Commissioner of Internal Revenue v. Estate of Bosch/Opinion of the Court

by Tom C. Clark

United States Supreme Court

387 U.S. 456

Commissioner of Internal Revenue  v.  Estate of Bosch

 Argued: March 22, 1967. --- Decided: June 5, 1967

These two federal estate tax cases present a common issue for our determination: Whether a federal court or agency in a federal estate tax controversy is conclusively bound by a state trial court adjudication of property rights or characterization of property interests when the United States is not made a party to such proceeding.

In No. 673, Commissioner of Internal Revenue v. Estate of Bosch, 363 F.2d 1009, the Court of Appeals for the Second Circuit held that since the state trial court had 'authoritatively determined' the rights of the parties, it was not required to delve into the correctness of that state court decree. In No. 240, Second National Bank of New Haven, Executor v. United States, 351 F.2d 489, another panel of the same Circuit held that the 'decrees of the Connecticut Probate Court * * * under no circumstances can be construed as binding' on a federal court in subsequent litigation involving federal revenue laws. Whether these cases conflict in principle or not, which is disputed here, there does exist a widespread conflict among the circuits ^[1] over the question and we granted certiorari to resolve it. 385 U.S. 966, 968, 87 S.Ct. 499, 512, 17 L.Ed.2d 432. He hold that where the federal estate tax liability turns upon the character of a property interest held and transferred by the decedent under state law, federal authorities are not bound by the determination made of such property interest by a state trial court.

(a) No. 673, Commissioner v. Estate of Bosch.

In 1930, decedent, a resident of New York, created a revocable trust which, as amended in 1931, provided that the income from the corpus was to be paid to his wife during her lifetime. The instrument also gave her a general power of appointment, in default of which it provided that half of the corpus was to go to his heirs and the remaining half was to go to those of his wife. In 1951 the wife executed an instrument purporting to release the general power of appointment and convert it into a special power. Upon decedent's death in 1957, respondent, in paying federal estate taxes, claimed a marital deduction for the value of the widow's trust. The Commissioner determined, however, that the trust corpus did not qualify for the deduction under § 2056(b)(5) ^[2] of the 1954 Internal Revenue Code and levied a deficiency. Respondent then filed a petition for redetermination in the Tax Court. The ultimate outcome of the controversy hinged on whether the release executed by Mrs. Bosch in 1951 was invalid-as she claimed it to be-in which case she would have enjoyed a general power of appointment at her husband's death and the trust would therefore qualify for the maritalde duction. While the Tax Court proceeding was pending, the respondent filed a petition in the Supreme Court of New York for settlement of the trustee's account; it also sought a determination as to the validity of the release under state law. The Tax Court, with the Commissioner's consent, abstained from making its decision pending the outcome of the state court action. The state court found the release to be a nullity; the Tax Court then accepted the state court judgment as being an 'authoritative exposition of New York law and adjudication of the property rights involved,' 43 T.C. 120, 124, and permitted the deduction. On appeal, a divided Court of Appeals affirmed. It held that '(t)he issue is * * * not whether the federal court is 'bound by' the decision of the state tribunal, but whether or not a state tribunal has authoritatively determined the rights under state law of a party to the federal action.' 363 F.2d, at 1013. The court concluded that the 'New York judgment, rendered by a court which had jurisdiction over parties and subject matter, authoritatively settled the rights of the parties, not only for New York, but also for purposes of the application to those rights of the relevant provisions of federal tax law.' Id., at 1014. It declared that since the state court had held the wife to have a general power of appointment under its law, the corpus of the trust qualified for the marital deduction. We do not agree and reverse.

Petitioner in this case is the executor of the will of one Brewster, a resident of Connecticut who died in September of 1958. The decedent's will, together with a codicil thereto, was admitted to probate by the Probate Court for the District of Hamden, Connecticut. The will was executed in 1958 and directed the payment 'out of my estate my just debts and funeral expenses and any death taxes which may be legally assessed * * *.' It further directed that the 'provisions of any statute requiring the apportionment or proration of such taxes among the beneficiaries of this will or the transferees of such property, or the ultimate payment of such taxes by them, shall be without effect in the settlement of my estate.' The will also provided for certain bequests and left the residue in trust; one-third of the income from such trust was to be given to decedent's wife for life, and the other two-thirds for the benefit of his grandchildren that were living at the time of his death. In July of 1958, the decedent executed a codicil to his will, the pertinent part of which gave his wife a general testamentary power of appointment over the corpus of the trust provided for her. This qualified it for the maritl deduction as provided by the Internal Revenue Code of 1954, § 2056(b)(5). In the federal estate tax return filed in 1959, the widow's trust was claimed as part of the marital deduction and that was computed as one-third of the residue of the estate before the payment of federal estate taxes. It was then deducted, along with other deductions not involved here, from the total value of the estate and the estate tax was then computed on the basis of the balance. The Commissioner disallowed the claimed deduction and levied a deficiency which was based on the denial of the widow's allowance as part of the marital deduction and the reduction of the marital deduction for the widow's trust, by requiring that the estate tax be charged to the full estate prior to the deduction of the widow's trust. After receipt of the deficiency notice, the petitioner filed an application in the state probate court to determine, under state law, the proration of the federal estate taxes paid. Notice of such proceeding was given all interested parties and the District Director of Internal Revenue. The guardian ad litem for the minor grandchildren filed a verified report stating that there was no legal objection to the proration of the federal estate tax as set out in the application of the executor. Neither the adult grandchildren nor the District Director of Internal Revenue filed or appeared in the Probate Court. The court then approved the application, found that the decedent's will did not negate the application of the state proration statute and ordered that the entire federal tax be prorated and charged against the grandchildren's trusts. This interpretation allowed the widow a marital deduction of some $3,600,000 clear of all federal estate tax. The Commissioner, however, subsequently concluded that the ruling of the Probate Court was erroneous and not binding on him, and he assessed a deficiency. After payment of the deficiency, petitioner brought this suit in the United States District Court for a refund. On petitioner's motion for summary judgment, the Government claimed that there was a genuine issue of material fact, i.e., whether the probate proceedings had been adversary in nature. The District Court held that the 'decrees of the Connecticut Probate Court * * * under no circumstances can be construed as binding and conclusive upon a federal court in construing and applying the federal revenue laws.' 222 F.Supp. 446, 457. The court went on to hold that under the standard applied by the state courts, there was no 'clear and unambiguous direction against proration,' and that therefore the state proration statute applied. Id., at 454. The Court of Appeals reversed, holding that the decedent's will 'would seem to be clear and unambiguous to the effect that taxes were to come out of his residual estate and that despite any contrary statute the testator specifically wished to avoid any proration.' 351 F.2d, at 491. It agreed with the District Court that, in any event, the judgment of the State Probate Court was not binding on the federal court.

Petitioner in No. 240 raises the additional point that the Court of Appeals was incorrect in holding that decedent's will clearly negated the application of the state proration statute. While we did not limit the grant of certiorari, we affirm without discussion the holding of the Court of Appeals on the point. The issue presents solely a question of state law and '(w)e ordinarily accept the determination of local law by the Court of Appeals * * * and we will not disturb it here.' Ragan v. Merchants Transfer Co., 337 U.S. 530, 534, 69 S.Ct. 1233, 1235, 93 L.Ed. 1520 (1949); General Box Co. v. United States, 351 U.S. 159, 165, 76 S.Ct. 728, 732, 100 L.Ed. 1055 (1956); The Tungus v. Skovgaard, 358 U.S. 588, 596, 79 S.Ct. 503, 508, 3 L.Ed.2d 524 (1959). The Court of Appeals did not pass on the correctness of the resolution of the state law problem involved in Bosch, No. 673, and it is remanded for that purpose.

The problem of what effect must be given a state trial court decree where the matter decided there is determinative of federal estate tax consequences has long burdened the Bar and the courts. This Court has not addressed itself to the problem for nearly a third of a century. ^[3] In Freuler v. Helvering, 291 U.S. 35, 54 S.Ct. 308, 78 L.Ed. 634 (1934), this Court, declining to find collusion between the parties on the record as presented there, held that a prior in personam judgment in the state court to which the United States was not made a party, '(o)bviously * * * had not the effect of res judicata, and could not furnish the basis for invocation of the full faith and credit clause * * *.' At 43, 54 S.Ct. at 311. In Freuler's wake, at least three positions have emerged among the circuits. The first of these holds that

'* * * if the question at issue is fairly presented to the state court for its independent decision and is so decided by the court the resulting judgment if binding upon the parties under the state law is conclusive as to their property rights in the federal tax case * * *.' Gallagher v. Smith, 223 F.2d 218, at 225.

The opposite view is expressed in Faulkerson's Estate v. United States, 301 F.2d 231. This view seems to approach that of Erie R. Co. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188 (1938), in that the federal court will consider itself bound by the state court decree only after independent examination of the state law as determined by the highest court of the State. The Government urges that an intermediate position be adopted; it suggests that a state trial court adjudication is binding in such cases only when the judgment is the result of an adversary proceeding in the state court. Pierpont v. C.I.R., 336 F.2d 277. Also see the dissent of Friendly, J., in Bosch, No. 673.

We look at the problem differently. First, the Commissioner was not made a party to either of the state proceedings here and neither had the effect of res judicata, Freuler v. Helvering, supra; nor did the principle of collateral estoppel apply. It can hardly be denied that both state proceedings were brought for the purpose of directly affecting federal estate tax liability. Next, it must be remembered that it was a federal taxing statute that the Congress enacted and upon which we are here passing. Therefore, in construing it, we must look to the legislative history surrounding it. We find that the report of the Senate Finance Committee recommending enactment of the marital deduction used very guarded language in referring to the very question involved here. It said that 'proper regard,' not finality, 'should be given to interpretations of the will' by state courts and then only when entered by a court 'in a bona fide adversary proceeding.' S.Rep. No. 1013, Pt. 2, 80th Cong., 2d Sess., 4. We cannot say that the authors of this directive intended that the decrees of state trial courts were to be conclusive and binding on the computation of the federal estate tax as levied by the Congress. If the Congress had intended state trial court determinations to have that effect on the federal actions, it certainly would have said so-which it did not do. On the contrary, we believe it intended the marital deduction to be strictly construed and applied. Not only did it indicate that only 'proper regard' was to be accorded state decrees but it placed specific limitations on the allowance of the deduction as set out in § 2056(b), (c), and (d). These restrictive limitations clearly indicate the great care that Congress exercised in the drawing of the Act and indicate also a definite concern with the elimination of loopholes and escape hatches that might jeopardize the federal revenue. This also isin keeping with the long-established policy of the Congress, as expressed in the Rules of Decision Act, 28 U.S.C. § 1652. There it is provided that in the absence of federal requirements such as the Constitution or Acts of Congress, the 'laws of the several states * * * shall be regarded as rules of decision in civil actions in the courts of the United States, in cases where they apply.' This Court has held that judicial decisions are 'laws of the * * * state' within the section. Erie R. Co. v. Tompkins, supra; Cohen v. Beneficial Loan Corp., 337 U.S. 541, 69 S.Ct. 1221, 93 L.Ed. 1528 (1949); King v. Order of United Commercial Travelers, 333 U.S. 153, 68 S.Ct. 488, 92 L.Ed. 608 (1948). Moreover, even in diversity cases this Court has further held that while the decrees of 'lower state courts' should be 'attributed some weight * * * the decision (is) not controlling * * *' where the highest court of the State has not spoken on the point. King v. Order of United Commercial Travelers, supra, at 160-161, 68 S.Ct. at 492. And in West v. American Tel. & Tel. Co., 311 U.S. 223, 61 S.Ct. 179, 85 L.Ed. 139 (1940), this Court further held that 'an intermediate appellate state court * * * is a datum for ascertaining state law which is not to be disregarded by a federal court unless it is convinced by other persuasive data that the highest court of the state would decide otherwise.' At 237, 61 S.Ct. at 183 (Emphasis supplied.) Thus, under some conditions, federal authority may not be bound even by an intermediate state appellate court ruling. It follows here then, that when the application of a federal statute is involved, the decision of a state trial court as to an underlying issue of state law should a fortiori not be controlling. This is but an application of the rule of Erie R. Co. v. Tompkins, supra, where state law as announced by the highest court of the State is to be followed. This is not a diversity case but the same principle may be applied for the same reasons, viz., the underlying substantive rule involved a based on state law and the State's highest court is the best authority on its own law. If there be no decision by that court then federal authorities must apply what they find to be the state law after giving 'proper regard' to relevant rulings of other courts of the State. In this respect, it may be said to be, in effect, sitting as a state court. Bernhardt v. Polygraphic Co., 350 U.S. 198, 76 S.Ct. 273, 100 L.Ed. 199 (1956).

We believe that this would avoid much of the uncertainty that would result from the 'non-adversary' approach and at the same time would be fair to the taxpayer and protect the federal revenue as well.

The judgment in No. 240 is therefore affirmed while that in No. 673 is reversed and remanded for further proceedings not inconsistent with this opinion. It is so ordered.

Judgment in No. 240 affirmed and judgment in No. 673 reversed and case remanded.

Mr. Justice DOUGLAS, dissenting.

Notes

1. Illustrative of the conflict among the circuits are: Gallagher v. Smith, 223 F.2d 218 (C.A.3d Cir., 1955); Faulkerson's Estate v. United States, 301 F.2d 231 (C.A.7th Cir.), cert. denied, 371 U.S. 887, 83 S.Ct. 182, 9 L.Ed.2d 121 (1962); Pierpont's Estate v. C.I.R., 336 F.2d 277 (C.A.4th Cir., 1964), cert. denied, 380 U.S. 908, 85 S.Ct. 890, 13 L.Ed.2d 795 (1965).
2. Section 2056(b)(5) of the Internal Revenue Code of 1954, 26 U.S.C. § 2056(b)(5), provides:
3. It may be claimed that Blair v. Commissioner, 300 U.S. 5, 57 S.Ct. 330, 81 L.Ed. 465 (1937), dealt with the problem presently before us but that case involved the question of the effect of a property right determination by a state appellate court.