Untitled Texas Attorney General Opinion

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THEATTORNEY GENERAL

OF TEXAS

Honorable Robert S. Calvert Opinion No. ~~-668 Comptroller of Pubiic Accounts Capitol Station Re: Taxability for inheritance Austin 11, Texas purposes of proceeds of National Service Life ,n- surance Policies and proper method of taxing partner- ship interest subject to a buy,and sell agreement be- Dear Mr. Calvert: tween the partners. You have requested that we advise you as to the taxability for inheritance tax purposes of two National Service Life Insurance policies on the life of Alex Goldstein, herein- after referred to as the Decedent, in the total amount of $10,000, pay~ableto his sister. The p.ertinentpart of Article 7117, Vernon's Civil Statutes, which levies the inheritance tax is the following: "All property withih the jurisdyictionof this State,. . .including the proceeds of li,,feinsurance to the extent of the amount receivable iby,the exoc- utor or ad:ministratoras insurance under policies t&en out by the decedent upon his own life, and to the extent of the excess over Party Thousand Dollars ($40,000) of the amount receivable by,all other beneficiaries as insurance under policies tnken out by the decedent upon his own life,. y .shall, upon passing. .be subject to a tax for the benefit of the State's ;eneral Revenue Fund. . . *" The insurance in-solvedis authorized by the National Service Life Insurance Act. 38 C.S.C.A., Sec. 801, et seq. At the time of the death of the Decedent, August 7, 1957, Section 816 of the Act made Sec,kionk5Ga of the same Title (World War Veters.nsLAct, 192il)appl~icable to National Service Li,feInsur- ance. The pertinent portion of Section 4543.is the followings "Payments of benefits due or to become due shall not be assignable, and such payments made to, or on account of, a beneficiary under any of the laws relating .toveterans shall be exempt from taxation, shall be exempt from the claims of creditors, and shall not be liable to attachment, levy, or seizure

Hon. Robe,rtS. Calvert,'Page 2 (Opinion No. WW-668)

by o&under any'legal or equitable process whatever, either before or after receipt by the,beneficiary. Such provisions shall not attach.to,claims of the 'United States arising,under such laws nor shall the exemption herein.contained &sto taxation extend to, any:property purchasedGin part or wholly'out of such payments."., '. In'the brief which has been submitted in connection with your request, the attorneys ~for the estate take the posi- tion that this.exemption provlsion effectuates anexemption from State inheritance taxes. They cite the cases footnoted below in support of their position.1 'The War Risk Insurance Act of September 2, 1914, and its amending acts provided for the insuranc,eby the United States of Ame,ricanvessels, their cargoe's,and crews.against the risks of war. This Act was subsequently amended; and the Act of June 7, 192,4,known as the World War Veterans' Act of 1924, made a new codificatio~nabolishing and repealing the previous acts,,with certain exceptions. There is a great body of case law involving the construction ~and:applicationof the old War Risk Insurance and the World War Veterans' Acts. As stated in 147 A.L.R:1185, in an Annotation entitled "National Service Life Insurance Act": "Because of the similarity in many~respects between the older act'sand the New National Ser-, vice Life Insurance Act, much,of this earlier case law is per-. tinent and valuable authority in the construction of the new act." The Federal exemption provision previou$'lyquoted was not incorporated into the World War Veterans' Act until 1935. However, under similar exemp,tionprovisions, even prior to the enactment of the Act of 1935, veterans' benefits had been held

1109); Watkins v. Hali, ; 876 (1929). See RemCram 2 Wash. 469, 267 P. 4ifr (1929), overruled on other ISee 108 5iliii&. A.L.R. 1110); Re Verchot, 4 Wash 2d 574, 104 P. 2d-(1940); Sorensonv. Security Bank, 121 Neb. 521, 237:N.W. 620 (1931), overruled on other grounds; Sorenson v. Horace State Ba~nk,125 Neb. 638, 251 N,.W.119 (1933).

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Hon. Robert S. Calvert, Page 3 (Opinion No. WW-568)

exempt, under the Pederai statutes, from taxation. See ..' Kimbrough ,and IGlenon American Law of Veterans, 2d Ed., 1954, 596, Sec. %kOl ?;r this reason, and for the reason stated in the A.L.R. Annotation above referred to, we recognize the per- tinence of the decisions cited in the brief submitted in con- nection ,with.thisrequest. There is, however,, authori,tyto the contrary. The attorneys for ~the estate recognize that certain New. York cases ,deniedan exemption for inheritance taxes.* They also recognize that the United States Supreme Court has held that the above quoted exemption does not preclude the ; inclusion of the proceeds of a War Risk Insurance policy in the deceased veteran's gross estate for estate tax purposes. United States Trust Co. v. Relvering, 307 U.S. 57. (Decided April 1/ 1939 : This case is still controlling for Pederal estate tkx purposes. See American Law of Veterans3 supra; * Rev. Rul. 55-622. However,'they urge that the difference in. the nature of inheritance taxes and,estate taxes justifies a different result under irheritance tax statutes. We cannot agree since we regard the Helvering case as controlling for Texas inheritance tax purposes~. In the Relvering case, the sole question was whether Risksurance prrceeds of a War policy payable to a deceased vetieran'swidow were properly included in his gross estate fcr Federal esta+;otax purposes. Sectinn 32 (g) Reva.nueAct of [Februa,ry 262.1926, as.amended, 26 U,S.C,A, Sec. 411 included in a decsdc<ntbs gross esta.iethe amount In ,excessof $4.0,000received by "beneficiaries [other ;than his estate1 as insurance under policies taken out by the decedent upon his own life." lh.e vetersn"s total life insurance for;beneficiaries stker than his estate excee,ledat death the statutory~exemption 0:' $4C,OOO iE his Whr Risk insursancepolicy,WB.Si.n~l~ded. The Commissicner assessed an es~ta?.he t;axmeas?uredby this excess. The decedent:s executor contended the War Risk Insurance pol- , icy should riotb9?.inc.luded !.nthe esi,atebecause ?f Section 22'of the Ws~ld War 7eteran:s ,A& /-;une 73, '1923,providing tkLat" such.irmdi3n.e

Ron. Robert S. Calv,ert,Page 4 (Opinion No. W-668)

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The court reasoned that the proceeds of the War Risk Insurance policy should be.included in the decedent!s estate for the following reasons: The Revenue Acts from 1918 to 1934, the date of the veteran's death, manifest a consistent policy to tax the pro- ceeds of all life insurance (not payable to an insured's es- tate) in excess of $40,000; and the Treasury Regulations ex- . pressly stated that the term "insurance" as used in the statute refers to life insurance of every’ description. ~With regard to the exemption provision, the court stated that the statutory immunity,of War Risk Insurance from taxation cloesnot includy an immunity from excises upon the occasion oftshifts of economic interests brought about by the death of an insured. The court regarded as analogous the cases in which Federal bonds~exempt by statute from all taxa- tion have been subjected to both State and Federal death taxes. tiurdockv. Ward, 178 U.S. 139 (1900); Elummer v. Coler, l'(oU.S. 115 (1500). With the exception of Re Verchot, supra.,all of the cases cited in footnote 1, as according exemption from death taxes, were decided prior to the decision in the Helvering case. Whether 'the jurisdictions in which these cases were decided would reach the same results in view of the Helvering decision is immaterial since we are bound to follow that case by,the decision in Blackman v. Hansen, ,140 Tex. 536, 169 S.W. 2d 962 (1943). In the Rlackmsn case i,twas held that where community~ funds were used to pay premiums on a deceased~husband's life t insurance policies only~one half of the proceeds in excess of the $40,000,exemption were subject to inheritance taxes. The court pointd'ed out that prior to 1939, proceeds of life instir- ante payable to named beneficiaries were no subject to a Texas inheritance tax. The 1939 amendement3 taxing such in- surance proceeds was almost identical with the Federal statute taxing such proceeds. The court said that since the Texas Statute was literally taken from the Federal statute, the pre- sumption is that the Texas Legisl,atureknew of the $onstruction given such statute at the time of its adoption and intended to adopt such statut,eas construed,by,the .Federalcourts. Such statute, therefore, is to be considered by the cou~rtsof this

- -,- ,- 3 H.B. 990,~Acts 1939, 46th Leg., p. 646, was passed by,the House Mayo9, 1939; by the Senate June 20, 1939, with amendments; the House concurred in Senate amendments June 20, 1939. H.B. 990 became effective ninety days after addournme'nt.

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. state In ?;helight of’suck c3t?StluCtlon~.Since the United had he13 that under the same fact situa- Sttates32premc3Co7Jr-t tion as presented by,the B;a.o1nnon cese only rne half of tne proceeds of the insurance poiicy was includible in the deced dent's,gross estate'fr~:estate tar purposes, Lang v.C%!mis7 sioner, 304 3.~~.264 (1938), the %xas Slupremecourt reached the conclusion above stated. ~/:

In the instant case;the same principles are appli- cable; and it must therefone be presumed that the Legislature intended to .adoptthe construction which had been placed upon the E'ederalstatute ir?the Xelvering case. This being so, the pr'oceedsof the War Risk Insurance polibies..arenot ex- 'empt from inclusion,within Article 7117, V.C;S., for the pur- pose of,calculating inheritance taxes. You have also requeated'that we-advise you as to the ,proper valtiitionto be placed upon'the interest which Dece- dent had in a partnership at the time of ,hls death. The Decedent and C. M, McElhannon were partners fin a business known as the Bonded Warehouse Company~. In February of 1956, the partners entered into a contract and agreement which pe- cited that they'were equal partners in said business, that the value of said partnership was largely dependent upon their individual efforts, and that it was "the desire,,ofthe parties hereto,that in ~theevent of the death of either of such part-, ners. . .the survivor succeed the partnershIp Csic_jf,in the ownership and operation of said business and relieve the es- tate of deceased of the hazards of the operation of such business and~leave unto the estate of the deceased a sum certain." The remaining portion of the agreement reads as follows: "NOW, 33RE%ORZ, in consideration of the mutual benerits, covenants, promises and agree- ments of t'heparties hereto, to bfikept and performed, the pz..r,t,ies hereto agree as fellows:

*. "(1) That the survivor of said partners?J.p will within 3.::?:;!sonable time zfte:r; the death of first dece?sed pay to t;heestate of deceased the full sum of Twenty-five Thousand,Dollars ($;S,OOO) cash, less all debts or overdrafts cf deceesc.1due to partnership, an&assume e.11pa,rtnershipindebt- edness of any ar.dall zature whatsoever. "(2) I2 consideration of performance by suy- vivor;of t'hecond,itionso,?paragraph (1) hereof, each of the'partiea hereto does by these p:&sents bind the!,rheirs; assigns, execrators,adminlstra-

Hon..RobertaS. Calvert, Page 6 (Opinion No. WW-668)

tors and estates, that in the event he should prior decease the,other partner, that his execu- tors, administrators and estate will pass full legal title to all of the assets of said partner- ship to the survivor. "(3)~ All expenses in connection with the transfers and assignments described in paragraphs (I) and (2) hereof shall be borne and paid by the survivor. "(4) Inthe.ev,ent of decease of survivor prior to full payment and performance of condi- tions of paragraph (1) hereof, the assets of said partnership shall pass share and share alike to the estate of said partner." In an affidavit submitted by,Clifford M. McElhannon in connection with the inheritance tax return, he states that he.and the deceased partner had entered into a verbal agree- ment that each partner would take out life insurance on his own life making the,co-partner the beneficiary. The amount of life insurance was to be increased from time to time according to the mutyal.desires of the partners, with the amount of in- surance payable to each partner remaining at all times sub-, stantially the same. It was further orally agreed between.the partners that no change would be made in such life insurance without the,consent of the partner named as beneficiary,. Pre- miums on these policies were paid for by check issued on the partnership account. Subsequent to the death of the Decedent, Mr. McElhannon received $30,226.91 as beneficiary under various policies taken out by the Decedent,pursuant to the foregoing agreement.~ At the date of Decedent's death, the value of his partnership in- terest was $33,521.40. The attorneys for the estate have not reported the value~of thepartnership assets"but have 'repor,ted~ $25,00Cworth of insurance as the value of an asset which replaced it and are claiming a pro rata share of the $40,000 exemption! You ask whether the partnership interest should be reported as an in- tangible asset of the estate. The )attorneysfor.the estate take the position that the Decedent's partnership interest should be,taxed in .accord- ante with the Federal rule which has been stated as follows: "Where the,stock of the,decedent in a close carp- oration or his interest in a business as partner

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I .Hon. Robert S. Calvert, Page 7 (Opinion No. WW-665)

is subject at his death to an zgreemen~ cf sale sir to anotherm'slegally binding option to purchase at a fixed pr'ice,the fair market vai,uefor Pederal tax purposes is Ilimitedto such price, provided the price was f'ai.r nt the tim'eIt was established and the decedent couid not have disposed ,of the pro,; perty~at any time prior to his death: Iielveringv. Sa.lv;?.ge, 297 V.S. 106 156 S.ct. 375. 8~ L.Ed. (1935); Wilson v. Bowers, 57 F.2d 682' dCA-2, Lcmb v. Sugden, 82 F.2d 166 (CCA-2 193 !; Claire C. Ho:fman, 2UT.;::115C (1943 ;‘Estate of iames H. Matthews, :3T.C. 525 11944. I ." 1 Polisher, Estate Planning and Estate Tax Saving, 311. We agree With the attorneys for the estate that the buy and sell agreement in this case was a valii!and enforce- able one. We think that the consideration was adequate and that the agreement was no,tintended asa substitute for tes- tamentary dispositionor as a device to avoid estate taxes, The partners are unrelatezd, and there would have been no reason to consider either a natural object of the other's bounty. Even though the agreement does not specifically pro- hibit either partner selling his interest in the partnership prior to his death.'.wethink that such prohibition should be implied In view ofthe formality of the agreement and the absolute natu?e,cf its provisions: See "Estate Tax Conse- quences of Agreements for the Sale of 3 Partnership Interest Effective at the Partner's Death--An Appraisal of the Law" by Wright Katthew3, 26 T.L.R. 729, for a discussion of the var- .*ious tests whi-'3the cocrts have applied in determining the validity,and.effect of such partnership agreements. && is -?hisapeement binding on the State ',ndeter- mining the value of the ~decsd~ent's partnership interest at his dea.th? We think.nct. The transaction is ens which comes squarely,wi?;hinthe provision of Artic,le7177, ';,S.S.,which imposes a t,axupon transfers "by deed, grant, sale,-o'rgift made or intended to take effect in possession or enjoy~menta5 or after the death of the grantor or donor, . . .' (%lPh~3SiS supplied.) ConsiderTng the transfer in question as a b?ria fide sale of ,t?epartnership interest, nevertheless, the pre- p>svealth.atit '~3sa sale for less t?ia~!l viously stated,f'a.8zt.s the full vaius of such il-iterest at the Decedent's death and does not reflect the true amount which the surviv,ingpartner received~'byvirl~~~.z of t;iesale intended~to take effect at the deathsof the Decedent. The ba.si:distinction between a tax in the natv;::e of an inheritance ta,xand a tax in the nature of an estate tax

Hon. Robert S. Calve&, Page 8 (Opinion No. m-668)

necessitates a,dif'ferentconclusion from that reached by the' Federal courts. 'TheFederal rule is obviously'sound because the Federal tax is based upon the net taxable estate of the decedent at his death..~Therefore, where the estate receives less than the full value of the partnership interest under a bona fide sales agreement,,only the amount actually received should be included in computing the estate tax. But our inheritance tax,statute looks not to,the net estate of a decedent but to the amount received by an individual by virtue of a taxable transfer. ,4 In Schroeder v. Zink, 7l'A.2d 321, the court in considerine:a similar fact situation reached the same result that we he:e reach. In this case the court pointed out,that in determining whether,a particular transfer is intended to take effect at,or after'the transferor's death, the important question is whether the vesting of possession and enjoyment is dependent upon the settler's death. There can be no doubt that the transfer of~the Dscedent's partnership interest took effect in possessionand enjoyment at or after the deceased partner's death.: The court also stated ,that obviously it was only when there was an adequate consideration substantially equal to the value ,ofthe property that sales intended to take effect at death are not taxable and that therefore to~the ex- tent that consideratio? paid was inadequate,in value as com- pared to the value received, it is tantamount to a gift. It is, in effect, a substitute for a testamentary disposition, and taxable. Ar~ticle713d,'V.C.S., provides for the appraisal of property for inheritance tax purposes '. . . at its actual market -value if it has a market value, and in case it has none, then its zeal value at the time of the death of the decedent, . . . In Calvert v. Kattar, 301 S.W.2d 318 (Tex. Civ.App., error ref.,n.r.e.), the court held that market value for inheritance tax purposes was the following accepted definition as approved by the Supreme Court in Sta.tev. Carpenter;.'126Tex. 604, 89 S.W.2d 979 (1936): ". . . The price the property will bring when offered for sale by one

4 Cited and followed in Minoff v. Margetts, 81 A. 2d 369 (Superior Ct,.. of N. J., ~mlj;, See In re Cowles' Estate, 219 p. 2d '964 (Wash.Sup., 1950) for a discussion of the conf1icting solutions of the problem.

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. Hon. Robert S. Calvert, Page 9 (Opinion No. WW-668)

who desires to sell, but is not obligated to sell, and is bought by one who desires to buy, but is under no necessity of buying." . The New Jersey statu%e in the Schroeder case re- quired an aopraisal at "fair market value," which term had been defined in the same terms as the above quoted defini- tion. At page 327, the court states: "To ascord a binW.ng effect to the ante mortem value,set in.the agreement before u=ur necessarily oust the tax appraiser of his stat- utory duty to appraise the property transferred at its 'fair market value', R. S. 54:34-g, N.J.S.A. Such construction would open the.door to tax evasion and frustration of the clear legislative mandate. Cf. In re Hartford's Estate, supra, 122 N.J. Eq. at page 498, 194 A. 300." You are therefore advised that all the insurance received by the surviving partner should be taxed as in- surance and accorded ,its pro rata share of,the allowable insurance exemption. You are further advised that the surviving partner owes,an additional tax on the value of the partnership assets as such in excess of the contract price.

The proceeds of National Service Life Insurance policies are subject to,. inheritance taxes ,under Article 7117, V.C. S. Where partners entered.into agreement which provided that survivor would pur- chase deceased partner's interest for $25,000 and further verbally agreed that each partner would take out life insur - l

ante on his own life naming co-partner as beneficiary,,the proceeds of all life in- surance policies received bye the surviving partner are taxable as insurance and enti- tled to their pro rata share of exemption from inheritance taxes. The surviving partner also owes an ideritance tax on the value of the partnership assets to

Hon. Robert .S. Calvert, Page 10 (Opinion No.,W-668)

the extentof,the value,in,excess of the c~cntra.ct price. : Verytruly yours, :' WILL-WILSON :Attorney'GenerBl *, , .

., -i Assistant MMP:bct :: APPROVED:. OPINION~COMMITTEE: I?organNesbitt, Chairman ', Tom L.'l%Farlin'g' Howard Mays Lawrence Jones REVIEWED FOR TXE ATTORNEY GENERAL By: W. V. Geppert

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