PROPERTY OWNED BY THE DECEDENT AND JOINT TENANCY

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1 PROPERTY OWNED BY THE DECEDENT AND JOINT TENANCY Albert S. Barr, III Albert S. Barr, III llc 111 S. Calvert St., Suite 2700 Baltimore, Maryland Phone: Fax: I. PROPERTY OWNED BY THE DECEDENT - IRC SECTION 2033 A. Introduction Section 2033 of the Code provides that the gross estate of a citizen or a resident of the United States includes all property "to the extent of the interest therein of the decedent at the time of his death." Section 2033 only applies to beneficial interests of the decedent, not to interests that the decedent may hold solely as a fiduciary. B. Applicable Law Section 2033 requires the application of a combination of state and federal law. "State law creates legal interests and rights. The Federal Revenue Acts designate what interests or rights, so created, shall be taxed." Morgan v. Comm., 309 U.S., 78, 80 (1940). 1. State court adjudications of legal interests and rights are binding for federal tax purposes only if the state decision is by the state's highest court. Comm. v. Estate of Bosch, 387 U.S. 456 (1967). Even a state Supreme Court decision may be disregarded if the issue pertinent to federal taxes is nonadversarial at the appellate level. Sappington, Exr., 68-1 U.S.T.C. Par , aff'd 69-1 U.S.T.C. Par (9th Cir., 1969); S. Broadhead Trust, 31 T.C.M. 975, T.C. Memo (1972). Further, the IRS will not recognize any retroactive effect of judicial decisions (PLR ), despite some judicial authority that it should in Flitcraft v. Comr., 328 F.2d 449 (9th Cir., 1964).

2 2. The Bosch principal does not apply, however, to determinations of rights and interests settled by local adjudication and res judicata before the federal tax question occurred. Rev. Rul , C.B In such cases the local adjudication will be binding for federal tax purposes. Further, the IRS often accepts lower court adjudications if it believes state law was properly applied. See PLR C. Property Owned Outright Property owned outright by the decedent is includable in the decedent's gross estate for federal estate tax purposes under section Although the two concepts are not identical, it is fairly accurate to state that section 2033 describes the decedent's "probate estate". 1. Section 2033 requires the inclusion in a decedent's gross estate for federal estate tax purposes of real property, tangible personal property, and intangible personal property owned outright by the decedent. 2. Section 2033 also requires the inclusion in a decedent's gross estate of such income items as salary due at death, dividends on stocks "of record", interest accrued on bank accounts or bonds, and accrued rent. These items generally fit the description of "income in respect of a decedent", or IRD (Section 691). 3. Section 2033 does not include property contained in decedent's revocable trust, even if the decedent is also Trustee, because such assets are owned by the trust, not the decedent. These assets will be included in decedent's gross estate, but by application of another Code section, not section D. Partial Interests in Property Section 2033 includes in the gross estate many limited, or partial interests in property owned by the decedent. 1. The decedent's interests in property as a tenant-in-common or community property (See Appendix I) are includable under section Most recently, the repeal of section 2039(c) of the Code for decedents dying after October 22, 1986, has required the inclusion in a decedent's gross estate of his or her community property interest in the surviving spouse's employee benefit plans. 2. The decedent's interests in property as a joint tenant with right of survivorship or as a tenant by the entirety, however, are governed exclusively by section 2040 of the Code, and are not interests covered by section Such interests are not inheritable and are not subject to the decedent's testamentary direction. Stated in terms of section 2033, decedent had no interest in such property at the time of his death because his interest may be said to have expired at his death.

3 3. a. Successive interests in property which expire at the decedent's death are not includable under section 2033, because of the expiration of the interest at the decedent's death. Williams v. United States, 41 F.2d 895 (Ct. Cl. 1930). b. This principle was the basis for the popular "joint purchase" when a parent would buy the life estate in property and a child or grandchild would buy the remainder interest. Stated differently, the remainderman has purchased the right to own the property at the life tenant's death, and the life tenant has no interest which survives him. Thus, a life estate in a farm is not taxable in the decedent's estate, but the decedent's interest in the crop, which is subject to his testamentary disposition, is includable in his gross estate. Martin v. United States, U.S.T.C. Par. 10,844 (1952). Joint purchases have been severely discouraged by the enactment of Chapter 14, Section 2702(c)(2), effective October 8, E. Business Interests 1. An incorporated business interest is includable in a decedent's gross estate under section 2033 as shares of corporate stock which the decedent may own, not as the decedent's pro rata share of the underlying assets, since the decedent had no direct ownership interest in the corporate assets. But see George v. C.I.R., 88-1 U.S.T.C. Par (5th Cir., 1988) on remand from United States Supreme Court, 88-1 U.S.T.C. Par (1988); C.I.R. v. Bollinger, 88-1 U.S.T.C. Par (Sup. Ct., 1988), for the proposition that a corporation which acts as an agent for its shareholders rather than as a principal will be disregarded for tax purposes with respect to those transactions in which it so acts. 2. A decedent's interest in a partnership may be included as a partnership interest, much like a share of stock, or as a pro rata share of each partnership asset, depending upon the decedent's rights in the partnership at death. a. If the partnership agreement directed the termination of the partnership at death, the decedent's gross estate would correctly include his pro rata share of the underlying assets, because that is what the decedent could pass by his Will. b. If, however, the partnership agreement provides for the continuation of the partnership and the substitution of the decedent's estate for the decedent as a partner, the value of the business interest would be

4 includable as a portion of the going concern, partially determined by the partnership's potential to earn future profits and goodwill. c. The valuation of the decedent's interest might differ substantially in these two cases. The first approach emphasizes asset values and the second emphasizes earnings and goodwill. See, Treasury Regulation ; Ball v. United States, 295 U.S. 247 (1935); Goodall, 391 F.2d 775 (8th Cir., 1968); Minskoff v. United States, 349 F. Supp (S.D.N.Y., 1972); Ltr. Rul The last cited Letter Ruling states the government's position that a partnership interest is valued by the partner's share of the partnership assets, rather than earnings, if the deceased partner has the power to dissolve the partnership. F. Compensation for Death Damages for "wrongful death" are generally not includable in the estate of the decedent because they do not represent a continuation of the decedent's rights against the wrongdoer, but rights of the decedent's survivors which grew out of the decedent's death but never belonged to the decedent himself. Maxwell Trust v. Comm. 58 T.C. 444 (1972); Acq C.B. 2 (1973). Recoveries under survival statutes are likewise excludable from the decedent's gross estate except to the extent that they are compensation for the decedent's pain and suffering or expenses during his lifetime. Rev. Rul , C.B Similar results apply to benefits payable to a decedent's survivors under Social Security (Rev. Rul , C.B. 322), Workman's Compensation Acts (Rev. Rul , C.B. 600), and similar statutes. G. Reporting Property Includable under Section 2033 on the Decedent's Estate Tax Return. The estate tax return provides four schedules for reporting property included in the gross estate under section They are as follows: 1. Schedule A--Real Estate. Schedule A should include all real estate interests owned by the decedent at the date of his death which are includable under section Schedule B--Stocks and Bonds. All stocks and bonds owned by the decedent should be listed on Schedule B, complete with CUSIP numbers, where applicable. Interest on bonds accrued to the date of decedent's death, whether or not due and payable, should be listed separately immediately under the bond itself. Similarly, "ex-dividends" and dividends of record should be listed under the appropriate stock.

5 3. Schedule C--Mortgages, Notes, and Cash. Schedule C includes mortgages and promissory notes held by the decedent, contracts by the decedent to sell land, and cash. 4. Schedule F--Other Miscellaneous Property. Schedule F includes all property owned by the decedent at the date of his death that is not returnable under any other schedule. In particular, this Schedule should include household goods and personal effects, including clothing and jewelry. It is also the place to list refunds due the decedent, such as income tax refunds. Partnership interests are returned on Schedule F. 5. Overlapping. The provisions for inclusion of property in the gross estate overlap. If a decedent has property included in his gross estate under section 2033 and some other section, it should be reported only once, in the schedule applicable to such other section, rather than the schedule applicable to section III. OBSERVATION A. No Aggregation of Unincludible Interests It appears that no aggregation of a decedent's partial interests in the same property will bring that property into his gross estate unless one of those interests, standing alone, is sufficient to cause taxation under section 2033, 2041 or some other section. e.g. Helvering v. Safe Deposit and Trust Company, 316 U.S. 56 (1942); Second National Bank of Danville v. Dallman, 209 F.2d 321 (7th Cir., 1954); Keeler v. United States 461 F.2d 714 (5th Cir., 1972). B. Foundation of Estate Planning This principle, that no aggregation of otherwise unincludible interests will require inclusion in the gross estate, is the foundation upon which much estate planning is laid. For example, a surviving spouse's interest in a credit shelter trust may include being sole Trustee, receiving income, receiving principal for her health, maintenance, and support, having the power to with-draw up to the greater of Five Thousand (5,000) Dollars or five (5) percent of trust corpus each year, and being allowed to appoint by Will or during her lifetime any or all trust assets to anyone other than herself, her estate, her creditors or her estate's creditors. In the aggregate, these rights and powers come very close to outright ownership and very close to a general power of appointment. Yet neither section 2033 nor 2041 alone can quite bring the property into the gross estate, and the IRS cannot aggregate its "near misses" to require the Trust to be included in the survivor's gross estate. This is the principal, and these are the facts and trust provisions upon which most basis revocable trusts and estate plans are based. (Appendix III)