Estate of Moore

Citations: 29 Cal. App. 3d 481; 105 Cal. Rptr. 568Docket: 11184

Court: California Court of Appeal; December 18, 1972; California; State Appellate Court

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The California Court of Appeals addressed the inheritance tax implications regarding two trusts: the irrevocable inter vivos trust created by Claus Spreckels and the trust established by Ellis M. Moore. The Controller of California appealed a judgment that sustained objections against taxing the Spreckels trust assets, while the executor of Moore's estate cross-appealed the judgment that allowed taxing the full value of the Moore trust assets.

Claus Spreckels' trust, established in 1928, was set to terminate upon the death of the last surviving child of Claus and Ellis, with Ellis entitled to one-quarter of the income and a discretionary power to appoint one-quarter of the principal. A provision stipulated that any waived share by Ellis would be distributed among the surviving children of Claus and their descendants.

Ellis remarried in 1942 and subsequently relinquished her power to appoint her interest, except to select relatives. Upon her death in 1967, she used her power of appointment in her will to distribute part of the trust's principal among her surviving children and their descendants. At the time of her death, Ellis was 78 years old, with her oldest child being 56 and all her grandchildren, mostly female, still living.

Ellis M. Spreckels established an irrevocable inter vivos trust on March 7, 1933, with Crocker First Federal Trust Company as trustee. The trust specified that all income would be paid to Claus Spreckels during his lifetime. After Claus's death, income would be divided among Ellis and her four children, with specific provisions for managing the children's share until they reached certain ages. The trust was designed to terminate upon the occurrence of specific events: the death of the trustor with surviving issue, the death of the last surviving child, or the death of Claus Spreckels. Upon termination, trust assets would be distributed according to a hierarchy of beneficiaries, including Claus's issue, the trustor’s cousins, or the appointee under a last will.

In the event of a child's death, their share would be distributed to their issue or, if they predeceased Claus, the same rules applied upon Claus's death. The trust prohibited income beneficiaries from assigning their rights or having those rights subjected to creditor claims. Following Frank Spreckels's death in 1948 without issue, the trust principal remained intact. The trial court determined that the four-sixteenths interest in the trust appointed by Ellis M. Moore was not subject to inheritance tax, while the Moore trust was taxable according to rates effective on March 7, 1933. The Controller argued the 1942 agreement constituted a release of power under tax law, which could trigger taxability, but faced a challenge: if the agreement was indeed a transfer, it would not be taxable at that time.

The Controller argues that the transfer in question is an "incomplete transfer" under inheritance and gift tax law, as defined in regulation 13304, subdivision (c). This designation applies to transfers where the transferee's rights are contingent, or the transferor retains the ability to modify the transferee's interests. The Controller asserts that the transfer only became complete upon the decedent's death, at which point inheritance tax is applicable. The argument references Keck v. Cranston, highlighting that the ultimate beneficiaries were not determined until death, and points to the Estate of Madison to support the claim that the taxable transfer occurred at that moment.

The Controller has clarified that the trust interest is not taxable under section 13695. Instead, the key issue is whether the 1942 agreement represented a release of a power related to property that would otherwise be taxable under section 13696. If so, it would have constituted a taxable transfer at the decedent's death, as per Revenue and Taxation Code section 13697. The document outlines a comparison between the actions of a trust creator who relinquishes reserved rights and a donee of a power of appointment who surrenders that power. The Controller's position necessitates examining whether Mrs. Moore's 1942 agreement would be deemed a release of a power had it been reserved in an irrevocable trust created by her.

Additionally, if the trust had been established by Ellis Moore, with a reserved life interest and power of appointment, the transfer would still be taxable under sections 13643 or 13644, independent of the 1942 agreement. Section 13696 stipulates that the exercise or non-exercise of a general power of appointment at death is taxable, while section 13697 states that the lapse of such a power during the individual's lifetime is considered a release. The release executed through the 1942 agreement may have aimed to mitigate federal estate tax liabilities.

Prior to the 1942 Revenue Act, effective October 21, 1942, only the exercise of a power of appointment was subject to taxation, specifically general powers, while the possession of unexercised powers was not taxed. The 1942 Act introduced taxation on certain special or limited powers of appointment and the mere possession of unexercised powers, applying retroactively to powers created before and after its enactment. It allowed a short window until January 1, 1943, for the tax-free release of pre-existing powers. The 1954 Internal Revenue Act stated that if a general power of appointment created before October 21, 1942, was partially released before November 1, 1951, it would no longer be treated as a general power for tax purposes.

The 1942 agreement involved a release that limited the beneficiaries of the power, aligning with Civil Code section 1060, which validated such releases made prior to its enactment in 1945. This section permitted both limitations on beneficiaries and releases affecting the property subject to the power. Although the 1942 agreement lacked statutory authorization at the time, it was not invalid.

Section 13696 of the Revenue Tax Code imposes tax on the exercise or non-exercise of a general power of appointment held at the time of death. If Mrs. Moore had a general power at her death, its exercise would have been taxable. However, section 13697, enacted in 1965, states that a release is a taxable transfer but does not apply retroactively to the 1942 agreement. The 1942 agreement was not classified as a transfer under section 13697, nor was it a transfer made in contemplation of Mrs. Moore's death, per section 13642. Thus, the appointed property was not taxable under sections 13696 and 13697.

Regarding the Moore Trust, the key question is whether the transfer was intended to take effect at or after the transferor's death. Significant factors include the distribution of trust assets to the surviving issue of a deceased child of the trustor, and the trust's duration dependent on the trustor surviving her husband and their children, with living descendants of the children at that time.

Upon the death of Mrs. Moore, the trust would distribute its assets primarily to the surviving descendants of at least one of her children with Claus Spreckels. The total corpus available could be limited to half, contingent on prior distributions to the descendants of any deceased children. If only one child’s descendants survived, they would receive half of the total trust income. Mrs. Moore's death would trigger a contingent reversionary interest, but this would not increase the income rights of the three living children. For the trust to revert entirely to Mrs. Moore, all her children and their descendants must predecease her.

The trust corpus would be subject to taxation upon reversion to Mrs. Moore’s heirs, and her death before any child turned 30 could impact income distribution. However, surviving children who reached 30 would have an absolute right to a fixed income share, independent of Mrs. Moore’s life. No child could possess any part of the trust corpus regardless of the timing of her death. The last surviving child could appoint the trust property via will only if they survived both parents and were the sole surviving issue.

The executor contended that four separate trusts existed, but the court maintained there was only one trust at its inception, with all income designated for one individual. The distribution of assets due to a child's death did not create separate trusts but rather adjusted the division of the single trust. Ultimately, despite the complex contingencies, the trust did not terminate with Mrs. Moore’s death, and beneficiaries' interests in the corpus remained uncertain until the settlor's passing, reflecting only an expectancy.

Under current federal law, a reversionary interest held by the settlor of a trust does not render the trust transfer taxable unless the value of that interest exceeds 5% of the property transferred at the time of the decedent's death, as per 26 U.S.C.A. 2037. This statutory rule was established to counter the implications of the Fidelity Co. v. Rothensies decision, which emphasized that tax liability should not be based on speculative assessments of a decedent's reversionary rights. Instead, the tax is based on the actual value of the property subject to the reversionary interest.

California has historically aligned its interpretation of transfer taxation with federal law but has failed to enact legislation to mitigate the effects of the Fidelity Co. ruling. Consequently, the established rule remains that a reserved reversionary right subjects the transfer to taxation. California law, specifically section 13648, articulates the intent to tax transfers designed to circumvent the distribution of property via wills or succession laws. Prior to the introduction of a gift tax, gifts made independently of death were not taxable, which laid the groundwork for understanding inter vivos transfers as taxable based on incomplete gifts.

In comparing the Fidelity Co. case to the current matter, notable differences arise in the conditions of income retention and powers granted to the trustor. The Moore trust, established before California's 1939 gift tax legislation, retained a reversionary clause allowing the trustor to reclaim property if all potential beneficiaries predeceased her. Additionally, the trust terms provided for the division of remaining principal at the trustor's death under specific conditions. A scholarly analysis by Professor Henry Rottschaefer affirms that a transfer in which a grantor entirely relinquishes interest, with no contingencies upon the grantor’s death, is not intended to take effect at death and, thus, is not subject to tax.

Determining the tax implications of a property transfer involves considering whether the grantor retains any powers, such as the ability to revoke or a possibility of reverter, which may keep the interests contingent until the grantor's death. In the absence of specific statutory authority to disregard such reversion possibilities, the transfer is regarded as intended to take effect after the transferor's death concerning the property subject to reversion, specifically the trust corpus. The potential reversion applies only to the portion of the trust corpus remaining after the death of the grantor's descendants and does not affect life income interests, which must end before death.

The taxable event pertains to the transfer in trust, assessed at the time of that transfer, reflecting the value the beneficiaries receive due to the grantor's death. The executor argues for valuation adjustments based on life estates enjoyed by the surviving children, referencing the Estate of Johnson case. However, the context differs as the trust's creation in the Moore case was subject to California law, while Johnson's trust was not. 

In the Estate of Madison, the beneficiaries received income from trusts, and taxes were based on the full corpus value. Key distinctions between the Moore trust and Madison include the nature of the trust and the grantor's intentions regarding property management. The decedent's children were adults, suggesting confidence in their ability to manage the property, and the trust was structured to maintain the principal while providing income to the family, differing from typical family settlements. The Moore trust included provisions for life estates and remainders, allowing the corpus to be distributed upon a child’s death, indicating a deliberate choice by the decedent regarding the trust's structure and duration.

The Moore trust does not terminate upon the settlor's death unless she survives her husband and all her children. At the establishment of the Moore trust, the ages of the children ranged from 4 to 21 years. It is characterized as a family settlement, particularly in relation to the earlier Spreckels trust. Under the precedent set in Estate of Madison, the right of a beneficiary to income is tied to the life of the trustor, determining the trust's duration. Upon the trustor's death, the remaining corpus passes to the income beneficiary without reduction from any income estate. In the Moore trust, three of the children hold vested income estates that could persist beyond the settlor's death, encumbering three-fourths of the corpus. The only provision ensuring the trust's transfer at the settlor's death is the possibility of reverter. If the California Gift Tax Law had been in effect when the Moore trust became irrevocable, it would have constituted a taxable gift of income to the settlor's four children.

A discussion on federal estate tax indicates that if property is transferred creating a life estate for someone other than the grantor, and that life estate vests immediately and is outside the grantor's control, its value must be deducted from the property value for estate tax purposes, assuming the life tenant survives the grantor. The text cites several cases supporting this view. The remaining values of the three life estates should be deducted from the corpus value when calculating tax obligations. This method aligns with the case of Miller v. Connelly, where an irrevocable trust provided life income to a daughter with a remainder to her sons, and the possibility of reverter rendered the trust assets taxable in the settlor's estate. Professor Rothschaefer's writings address the taxability of life estates extending beyond the settlor's death, suggesting that portions of such estates enjoyed prior to the grantor's death should not be taxed.

Life tenants may be subject to taxation on the economic benefits derived from life estates after the grantor's death, with the valuation based on the date of death. However, in this case, there was no power of revocation, and the life estates continued unaffected by the grantor's death. The value of the life estates enjoyed prior to death did not diminish the property’s value at the time of death, which affected tax liability. Consequently, the one-fourth interest in the trust assets that Mrs. Moore enjoyed is fully taxable. The three-fourths interest held by her children is also taxable, adjusted for the remaining life interests. The order regarding the nontaxability of the Spreckels trust is affirmed, while the decision on the Moore trust tax liability is reversed, directing the court to reassess the tax. The executor is entitled to recover appeal costs. Judicial concurrence is noted, along with the denial of rehearing and Supreme Court review. Sections 13696 and 13697 clarify the implications of powers of appointment and their taxability upon the decedent's death.

Section 13695 establishes that if a limited power of appointment is exercised by a donee after June 25, 1935, and the donor died before that date, the exercise is treated as a taxable transfer to the designated appointee, as if the property belonged to the donee. The argument against the applicability of this section hinges on whether the limited power was granted at the time of property disposition, with the conclusion that it was only granted by Claus Spreckels when he created the trust. Although the limited power was initially part of a general power, the statute specifically outlines taxation for the exercise of a limited power, not extending to the general power. The 1942 agreement did not effectuate any property disposition nor exercised the power of appointment. Historical context indicates that the law has evolved, starting from a provision in 1925 that taxed the exercise of any power of appointment and later amendments that narrowed the focus to only taxing the exercise of a limited power of appointment after the effective date of the Inheritance Tax Act of 1935. Thus, the crux of the matter is determining when the limited power was granted relative to the property disposition.

At the time of the 1942 agreement limiting the power of appointment, the relevant statute classified gifts of power of appointment as taxable transfers from the donor to the donee at the donor's death. If the donor died before June 25, 1935, and the power was exercised afterward, the transfer was taxed under the Inheritance Tax Act of 1921. In 1943, the statute was amended to clarify that if a power of appointment was exercised after the donor's death (for donors who died before June 25, 1935), the transfer was treated as if the property belonged to the donee and was subject to taxation as a testamentary transfer. 

In 1965, the relevant sections of the code were repealed and replaced, but prior to this repeal, any exercise of power by Mrs. Moore was explicitly taxable. Post-1965, the taxation of powers of appointment depended on whether the donor survived past June 25, 1935. If the donor did survive, the gift of the power would be taxed upon the donor's death; for powers exercised upon the donee's death, taxation fell under a different section as a gift from the donee.

The 1965 changes did not suggest an intention to exempt from taxation property appointed under a pre-1935 general power exercised after the donor's death. It is argued that such property remains taxable under the new provisions. The Controller acknowledged this argument, indicating the property should be viewed as owned by the decedent, thus subject to taxation as intended to take effect at or after death. The legal precedent suggests that property deeded in trust with a reserved power of appointment is taxable similarly. Additionally, references to previous case law indicate the nuances of revocable versus irrevocable trusts and their tax implications.