WHO SHOULD BEAR THE BITE OF ESTATE TAXES ON NON-PROBATE PROPERTY?

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1 WHO SHOULD BEAR THE BITE OF ESTATE TAXES ON NON-PROBATE PROPERTY? MARK R. SIEGELt I. INTRODUCTION AND OVERVIEW A. INTRODUCTION: SETTING THE STAGE As you begin to study the property transfer provisions in the will, you immediately detect a similar pattern. The initial articles of the will that you are reviewing make several different dispositions of property. One disposition is a general bequest of cash. Further, the preliminary articles bequeath personal property and thereafter devise the home. The final provision disposes of the balance of the property. 1 Several hundred thousand dollars are owed in estate taxes. The estate tax bill is attributable not only to assets disposed of by the will, known as the probate estate, but also to assets passing outside of the will, or the non-probate estate. 2 Will each asset be responsible for its pro rata share of the taxes, or will certain assets be relieved of the burden of taxation? How the tax liability is shared will undoubtedly create the potential for adversarial relations if certain beneficiaries receive their property free and clear of any pro rata share of tax liability while others bear more than their pro rata share. In this manner, one can readily see how an allocation of tax liability in the tax clause of the governing instrument is most properly viewed as a dispositive provision even if the tax clause is not technically a pre-residuary or residuary disposition. A long standing tradition exists in this country to impose a tax on property held by the decedent at the time of death. Taxes imposed upon death may take one of two primary forms. An estate tax is levied on the transfer of property by the decedent. 3 The federal estate tax is an example of this form because it is a tax on the right to transfer t Professor of Law, South Texas College of Law; LL.M., Emory University; J.D., Florida State University; B.S.B.A., University of Florida. 1. This provision is commonly referred to as the residuary clause. Those dispositions made prior to the residuary clause are known as pre-residuary clauses or dispositions. 2. In JESSE DUKEMINIER, ET AL., WILLS, TRUSTS, AND ESTATES 38 (8th ed. 2009), the following helpful definition states: Probate property is property that passes through probate under the decedent's will or by intestacy. Nonprobate property is property that passes outside of probate under an instrument other than a will. 3. In re Will of Cooney, 541 N.W.2d 467, 476 (Wis. 1995).

2 CREIGHTON LAW REVIEW [Vol. 43 property. An inheritance tax, in contrast, is imposed on the beneficiaries receiving the property from the estate. 4 As a wealth transfer tax, the federal estate tax is not limited to those assets disposed of by will or transferred through intestacy. The federal estate tax is imposed on the transfer of probate and non-probate property. By federal statute, the personal representative of the estate has personal liability for the payment of federal estate taxes attributable to the probate and non-probate property. Few tax lawyers and estate planners would contest the notion that a will should address how any estate taxes owed are to be paid and by whom. Charging the taxes solely to the assets passing under the will achieves a very different outcome compared to apportioning the taxes to all beneficiaries of the decedent's wealth, including those receiving assets passing outside of the will. 5 Suppose Tom Testator's will left cash bequests to his children, a specific bequest of his car to his brother, a devise of his principal residence to his sister, and the residue of his estate to be divided equally among his siblings and descendants. At common law, because the preresiduary dispositions of cash, the car, and the principal residence were not responsible for the payment of the estate taxes, these beneficiaries received these assets without reduction for any estate taxes attributable to them. The residuary estate, and in turn, the residuary beneficiaries, would ultimately be responsible for the estate taxes, including any taxes on amounts passing to the pre-residuary beneficiaries or passing outside of the will. Payment of the estate taxes by the residuary beneficiaries reduces the value of the property passing to them. This common law rule came to be known as the "burden on the residue" rule. This rule serves to facilitate administration of the decedent's estate because the executor does not have the task of collecting from each beneficiary a proportionate share of the estate tax. Moreover, by making the residuary beneficiaries responsible for the estate tax, those beneficiaries receiving pre-residuary bequests or property outside of the will were absolved from liability for any portion of the estate tax. Thus, pre-residuary and non-probate beneficiaries did not have to find an available source of cash to contribute to the executor. The balance struck by the burden on the residue rule avoided cash liquidity problems for pre-residuary takers but created concerns for residuary beneficiaries who were then burdened by the taxes. Depending on the magnitude of both pre-residuary dispositions 4. Cooney, 541 N.W.2d at For example, this would include recipients of life insurance proceeds, retirement plan/ira distributions, and joint tenancy with rights of survivorship property bearing a share of the estate tax payment.

3 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 749 and property passing outside of the will, the consequences to the residue may range from diminution to complete depletion. Since the common law approach 6 failed to apportion the estate tax to property contributing to the tax liability, complaints arose from residuary beneficiaries whose bequests were effectively reduced by the estate taxes. This displeasure prompted many state legislatures and courts to change state law by adopting estate tax apportionment rules. The apportionment rules addressed the issue by striking a balance different from the burden on the residue rule. The standard rule divides the burden of estate taxes among the decedent's beneficiaries creating a burden on the recipient rule. Under the estate tax apportionment regime, the estate tax is allocated among the recipients of both probate and non-probate property, as both classes of property are included in the estate tax calculation and contribute to the tax liability. Equitable apportionment reflects an important principle that non-probate property should bear a proportionate share of the estate tax where such property contributes to the tax amount due. This principle, provided for in the Uniform Estate Tax Apportionment Act, 7 will yield to the testator's expressed desire to have estate taxes paid in a different manner. 8 Under equitable apportionment, the notion of burdening the recipient rather than the residue does not universally make estate administration more difficult. Not only may the non-probate assets be liquid 9 but also the residue may be comprised of illiquid assets. 10 Therefore, the needed cash that the executor must generate for the estate tax payment may be more readily forthcoming from the nonprobate property than illiquid residuary assets. Further, testators frequently designate beneficiaries for property passing outside of probate. By applying rules that make beneficiaries of non-probate property responsible for any estate tax liabilities attributable to such property, potential inequitable and unintended results may be avoided. 6. As noted, the common law approach promoted administrative efficiency by obviating the need for the executor or administrator of the decedent's estate to collect or seek recovery or reimbursement from each beneficiary of the decedent's property. 7. Unif. Estate Tax Apportionment Act of 2003, 8A U.L.A. 191 (Supp. 2009). The Act's apportionment concept was first adopted in 1958, Unif. Estate Tax Apportionment Act of 1958, 8A U.L.A. 281 (West 2003 & Supp. 2009) and revised in 1964, Unif. Estate Tax Apportionment Act of 1964, 8A U.L.A. 261 (West 2003 & Supp. 2009) and 2003, Unif. Estate Tax Apportionment Act of 2003, 8A U.L.A. 191 (Supp. 2009). 8. Although apportionment under state law may be overridden by the decedent's contrary direction, there remains a bias in favor of apportionment under state law. See discussion, infra notes 24, 172 and accompanying text. 9. For example, cash in jointly held bank accounts and life insurance proceeds. 10. For example, closely held corporate stock and limited partnership interests.

4 750 CREIGHTON LAW REVIEW [Vol. 43 The question arises whether a decedent who provides for a beneficiary through a pre-residuary bequest or non-probate transfer necessarily intends for that person to be exonerated from state law apportionment of estate taxes so that such beneficiary receives the financial benefit of the property in full. B. OVERVIEW: COMPONENTS OF THE WILL AND GENERAL APPROACHES TO APPORTIONMENT Well drafted wills not only provide for property dispositions but also do so in a particular order. There are several classes of dispositions within the will. The pre-residuary dispositions under the will most typically take the form of specific, 1 1 general, 12 and demonstrative. 13 As its name implies, the residuary clause operates to dispose of all other property not effectively disposed of by the pre-residuary specific, general, or demonstrative bequests. The focal point in estate tax apportionment concerns where the burden of the estate tax falls. If applicable state law 14 or the governing instrument allocates the estate tax burden to the residuary probate estate, these assets are subject to consumption and attendant reduction while the recipients of the pre-residuary bequests are spared. As an alternative approach to estate tax apportionment, governing law may apportion estate taxes against each asset included in the gross or taxable estate based on the value of those assets. In contrast to the first approach, this alternative approach places responsibility on each beneficiary under the will, whether the recipient of a specific, general, demonstrative, or residuary bequest, for a proportionate share of the estate taxes payable. An approach to estate tax apportionment that allocates the tax to those assets generating the tax may give rise to further complications beyond the preceding probate estate example. Suppose there are beneficiaries of probate and non-probate assets, all of which contribute to the estate tax liability. 15 Full apportionment would mean that each 11. A testamentary gift of a specific or particular item of the estate. For example, "I leave my shares of General Motors stock." 12. A testamentary gift payable out of the general assets of the estate. For example, "I leave the sum of $1,000." 13. A testamentary gift, which by its terms, must be paid from a specific fund rather than the general estate. For example, "I leave the sum of $1,000 to be paid from my shares of General Motors stock." 14. The applicable state law may be determined either by statute or judicial decision. 15. A non-probate asset - required to be included in the gross estate - payable to a surviving spouse or qualified charity will qualify for an estate tax marital deduction, 2056, or charitable deduction, I.R.C (2006). As a result, no estate taxes will be due from the estate for such property.

5 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 751 asset, whether or not the asset passes under the will, bears a proportionate share of the tax the asset helps generate. In this manner, each beneficiary, including the beneficiaries of non-probate assets contributing to the estate tax bill, bears a fair share of the taxes. For a typical estate comprised of both probate and non-probate assets, in the absence of full apportionment, the residuary assets would be responsible for paying the taxes attributable to the non-probate property. The presence of non-probate property may serve to diminish or even exhaust the residuary estate if there is significant fair market value inherent in the non-probate assets. In certain situations full apportionment may trigger unwanted results. Property passing in a qualified manner to a surviving spouse or qualified charity will generate an estate tax marital 16 or charitable deduction. 1 7 However, if the spouse or charity is obligated to pay its proportionate share of the estate taxes, the amount of the marital or charitable deduction is reduced by the amount of the taxes. 1 8 Reducing the amount of the deduction increases the amount of estate taxes. As a variation on full apportionment, equitable apportionment relieves marital and charitable gifts from contributing toward the payment of estate taxes and prevents reduction of the estate tax deduction. The equitable apportionment doctrine modifies the full apportionment approach by recognizing that deductible gifts to a spouse or charity do not contribute to the estate tax and should not therefore be charged with a proportionate share of the overall estate tax. Thus, equitable apportionment principles would prevent the estate tax deduction reduction problem described above from occurring where non-probate assets pass to a surviving spouse or qualified charity. 19 The federal estate tax is imposed on the decedent's entire gross estate. 20 The gross estate is comprised of both assets included in the probate estate 2 ' as well as non-probate property. 22 Since both categories of property contribute to the estate tax liability, the majority of 16. Id Id Id. 2056(b)(4), 2055(c). 19. Equitable apportionment rather than full apportionment would prevent the non-probate property from being charged with any proportionate share of estate tax. 20. The scope of the federal gross estate is discussed infra Section II. As a technical matter, the estate tax is imposed on the taxable estate of the decedent. I.R.C (2006). In order to calculate the taxable estate, the value of property included in the gross estate is reduced by deductions, 2051, including deductions provided in 2053 (relating to certain administration expenses and claims), 2054 (relating to casualty and theft losses incurred during administration), 2055 (relating to qualified gifts to charity) and 2056 (relating to qualified gifts to surviving spouse). 21. Treas. Reg (a)(1) (1960). 22. Treas. Reg (a)(2)-(3).

6 CREIGHTON LAW REVIEW [Vol. 43 states have moved to apportion the tax on the entire gross taxable estate rather than charge the entire tax solely to the probate estate. Whether the result occurs by statute or judicial decision, the principle underlying estate tax proration is that those interests creating or contributing to the tax should bear their share of the tax burden or liability. 23 Even in states that have shifted to a policy favoring proration and its attendant fair share principles, a testator may expressly shift the tax burden in a manner contrary to the proration mandate. In determining whether the decedent has expressed an intention contrary to proration, courts have recognized that apportionment of estate taxes is the general rule to which exception is made only when the decedent clearly and unambiguously directs to the contrary. Vague and uncertain language is insufficient to shift the tax burden from where the law places it. Ambiguities in the language regarding payment of taxes are to be resolved and interpreted in favor of apportionment. 24 When an estate contains both probate and non-probate property, the necessary point of inquiry becomes whether the language utilized by the decedent indicates that the estate taxes attributable to the probate and non-probate assets should be imposed entirely on the probate estate rather than prorated within the adopted fundamental public policy. II. THE FEDERAL ESTATE TAX A. SCOPE OF THE FEDERAL GROSS ESTATE As a starting point, the federal estate tax is based on the decedent's gross estate. A number of estate tax provisions exist that expressly require inclusion in the federal gross estate. 2 5 While the value of the gross estate includes assets of the probate estate, 2 6 the gross estate concept is broader than the concept of the probate estate. Any interest in property the decedent had at the time of death is included in the gross estate under Internal Revenue Code ("IRC") section Under IRC section 2034,28 a surviving spouse's dower or curtesy interest in the decedent's property will not avoid gross estate inclusion. The combination of sections 2033 and 2034 focus on the probate estate. 23. In re Armstrong's Estate, 366 P.2d 490, 493 (Cal. 1961). 24. In re Estate of Kelly, 584 P.2d 640, 641 (Colo. App. 1978); In re Estate of Kirby, 498 N.E.2d 64, 66 (Ind. Ct. App. 1986); In re Estate of Kyreazis, 701 P.2d 1022, 1024 (N.M. Ct. App.1984); In re Estate of Brownlee, 2002 SD 142, [ 25, 654 N.W.2d 206, See I.R.C (2006). 26. Id I.R.C (2006). 28. I.R.C (2006).

7 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 753 A number of additional code sections expand the scope of the gross estate. Several sections address property given away during life but nevertheless bring such property within the gross estate. 2 9 IRC section requires the gross estate to include property transferred during life if the decedent, with respect to the transferred property, retained the income or the power to designate who shall enjoy the income. IRC section causes the gross estate to include certain lifetime transfers under which beneficial enjoyment can occur only by surviving the decedent. Under IRC section 2038,32 the gross estate includes property transferred during life if at the time of death the decedent had the power to change beneficial enjoyment of the property. There are additional sections requiring gross estate inclusion for specific types of property and powers. IRC section addresses the gross estate inclusion of annuities, and IRC section covers jointly held property. 35 IRC section includes property over which the decedent has a general power of appointment. 3 7 IRC section governs the circumstances in which the gross estate requires including life insurance proceeds. 39 IRC section includes the value of any property in which the surviving spouse had a qualifying income interest at the time of the decedent's death. 4 1 IRC section includes any interest in property that would have been included under sections 2036, 2037, 2038, or 2042, but for its transfer within three years of death. 29. These sections include IRC sections 2036 through I.R.C (2006). 31. I.R.C (2006). 32. I.R.C (2006). 33. I.R.C (2006). 34. I.R.C (2006). 35. Section 2040 addresses jointly owned property so long as there is a right of survivorship in the property. Lacking survivorship rights, section 2040 does not apply to tenancy in common. 36. I.R.C (2006). 37. To constitute a general power of appointment, the power must be exercisable in favor of the decedent, the decedent's estate, the decedent's creditors, or creditors of the decedent's estate. I.R.C. 2041(b)(1). 38. I.R.C (2006). 39. Insurance proceeds receivable by the executor are included under section 2042(1). For insurance proceeds receivable by other beneficiaries and over which amounts the decedent had, at the time of death, any incident of ownership, the insurance proceeds are required to be included in the gross estate under section 2042(2). 40. I.R.C (2006). 41. Section 2044 is the gross estate inclusion counterpart to the gift tax or estate tax marital deduction provisions applicable to the predeceasing spouse under 2523(f) or 2056(b)(7), respectively. Qualified terminal interest property ('QTI1") trusts are discussed more fully at notes and accompanying text. 42. I.R.C (2006).

8 CREIGHTON LAW REVIEW [Vol. 43 B. FEDERAL APPORTIONMENT PROVISIONS The federal tax code contains several provisions 43 relevant to the allocation of the estate tax liability among the decedent's beneficiaries. As the federal estate tax is a tax on the transfer of property rather than the receipt of property, the federal estate tax is a charge against the estate, rather than its beneficiaries, absent a contrary will provision. 44 Under Internal Revenue Code ("IRC") section a beneficiary whose interest is diminished by the collection of tax, but who is not the person upon whom the decedent imposed the tax burden, may be entitled to reimbursement from the estate or from other beneficiaries. In general, IRC section requires beneficiaries receiving proceeds of insurance on the life of the decedent contribute to payment of the estate tax. 4 7 Similar to section 2206, IRC section requires anyone who has or receives property subject to a general power of appointment contribute to payment of the estate tax. 4 9 IRC section 2207A 5 0 creates a right of recovery applicable to marital deduction property included in the surviving spouse's gross estate as qualified terminable interest property under IRC section If section 2044 causes gross estate inclusion, the surviving spouse's estate is entitled to recover the estate taxes attributable to the inclusion from the parties receiving the property, unless the surviving spouse has provided to the contrary. 5 2 IRC section 2207B 53 creates a right of recovery in the estate against the recipient of property included in the decedent's estate under the IRC section retained interest rules. 55 In sum, sections 2206, 2207, 2207A, and 2207B create a right of recovery for estate taxes against certain non-probate property beneficiaries The sections are I.R.C. 2205, 2206, 2207, 2207A, and 2207B. 44. I.R.C (2006). 45. I.R.C (2006). 46. I.R.C (2006). 47. According to the statute, the general rule of contribution may be overridden by a contrary provision in the decedent's will. 48. I.R.C (2006). 49. By statute, the contribution rule for section 2041 general powers of appointment yields to a contrary will provision. 50. I.R.C. 2207A (2006). 51. I.R.C (2006). 52. See infra notes and accompanying text. By statute, the contrary direction may be provided by will or revocable trust. I.R.C. 2207A(a)(2) (2006). 53. I.R.C. 2207B (2006). 54. I.R.C (2006). 55. In accord with the other recovery provisions, section 2207B provides that a contrary provision in the decedent's will prevails. 56. Other than these few statutes, Congress has not enacted further apportionment type provisions to correspond to the other gross estate inclusion sections covering non-probate property. The federal apportionment provisions as they exist for limited

9 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 755 The rights of recovery against life insurance beneficiaries, the recipients of general power of appointment property, persons receiving qualified terminable interest property upon the termination of the surviving or donee spouse's interest, and the recipient of property included in the decedent's gross estate because of the proscribed retained interests are subject to contrary direction by the decedent regarding payment. As a result, the decedent may be able to override the statutory directive calling for contribution from these beneficiaries and thereby determine those alternative interests to be diminished by the estate tax. However, as Section VI will further discuss, the decedent should be required to have expressly directed against recovery of taxes to negate an apportionment statute. The Economic Recovery Tax Act of created a marital deduction for property in a qualified terminable interest property ("QTIP") trust. 58 The QTIP trust provides the surviving spouse with all of the income from the trust for life. Upon the surviving spouse's death, the trust assets remaining are to be distributed to the remaindermen that the predeceasing spouse 59 specified in the governing trust agreement. Technically, the surviving spouse neither owns the QTIP trust assets outright nor has any control, power, or direction over the assets. However, if a marital deduction election is made for the QTIP trust, 60 then the QTIP trust is included in the surviving spouse's federal gross estate for estate tax purposes. 6 1 The marital deduction essentially defers the tax incidence on the QTIP trust assets until the surviving spouse's death. Congress sought to ameliorate the estate tax burden attributable to the inclusion of QTIP property in the surviving spouse's estate when it enacted section 2207A, a section containing two important provisions. First, in general, the personal representative, on behalf of the surviving spouse's estate, is empowered to recover the estate taxes categories of non-probate property included in the gross estate reflect the fact that such property is not actually handled as part of the probate estate by the executor because it does not pass through the hands of the executor. See Riggs v. Del Drago, 317 U.S. 95, 102 (1942) discussed infra note The Economic Recovery Tax Act of 1981, Pub. L. No , 95 Stat I.R.C. 2056(b)(7) (2006). 59. The predeceasing spouse is the settlor of the QTIP trust. 60. The marital deduction prevents the estate tax liability from being due at the time of the first decedent's death with respect to the QTIP trust assets. 61. I.R.C (2006). By including the QTIP trust in the survivor's estate, 2044 is one example of estate tax inclusion for non-probate property. For federal estate tax purposes, this section treats the entire trust as part of the surviving spouse's federal gross estate even though the survivor only has an income interest for life. In this manner, rather than impose estate tax liability upon the first spouse's death, one sees that the estate tax marital deduction defers or postpones the estate tax until the surviving spouse's death.

10 CREIGHTON LAW REVIEW [Vol. 43 allocable to the QTIP trust from the QTIP trust remaindermen. 62 The right of recovery is effectively a federal rule of estate tax apportionment, 63 placing the tax liability on the recipients of the QTIP trust assets. 64 Second, to shift the burden the statute initially places on the QTIP trust, the surviving spouse could waive the federal recovery right, as originally enacted, if the surviving spouse "otherwise direct[ed] by will."65 An effective waiver would exonerate the QTIP trust beneficiaries from having to pay the estate taxes caused by the QTIP trust inclusion in the surviving spouse's estate. The impact of state law on the apportionment of estate taxes, whether by statute or judicial decision, cannot be overlooked and does not necessarily conflict with the federal apportionment statutes discussed above. In Riggs v. Del Drago, 66 the Supreme Court of the United States recognized that the ultimate burden of the federal estate tax is to be determined according to applicable state law. The Court addressed the intersection of the then-existing federal right of contribution statute and a New York tax apportionment statute that allocated the federal estate tax among the estate beneficiaries on a pro rata basis unless otherwise directed by the decedent's will. The beneficiaries of pre-residuary bequests whose interests were reduced by estate taxes under the New York statute remained disgruntled, as the Court upheld the constitutionality of the state apportionment statute 67 and rejected the beneficiaries' argument that Congress created a burden on the residue rule as a matter of federal law. In preserving the role of state law addressing estate tax apportionment, the Court failed to embrace the argument advanced by the beneficiaries that other than as provided by the then existing federal statute, 68 apportionment under state law is precluded. Thus, federal law did not create a burden on the residue rule and left the issue of who shall bear the ultimate burden of the estate tax to state law. 62. I.R.C. 2207A(a)(1). 63. The statutory right of recovery creates a presumption of tax apportionment. Donna Litman, Apportionment of the Federal Estate Tax - Effect of Selective Federal Apportionment and Need for Reform, 33 REAL PROP. PROB. & TR. J. 327, (1998). 64. Section 2207A(a)(1) contains a burden on the recipient rule. 65. I.R.C. 2207A(a)(2). The waiver provision language of section 2207A was amended in See infra note 169 and accompanying text U.S. 95 (1942). 67. In Riggs v. Del Drago, The Supreme Court of the United States rejected the challenge to the New York apportionment statute as violative of the supremacy and uniformity clauses contained in the Constitution. 68. The predecessor provisions to sections 2206 and 2207 are discussed supra notes

11 20101 ESTATE TAXES ON NON-PROBATE PROPERTY 757 III. THE ADVENT OF STATE APPORTIONMENT STATUTES The common law approach to the burden of estate taxes was to treat the taxes like any other estate administration expense. This created a burden on the residue rule that generally imposed the incidence of the estate taxes on the residuary beneficiaries of the probate estate. 6 9 Under the United States Supreme Court's ruling in Riggs v. Del Drago, 70 state law generally determines the ultimate impact of the incidence of federal estate taxation. Unhappiness with the common law burden on the residue rule 71 and empowered by Riggs, many states legislatures enacted apportionment statutes to equalize the tax burden among those interests contributing to the estate tax liability. These statutes typically recognized that both probate and non-probate assets were taxable, and therefore each should be responsible for a share of the tax. Although the statutes create a default apportionment regime, the statutes permitted the decedent to prevent the statute from applying by contrary provision in the governing instrument. Therefore, the statutes preserved the freedom of the decedent to provide an alternative scheme from that contemplated by the state apportionment statute. Of increasing concern is the degree of specificity required for the decedent to negate statutory apportionment or defeat apportionment to non-probate assets. For example, a question arose whether a will directing "payment of all taxes on all property which I may own at the time of my death" would properly allow the executor to obtain pro rata contribution from the beneficiaries of decedent's non-testamentary interests. 7 2 Apportionment to the non-testamentary transfers was applicable as the tax clause in the will was found to refer solely to the testamentary or probate estate. Therefore, as construed by the Court, the clause is an example of a partial apportionment 73 result - one that favored the pre-residuary transfers without shifting the entire tax burden to the residue - with both non-probate assets and the residue bearing the ultimate tax burden. 69. This presumes that applicable state law does not recognize apportionment by statute or judicial decision U.S. 95 (1942). 71. The burden on the residue rule favors specific devises and bequests over residuary dispositions even though all of such property may be included in the gross estate for purposes of calculating the estate tax. This rule may also be seen as favoring nonprobate assets by charging the taxes attributable to the non-probate property to the residuary estate. 72. Trimble v. Hatcher's Estate, 173 S.W.2d 985 (Ky. Ct. App. 1943) (discussing the executors' claim of a ratable recovery from donees of gifts that were required to be included in the decedent's gross estate). 73. See infra notes 81-87, , , 180 and accompanying text.

12 CREIGHTON LAW REVIEW [Vol. 43 As the courts have recognized, there is a strong presumption in favor of statutory apportionment. A general tax clause should not serve to validly override the tax apportionment to non-probate assets. The tax clause in the governing instrument should not necessarily be recognized as constituting a direction to control apportionment. Rather than providing a basis to ignore apportionment created by applicable state law, a tax provision failing to mention estate taxes should be deemed ineffective to shift the apportioned tax burden. 74 That is not to say the inclusion of estate taxes in the tax clause will be sufficient to control the apportionment. Suppose the will contained the following direction: "All estate taxes shall be paid out of the residue of my estate." The explicit reference to estate taxes remains part of the general provision for the payment of taxes and has a boiler plate flavor to it. The direction fails to mention whether non-probate property is contemplated or that such property is not responsible for the corresponding taxes attributable to it. IV. UNIFORM ACTS AND THE RESTATEMENT (THIRD) OF PROPERTY (WILLS AND OTHER DONATIVE TRANSFERS) The provisions of the Uniform Estate Tax Apportionment Act ("UETAA") have been incorporated into the Uniform Probate Code ("UPC") at UPC sections 3-9A-101 to 3-9A These provisions retain the concept that the decedent's expressed intentions may govern apportionment of estate taxes. Section 3-9A-103 provides: (a) Except as otherwise provided in subsection (c), the following rules apply: (1) To the extent that a provision of a decedent's will expressly and unambiguously directs the apportionment of an estate tax, the tax must be apportioned accordingly. 76 The "otherwise directed" exception for overriding mandated apportionment is replaced with an "expressly and unambiguously directed" exception. While the decedent may direct tax apportionment, the statutory language, as amplified by the commentary, makes it clear that such "direction will not control the apportionment of taxes unless it explicitly refers to the payment of an estate tax and is specific and unambiguous as to the direction it makes for that pay- 74. See discussion infra section IV dealing with Uniform Act and Restatement (Third) Property (Wills and Other Donative Transfers). 75. UNIF. PROBATE CODE 3-9A-101 to 3-9A-114 (amended 2006), 8 U.L.A. (Supp. 2009). 76. UNIF. PROBATE CODE 3-9A-103(a)(1) (amended 2006), 8 U.L.A. 90 (Supp. 2009). Uniform Probate Code section (1990) contained the predecessor version.

13 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 759 ment." 7 7 A failure to comply with section 3-9A-103(a)(1) makes the statutory apportionment rules applicable because the decedent did not make "a valid provision as to how estate taxes are to be apportioned." 78 Although incorporating the narrower and more restrictive language of the "expressly and unambiguously directed" exception seems to prove that a general pay-all-taxes clause, even one mentioning "estate taxes," is ineffective to shift the taxes attributable to non-probate assets to the residuary beneficiaries, this may not be the case. The matter may not be resolved because according to the commentary: [w]hether other directions of a decedent that explicitly mention estate taxes comply with the UETAA's requirement that they be specific and unambiguous is a matter for judicial construction. For example, there is a split among judicial decisions as to whether a direction such as "all estate taxes be paid out of the residue of my estate" is ambiguous because it is unclear whether it is intended to apply to taxes attributable to non-probate assets. 7 9 The approach to estate tax apportionment found in the Restatement (Third) of Property (Wills and Other Donative Transfers) ("Restatement") does not fully track the UPC. The Restatement declines to follow the view of the common law burden on the residue rule imposing the entire tax liability on the probate estate. 80 Rather than charging the whole tax liability on the residue of the probate estate, the Restatement apportions the estate taxes attributable to non-probate assets among the non-probate property so that they pay their proportionate share of the estate tax liability and also imposes the es- 77. UNIF. PROBATE CODE 3-9A-103(a)(1) cmt. (amended 2006), 8 U.L.A. 91 (Supp. 2009). The commentary also provides the following: For example, a testamentary direction that "all debts and expenses of and claims against me or my estate are to be paid out of the residuary of my probate estate" is not an express direction for the payment of estate taxes and will not control apportionment. While an estate tax is a claim against the estate, a will's direction for payment of claims that does not explicitly mention estate taxes is likely to be a boiler plate that was written with no intention of controlling tax apportionment. To protect against an inadvertent inclusion of estate tax payment in a general provision of that nature, the UETAA requires that the direction explicitly mention estate taxes. On the other hand, a direction in a will that "all taxes arising as a result of my death, whether attributable to assets passing under this will or otherwise, be paid out of the residue of my probate estate" satisfies the UETAA's requirement for an explicit mention of estate taxes and is specific and unambiguous as to what properties are to bear the payment of those taxes. 78. UNIF. PROBATE CODE 3-9A-103(a)(1) (amended 2006), 8 U.L.A. 92 (Supp. 2009). 79. Id. 80. RESTATEMENT (THIRD) OF PROPERTY (WILLS AND OTHER DONATIVE TRANSFERS) 1.1 cmt. g (1999). The rejected view imposes liability on the residuary estate except to the extent that state or federal law, or the decedent's will, provide otherwise. Id.

14 760 CREIGHTON LAW REVIEW [Vol. 43 tate tax liability from probate assets on the taxable part of the residuary estate81 V. CASELAW DEVELOPMENT A. STATE LAW APPORTIONMENT CASES The Supreme Court of New Hampshire was called upon to construe the scope of the tax clause in its In re Crozier's Estate 8 2 decision. The opening clause of Annie Crozier's ("Crozier") will directed the executor to pay all debts, funeral expenses, administration expenses, and inheritance taxes out of her estate as soon as practicable. 8 3 The court was required to determine whether state and federal estate taxes were to be paid out of the residue of Crozier's estate. At the time of its decision, New Hampshire was one of three states to have adopted the Uniform Estate Tax Apportionment Act ("UETAA"). 8 4 Under the statute, death taxes were to be apportioned among the decedent's beneficiaries "unless the will otherwise provides." The court broadly construed the will provision directing payment of "inheritance taxes out of my estate." 8 5 Although New Hampshire had enacted an apportionment statute, the tax payment clause in the will, though stated to be "artless and ambiguous," was held to be "an effective provision against apportionment of death taxes." 8 6 Rather than apportioning the tax liability pursuant to the statute, ultimate liability for the estate tax payment was shifted to the residuary estate. 8 7 In a subsequent case, the New Hampshire Supreme Court held that where the will instructed the executor to pay "any and all inheritance taxes... from the residue," the language failed to alter the state apportionment for the federal estate taxes but was sufficient to shift the burden of 81. The view adopted in this Restatement is that, unless the decedent's will provides otherwise, liability for estate taxes is "equitably apportioned," meaning that a proportionate part of the estate tax burden is placed on non-probate assets that are includible in the taxable estate. That is to say, assets not forming a part of the decedent's probate estate but nevertheless includible in his or her taxable estate abate proportionally to pay the federal estate tax liability owed by the estate. Within the probate estate, however, the full burden falls on the taxable portion of the residue, or if the residue is entirely nontaxable, on the general or pecuniary devises, and is not apportioned among general and specific devises. 1.1 cmt. g. Some commentators and courts would refer to the Restatement view as adopting partial apportionment. The Restatement also contains elements of equitable apportionment to the extent that non-taxable assets would be exonerated from having any tax liability A.2d 895 (N.H. 1964). 83. In re Crozier's Estate, 201 A.2d 895, (N.H. 1964). 84. Crozier, 201 A.2d at 896. The court noted that Michigan and Wyoming were the two additional states to have enacted the uniform act. 85. Id. 86. Id. at The phrase "inheritance taxes" indicated an intention both to include estate and inheritance taxes as well as having these items paid from the residue of the estate.

15 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 761 state succession taxes on jointly held property to the residue. 8 8 The residuary beneficiaries were charged with those taxes ordinarily charged to the recipients of the property. Shortly after the Crozier decision, the Wyoming courts similarly determined whether a will provision was a sufficient directive against apportionment of federal estate taxes and state inheritance taxes. 8 9 In In re Estate of Obgurn, 90 the first article in the will stated "I direct the payment of all my just debts, taxes, funeral expenses and expense of administration of my estate." Virtually all courts have found that to override statutory apportionment, the will or other controlling instrument must plainly state the directive in clear and unambiguous language. 9 1 In Ogburn, the Supreme Court of Wyoming importantly stated that "a sufficient tax clause should expressly state (1) what gifts or beneficiaries are freed of the burden of taxes, (2) what taxes are affected, and (3) where the burden of taxes is shifted." 92 The Ogburn court could not commend the provision as "a model directive against apportionment" and found it to be "a superficial, artless, and inept expression." 9 3 Even though the court in Ogburn criticized the provision, recognized the language's ambiguity, and called for an expression of clear and unambiguous intent not to apportion, as was the case in Crozier, the Ogburn court nonetheless found the clause a sufficient mandate against apportionment. 94 As a result, the court determined the will language sufficient to shift the estate taxes on the property passing under the will, that is, the probate property, to the residue, but the language was insufficient to shift the taxes attributable to the insurance proceeds and other property not controlled by the will. 95 In reaching its conclusion, the court stated the term "my 88. In re Robbins Estate, 356 A.2d 679 (N.H. 1976). The court found it "doubtful that either the testatrix or the scrivener gave any specific thought to the (federal estate tax) but in any event the will uses no language sufficient to show an intention to change the statutory incidence of the tax as provided by [the New Hampshire apportionment statute]." Robbins, 356 A.2d at In re Estate of Ogburn, 406 P.2d 655 (Wyo. 1965) P.2d 655 (Wyo. 1965). 91. Ogburn, 406 P.2d at 657. See Johnson v. Hall, 392 A.2d 1103, 1106 (Md. 1978). 92. Ogburn, 406 P.2d at 658 (quoting 28 AM. JuR. Inheritance, Estate, and Gift Taxes 488). 93. Id. at Id. at 658, 660. The language was an effective directive against apportionment of federal estate taxes upon the pre-residuary bequests and devises (the property passing by will) but was insufficient to shift the tax burden to the residuary estate for estate taxes on decedent's non-probate property (insurance proceeds) and state inheritance taxes. Id. at Id. at This point of limiting the scope of the tax clause to probate property recognized by the Ogburn court was articulated as early as 1939 by the court in Chase Nat'l Bank of City of New York v. Tomagno, 14 N.Y.S.2d 759 (N.Y. Sup. Ct. 1939), where it stated "a provision in a will that all taxes be paid out of the residuary or general estate applies only to property passing under the will unless it specifically re-

16 CREIGHTON LAW REVIEW [Vol. 43 estate" referenced the probate estate. Further, the court emphasized the absence of any reference to non-testamentary gifts, insurance beneficiaries, or proceeds. 96 As to state inheritance taxes, the clause failed to shift the burden of these taxes to the estate, and the recipients of the gifts remained liable. 97 The court relied upon the inherent distinction between an estate tax and an inheritance tax by stating that the "all my... taxes... of my estate" language did not refer to the decedent's taxes nor taxes imposed on the decedent's estate. 9 s While apportionment schemes preserve the ability of the decedent to designate tax responsibility, the courts in both Crozier and Ogburn criticized the tax clause provisions and yet allowed the provisions to defeat estate tax apportionment. These courts improperly rejected estate tax apportionment because they failed to follow the rule that the tax apportionment rules are to be observed absent expression in the will clearly and unambiguously indicating a contrary intent. In Johnson v. Hall, 99 two pre-residuary beneficiaries of specific bequests under the will opposed a pro-rata apportionment of federal estate taxes among all the beneficiaries. They contended the will directed payment of the taxes from the residuary estate.' 0 0 Dr. Johnson's will, in relevant part, stated "FIRST: I direct that [all] estate and inheritance taxes, be paid as soon after my death as can lawfully and conveniently be done."' ' The state apportionment statute applied to federal and Maryland estate taxes "[e]xcept as otherwise provided in the will." 10 2 While recognizing that the majority of courts faced with similar tax clauses concluded against apportionment, the Court of Appeals of Maryland aligned itself with the minority of courts that concluded such language failed to clearly and unambiguously indicate that the statute directing apportionment should be ignored In so doing, the court rejected fers to other property, and has no effect upon inter vivos dispositions, which for one reason or another are drawn into the gross estate for tax purposes. Tomagno, 14 N.Y.S 2d at 761. See also Reynolds v. Reynolds, NP , 2007 W.L (R.I. Super. Ct. 2007) discussed infra at note Ogburn, 406 P.2d at Id. at Id A.2d 1103 (Md. 1978). At the time of the Johnson v. Hall decision, Maryland, along with five other states, had adopted the 1964 revisions to the Uniform Estate Tax Apportionment Act. Id. at 1106, n The legatees were advancing the argument for the common law burden on the residue rule to apply Johnson v. Hall, 392 A.2d 1103, 1107 (Md. 1978) Johnson, 392 A.2d at 1106 (discussing MD. CODE, EST. & TRusTs (k), recodified at MD. CODE, TAX-GEN (k) (West 2002 & Supp. 2009)) Id. at 1108.

17 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 763 the contention that the residuary estate generates the funds to pay the taxes attributable to bequests to the legatees. In concluding that the tax provision did not direct against apportionment, the court criticized those decisions in the majority as "not soundly reasoned" and noted the "boiler plate" language did not come within the apportionment statute's exception. By apportioning estate taxes among the recipients of the property, the court recognized that the inheritance and estate taxes are charged to the parties receiving the gifts. In rejecting the legatees' argument that the decedent did not intend apportionment, the court found the decedent included the payment clause, together with another clause giving the executor the power to pay expenses in the payment clause from either real or personal property, to override the common law abatement rules requiring the executor to use personalty in the residue prior to the use of realty to discharge debts, expenses, and taxes In Ferrone v. Soffes, 10 5 the testator died owning probate and nonprobate property. At issue was the apportionment of estate taxes generated by the property held as joint tenants with rights of survivorship. The will directed the executor to pay "all estate, inheritance, succession and transfer taxes which may be assessed by reason of my death The District Court of Appeal of Florida affirmed the trial court's conclusion that the clause was insufficient to avoid application of the Florida apportionment statute. The court found the clause ambiguous because the will did not contain "clear and unequivocal" direction that the estate be charged with the estate taxes on property passing outside of the will. The statute governed in the absence of unequivocal language in the will The Florida legislature, in amending Florida Statute section in 1997, partially codified the result in Ferrone regarding the elements that a governing instrument must contain in order to direct that property passing under the instrument bear the taxation burden for property not passing pursuant to the governing instrument Id. at So.2d 146 (Fla. Dist. Ct. App. 1990) Ferrone v. Soffes, 558 So. 2d 146, 147 (Fla. Dist. Ct. App. 1990) Ferrone, 558 So. 2d at FLA. STAT. ANN (West 2005) FLA. STAT. ANN (5)(h)(4) (West 2005) provides: For a direction in a governing instrument to be effective to direct payment of taxes attributable to property not passing under the governing instrument from property passing under the governing instrument, the governing instrument must expressly refer to this section, or expressly indicate that the property passing under the governing instrument is to bear the burden of taxation for property not passing under the governing instrument. A direction in the governing instrument to the effect that all taxes are to be paid from property

18 CREIGHTON LAW REVIEW [Vol. 43 Montana has a statutory scheme for the apportionment of state inheritance taxes. n 0 Although the statute places the burden of the inheritance tax on the recipients, the statute permits the decedent to shift the burden and apportion the tax differently if the decedent's will provides otherwise. The Supreme Court of Montana considered the apportionment statute in the In re Estate of Morris' decision. The relevant tax clause directed the personal representative to pay "all taxes both State and Federal which become payable by reason of my death, out of my estate."" 2 The lower court, relying on Ogburn, determined the will insufficient to alter the burden on the recipient rule under the statute with respect to the state inheritance tax. 113 The lower court further relied on Ogburn in finding insufficient intent to bypass the apportionment of state inheritance taxes because state inheritance taxes are not taxes on the decedent's estate, but rather are taxes on the recipient of property. However, the Montana Supreme Court reversed, noting that unlike the Ogburn clause, the clause in the instant case specifically referred to "state" taxes which language was missing from the clause in Ogburn. Thus, by reasoning that inheritance taxes become payable as a result of death, the Morris court concluded that the "state taxes which become payable by reason of death" language was sufficient to include state inheritance taxes. Therefore, the burden of the state inheritance taxes was shifted from the recipients to the residuary estate. In permitting the tax burden shift from where the statute placed it, the Morris court overlooked the legislative intent to change the common law rule that obligated the residuary estate to pay estate taxes. The court failed to adopt the express reference approach utilized by the court in In re Estate of Gordon," 4 dealing with estate taxes on qualified terminable interest property ("QTIP") trust property. The Morris court exonerated the recipients from their share of the inheritance taxes even though the will clause failed to expressly refer to apportionment, non-apportionment, or the state inheritance statute." 5 The Ferrone court required an express reference or express indication before allowing the burden of taxation to be passing under the governing instrument whether attributable to property passing under the governing instrument or otherwise shall be effective to direct the payment from property passing under the governing instrument of taxes attributable to property not passing under the governing instrument MONT. CODE ANN (2009) P.2d 402 (Mont. 1992) In re Estate of Morris, 838 P.2d 402, 404 (Mont. 1992) According to the lower court, the will clause may have been sufficient to shift the tax liability for federal estate taxes to the residuary estate N.Y.S.2d 815 (N.Y. Sur. Ct. 1986) Morris, 838 P.2d at 405.