers with retained interests, those taking effect
at death, and revocable transfers.         Accordingly, a transfer
within three years of death of a retained life estate, as in Allen,
would be subject to the three-year inclusion rule under the current
formulation provided the transfer constituted a gift and was not a
bona fide sale for an adequate and full consideration. See note
12, supra
. Section 2035(c) includes in the gross estate the amount
of any gift tax paid by decedent (or his estate) on any gift by
decedent (or his spouse) after 1976 and during the three years
before the decedent’s death. Melton’s 1984 deed was not a taxable
gift because it was for an adequate and full consideration as
determined by the applicable tables under the regulations, as the
government concedes (nor was it within three years of his death).

                                37
adequate and full consideration is not met.              Section 2036(a) does

not, however, permit a perceived testamentary intent, ipse dixit,

to   determine   what   amount      constitutes     an    adequate    and   full

consideration.      Unless    and   until    the    Congress   declares     that

intrafamily transfers are to be treated differently, see I.R.C. §§

2701-2704 (West Supp. 1996) discussed below, we must rely on the

objective   criteria    set    forth    in    the    statute   and    Treasury

Regulations to determine whether a sale comes within the ambit of

the exception to section 2036(a).           The identity of the transferee

or the perceived testamentary intent of the transferor, provided

all amounts transferred are identical, cannot result in transfer

tax liability in one case and a tax free transfer in another.20

F.   Former Section 2036(c) and Chapter 14

      The   final   obstacle     preventing        our   acceptance    of   the

government’s construction of section 2036(a) is Congress’ enactment

of section 2036(c) in 1987 and its retroactive repeal and enactment

of chapter 14 in 1990.       Although we are not faced with the need to

determine the applicability of the 1990 estate freeze provisions to

20
        Some commentators embrace portions of the government’s
position regarding testamentary intent and section 2036(a) by
concluding that the nonadversarial aspect of intrafamily transfers
taints them as necessarily donative. See, e.g., Jordan, Sales of
Remainder Interests, at 717 (“While it may be the case that the
consideration received in a non-arm’s length transfer is sufficient
to prevent depletion of the taxpayer’s gross estate, the donative
character of the transaction combined with the taxpayer’s retention
of an interest in the property is nevertheless sufficient to make
the transfer testamentary in nature.”). We believe, however, that
such a view is a misconstruction of 2036(a).        The safeguards
concerning sham transfers and sham consideration, combined with
congressional prerogative to eliminate perceived abuses, see I.R.C.
§§ 2701-2704, counsel against reading back into the statute what
was removed statutorily in 1976.

                                       38
the facts of this case,21 we find that the abuses of the type which

the   government   perceives   in   the    challenged   transaction   were

addressed by Congress when it passed section former 2036(c) in 1987

and, subsequently in 1990, when it chose to replace former section

2036(c) with the special valuation rules of chapter 14.

      Congress enacted former section 2036(c) in 1987 to address

certain estate “freezing techniques”22 enabling taxpayers to take

advantage of the assumptions underlying the valuation tables in the

Treasury Regulations.    Omnibus Budget Reconciliation Act of 1987,

Pub. L. No. 100-203, 101 Stat. 1330-1431; see also Mitchell M.

Gans, GRIT’s, GRAT’s and GRUT’s:         Planning and Policy, 11 Va. Tax

Rev. 761, 791 & n.63 (1992).        Under the terms of former section

2036(c), the “exception contained in subsection [2036](a) for a

bona fide sale shall not apply to a transfer described in paragraph


21
       These provisions are (with minor, irrelevant exceptions)
inapplicable to transfers made on or before October 8, 1990. P.L.
101-508, sec. 11602(e), 104 Stat. 1388-500.
22

           “An ‘estate freeze’ is a technique that has the
      effect of limiting the value of property held by an older
      generation at its current value and passing any
      appreciation in the property to a younger generation.
      Generally, the older generation retains income from, or
      control over, the property.
           To effect a freeze, the older generation transfers
      an interest in the property that is likely to appreciate
      while retaining an interest in the property that is less
      likely to appreciate.       Because the value of the
      transferred interest increases while the value of the
      retained interest remains relatively constant, the older
      generation has ‘frozen’ the value of the property in its
      estate.” 5 Bittker & 
Lokken, supra, at 136-2
(quoting
      Staff of Joint Comm. on Tax’n, 101st Cong., 2d Sess.,
      Federal Tax Consequences of Estate Freezes at 9 (Comm.
      Print 1990)).

                                    39
(1) if such transfer is to a member of the transferor’s family.”

I.R.C. § 2036(c)(2) (West 1989), repealed by P.L. 101-508, sec.

11601, 104 Stat. 1388 (1990).          See also 
id. at §
2036(c)(3)(B)

(defining “family” to include a “relationship by legal adoption”).23

A paragraph (1) transfer involved a transfer by the holder of a

“substantial interest in an enterprise” while retaining an interest

in the income or rights of the transferred enterprise.               Former §

2036(c)(1)(A)-(B).       Although      “enterprise”    as     used   in   the

legislative history and the subsequent interpretation offered by

the IRS was capable of a more restrictive application, the reach of

former section 2036(c) could have “potentially embrace[d] almost

any activity relating to property held for personal use as well as

business or investment property.”             Karen C. Burke, Valuation

Freezes after the 1988 Act: The Impact of Section 2036(c) on

Closely Held Businesses, 31 Wm. & Mary L. Rev. 67, 91 (1989)

(citing H.R. Conf. Rep. No. 495, 100th Cong., 1st Sess. 996,

reprinted in 1987 U.S.C.C.A.N. 2313-1245, 2313-1742; I.R.S. Notice

89-99, 1989-38 I.R.B. 4); Bruce Bettigole, Use of Estate Freeze

Severely Restricted by Revenue Act of ‘87, 68 J. Tax’n 132, 133

(1988)   (“Read    literally,   this     provision    would    destroy    the

effectiveness of sales of remainder interests. . . . [B]ecause of

the   client’s    retained   interest    in    the   ‘enterprise’      (i.e.,

property), upon his death the full fair market value of the

23
        Paragraph (1) of former section 2036(c) applied only to
“transfers after December 17, 1987.” 
Id. § 2306(c)(1)(B).
The
1990 repeal of former section 2036(c) was applicable to “property
transferred after December 17, 1987.” P.L. 101-508, sec. 11601(c),
104 Stat. 1388-491.

                                    40
remainder interest will be included in his gross estate.”).

     In response to severe criticism of former section 2036(c)

passed in 1987, Congress enacted the Omnibus Budget Reconciliation

Act of 1990, Pub. L. No. 101-508, 104 Stat. 1388, which repealed

former section 2036(c) retroactively and replaced it with the

valuation rules set forth in I.R.C. sections 2701-2704.       See 5

Bittker & 
Lokken, supra
, 136-3 to 136-4.       Under section 2702,

transfers of interests in trust to a member of the transferor’s

family trigger special valuation rules.24      The general rule of

section 2702 values the remainder interest transferred as having

the value of the full fee interest by setting the value of the

retained interest at zero.    I.R.C. § 2702(a)(2).   In other words,

the general rule of section 2702 seems to accomplish, explicitly,

precisely what the government argues that 2036(a) accomplishes by

implication.25   Because there are overwhelming indications that the

24
     As the government’s brief observed, a transfer of an interest
in property is apparently treated as a transfer in trust if there
is a term interest in the property. I.R.C. § 2702(c)(1). “Term
interest” is defined as either a life interest or a term of years.
Id. § 2702(c)(3).
25
      We again emphasize that we take no position as to how section
2702 would affect this particular transaction had it been entered
into after October 8, 1990 (transfers prior thereto being excluded
from section 2702; see note 
21, supra
).       Although the special
valuation rules do not apply where the holder of a life or term
interest uses the property as his personal residence, I.R.C. §
2702(a)(3)(A)(ii), the Treasury Regulations provide that the
personal residence exception applies only where the residence is
placed in an irrevocable trust, 26 C.F.R. § 25.2702-5(b) (1996) (“A
[personal residence] trust does not meet the requirements of this
section if . . . the residence may be sold or otherwise transferred
by the trust or may be used for a purpose other than as a personal
residence of the term holder.”). Congress continues to tinker with
the transfer tax scheme. A new clause added to section 2702 on
August 20, 1996, strengthens the force of this Treasury Regulation.

                                 41
estate freeze provisions adopted by Congress in 1990 were designed

to address the perceived shortcomings of section 2036(a), we find

unconvincing the government’s suggestion on brief that “there is

nothing in [section] 2702 or its legislative history indicating

that a transfer with a retained life estate, even if within

[section] 2702, was not already subject to the provisions of

[section] 2036(a).”

     Accordingly, we hold that the sale of a remainder interest for

its actuarial value as calculated by the appropriate factor set

forth in the Treasury Regulations constitutes an adequate and full

consideration under section 2036(a).

                               III.

     As the government stipulated that the sale of the remainder

interest to Melton’s ranch was for its full actuarial value, the

only remaining issue is whether the sale of the remainder interest

was, in fact, a bona fide sale or was instead a disguised gift or

a sham transaction.

     The magistrate judge determined on summary judgment that sale

of the Melton ranch remainder interest was not bona fide.      The

magistrate judge cited the following factors as pertinent to his

recommendation: (1) John and David did not pay cash for the

remainder interest and were not capable of paying cash at the time

of the sale because of their relatively low annual salaries; (2)



See Small Business Job Protection Act of 1996, Pub. L. No. 104-188,
110 Stat. 1755 (adding I.R.C. § 2702(a)(3)(A)(iii) (“to the extent
that regulations provide that such transfer is not inconsistent
with the purposes of this section”)).

                                42
John and David began receiving substantial annual bonuses in 1986

and they used large portions of the bonuses to pay down the note;

(3) there were no negotiations regarding the purchase price of the

transaction; and (4) Melton forgave portions of the debt evidenced

by the note prior to its assignment to The Melton Company.    These

factors led the magistrate judge to conclude that the sale of the

Melton ranch remainder interest amounted to an attempt to color a

transaction that would otherwise be subject to section 2036(a)’s

inclusion rule.   See Estate of Maxwell v. Commissioner, 
3 F.3d 591
,

594 (2d Cir. 1993) (holding that, where children of the decedent

“bought” her personal residence and leased it back to her for

approximately the amount due under the note the children had

executed in her favor, the lease-back was merely an attempt to

“color” the transfer).     We find the stipulated facts and the

structure of the transaction lead to a contrary conclusion.

     First, the fact that John and David were not able, at the time

of the transfer of the remainder interest, to then pay the full

purchase price in cash provides little, if any, guidance on the

legitimacy of the   transaction.    It is not unusual for purchasers

of real property, whether purchasing a remainder interest or a full

fee, to lack the financial wherewithal to complete the transaction

without incurring a debt obligation.     Although it is conceivable

that the very issuance of such a debt instrument can make the

transfer donative (for example, if the obligors received a severely

discounted interest rate or presented the kind of credit risk that

would not justify the debt without a significantly higher yield on


                                   43
the note), the government did not challenge the terms of the note

or, for that matter, the creditworthiness of John and David.     The

“Real Estate Lien Note” executed by John and David provided,

initially, for annual principal payments of $10,000 at an annual

interest rate of seven percent.26      The interest rate on matured,

unpaid amounts was set at eighteen percent.       The note contained

acceleration provisions and provided for attorney’s fees in the

event of a default.   Each maker had personal liability for the full

amount. Finally, the note was fully secured and assignable. Aside

from the identity of the parties, no factor evinces a donative

transfer.

     The government contends that, without the substantial bonuses

received by John and David beginning in 1986, their base salaries

would not have enabled them to repay the debt evidenced by the

note.   Bonuses are a way of life in corporate America and the fact

that bonuses are used to compensate the employee-shareholders of a

close corporation should come as no surprise to the IRS.     See F.

Hodge O’Neal & Robert B. Thompson, O’Neal’s Close Corporations    §§

8.22-8.27 (3d ed. 1994 & Supp. 1996) (discussing the various forms

of bonus compensation plans used by close corporations and, inter

alia, their tax ramifications).   The determinative issue regarding

the payment of the bonuses to John and David is not, as the

government would have us believe, whether the bonuses enabled the

sons to pay the debt evidenced by the note, but rather whether the


26
        The parties soon thereafter agreed to monthly payments
without otherwise altering the terms of the note.

                                  44
bonuses were tied to the note’s repayment.                  The receipt of bonuses

simpliciter, even in a close corporation held by members of the

same family, does not transform compensation into a donative

transfer scheme.       Rather, bonuses serve many legitimate business

purposes, from recognizing a manager’s ability to rewarding an

employee proportionately for the success of the company.                          That a

particular company should choose to compensate their employees

chiefly through a system of cash bonuses——as opposed to straight

salary, options or warrants, commission, or on a per transaction

basis——does not control our analysis.                      The magistrate judge,

although      recognizing       that     “payment    on     the    note   was     not    a

precondition to receipt of the bonuses,” nevertheless found telling

the fact that “the note could not have been retired without the

bonuses.”      His first finding negated the relevance of his second.

       John   and    Michael      received      bonuses    in     addition   to    their

salaries in the following amounts:


       Year                John                  Michael

       1986                $ 50,000              $ 55,000
       1987                $250,000              $250,000
       1988                $125,000              $125,000
       1989                $200,000              $200,000
       1990                $ 45,000              $ 45,000
       1991                $150,000              $150,000

It is undisputed that John and Michael paid income tax on all bonus

amounts.      The bonuses continued, in fact increased, long after the

note   was    paid   off   in     full    in    January    1988.       There      are   no

indications that the ability of John and Michael to use the bonuses

was in any way restricted by Melton or The Melton Company.                          John


                                           45
and Michael’s decision to pay down the principal of the note and to

forgo   the   use   of    the   after-tax   amount    of   their   bonuses   in

alternative investments may well indicate the economic substance of

the remainder interest sale.        Their decision reflected an economic

decision that buying the remainder interest offered a return that

might outweigh the loss of the earning power of the purchase price.

On the other side of the transaction, Melton’s decision to sell his

remainder interest reflected a decision that the debt instrument

could improve his own financial status.27

       Nor do we find compelling the absence of negotiations over the

purchase price of the remainder interest.             The IRS can hardly set

forth actuarial valuation tables carrying the imprimatur of the

government, issue revenue rulings on their proper use, and advise

taxpayers through private letter rulings that the tables should be

used    in    remainder    interest    sales    and     then   protest   when

disinterested commercial parties——let alone family members——refuse

to bicker over the purchase price when the fair market value of the

fee has been properly determined, the measuring life meets the

rules governing the tables’ use, and the price calculated meets the

economic desires of the participants.

       The final factor cited by the magistrate judge is the fact

that Melton made gifts of $10,000 to both John and Michael in

December 1986 and made gifts and sales of stock during, and after,

the course of the indebtedness.        From the outset, we agree with the


27
        Melton, in fact, assigned the note in December 1986 in
partial payment of a $231,444 debt he owed The Melton Company.

                                      46
Melton estate that there is no testamentary synergy that arises

from a   taxpayer’s   decision   to   utilize   fully   the   annual   gift

exclusion and other tax-saving techniques sanctioned by Congress,

even where the taxpayer is of advancing years.28 To the extent that

a taxpayer exceeds the amount provided by Congress, the gift tax

adequately compensates the government for any amounts that leave

the estate.29   Moreover, there is no indication that the gifts of

stock were used by John and Michael to pay off the note; the

bonuses used were compensation, not dividends.

     Finally, the government argues, and the magistrate judge below

held, that even though each particular transaction may survive

scrutiny, “viewed as a whole” the entire series of transactions

between Melton and his sons was patently testamentary.          For us to

find the remainder interest sale qualifies under section 2036(a)’s

bona fide sale exception, it is urged, would elevate form over

substance.

     We have no doubt that cases have arisen——and will continue to

arise——where a clever estate planner frustrates the purpose of the

estate tax while meeting the precise requirements of the statute.

But, assuming Congress has not already addressed the situation

presented here by enacting chapter 14, we do not think that this



28
      Unless, of course, Congress provides otherwise. See, e.g.,
I.R.C. § 2035(a) & (d)(2) (West 1989); I.R.C. §§ 2701-2704 (West
Supp. 1996).
29
        And, where taxable gifts are made within three years of
death, the amount of gift tax paid thereon is also added to the
gross estate under section 2035(c).

                                  47
case is one of the rare few that come under that category.30             Here

the sons parted with real money in the form of a fully secured,

conventional   real   estate   lien    note   on   which   each   had   entire

personal liability; the purchase price of the remainder interest

was the uncontested fair market value of the ranch discounted by

the actuarial factor set forth in the government’s own regulations;

Melton received not only the principal amount due under the note,

but also interest income generated by the note prior to its

assignment to The Melton Company; no payments were missed, the note

was never in danger of default, and it was in fact paid off in

full, principal and interest, by January 1988, more than three

years before Melton’s death; although there were no negotiations


30
      Estate of Shafer v. Commissioner, 
80 T.C. 1145
(1983), aff’d,
749 F.2d 1216
(6th Cir. 1984), is more appropriately seen as the
type of transaction in which the decedent, in an intrafamily
transfer, attempted a form-over-substance maneuver. In Shafer, the
decedent “had the grantors execute the deed so as to convey a
remainder interest to [the children] as tenants in common while
retaining a life estate for himself.” 
Shafer, 749 F.2d at 1221
.
Accordingly, the decedent’s estate argued that there was no
“transfer” by the decedent to his children triggering section
2036(a).   
Id. The Tax
Court held that, because the decedent
furnished the entire consideration for the property which was
subsequently “unbundled” by the seller to accommodate the
children’s remainder interest, the decedent should be charged with
making a “transfer” with a “retained” life estate, regardless of
the property law niceties. Shafer, 
80 T.C. 1162-63
. The Sixth
Circuit affirmed, observing that “the inclusion or circumvention of
the intermediate step should not make a difference in the estate
tax consequences of the transaction.” 
Shafer, 749 F.2d at 1221
;
see also Gordon v. Commissioner, 
85 T.C. 309
, 324-25 (1985)
(stating that, “[i]n the context of a simultaneous, joint
acquisition from a third party . . . formally separate steps in an
integrated and interdependent series that is focused on a
particular end result will not be afforded independent significance
in situations in which an isolated examination of the steps will
not lead to a determination reflecting the actual overall result of
the series of steps.”).

                                      48
concerning the purchase price, it is patent that, at the time of

the transfer, a third party would have been ill-advised to pay more

than its actuarial value; the bonuses were compensatory, were

increased and continued long after the debt was wholly retired, and

were not linked to repayment of the note; and, finally, the

government, although maintaining that the sale of the remainder

interest was made “in contemplation of death,” concedes that

Melton’s death was not imminent at the time of the sale.31   This was

a bona fide sale.

                            Conclusion

     For the foregoing reasons, we REVERSE the judgment of the

district court and REMAND for entry of judgment in favor of the

Melton Estate reflecting its entitlement to a refund of all federal

estate taxes paid on the basis of the inclusion of the ranch in

Melton’s gross estate, plus interest.



                          REVERSED and REMANDED with directions




31
      Nor was there any evidence that his death was imminent at any
time while the note was outstanding.

                                49

Source:  CourtListener

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