Pledger v. Worthen Bank & Trust Co.

Elizabeth Robben Murray, Special Justice. In this appeal, the Director of the Department of Finance and Administration challenges the Summary Judgment of the Chancery Court that the Estate was entitled to a marital deduction and, accordingly, is entitled to a refund of Arkansas estate taxes paid under protest. We affirm. Granville M. Cook died on August 20, 1989. He executed his Last Will and Testament on December 2, 1970; the First Codicil on December 7, 1981; and the Second Codicil on July 6, 1983. He was survived by his wife, Ruby S. Cook. Under the terms of the Will, if Ruby S. Cook survived Mr. Cook for a period of six months, she received 50% of the Estate outright. In 1970, it is undisputed that 50% was the percentage that qualified for the marital deduction for federal estate tax purposes. Under the Will, the remaining 50% was placed in trust for the benefit of Mrs. Cook. Article Fourth of the Will mandated the distribution of the trust net income to Mrs. Cook at least quarter-annually for the remainder of her life. The 1981 First Codicil sought to take advantage of changes in the federal estate tax laws. Under the First Codicil, the Estate was divided into two shares. The first share (Share No. 1) passed outright to Mrs. Cook and was equal to the minimum amount necessary to secure the marital deduction and which will result in no federal estate taxes. Share No. 2, consisting of the balance of the Estate after deducting the amount allocated to Share No. 1, passed in trust. The Second Codicil, executed July 6, 1983 provides as follows: Because of the health of my wife, Ruby M. Cook, I hereby give, devise and bequeath the property, both real and personal, previously given to my wife, Ruby M. Cook, to People’s Bank and Trust Company, to be held in trust by them for my wife, Ruby M. Cook. The purpose of the trust being that said trustee holds such funds and property for the use and benefit of my wife Ruby M. Cook, and do all things necessary in their judgment, to assist the said Ruby M. Cook, included but not limited to investments, payment of bills, payment to said Ruby M. Cook of funds sufficient to maintain her station in life in any and other things which might be done with said funds by my wife, Ruby M. Cook, should she be in good health. The purpose of this Codicil is not to reduce any bequest given to my wife, but is merely for the purpose to provide for the support and care of my wife, by reason of her health. Said People’s Bank and Trust Company for the use and benefit of my wife shall be entitled to receive in trust for her all funds which I have previously designated as bequests to my wife. Said Trustee shall be required to use the same care in the management of this Trust as they are required to use in the management of all trusts now being administered by them. They shall have the power to sell, exchange, mortgage or otherwise (sic) any and all property coming to their hands under this Trust. As amended and modified by the First Codicil and this Second Codicil thereto, I hereby republish, and affirm my Last Will and Testament dated the second day of December, 1970. Following the death of Mr. Cook, Worthen Bank & Trust Company (successor to People’s Bank and Trust) as executor petitioned the Probate Court of Pope County for an Order construing the Will and the two codicils. The question for the Probate Court, as here, was the effect of the Second Codicil. If the Second Codicil created a completely new Trust, there were no instructions concerning distribution of income and principal, nor were there any provisions for the distribution upon the death of Mrs. Cook. In October, 1989, the Probate Court entered an Order construing the Will and the First and Second Codicils. The Probate Court found that the combined effect of the three instruments was as follows: (1) if Ruby S. Cook survived the decedent by six months the Estate was divided into two shares, the first funded by property which would be subject to the unlimited marital deduction and the other funded by the unified credit equivalent exemption from estate tax liability; (2) both shares of the Estate were to be held in trust for the benefit of Ruby S. Cook; (3) with respect to each Trust Article Fourth of the Will required that (a) the net income was to be distributed to Mrs. Cook at least quarter-annually for the remainder of her life and (b) the Trustee was to distribute from principal any amounts necessary for Mrs. Cook’s care and maintenance, if the net income was insufficient for that purpose; and (4) under Article Fifth of the Will, if Mrs. Cook did not survive the decedent for six months or following her death, the assets of each Trust would be distributed to the Cooks’ children. Neither the Internal Revenue Service nor the State of Arkansas were parties to the proceeding in the Probate Court, and no appeal was taken from the Probate Court’s Order construing the three instruments. On or before August 20,1990, Worthen Bank & Trust Company, Inc., as executor, timely filed a United States Federal Estate Tax Return (Form 706) electing to qualify Share No. 1 for the marital deduction and provided a copy of the return to the appellant. As a general rule, no marital deduction is allowed if a life estate passes to a surviving spouse and upon that spouse’s death, the remainder passes to someone other than the surviving spouse. The surviving spouse’s interest is considered to be a “terminable interest.” Section 2056(b)(7) of the Internal Revenue Code (26 U.S.C. § 2056(b)(7)), however, provides an exception to that general rule. If certain requirements are met, the surviving spouse’s interest is considered to be “qualified terminable interest property.” If under the terms of the Will and codicils, Mrs. Cook is entitled to all of the income from the property, payable annually or at more frequent intervals, and no person has the power to appoint any part of the property to any person other than Mrs. Cook, it is qualified terminable interest property. Upon examination of the return, the Internal Revenue Service notified the Estate that it was denying the Estate the marital deduction under § 2056(b)(7). This increased the taxable estate of the decedent and, accordingly, increased the amount of the federal credit allowable for state death taxes. Ark. Code Ann. § 26-59-106(a). The Department of Finance and Administration issued the Estate an assessment of estate taxes in the sum of $40,950 plus interest in the amount of $10,716. The Estate paid the assessed taxes and interest under protest and brought this suit for refund. Jurisdiction is in chancery court pursuant to Ark. Code Ann. § 26-18-406 (1987). Arkansas Code Annotated § 26-59-106(a) provides: A tax is imposed upon the transfer of real estate and personal property of every kind owned by every person who at the time of death was a resident of the State of Arkansas, the amount of which shall be a sum equal to the federal credit allowable under the Federal Estate Tax laws, 26 U.S.C. § 2001 et seq., as in effect on January 1, 1983. There is no dispute as to the material facts; only questions of law remain. For his first point on appeal, the appellant urges that contrary to the decision of the chancellor, he is “not required” to look behind the IRS disallowance of the marital deduction to see if the IRS examiner was correct as to the nature of the interest Mrs. Cook received. We note appellant does not go so far as to say he is bound by the IRS decision but only that he may, if he so chooses, accept it. We do not believe the parties or this Court are bound by the decision of the Internal Revenue Service as to the construction of a will and codicils under Arkansas law nor do we find the above quoted statutory language mandates that interpretation. The dissent suggests that by our ruling today we will create not only chaos but two asymmetrical taxation system procedures for estates. We disagree. First, this Court’s decision in McCastlain v. Berry, discussed infra, does not appear to have opened any floodgates for estate tax disputes. Further, we do not equate resolution of legal questions pertaining to the construction of a will and its codicils to appraisals of property, examination of financial records or other matters regarding valuation of an estate. The appellee and the Internal Revenue Service will necessarily have to resolve the effect of our decision today on any federal estate taxes. The appellant and apparently the Internal Revenue Service take the position that under the Second Codicil there is no provision for Mrs. Cook to receive the trust income at least annually, and so her interest does not meet the requirements of qualified terminable interest property pursuant to 26 U.S.C. § 2056(b)(7). The issue of Mrs. Cook’s rights to income or property under her late husband’s Will and codicils is a question of state law. Estate of Bowling v. Commissioner, 93 T.C. 286 (1989); Estate of Holland v. Commissioner, 64 T.C. 499 (1975). A similar situation faced this court in McCastlain v. Berry, 240 Ark. 587, 401 S.W.2d 38 (1966). In Berry, the Internal Revenue Service disallowed the estate a marital deduction on grounds the widow’s interest was subject to divestment. Accordingly, additional Arkansas estate taxes were assessed and paid under protest. We affirmed the probate court’s construction of the Will that, under Arkansas law, she received a bequest in fee simple and thus the bequest qualified for the marital deduction. We believe the Chancery Court’s decision was right in concluding that the probate court correctly ascertained Mr. Cook’s intentions and properly construed the Will in a manner that harmonizes the Will and the First and Second Codicils. Under the terms of the original Will, Mrs. Cook was to receive one-half of Mr. Cook’s adjusted gross estate outright. The residue of the Estate was placed in trust for the benefit of Mrs. Cook during the remainder of her life and the co-trustees (one of whom was to be Mrs. Cook) were directed to distribute the net income of the Trust to Mrs. Cook at least quarter-annually during her lifetime. In addition, the trustees were given discretion to invade the principal of the Trust if needed for Mrs. Cook’s care and maintenance as long as the distributions did not exceed $5,000 in any single year. Under the First Codicil executed in 1981, Mr. Cook republished his Will and added a paragraph to take advantage of recent changes in the marital deduction formula under federal estate tax laws. The First Codicil divided Mr. Cook’s estate into two shares. There is no language in the First Codicil that negated the mandatory distribution of all net income to Mrs. Cook from the portion of the Estate held in trust. Under the Second Codicil, Mr. Cook’s intentions are clear. Because of his wife’s health, he simply wished to change the bequest to Mrs. Cook from an outright bequest to one in trust. The Codicil specifically states: The purpose of this Codicil is not to reduce any bequest given to my wife, but is merely for the purpose to provide for the support and care of my wife, by reason of her health. If anything, the trustees were given broad powers to do anything necessary in their judgment to assist Mrs. Cook. Nothing in the Second Codicil negated the Will’s Fourth Article which provided for a mandatory distribution of net income at least quarter-annually to Mrs. Cook. To interpret the Second Codicil as not entitling Mrs. Cook to the net income from both Trusts would be contrary to Mr. Cook’s expressly stated intent that the Second Codicil “is not to reduce any bequest to my wife.” The cases relied on by the appellant are easily distinguishable. In Nicholson v. Commissioner, 94 T.C. 666 (1990) the trust document at issue was not merely construed, but modified by a Court Order after the decedent’s death. In Wisely v. United States, 893 F.2d 660 (4th Cir. 1990), where the court determined that a qualifying income interest had not been created the decedent’s Will expressly directed the trustees that any income not used for the care and support of the surviving spouse was to be accumulated and added to the corpus of the trust. This language is clearly distinguishable from that contained in the Fourth Article of Mr. Cook’s Will. Based on the above, we hold that the Chancellor properly granted summary judgment to the appellee and properly ordered the appellant to refund the taxes and interest paid under protest in the amount of $51,666 together with interest. Dudley and Newbern, JJ., dissent. Glaze, Corbin, and Brown, JJ., join. Holt, C.J., joins. Hays, J., not participating.