Rev. Rul. 1973-142

    Internal Revenue Service
 Revenue Ruling

Rev. Rul. 73-142

1973-1 C.B. 405

IRS Headnote

The value of trust property is not includible in the grantor-decedent's
gross estate where his power to appoint himself as trustee was effectively
extinguished by a lower court decree that was not appealed even though the
decree was inconsistent with decisions of the state's highest court. 

Full Text

Rev. Rul. 73-142 

Advice has been requested whether the value of certain property transferred
in trust by the grantor-decedent is includible in his gross estate under
section 2036 or section 2038 of the Internal Revenue Code of 1954, under
the circumstances described below. 

The decedent made substantial gifts of property in trust for the benefit of
his wife and children. Under the terms of the trust instrument, the
decedent reserved the unrestricted power to remove or discharge the trustee
at any time and appoint a new trustee, with no express limitation on so
appointing himself. The trustee was given unrestricted power to withhold
distribution of income or principal and to apportion between income and
principal notwithstanding any rules of law to the contrary. In 1965, in a
non-adversary action in which the decedent was petitioner, a lower state
court construed the trust instrument to mean that the decedent had reserved
the right to remove and appoint a trustee only once, that this power did
not include the right to appoint himself; and that once having exercised
that power, decedent would have exhausted his reserved powers. The
decedent, subsequent to the decree, did remove the original trustee and
appoint another (not himself) so that under the interpretation of the court
he no longer had such a right as of the date of his death in 1970. It
appears that the decree is contrary to the decisions of the highest court
of the state. 

In light of the holding in Commissioner v. Estate of Herman J. Bosch, 387
U.S. 456 (1967), Ct. D. 1915, 1967-2 C.B. 337, the specific question asked
is the effect to be given the above-mentioned court decree in determining
the estate tax consequences of the trust. 

Section 2036(a)(2) of the Code provides that the value of the gross estate
shall include the value of all property to the extent of any interest
therein of which the decedent has at any time made a transfer (except in
case of a bona fide sale for an adequate and full consideration in money or
money's worth), by trust or otherwise, under which he has retained for his
life the right, either alone or in conjunction with any person, to
designate the persons who shall possess or enjoy the property or the income
therefrom. 

Section 2038 of the Code provides that the value of the gross estate shall
include the value of all property to the extent of any interest therein of
which the decedent has at any time made a transfer (except in case of a
bona fide sale for an adequate and full consideration in money or money's
worth), by trust or otherwise, where the enjoyment thereof was subject at
at the date of his death to any change through the exercise of a power (in
whatever capacity exercisable) by a decedent alone or in conjunction with
any other person to alter, amend, revoke or terminate. 

If the decedent reserved the unrestricted power to remove or discharge a
trustee at any time and appoint himself as trustee, the decedent is
considered as having the powers of the trustee. Section 20.2036-1(b)(3) of
the Estate Tax Regulations. See also section 20.2038-1(a)(3). 

In Bosch the Supreme Court of the United States held that where the Federal
estate tax liability turns upon the character of a property interest held
and transferred under state law, federal authorities are not bound by a
determination made of such property interest by a state trial court.
Recognizing that state law as announced by the highest court of the state
is to be followed, the Court held that, where there is no decision by the
highest court, the federal court must apply what it finds state law to be,
after giving proper regard to decisions of other courts of the state. 

A close reading of the Bosch decision discloses that it does not in any way
indicate that a lower court decree that is inconsistent with the ruling by
the state's highest court on the particular issue is void as between the
parties to the action. The problem involved in Bosch concerns the effect to
be given such lower court decree where the same issue is critical in the
determination of a Federal tax question. The Court concluded that "federal
authorities are not bound" by a determination of a property interest by a
state trial court. This does not mean that the parties to the state court
action are not bound by the decree. 

In this case the lower court had jurisdiction over the parties and over the
subject matter of the proceeding. Thus, the time for appeal having elapsed,
its judgment is final and conclusive as to those parties, regardless of how
erroneous the court's application of the state law may have been.
Consequently, after the time for appeal had expired, the grantor-decedent
did not have the power to appoint himself as successor trustee. The
aforesaid rights and powers which would otherwise have brought the value of
the trust corpus within the provisions of sections 2036 and 2038 of the
Code were thus effectively cut off before his death. 

Unlike the situation in Bosch, the decree in this case was handed down
before the time of the event giving rise to the tax (that is, the date of
the grantor's death). Thus, while the decree would not be binding on the
Government as to questions relating to the grantor's power to appoint
himself as trustee prior to the date of the decree, it is controlling after
such date since the decree, in and of itself, effectively extinguished the
power. In other words, while there may have been a question whether the
grantor had such power prior to the decree, there is no question that he
did not have the power thereafter. 

Accordingly, it is held that the value of the property transferred to the
inter vivos trust is not includible in the grantor-decedent's gross estate
under section 2036 or section 2038 of the Code.