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.

19 20101 ESTATE TAXES ON NON-PROBATE PROPERTY 765 shifted The benefit to such an approach is that the decedent provides abundantly clear evidence that the decedent not only considered the matter but also made a deliberate decision concerning the impact of taxes The express language requirement can serve as a catalyst to minimize or even prevent the ever-present search for the decedent's intent regarding tax apportionment Cases where the testator's wishes are fully or definitely expressed in the will avoid difficult problems of proof concerning intent. In In re Estate of Shoemaker,' 1 9 Charles Shoemaker ("Shoemaker") died testate and his assets at the time of his death included non-probate property in the form ofjoint tenancy property. 120 His will contained a tax clause that provided "Payment of Taxes. I direct that all federal estate and inheritance taxes of every kind and nature, shall be paid from the residue of my estate." 12 1 In concluding that the will clause was insufficient to defeat the statutory apportionment and that the taxes attributable to the joint tenancy property passing outside of the will should not be paid by the estate, the Court of Appeals of Kansas stated: [T]he failure to specifically mention the non-probate or nontestamentary property in the tax clause indicates that the testator did not intend for the estate to pay the inheritance taxes on the joint tenancy property The court further supported its conclusion by finding that a direction to pay all taxes from the residue of the estate is presumed to apply only to the property disposed of in the will, that is, testamentary property. 123 The decisions in Chase National Bank of City of New York v. Tomagno, 124 Ogburn, and Shoemaker recognize the partial apportionment concept. A general tax clause charging all taxes to the residuary 116. Ferrone, 558 So. 2d at Id. The court's approach is consistent with and promotes those cases that "set a clear direction of requiring a testator to evince a desire to avoid generally applicable apportionment methods by so stating in highly specific and unambiguous terms." Estate of Swallen v. Commissioner, 98 F.3d 919, 924 (6th Cir. 1996) and cases cited therein. See also Reynolds v. Reynolds, NP , 2007 W.L (R.I. Super. Ct. 2007) cited infra note 144 and accompanying text See In re Estate of McClaran, 811 So. 2d 799 (Fla. Dist. Ct. App. 2002). In this regard it should be noted generally that there can be problems proving testator's intent so that resolving the intent question is not trouble free. Belt v. Oppenheimer, Blend, Harrison & Tate, Inc., 192 S.W.3d 780, 783 (Tex. 2006) (noting the problems associated with allowing extrinsic evidence to prove the testator's intent) P.2d 897 (Kan. Ct. App. 1996) In re Estate of Shoemaker, 917 P.2d 897, 898 (Kan. Ct. App. 1996) Shoemaker, 917 P.2d at Id. at Id N.Y.S.2d 759 (N.Y. Sup. Ct. 1939).

20 CREIGHTON LAW REVIEW [Vol. 43 estate favors specific and general bequests over the residue with respect to the taxes attributable to testamentary assets but leaves the taxes on assets held in non-probate form subject to apportionment. In 1987, the Texas legislature recognized that it was one of just ten states that failed to have some form of estate tax apportionment Under the former regime, one would look to the probate estate for payment of estate taxes. As a result, unless the decedent provided otherwise, assets passing under the will bore the full burden for estate taxes while the non-probate assets were spared.1 26 Apportioning estate taxes among the beneficiaries, probate and non-probate, would provide a fairer method more in line with the probable intent of the testator In enacting Texas Probate Code section 322A 128 and its system of equitable apportionment, the legislature believed statutory apportionment would provide certainty when allocating estate taxes between probate and non-probate assets.1 29 Consistent with other apportionment jurisdictions, a Texas decedent may supplant the 125. H.R. 508, 70th Leg., Reg. Sess. (Tex. 1987) The residuary beneficiaries would be responsible for the entire tax burden while the other beneficiaries would bear none of the burden H.R. 508, 70th Leg., Reg. Sess. (Tex. 1987). As noted by a commentator, the "system disregards distinctions between probate and non-probate transfers, and assesses the tax liability directly against the takers of all property which is subject to the estate tax. Moreover, the testate classifications of gifts as specific, general, pecuniary or residual are now meaningless for purposes of assessing the tax burden." Cenatiempo, 1987 Legislative Changes to the Payment of Death Taxes and other Charges Against a Decedent's Estate, State Bar Newsletter, Real Estate, 26 Probate and Trust Law No. 1/2 (October 1987/January 1988) TEX. PROB. CODE ANN. 322A (Vernon 2003 & Supp. 2009) H.R. 508, 70th Leg., Reg. Sess. (Tex. 1987). As originally enacted Texas Probate Code 322A(b)(1) (1987) provided: (b)(1) Unless otherwise provided in the will of a decedent, the representative shall charge each person interested in the estate a portion of the estate tax assessed against the estate. The portion of the total estate tax that is charged to each person interested in the estate must represent the same ratio as the taxable value of that person's interest in the estate bears to the total taxable value of the interests of all persons interested in the estate. Law of June 20, 1987, ch. 742, 322A, 1987 TEX. SESS. LAw SERv. 742 (West) (amended 1991 & 2003). In 1991 the section was amended to provide as follows: (b)(1) The representative shall charge each person interested in the estate a portion of the total estate tax assessed against the estate. The portion of each estate tax that is charged to each person interested in the estate must represent the same ratio as the taxable value of that person's interest in the estate included in determining the amount of the tax bears to the total taxable value of all the interests of all persons interested in the estate included in determining the amount of the tax. In apportioning an estate tax under this subdivision, the representative shall disregard a portion of the tax that is apportioned under the law imposing the tax, otherwise apportioned by federal law, or apportioned as otherwise provided by this section. TEx. PROB. CODE ANN. 322A(b) (Vernon 2003 & Supp. 2009).

21 20101 ESTATE TAXES ON NON-PROBATE PROPERTY 767 statute by a provision in the governing instrument addressing apportionment of estate taxes In Peterson v. Mayse, 13 1 the Court of Appeals of Texas addressed whether the testator had, contrary to the default apportionment statute, indicated an intent to charge the residuary estate for all estate taxes arising from the inclusion of probate and substantial non-probate property 13 2 in the taxable estate. The tax clause in question directed the executor to pay any death taxes from the residuary estate. Death taxes were defined to include "all estate, inheritance, and succession taxes... which are assessed by reason of my death...,,133 The Peterson court held the tax clause to be a sufficient directive under the statute to exonerate the non-probate assets from the burden of estate taxes. The court reached its holding despite noting that (1) apportionment of death taxes among both probate and non-probate assets is the general rule; (2) the trend in the law is to require nonapportionment directives to be specific in exonerating non-probate property; (3) the will did not expressly exonerate the decedent's nonprobate property; and (4) drafting the tax clause to expressly exonerate the non-probate assets would be an improvement over the language used The court, though mentioning the stricter "specific direction" language contained in the amended statute, appeared to emphasize the more lenient "provides otherwise" standard to support its decision to have the will control rather than apportioning estate taxes to the non-probate property as directed by the statute. The Peterson decision can be criticized for failing to find the tax clause ambiguous. By charging all estate taxes payable by reason of death against the residuary probate estate, the testator's tax clause language is equally consistent with merely exonerating his pre-residuary dispositions. Because of this ambiguity, the default apportionment provisions should apply to the tax treatment of the remaining non-probate property Texas Probate Code 322A(b) provides, in part, (2) Subdivision (1) of this subsection does not apply to the extent the decedent in a written inter vivos or testamentary instrument disposing of or creating an interest in property specifically directs the manner of apportionment of estate tax or grants a discretionary power of apportionment to another person. A direction for the apportionment or nonapportionment of estate tax is limited to the estate tax on the property passing under the instrument unless the instrument is a will that provides otherwise. TEx. PROB. CODE ANN. 322A(b) (Vernon 2003 & Supp. 2009) S.W.2d 217 (Tex. App. 1999) Non-probate assets comprised 72% of the gross estate. Peterson v. Mayse, 993 S.W.2d 217, 219 n.3 (Tex. App. 1999) Peterson, 993 S.W.2d at Id. at

22 CREIGHTON LAW REVIEW [Vol. 43 Too often the tax clause language utilized has a generic, boilerplate quality to it. This problem was noted by the United States Court of Appeals for the Sixth Circuit in Estate of Swallen v. Commissioner, 13 5 and likewise, in the case of In re Will of Adair 3 6 by the Supreme Court of New Jersey. 137 In Swallen, the clause provided: I further direct my Executor to pay from the residue of my estate, or from funds available to my Executor from other sources, all inheritance, succession or estate taxes, that may be lawfully levied by reason of my death upon the inheritance of, succession to or transfer of all property which may be included in my estate In Adair, the tax payment provision stated: All estate, inheritance, succession and other death taxes, including any interest or penalties thereon, imposed or payable by reason of [Mrs. Adair's] death with respect to all property comprising his [sic] gross estate for death tax purposes, whether or not such property passes hereunder, shall upon the written request of the Personal Representative of [Mrs. Adair's] estate [sic] be paid to such Personal Representative... out of the principal of the trust estate. The Trustee shall not be responsible for the determination of such taxes, nor shall the Trustee be required to determine or inquire into the availability of funds for such purposes from [Mrs. Adair's] probate estate. 139 As general pay-all-taxes clauses, both courts determined the provisions were insufficient to exonerate the non-probate property from paying its pro rata share of the taxes.1 40 The proper apportionment of estate taxes has recently been litigated in Rhode Island. Its version of the UETAA requires the tax be apportioned among all persons interested in the estate "unless the will provides." 14 1 In Reynolds v. Reynolds, 14 2 Charles Reynolds ("Reynolds") executed a will and directed his executor to "pay all my just debts, funeral expenses and expenses of administration, including as an expense of administration, all estate, legacy, succession and inheri F.3d 919 (6th Cir. 1996) A.2d 250 (N.J. 1997) Estate of Swallen v. Commissioner, 98 F.3d 919, 924 (6th Cir. 1996); In re Will of Adair, 695 A.2d 250, 256 (N.J. 1997) Estate of Swallen, 98 F.3d at In re Will of Adair, 695 A.2d, 250, (N.J. 1997) Although the language in Adair specified property whether or not passing under the instrument, the provision was still characterized as boilerplate R. I. GEN. LAWS (2005) No. NP , 2007 W.L (R.I. Super. Ct. 2007).

23 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 769 tance taxes." 14 3 Upon his death, more than $1.6 million in non-probate property passed to his children from a prior marriage. These children and Reynolds's surviving spouse disputed who was responsible for paying the estate taxes. The surviving spouse argued that the taxes were to be apportioned under the applicable apportionment statute while the children took the position that the will provided for the estate taxes to be paid from the estate without apportionment. Therefore, the will directive was sufficient to burden the residuary estate with all of the estate taxes, including the taxes attributable to the non-probate assets. In deciding whether the tax clause was sufficient to relieve the non-probate assets from their proportionate share of the estate taxes, the Reynolds court noted that the "overwhelming majority of jurisdictions... have held that a directive against apportionment should be expressed in clear and unambiguous language." 14 4 Finding that the clause neither precluded apportionment nor required the residue to be the primary source for payment of the estate taxes, the court reasoned that before determining whether the tax clause constituted a direction against apportionment, it was necessary first to determine whether the clause covered the property passing outside of the will. As the tax clause neither expressly relieved the children nor mentioned the nonprobate property, there was no clearly expressed intent to include non-probate property. Therefore, the estate taxes generated from the property passing to the children outside of the will were apportioned under the statutory command contained in the apportionment statute. 145 B. FEDERAL STATUTORY APPORTIONMENT CASES With federal enactment of a rule permitting the surviving spouse to shift the burden of estate taxes on the qualified terminable interest property ("QTIP") trust from the trust remaindermen to the surviving spouse's estate, litigation followed to determine whether the spouse had in fact otherwise directed by will. Would a general tax clause providing that all estate taxes payable as a result of the surviving spouse's death be paid from the residuary estate waive the right of recovery and constitute a direction against apportionment to the QTIP property? 143. Reynolds v. Reynolds, No. NP , 2007 W.L (R.I. Super. Ct. 2007) Reynolds, No. NP , 2007 W.L Id.

24 CREIGHTON LAW REVIEW [Vol. 43 In In re Estate of Gordon 146 the Surrogate's Court for New York County, New York held that the surviving spouse's estate could recover from the trust remaindermen estate taxes attributable to the QTIP trust created by the decedent's late husband. The tax clause in Gordon's will, which the court characterized as a formbook example of a tax exoneration clause, stated: I direct that all Estate inheritance and death taxes (including any interest and penalties) imposed by any jurisdiction by reason of my death with respect to any property includable in my estate for the purpose of such taxes, whether such property passes under or outside my will be paid out of my Residuary Estate as an administration expense, without apportionment. 147 Despite the broad language contained in the tax clause, the provision did not, according to the court, contain specific language sufficient to constitute an "otherwise direction" under Internal Revenue Code ("IRC") section 2207A(a)(2) 148 to exonerate the remaindermen beneficiaries of the QTIP trust from contributing their share of estate taxes. 149 As a result, taxes were apportioned to the QTIP trust. In In re Estate of Miller, 150 Miller left the residue of his estate in trust for his wife for her life The trust qualified for the QTIP marital deduction for his estate. The tax clause in his wife's will provided as follows: "I direct my Personal Representative...to pay all of my legal debts...without reimbursement or contribution, all estate taxes, inheritance taxes, death taxes and succession duties assessed by reason of my death...."152 A dispute arose concerning whether the taxes should be paid out of the estate or the QTIP trust. In Miller, the Appellate Court of Illinois applied a different analysis than did the court in Gordon. The Miller court concluded that the plain and ordinary meaning of the tax provision required the estate taxes attributable to the QTIP trust be paid out of the estate even if that meant that the estate would be exhausted. 153 Whether a clause in the QTIP trust income beneficiary's will waived the claim to reimbursement for estate taxes attributable to the N.Y.S.2d 815 (N.Y. Sur. Ct. 1986) In re Estate of Gordon, 510 N.Y.S.2d 815, 817 (N.Y. Sur. Ct. 1986) I.R.C. 2207A(a)(2) (2006) Gordon, 510 N.Y.S.2d 815, 819. The basis for requiring express mention of a QTIP trust is the presumption that most testators do not intend to apply a general tax exoneration clause to QTIP property N.E. 2d 630 (Ill. App. Ct. 1992) In re Estate of Miller, 595 N.E. 2d 630 (Ill. App. Ct. 1992) Miller, 595 N.E. 2d at Id. at 633.

25 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 771 trust once again was addressed in the In re Will of Cooney 1 54 decision. Article I of the surviving spouse's will contained a general pay-alltaxes clause as follows: "I also direct my personal representative to pay expenses of administration of my estate and all valid inheritance and estate taxes payable by reason of my death, including any interest or penalties, without seeking reimbursement from or charging any person therefor." 1 55 For the Supreme Court of Wisconsin the issue was whether, pursuant to section 2207A(a)(2), the clause "otherwise direct[ed]" that the surviving spouse's estate shall pay the estate taxes resulting from inclusion of the QTIP trust in the surviving spouse's estate. Although applicable statutory law contained no requirement making specific reference to the QTIP trust, relying in part on Gordon, the court concluded that the tax clause, as a general direction to pay all taxes from the estate, was not sufficient to shift the tax burden from the QTIP trust beneficiaries to the survivor's estate in the absence of a clear and specific indication of testamentary intent. Without the necessary specificity, the tax burden was left where the law placed it According to the general view, specific will provisions relating to the payment of taxes are necessary "if it is intended that the tax burden should fall differently than as provided by law." 157 Importantly, the "requirement of specificity decreases the potential for tax clause ambiguity and makes resort to extrinsic evidence to reveal intent unnecessary, thereby alleviating uncertainty for fiduciaries in the administration of trusts and estates." 158 The specific reference requirement also prevents inadvertent waivers of the section 2207A(a) right to recover against the trust beneficiaries In discussing the pay-all-taxes clause language and finding against exoneration of the trust beneficiaries, the Cooney court noted that the clause did not contain express language limiting payment of taxes to taxes on testamentary property. Nevertheless, the court found the provision limited to taxes payable on such testamentary property rather than more broadly encompassing non-probate property as well. 160 Therefore, the clause was insufficient to shift the bur N.W.2d 467 (Wis. 1995) In re Will of Cooney, 541 N.W.2d 467, 469 (Wis. 1995) Cooney, 541 N.W.2d at 474 (citing In re Estate of Joas, 114 N.W.2d 831, 833 (Wis. 1962)) Id. (citing In re Estate of Bauknecht, 182 N.W.2d 238 (Wis. 1971)) Id Id. at 472 n Id. at 475. In this regard, the Cooney court noted In re Estate of Miller, 595 N.E. 2d 630 (Ill. App. Ct. 1992) as construing similar language failing to include any specific reference to nevertheless require the estate to pay the estate tax on the QTIP property but declined to follow it as formulaic and inconsistent with applicable case law governing shifting the burden of taxation. Cooney, 541 N.W.2d at 473.

26 CREIGHTON LAW REVIEW [Vol. 43 den of estate taxes attributable to the QTIP trust from the trust to the decedent's estate. The Court of Appeals of Indiana applied Florida law in In re Maurice Jones Trust 16 1 to determine who was the proper party to pay estate taxes upon a QTIP marital trust included in the surviving spouse's gross estate. At issue in the case was whether the wife, as surviving spouse, intended for her estate to pay the estate taxes on the QTIP trust established by her predeceased husband. In relevant part her will stated: I direct that all estate, inheritance, succession and other death taxes of any nature, together with any interest and penalties thereon, which may be levied or assessed by reason of my death, by the laws of any State or the United States, with respect to property passing under this Will or any other property, shall be considered a cost of administration of my estate, and that such taxes, together with all debts which I am legally obligated to pay at the time of my death, my last illness and funeral expenses and costs of administration of my estate, (including the cost of a suitable monument at my grave), shall be paid out of my residuary estate without apportionment In comparing the clause to the mere "direction to pay" clause found in Ferrone v. Soffes, 163 the court recognized the more expansive language utilized but still found the clause an insufficient direction to reflect an intention to shift the tax burden, as required by section 2207A(a)(2), from the recipients of the QTIP trust assets, the source of payment of the estate tax, to the estate. The clause was susceptible to more than one interpretation. The section 2207(A)(a)(1) right of recovery prevented the wife from having the legal obligation to pay the estate taxes on the QTIP assets. The phrase "which I am legally obligated to pay" created an ambiguity because the wife was not legally obligated to pay the estate taxes attributable to the QTIP trust assets and, therefore, was not directing the payment of taxes attributable to those assets. 164 The holdings in Gordon and Cooney are aligned and consistent with those cases concluding that a pay-all-taxes provision that fails to make reference to non-probate property is insufficient to shift the es N.E.2d 1301 (Ind. Ct. App. 1994). Florida law applied as the wife was a Florida resident, died in Florida, and her will was executed in Florida. In re Maurice Jones Trust, 637 N.E.2d 1301, 1304 (Ind. Ct. App. 1994) Jones Trust, 637 N.E.2d at So. 2d 146 (Fla. Dist. Ct. App. 1990) Id. at

27 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 773 tate tax burden from such property to the probate estate They also stand for the recognized proposition of "an expressed reluctance to shift tax burdens in the absence of a clear and specific indication of testamentary intent." 16 6 With regard to QTIP trusts and section 2207A(a)(2), there are cases contrary to Gordon and Cooney construing similar tax clause language, even without any reference to the QTIP trust, as sufficient to otherwise direct against apportionment to the QTIP trust beneficiaries.1 67 However, Gordon and Cooney reflect the majority rule requiring explicit reference to QTIP trusts in tax apportionment clauses In 1997, recognizing that cases held contrary to the decisions in Gordon and Cooney, Congress amended the waiver provision contained in section 2207A(a)(2) To make the provision more stringent than originally enacted, Congress replaced the "otherwise directs" language, and the section now states: (2) Decedent may otherwise direct. - Paragraph (1) shall not apply with respect to any property to the extent that the decedent in his will (or a revocable trust) specifically indicates an intent to waive any right of recovery under this subchapter with respect to such property.170 The amendment's legislative history stated that the "bill provides that the right of recovery with respect to QTIP is waived only to the extent that language in the decedent's will or revocable trust specifically so indicates (e.g., by a specific reference to QTIP, the QTIP trust, section 2044, or section 2207A)" and that "a general provision specifying that all taxes be paid by the estate is no longer sufficient to waive the right of recovery." 17 1 Consequently, the amendment narrowed the requirements and demanded more explicit language before courts will find a directive against apportionment The contrary view is that such a clause is sufficient to shift the tax burden on non-probate property to the probate estate notwithstanding the fact that the tax clause is silent regarding non-probate property. See Maurice T. Brunner, Annotation, Construction and Effect of Will Provisions Expressly Relating to the Burden of Estate or Inheritance Taxes, 69 A.L.R.3d 122, (1976) 166. Cooney, 541 N.W.2d at See In re Estate of Klarner, 113 P.3d 150 (Colo. 2005), Miller, 595 N.E.2d 630 (Ill. App. Ct. 1992); In re Will of Adair, 695 A.2d, 250 (N.J. 1997) and infra note See Estate of Vahlteich v. Commissioner, 69 F.3d 537 (6th Cir. 1995); Branch Banking & Trust Co. v. Staples, 461 S.E.2d 921 (N.C. Ct. App. 1995); Adair, 695 A.2dat 256. See also Klarner, 113 P.3d at Taxpayer Relief Act of 1997, Pub. L. No , 111 Stat I.R.C. 2207A(a)(2) (2006) (emphasis added) H.R. REP. No (1997).

28 CREIGHTON LAW REVIEW [Vol. 43 VI. THE PROBLEM AND PROPOSED SOLUTION As the preceding cases demonstrate, statutory apportionment jurisdictions are inconsistent with regard to the degree of clarity and specificity required to override the apportionment statute. A frequently litigated concern involves the question of whether the estate taxes attributable to non-probate property are to be paid from assets in the probate estate. Many of these jurisdictions seem to require very little to establish a shift in the tax burden notwithstanding the recognized strong public policy in favor of statutory apportionment The essentially same clause may be found insufficient to shift the burden from where the statute places it in another jurisdiction. Further, these state decisions conflict with the applicable standards applied by the decisions governing federal statutory apportionment. It may be possible for the courts to eliminate these inconsistencies to better support and bolster apportionment principles. However, rather than relying on the courts, legislatures desiring to promote and strengthen the equitable apportionment rules thought to have been enacted may need to amend these statutes to achieve results more consistent with the policy objectives underlying their original enactment. Apportioning the estate tax among the beneficiaries of the estate not only prevents favoring those receiving general and specific bequests, but also avoids undue erosion of the residue,1 7 3 particularly when a sizable portion of the estate passes outside of the residue or is attributable to non-probate property. As a consequence of charging the taxes entirely to the residue, the testator's dispositive plans may be frustrated. If the testator's wishes are not consistent with applicable state law allocating the tax burden among all of the recipients of the estate, including non-probate beneficiaries, clear and specific lan In re Estate of Stokley, 166 Cal. Rptr. 587 (Cal. Ct. App. 1980); In re Estate of Webb H. Coe Marital & Residuary Trusts, 593 N.W.2d 190 (Mich. Ct. App. 1999); In re Estate of Roe, 426 N.W.2d 797 (Mich. Ct. App. 1988); In re Estate of Gilligan, 668 N.Y.S.2d 656 (N.Y. App. Div. 1998); In re Estate of Schneider, 267 N.Y.S.2d 852 (N.Y. Sur. 1966); In re Estate of Huffaker, 641 P.2d 120 (Utah 1982) Cases where the residue was depleted include In re Valma Hanson Revocable Trust, 779 N.E.2d 1218 (Ind. Ct. App. 2002); In re Estate of Passoff, 819 A.2d 26 (N.J. Super. Ct. Ch. Div. 2002); Rosen v. Wells Fargo Bank Texas, N.A., 114 S.W.3d 145 (Tex. App. 2003). See also Estate of McManus, 140 Cal. App.3d 62, (Cal. Ct. App. 1983); In Re Estate of Kyreazis, 701 P.2d 1022 (N.M. Ct. App. 1984); In re Estate of Jones, 796 A.2d 1003 (Pa. Super. Ct. 2002). In Emmertz v. Cherry, 520 S.E.2d 219 (Ga. 1999), the court, citing In re Will of Cooney, noted that its pay-all-taxes provision did not authorize payment of taxes on non-probate property out of estate's residuum where nothing in will indicated testator's awareness of non-probate property and payment of taxes on such property would deplete residuum, thereby thwarting testator's bequests to charity. In re Will of Cooney, 541 N.W.2d 467 (Wis. 1995). See In re Estate of Armstrong, 366 P.2d 490 (Cal. 1961) (taxes were apportioned rather than payable entirely from the probate estate where the death taxes on probate and non-probate assets exceeded the value of the probate estate).

29 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 775 guage is required to constitute an appropriate direction contrary to the default rule. By requiring such language, courts can safely conclude that the testator not only considered and addressed the issue but also made decisions about how the taxes would be charged. The initial point of inquiry needs to be whether the language utilized identifies the source from which payment of the tax should be made. A general direction that taxes be paid, even coupled with a designated source such as the residuary estate, may be insufficient to shift the allocation of the tax obligation. Language in the will specifying the residue as the source of payment does not clearly and expressly establish that the residuary estate should be charged with all taxes without regard to the probate nature of the property. Before non-probate property transferees are exonerated from the payment of taxes and overcome applicable tax apportionment rules, the tax clause must contain language sufficient to include non-probate property. Without a clearly expressed intent to embrace non-testamentary property, the will fails to provide for the payment out of the residue for taxes attributable to property passing outside of the will Judicial decisions addressing apportionment of estate and inheritance taxes have been inconsistent in following the legislative directive that apportionment of these taxes is required unless the will clearly and specifically directs otherwise. Rules applicable to estate tax proration contain an exception to allow for the decedent to execute a contrary directive. Numerous cases have cited the proposition that a directive must be clear and unambiguous to alter the apportionment statute and shift the tax burden from those upon whom the statute places it As numerous decisions call for apportionment of estate taxes when the will provision is ambiguous, it is urged that such an ambiguity exists with general pay-all-tax clauses charging the residue of the probate estate. As previous cases amply demonstrate, one interpretation is that the estate taxes on both probate and non-probate assets are to be paid from the residuary estate. However, where the clause fails to include non-probate property, other decisions limit the taxes payable from the residuary estate to those amounts attributable to the probate property and require the balance of any taxes to be apportioned among the non-probate property. In this manner, because 174. While insufficient to shift the allocable tax burden on non-probate property to the residue, the clause would be sufficient to shift the burden on property passing under the will to the residue, thereby exonerating general and specific bequests In re Estate of Stokley, 166 Cal. Rptr. 587 (Cal. Ct. App. 1980); In re Estate of Kelly, 584 P.2d 640 (Colo. App. 1978); In re Estate of Webb H. Coe Marital & Residuary Trusts, 593 N.W.2d 190 (Mich. Ct. App. 1999); In re Estate of Roe, 426 N.W.2d 797 (Mich. Ct. App. 1988); In Re Estate of Kyreazis, 701 P.2d 1022 (N.M. Ct. App. 1984); In re Estate of Schneider, 267 N.Y.S.2d 852 (N.Y. Sur. 1966); In re Estate of Ogburn, 406 P.2d 655 (Wyo. 1965).

30 CREIGHTON LAW REVIEW [Vol. 43 the clause is susceptible to more than one interpretation, courts should follow established precedent regarding ambiguities and resolve the matter in favor of the partial apportionment Because of the recognized policies favoring estate tax proration in the caselaw, the willingness of the courts to broadly apply the exception may seem surprising and even perplexing. Notwithstanding the recognized strong public policy in favor of statutory apportionment, many of these jurisdictions require very little to establish a shift in the tax burden. The inconsistency may spring from the exception contained in the apportionment statute. Therefore, the source of the problem may be the statute itself. The inconsistency may arise from the "otherwise directed" or "provided otherwise" exception to the apportionment rules. This statutory language contributes to courts trying to ascertain the decedent's intent by construing other provisions of the will beyond the tax clause. Some courts then find these general pay-all-tax clauses insufficient to defeat the apportionment statutes, while other courts take a far more lenient approach to construing their apportionment statutes, thus finding the statutes overridden and therefore inapplicable. Before courts find these general boilerplate or form book clauses sufficient to impose the entire tax burden attributable to probate and non-probate assets on the residuary probate estate - a result that fails to further the purposes of the apportionment statutes - more specific and precise language should be required. Absent an explicit direction, a general pay-all-taxes clause included in a will should not include taxes attributable to property that does not pass under the will. By requiring more explicit language, courts can be certain that the decedent had the intent and made the deliberate decision to shift the tax burden on such property. Consistent with the strong policy in favor of statutory apportionment, courts have recognized that before they can ignore the legislative scheme under tax apportionment statutes, the will or other governing instrument must plainly state the intention not to apportion. 177 This in turn establishes a framework for analysis. Consequently, "in a tax allocation problem the text of the will is to be scanned only to see if there is a clear direction not to apportion; and if such [e]xplicit direction is not found, construction of text ceases because the statute states the rule." 1 78 Before proceeding with an inquiry into whether the tax clause in the governing instrument is a specific, clear, and unambiguous direc See supra notes 24, 174 and accompanying text Johnson v. Hall, 392 A.2d 1103 (Md. 1978) Johnson, 392 A.2d at 1107 (citing In re Mill's Estate, 64 N.Y.S.2d 105, 110 (N.Y. Sur. Ct. 1946)).

31 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 777 tive against statutory apportionment, at least one court has articulated the importance of initially determining whether the tax clause embraces the property for which tax exoneration or relief is sought. 179 For example, the court would first review the tax clause to determine the requisite intent to relieve non-probate taxable assets from their proportionate burden of death taxes. Because of the need for more clarity and precision in drafting, a will provision that "all taxes" or "all estate, inheritance, transfer, or death taxes" be paid out of the residuary or general estate would be too general under this approach. The above language broadly addresses the type of taxes covered and even designates the fund from which these taxes are to be paid. The clause would be adequate for the residuary probate estate to bear the burden of estate taxes on property passing under the will.' 8 0 Importantly, however, the will clause remains insufficient to exonerate non-probate property because there is neither express or specific reference to property that does not pass under the will nor a direction for payment whether or not the property generating the taxes passes under the will. If courts remain unwilling to require the degree of particularity suggested above for the "otherwise directed" exception, it will be up to the legislatures to strengthen the apportionment statutes by amending them to require more unequivocal language to prevent the statute from governing. As amended, the statutes would replace the "otherwise directed" exception with an "expressly indicated" exception. Thus, the tax clause would need to expressly indicate that property passing under the will should be used to pay taxes on property passing outside the will. The exception, as modified, preserves the ability of the decedent to provide for non-apportionment and, importantly, would be more consistent with the shift from a burden on the residue 179. Reynolds v. Reynolds, No. NP , 2007 W.L (R.I. Super. Ct. 2007) In general, a "pay all taxes out of the residuary estate" clause applies only to probate property. Chase Nat'l Bank of City of New York v. Tomagno, 14 N.Y.S.2d 759 (N.Y. Sup. Ct. 1939). With regard to a tax clause directing payment of all estate and inheritance taxes from the residuary estate, the court in In re Estate of Shoemaker, 917 P.2d 897, (Kan. Ct. App. 1996) recognized: A provision for paying 'all federal estate and inheritance taxes of every kind and nature" from the residue of the estate is presumed to apply only to the property disposed of in the will, unless a wider meaning is clearly expressed... Only by such clear reference to nontestamentary property can the statutory apportionment be defeated. See Reynolds discussed supra note 142 and accompanying text; Ogburn discussed supra note 89 and accompanying text. There would be partial apportionment since the residue would bear the burden as to probate property and the recipients of the non-probate assets would be responsible for a proportionate share of the taxes attributable to these assets that pass outside of the will.

32 CREIGHTON LAW REVIEW [Vol. 43 rule to a burden on the recipient rule - a purpose underlying the enactment of apportionment statutes in the first instance. An express language requirement would promote and require better drafting of documents. Further, testators would need to address, contemplate, and make informed decisions about the manner in which the tax burden will be shared. Moreover, as one court has recognized, an express language requirement would minimize the number of cases in which courts must search for the intent regarding apportionment of taxes. 8 1 Provisions of federal and state statutory apportionment rules have been amended in a number of instances to address the requisite clarity necessary for applying the exception to the default apportionment system. In general, these amendments require greater precision by making the exception subject to more stringent standards. These statutory approaches provide a useful roadmap for those jurisdictions desiring to strengthen their general rule of estate tax apportionment. Several states have already taken the lead and addressed the concern regarding the sufficiency of directions contrary to applicable apportionment. Whether property passing under the governing instrument is to bear the burden of taxation for property not passing under the governing instrument is of critical importance. These states' statutory language requires greater clarity and particularity of language in the governing instrument before the burden of taxation is shifted from where the statute places it. In Oregon, although the statute retains the "otherwise directed" exception, the statute also provides that a "mere testamentary direction to pay debts, charges, taxes or expenses of administration shall not be considered a direction against apportionment of estate taxes."' 8 2 Maryland has adopted statutory apportionment with an exception based on the weaker "otherwise provided" language.' 8 3 However, despite the relaxed contrary direction exception provision, Maryland caselaw has aligned with the stricter view requiring explicit language stating the intention for non-apportionment In aligning itself with those courts following a stricter standard for avoiding estate tax ap In re Estate of McClaran, 811 So.2d 799, 802 (Fla. Dist. Ct. App. 2002) OR. REV. STAT. ANN (West 2003) MD. CODE ANN., TAX-GEN (k) (West 2002 & Supp. 2009) Johnson v. Hall, 392 A.2d 1103 (Md. 1978); Gordon v. Posner, 790 A.2d 675 (Md. Ct. Spec. App. 2002). In Johnson, the court of appeals aligned itself with the selfdescribed small minority of courts requiring explicit language to constitute a direction that the residuary estate fund the payment of estate taxes. As the will language failed to establish an intent not to apportion and opt out of statutory apportionment, the estate taxes were charged to the beneficiaries named in the will rather than be charged solely to the residuary estate.

33 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 779 portionment, the approach adopted by the Maryland court prevents inadvertent alteration of the tax apportionment rules. California and Florida have also rewritten their estate tax proration exceptions to contain a more rigorous test before apportionment is bypassed. Before amendment, the California proration statute made an exception "where a testator otherwise directs in his or her will." 18 5 California now provides for an exception to the equitable proration of federal and state estate taxes but does so without utilizing more relaxed and lenient "otherwise directed" language. The exception in the California Probate Code provides: (b) This section does not apply: (1) To the extent the decedent in a written inter vivos or testamentary instrument disposing of property specifically directs that the property be applied to the satisfaction of an estate tax or that an estate tax be prorated to the property in the manner provided in the instrument. As used in this paragraph, an "instrument disposing of property" includes an instrument that creates an interest in property or an amendment to an instrument that disposes of property or creates an interest in property The current exception replacing the "otherwise directs" language of the former exception was rewritten in 1987 to "apply only where 'the decedent in a written...instrument...specifically directs' a particular method of payment or proration." 18 7 In light of these amendments, and reaffirming the general rule of estate tax apportionment under the statute, a California court has recognized that "the narrow but firmly based policy now expressly stated in the proration statute" takes precedence over the more general policy of construction to effectuate a testator's intent Florida's apportionment statute, Florida Statutes section ,189 containing a complex arrangement for the proration of estate taxes, has been amended several times to address the rules applicable to beneficiaries' responsibility for contributing their proportionate share of estate taxes. The statutory system may be superseded provided the governing instrument has "effectively directed" 190 or "otherwise directed."' 9 1 This arguably broad language is narrowed and made subject to more restrictive standards by later 185. CAL. PROB. CODE 970, repealed by 1986 Cal. Stat. ch CAL. PROB. CODE 20110(b)(1) (West 1991) (emphasis added) In re Estate of Malpas, 9 Cal. Rptr. 2d 806, 809 (Cal. Ct. App. 1992) Malpas, 9 Cal. Rptr. 2d at FLA. STAT (West 2005 & Supp. 2010) Id (4)(a) Id (5).

34 CREIGHTON LAW REVIEW [Vol. 43 statutory provisions, particularly with respect to shifting the tax burden on non-probate property to the probate estate. Section (5)(h)(1) provides: To be effective as a direction for payment of tax in a manner different from that provided in this section, the governing instrument must direct that the tax be paid from assets that pass pursuant to that governing instrument, except as provided in this section Section (5)(h)(4) contains the narrow and explicit requirement and states: 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 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 Even prior to the provisions of the current statute, the Florida legislature recognized that effective directives against proration in the governing instrument needed greater specificity. The statute, in relevant part, formerly provided: A direction against apportionment under this section may be explicit or implicit from the terms of the governing instrument, but must be clear and unequivocal; provided, however, that an implicit direction against apportionment is not sufficient to avoid the apportionment under state or applicable federal law unless the court also finds that the testator considered and made a deliberate and informed decision about the burden of taxation State legislatures have not been the only governing bodies perplexed by tax apportionment concerns. Prior to its 1997 amendment, Internal Revenue Code ("IRC") section 2207A 19 5 allowed a decedent to 192. Id (5)(h)(1) Id (5)(h)(4) FLA. STAT (2)(d), amended by 1997 FLA. LAws ch This section is, in part, a codification of the decision in Ferrone v. Soffes, 558 So.2d 146 (Fla. Dist. Ct. App. 1990). See Trent S. Kiziah & Felix J. Chmiel, Estate Tax Apportionment Statutory Modification, 67 FLA. B. J. 22 (Feb. 1993) I.R.C. 2207A (2006).

35 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 781 "otherwise direct" the payment of estate taxes attributable to qualified terminable interest property ("QTIP") assets. 196 In order to exonerate the QTIP property, the amended section 2207A now requires the decedent do so by specifically indicating the waiver of any recovery rights against the QTIP property. The amendment effectively codified the majority rule announced in In re Estate of Gordon 19 7 by the Surrogate's Court for New York County, New York. 198 The legislative history to the 1997 amendments instructed that a decedent who makes specific reference to QTIP, the QTIP trust, IRC section 2044,199 or section 2207A will satisfy the "specific indicat[ion]" exception The legislative history also stated that a provision that all taxes be paid by the estate, that is, a general pay-all-taxes clause, will be insufficient to exonerate the QTIP assets The majority rule under Gordon 20 2 and the current statutory language in section 2207A are consistent with and support the notion that a general tax clause charging estate taxes to the residuary estate without making reference to non-probate property, or assets passing outside of the governing instrument, is insufficient to shift the estate taxes on non-probate property to the probate residuary estate. QTIP trust cases involving a will direction that all estate taxes be paid out of the residuary estate would not otherwise provide or direct so as to exonerate beneficiaries of the QTIP trust from contributing their share of estate taxes. Those principles relied upon in the QTIP trust cases apply with equal force to the contention that like clauses fail to exempt beneficiaries of property passing outside of the will from payment of their share of the estate taxes I.R.C. 2207A(a)(2) provided that "[plaragraph (1) shall not apply" if the decedent otherwise directs by will. In In re Estate of Gordon, 510 N.Y.S.2d 815 (N.Y. Sur. Ct. 1986), a general pay-all-tax clause that failed to make reference to the QTIP trust was held to be insufficient to shift the estate tax burden on the QTIP trust to the residuary estate. In In re Estate of Miller, 595 N.E. 2d 630 (Ill. App. Ct. 1992), the court of appeals applied a less stringent statutory standard to conclude that the pay-all-tax clause was sufficient under the otherwise directed" exception and exonerated the QTIP trust. The result in Gordon was followed in In re Will of Cooney, 541 N.W.2d 467, 476 (Wis. 1995). The pay-all-tax clause in the surviving spouse's will did not exonerate the QTIP trust remainder beneficiaries because the clause did not expressly mention or refer to the QTIP trust. The court interpreted the clause to refer to taxes payable only on the transfers made in the will. Cooney, 541 N.W.2d at N.Y.S.2d 815 (N.Y. Sur. Ct. 1986) See Gordon discussed supra note I.R.C (2006) 200. H.R. REP. No (1997) Id In re Will of Adair 695 A.2d, 250, 256 (N.J. 1997) recognized Gordon as stating the majority rule.

36 CREIGHTON LAW REVIEW [Vol. 43 VII. CONCLUSION Through either statutory enactment or judicial decision, applicable law in most states follows the principles of apportionment of estate taxes. Within these rules, however, the decedent is permitted to alter the tax liability scheme from that provided under the default rules. Rules calling for the apportionment of estate tax liabilities, whether by statute or caselaw, may be circumvented or bypassed by appropriate provisions in the will or other controlling instrument. Following the majority rule, most courts have stated that general pay-all-tax clauses in the governing instrument are sufficient to indicate the decedent intended to make provision for the payment of estate taxes contrary to the applicable estate tax apportionment rules. An unfortunate consequence of this approach is property passing under the will, for example probate property or assets, becomes the source of payment for property passing outside of the will, for example non-probate property. By interpreting the direction to the executor to include payment of estate taxes on property not passing under the will, taxes, which otherwise applicable apportionment rules attribute to the nonprobate assets, diminish the probate estate. The call to pay-all-taxes from the residue may have been a sufficient expression of intent to avoid apportionment among the probate assets, thereby freeing the pre-residuary bequests and devises from sharing in the estate tax burden. However, it may be too great a leap to conclude that the same clause avoids sharing of the tax burden between non-probate assets and the residuary probate estate. These general tax clauses should not be interpreted to contain a specific contrary direction exonerating the recipients of non-probate assets from paying a portion of the tax. Greater specificity should be required to circumvent statutorily or judicially required sharing of the ultimate burden of estate taxes. Charging the residue with the payment of estate taxes indicates an intent that specific bequests should not bear any portion of the estate tax, but this charge is an insufficient direction to preclude using applicable apportionment rules on those assets passing outside of the will. Designating the source of payment as the residuary does not automatically shift the burden of taxation on non-probate property from the recipients to the residuary estate. It may have been written without any intention of controlling the apportionment of estate taxes on property passing outside of the will. The pay-all-tax clause is too general to negate application of apportionment rules mandating that estate taxes be shared pro rata by the recipients of property included in the decedent's taxable estate.

37 2010] ESTATE TAXES ON NON-PROBATE PROPERTY 783 Moreover, rather than constituting a clear and unambiguous statement, these clauses reveal an ambiguity because whether they are intended to apply to the estate taxes attributable to non-probate assets is unclear. Therefore, precedent supports the application of the state apportionment statute While a decedent may alter the applicable apportionment scheme, this Article argues that the language in a pay-all-taxes clause, being too general and, at best, ambiguous, is insufficient to shift the estate tax burden from where the applicable apportionment rules place it. The better approach is to require express or more specific language in the tax clause constituting a direction sufficient to burden the residuary estate for estate taxes regarding the non-testamentary property. The virtues of this option include decreasing the potential for tax clause ambiguity and eliminating the need to resort to extrinsic evidence to search for testator's intent as to tax apportionment. These benefits remove uncertainty in the estate administration process and thus will assist fiduciaries. Application of the more stringent standard exists under the federal tax statute in the context of estate taxes attributable to the inclusion of qualified terminable interest property ("QTIP") trust assets in the estate of the surviving spouse. Moreover, the majority of courts reached this result under the then applicable statute's original language permitting the governing instrument to "otherwise direct." Unfortunately, the majority of courts faced with the question have not extended the QTIP analysis to other non-probate assets. There is some indication from the cases that the problem for some courts may stem from the statutory language authorizing the decedent to trump the applicable apportionment rules by providing a different method of apportioning estate taxes and "shift the tax burden from those upon whom the statute imposes it." 20 4 Courts may be reticent to apply the stricter standard urged in this Article if the applicable state statute merely provides in a less stringent manner for the decedent "to direct 203. Brunetti v. Comm'r, 56 T.C.M. (CCH) 580 (1988). See supra note 24 and accompanying text In re Estate of Morris, 838 P.2d 402, 405 (Mont. 1992). In In re Estate of Klarner, the court noted a material difference between the state statute and the federal statute. 113 P.3d 150, 155 (Colo. 2005). The statute did not contain the federal language to require the decedent to "specifically" indicate an intent to waive apportionment but rather merely provided decedent to "direct a method of apportionment different from that described in the statute." Klarner, 113 P.3d at 155. According to the dissent in Johnson v. Hall, had the statute used the stricter standard of requiring the intention to be "expressly indicated" or "specifically provided" rather than the less rigid language of "providing otherwise," the dissent would have agreed with the analysis contained in the majority decision. 392 A.2d 1103, (Md. 1978) (Murphy, J., dissenting).

38 CREIGHTON LAW REVIEW [Vol. 43 or provide otherwise." 20 5 Perhaps the fault lies with the statutory language. By creating a too lenient threshold to evaluate the decedent's tax clause direction in the governing instrument, legislatures may have inadvertently simplified the ability to override the default apportionment standard. If this is the case, applicable estate tax apportionment statutes should be strengthened by replacing statutory language enabling the decedent "to direct or provide otherwise" with a requirement that the governing instrument expressly or specifically indicate that the residue of the probate estate be responsible for and charged with the payment of estate taxes on property passing outside of the will. There are judicial and legislative solutions to the problem of charging the residuary probate estate with responsibility for payment of the estate taxes on non-probate assets. The courts should be more vigilant in the apportionment context by interpreting the directive exception more stringently and restrictively. A general pay-all-taxes clause does not contain the higher standard of clarity required for a decedent's clear and unambiguous expression to opt out of the pro rata sharing of estate tax liability for non-probate property. If the higher standard is not met, the recipients of the non-probate assets should be responsible for their fair share of the ultimate incidence of taxation. Where the decedent fails to adequately state that the property passing outside of probate is exonerated from the tax burden, these non-probate assets should remain subject to their pro rata share of estate tax liability. To date, too few courts have been willing to exact this called for level of precision and have allowed ambiguous language in the governing instrument to serve as a direction against apportioning any estate tax liability to non-probate property. In recognition of this practice, the solution may need to shift from the courts to the legislature to restore the fundamental principles underlying applicable apportionment doctrine. If the courts are otherwise unwilling to refrain from too broadly interpreting the general pay-all-taxes clauses, legislatures should intervene and consider statutory amendments that strengthen apportionment rules. With this alternative solution, guidance already exists. These statutory amendments aimed at strengthening should be patterned following the federal lead of Congress in Internal Revenue Code section 2207A(a)(2) or by looking to the states of Florida and California But see Gordon and Johnson, supra notes 146 and 99 and accompanying text respectively (giving examples of decisions declining to find the tax clause as sufficient under the more lenient language).