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09/16/94 HENRY BROOKS CLEVELAND v. COMPASS BANK

September 16, 1994

HENRY BROOKS CLEVELAND, INDIVIDUALLY AND AS EXECUTOR OF THE ESTATE OF MABEL B. CLEVELAND, DECEASED
v.
COMPASS BANK; COMPASS BANK V. HENRY BROOKS CLEVELAND, INDIVIDUALLY AND AS EXECUTOR OF THE ESTATE OF MABEL B. CLEVELAND, DECEASED



Appeals from Jefferson Circuit Court. (CV-90-8006). Jack D. Carl, Trial Judge.

Rehearing Denied January 13, 1995. Released for Publication April 22, 1995.

Almon, Hornsby, C. J., and Kennedy, Ingram, and Cook, JJ., concur. Shores and Houston, JJ., recused.

The opinion of the court was delivered by: Almon

ALMON, JUSTICE.

Henry Brooks Cleveland ("H. B. Cleveland"), individually and as executor of the estate of Mabel Cleveland, appeals from a judgment apportioning estate tax liability among various trusts and estates. Compass Bank (successor to Central Bank), as trustee of certain trusts and as executor of the estate of Henry Fling Cleveland ("H. F. Cleveland"), filed a declaratory judgment action for a determination as to which estate or trust owed certain estate taxes. Compass Bank also appeals from the judgment. These appeals involve the estates of H. F. Cleveland, who died July 9, 1988, and his wife Mabel Brooks Cleveland ("Mabel Cleveland"), who died January 15, 1990. Also involved is a revocable inter vivos trust created by H. F. Cleveland on July 8, 1985 ("H. F. Cleveland Trust"), and an irrevocable inter vivos trust created by Mabel Cleveland on July 15, 1986 ("Mabel Cleveland Trust"). The Q-TIP *fn1 portion of the H. F. Cleveland Trust and all of the Mabel Cleveland Trust were included in Mabel Cleveland's gross estate. The issues concern the apportionment of estate tax liability of Mabel Cleveland's estate among the H. F. Cleveland Trust, the Mabel Cleveland Trust, and the estate of Mabel Cleveland.

Under the terms of the H. F. Cleveland Trust, H. F. Cleveland was to receive income for his lifetime. Upon his death, Mabel Cleveland was to receive income for her lifetime. Upon her death, income from the H. F. Cleveland Trust was to be paid to H. B. Cleveland, the couples' only child. Upon the death of H. B. Cleveland, the remainder of the H. F. Cleveland Trust was to be paid to another trust called the "Henry Fling Cleveland Trust," a charitable trust for the benefit of Birmingham-Southern College and First United Methodist Church of Birmingham. Compass Bank was also named trustee of the Henry Fling Cleveland Trust.

After H. F. Cleveland's death on July 9, 1988, his will and codicils were offered for probate. In his will, H. F. Cleveland directed that his executor make a Q-TIP election after considering the best interests of his family. Central Bank elected to treat a fractional part of the H. F. Cleveland Trust as "qualified terminable interest property" ("Q-TIP"), qualifying this part of the H. F. Cleveland Trust for the marital deduction under I.R.C. § 2056(b)(7). The total Q-TIP portion of the H. F. Cleveland Trust is approximately $2.9 million.

As suggested above, a Q-TIP election bears on the right to exercise the marital deduction of I.R.C. § 2056(b)(1) with regard to property that would not otherwise qualify for it. The general rule of I.R.C. § 2056(b)(1) provides that an interest passing to a spouse does not qualify for the marital deduction (1) if the interest is terminable, (2) if the decedent has also given an interest in the property to another, and (3) if upon the termination or failure of the spouse's interest, the other person comes into possession or enjoyment of the property by way of his interest. In 1981, Congress enacted the Qualified Terminable Interest Property provision, creating an exception to this rule, whereby an executor may elect to treat a life estate as a non-terminable interest. I.R.C. § 2056(b)(7). The exercise of this election and the taking of the marital deduction have the legal effect of removing this Q-TIP property from the estate of the creator of the Q-TIP property and including it in the estate of the recipient spouse when he or she dies.

To ameliorate the tax burden caused to the spouse in whose gross estate the Q-TIP property is included, Congress enacted I.R.C. § 2207A. Section 2207A provides that if a decedent's gross estate includes any Q-TIP property, the executor or administrator may recover the amount of estate tax attributable to the inclusion of that property from a "person receiving the property," unless the decedent's will provides otherwise. A "person receiving the property" is defined to include the trustee of a trust holding the Q-TIP property at the time of the decedent's death and any person receiving a distribution of such property if the property does not remain in trust.

The equitable life estate of Mabel Cleveland was by definition a terminable interest, which would not otherwise qualify for the marital deduction. To allow the estate of H. F. Cleveland to take the marital deduction with regard to this part of the estate, Central Bank made the Q-TIP election. The effect of the exercise of the Q-TIP election and the marital deduction was that the estate of H. F. Cleveland did not pay any estate tax and that the Q-TIP portion of the H. F. Cleveland Trust was included in the gross estate of Mabel Cleveland when she died.

On July 15, 1986, Mabel Cleveland created an irrevocable inter vivos trust, the Mabel Cleveland Trust, under which she retained a life income interest *fn2 and under which H. B. Cleveland was named trustee. Under the terms of the Mabel Cleveland Trust, upon the death of Mabel Cleveland the trust terminated and H. B. Cleveland received a distribution of the trust corpus. The Mabel Cleveland Trust provided that the trustee of the Mabel Cleveland Trust would "reimburse [from trust funds] the executor of Mabel Cleveland's estate for the proportionate part of death taxes paid by reason of the inclusion of such trust property [i.e., the property in the Mabel Cleveland Trust] in the gross estate" of Mabel Cleveland. Compass Bank filed a declaratory judgment action to determine the respective liabilities of the estate of Mabel Cleveland, the H. F. Cleveland Trust, and the Mabel Cleveland Trust for the federal and Alabama estate taxes due on the estate of Mabel Cleveland. On November 18, 1991, the circuit court entered an order granting in part and denying in part a motion for a partial summary judgment filed by Compass Bank and the motion for a partial summary judgment filed by H. B. Cleveland. In that order, the circuit court correctly held that the H. F. Cleveland Trust was liable under § 2207A for that portion of the federal estate taxes attributable to the inclusion of the Q-TIP property in the estate of Mabel Cleveland, together with interest and penalties. The circuit court held that Compass Bank, as trustee, was liable for $867,407 in federal estate tax, exclusive of interest and penalties.

The circuit court also held that the estate of Mabel Cleveland was liable for all other federal and Alabama estate taxes other than that amount of federal and Alabama estate tax attributable to the inclusion in the estate of any property of the Mabel Cleveland Trust, whose payment the trustee of the Mabel Cleveland Trust was obligated to reimburse.

H. B. Cleveland's appeal raises the issue whether the H. F. Cleveland Trust is liable to the estate of Mabel Cleveland for Alabama estate tax attributable to the property included in her gross estate as a result of the Q-TIP election of the estate of H. F. Cleveland.

H. B. Cleveland argues that, as executor, he is entitled to recover from the H. F. Cleveland Trust the Alabama estate tax, in addition to the federal estate tax, attributable to the inclusion of the value of the Q-TIP property in the estate of Mabel Cleveland. He argues that I.R.C. § 2207A preempts the question of the apportionment of Alabama estate tax liability between the estate of Mabel Cleveland and the H. F. Cleveland Trust. H. B. Cleveland contends that I.R.C. § 2207A and C.F.R. § 20.2207A-1 govern apportionment of Alabama, as well as federal, estate tax ...


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