CORY v. SMITH (1979)

Kenneth Cory, State Controller, appeals from an order of the trial court fixing inheritance tax.

FACTS

On May 24, 1977, the report of the inheritance tax referee was filed in the probate of the estate of Edwina F. Butler, who died on May 7, 1976. Eloise Stabler and Grace Smith, the daughters and coexecutrixes of Edwina F. Butler's will, filed an objection to the report insofar as it purported to include in the Butler estate for purposes of assessing California inheritance taxes the assets in certain trusts created by the decedent during her lifetime.

Following oral argument the objections were sustained by the court and the State Controller requested findings of fact and conclusions of law. When the proposed findings and conclusions were filed, the State Controller objected thereto. The trial court thereafter made and entered its order sustaining the executrix' objections to the referee's report, overruling the Controller's objections to the proposed findings, vacating the order fixing tax, and directing a refund of California inheritance tax in the amount of $32,861.¹ The State Controller filed timely notices of appeal following notice of entry of judgment and again following entry of the court's order fixing tax. We dismiss the first appeal as premature.

The principal facts relative to the creation of the trusts were stipulated by the parties. Prior to creation of the trusts Edwina Butler was the owner of a parcel of real property in Los Angeles County, containing approximately 7.012 acres which is for convenience hereinafter referred to as the “El Monte acreage.” The improvements on the El Monte acreage included a small residential building, a garage and a dairy barn, which were old and in poor condition. Therefore, the El Monte acreage was essentially unproductive land with a stipulated fair market value of $168,500 in December of 1964.

By a series of interdependent transfers the decedent conveyed to trusts the major part of her interest in the El Monte acreage. On December 30, 1964, decedent transferred without consideration an undivided 45.73 percent of the El Monte acreage to Ronald C. Winger, as trustee of an irrevocable trust in which decedent retained the right to receive income for her lifetime, reserving the right to transfer that life estate at any time. It was provided that the trust should terminate upon the death of the trustor with the remainder to pass by right of representation to her then living lawful issue. On the same date the decedent transferred to each of her daughters, Grace Smith and Eloise Stabler, an outright, undivided 2.135 percent of the El Monte acreage (a total of 4.27 percent) and also transferred to each daughter one-half of the life estate she had retained in the property. These transfers were made in consideration of each daughter's separate written promise to pay her mother an annuity of $150 per month during her lifetime. These 1964 annuities each had a present value of $13,693.61 and were exchanged for $13,693.61 present value of transfers from the decedent ($10,096.14 for her life estate and $3,597.47 for 2.135 percent of the El Monte acreage).

On January 25, 1965, decedent disposed of the remaining 50 percent of her interest in the El Monte acreage through a series of transfers identical to those made on December 30, 1964. In this manner decedent by the end of January 1965 had transferred her entire interest in the El Monte acreage to her daughters and to irrevocable trusts (hereinafter designated the 1964 trust and the 1965 trust respectively). She had relinquished all interest she reserved in the trusts, and she was receiving annuities representing total payments of $600 per month. At the time of the trustor's death on May 7, 1976, sole living issue consisted of her two daughters, Grace Smith and Eloise Stabler, who are the respondents herein.

The values of the various property transfers when made in 1964 and 1965 were, pursuant to the federal estate and gift tax regulations at that time, the following: (1) The remainder interest in each of the trusts created in 1964 and 1965 was valued at $56,862.77; (2) the lifetime income from each trust was valued at $20,192.28; (3) the 4.27 percent fee interest in the El Monte acreage transferred at the creation of each trust was valued at $7,194.95. The remainder interests which were transferred without consideration represented a total $113,725.54 value.

The transfers of the remainder interests to the irrevocable trusts were reported by the trustor as gifts and both federal and state gift taxes were assessed and paid by the decedent at the time of the transfers. The court found as a fact that each transfer of a one-half interest in decedent's reserved life estate, which had a total value of.$40,384.56, was made in exchange for the promises of the daughters to make annuity payments of $442.20 per month. The balance of the $600 per month annuity payments the court attributed to the outright transfers of the El Monte real property to the daughters. The value of the $442.20 annuity payments promised exactly equaled under table 1 of the federal estate and gift tax regulations then in effect the.$40,384.56 value of the life estates in the income of the 1964 and 1965 trusts which were transferred to the daughters.

Each of the daughters paid individually, and not from trust income received, the actual annuity payments substantially in accord with her promise and the total amount paid by decedent's death was $76,800. Of this amount $56,601.60 or 73.7 percent was attributed to the transfers of the life estates and the balance was attributed to the proportion of the El Monte acreage which the daughters received outright.

It was stipulated that by creation of the trusts, the outright conveyances, and the transfers of the life estates the decedent intended to (a) obtain a monthly income for life beginning in January 1965 and (b) provide that the annuity payments made by her daughters would be deductible for federal income tax purposes. The trial court found that this was accomplished even though the transferred property remained substantially unproductive of income until 1969 and that the daughters' annuity promises were unrelated to the income from the transferred property. The property was apparently not rented and produced no income in 1964 prior to creation of the trust; between 1965 and 1969 it yielded no income except $845 in 1967. It was only following the sale of the El Monte acreage in 1969 that the trust assets began to generate steady income. The total income from the trust assets reported by the trustee up to the date of decedent's death in 1976 totaled $136,642.

The court found on the basis of stipulated facts relative to the degree of management and control exercised by the daughters after creation of the trusts that the decedent intended that the transfers take effect “in her daughters' possession and enjoyment immediately as made, and not that such possession and enjoyment be delayed to take effect at or after her death.” This applied to both the outright transfers and the transfers in trust. In support of this finding the court relied upon the following recital of facts: “This intention was borne out in practice. From the dates of the transfers to the date of the decedent's death, the trustee managed the trust properties in constant communication with, and according to the desires of, the two daughters. When the El Monte acreage was sold, the proceeds were invested and reinvested at the daughters' direction, with later turnovers and reinvestments as they directed. Property was bought and sold when and as they wished, with money borrowed, improvements made and leases signed as they directed. The trusts' assets as listed on page 3 of the Report of the Inheritance Tax Referee were the final product of those directions. The decedent had no part in any of this and was not consulted with respect to it. Her approval or disapproval was neither sought nor obtained. Title remained in the trustee until the decedent's death.”

Accordingly, the trial court concluded that Revenue and Taxation Code section 13643 was inapplicable to tax the trust corpus in Edwina Butler's estate because possession and enjoyment were not deferred till her death (Estate of Madison (1945) 26 Cal.2d 453, 159 P.2d 630); that no part of the trust corpus was includable as a gift in contemplation of death because the trustor relinquished her life estate over 11 years prior to her death (Estate of Thurston (1950) 36 Cal.2d 207, 223 P.2d 12; Rev. & Tax.Code, ss 13642, 13644); and that the property for which the annuity was paid was not includable in the estate under Revenue and Taxation Code section 13645 because it was a bona fide sale for adequate and full consideration in money or money's worth. The State Controller has appealed the trial court's determination that no part of the trust assets is includable in Edwina Butler's estate for inheritance tax purposes.

ISSUES

The State Controller contends that the daughters' remainder interests in trust corpus are includable in Edwina Butler's estate because the transfer was one in which possession or enjoyment was intended to shift at or after the trustor's death. (Rev. & Tax.Code, s 13643.) The State Controller contends that in the alternative the trust corpus is includable in decedent's estate because this was a transfer conforming to section 13641 and under which the daughters, as transferees, promised to make payments to decedent. (Rev. & Tax.Code, s 13645.)

DISCUSSION

The initial contention of the State Controller is that the corpus of each trust (i. e., the remainder interest) is includable in the estate of Edwina Butler pursuant to Revenue and Taxation Code section 13643² because possession or enjoyment were in fact deferred according to the trust instruments, which express the presumed intent of the trustor, until after her death. The crucial provision of the trust instruments is found in paragraph “THIRD” which declares: “This Trust shall terminate upon the death of the Trustor. Upon such termination, the entire principal and any undistributed income of the Trust Estate shall be distributed by right of representation to the then living lawful issue of the Trustor.”

Among the devices most commonly resorted to to avoid inheritance taxes are inter vivos transfers in trust whereby the transferor reserves to himself a life estate in the use or income of the trust property. (Estate of Crowell (1976) 56 Cal.App.3d 564, 567, 128 Cal.Rptr. 613.) Sections 13641-13648 represent attempts to tax those inter vivos transfers whereby the transferor retains such an interest in the transferred property or imposes such restrictions on the uses thereof that at his death the donor may still be regarded as the owner of the property and the transfer should be regarded as essentially testamentary in nature. (See Estate of Thurston, supra, 36 Cal.2d 207, 209-211, 223 P.2d 12.)

One of the leading California cases concerning the imposition of inheritance tax on inter vivos transfers intended to take effect in enjoyment or possession at or after death is Estate of Madison, supra, 26 Cal.2d 453, 159 P.2d 630. In Madison the decedent had created separate irrevocable trusts for each of his three children providing that each should terminate at his death and the corpus be paid to the beneficiary or that person the beneficiary might appoint by will. The decedent retained no interest in the corpus of these trusts. Section 2, subdivision (3)(b), of the Inheritance Tax Act of 1935, predecessor to present section 13643, taxed transfers in trust or otherwise intended to take effect in possession or enjoyment at or after death. The California Supreme Court in holding these transfers taxable at the death of the trustor emphasized that the critical element in relation to that section of the code is not the retention of possession or interest by the creator of the trusts but the intent to have the inter vivos gift take effect in possession or enjoyment of the beneficiary at or after the trustor's death. “(T)he issue is not whether the donor retained some power or interest until his death, but rather whether he tied up the property with so many strings, which could not be loosened until his death, that the transfer may be regarded as having been intended to take effect in possession or enjoyment at his death within the meaning of the statute. . . .” (Estate of Madison, supra, 26 Cal.2d at p. 457, 159 P.2d at p. 633.) The question is whether the limitations of the trust instrument and management provisions render the transfer one which takes effect in possession and enjoyment only at the trustor's death. The Madison court answered this question affirmatively taking into consideration the presumed continued de facto use of the income by the trustor for the benefit of the family during his life, the spendthrift provisions of the trusts which prevented the beneficiaries from disposing of their interests in the corpus, and the fact that persons as yet unborn had possible interests in the trust property under the distribution clause.

The principles elucidated in Madison were recently applied to tax the corpus of irrevocable inter vivos trusts created for the decedent's three nephews and two nieces (Estate of Crowell (1976) 56 Cal.App.3d 564, 128 Cal.Rptr. 613). The trust provided that the income was to be accumulated until the trustor's death and thereafter paid to the nephews and nieces for life with remainders to their issue. It is clear that the beneficiaries under the circumstances could receive nothing until the trustor's death and the court found that to be her intention and the corpus taxable under section 13643.

The daughters of Edwina Butler point out that their possession or enjoyment was not deferred until the death of their mother because only legal title passed to them at that time, i. e., the daughters held both possession and enjoyment of the trusts' assets from the date the trusts were created. There was no spendthrift provision to prevent them from disposing of their interests as in Madison and the trusts were established by their mother solely to obtain income for herself from a nonincome producing asset while at the same time obtaining an income tax deduction for her daughters in making the private annuity payments. The retention of legal title by the trustee is likened to a “gossamer-thread” rather than “so many strings” which could not be loosened until the trustor's death.

Under the provisions of the trust in the present case neither daughter was given the right to compel the trustee to execute “any instrument not satisfactory to him in form and substance” whatever she might desire or believe best for her individual interests. Although the trustee sought the advice of the beneficiaries and acted in accordance with their counsel, management decisions remained subject to his discretion. Additionally, the daughters' interests in the trust were contingent upon their surviving the trustor, and only at her death could they exercise the unbridled right to dispose of the trust assets as they wished. Since at decedent's death full legal title passed to the daughters, the State Controller argues that this establishes the trustor's intent that the transfer take effect in possession and enjoyment only at her death under section 13643.

The lower court nonetheless made an express finding that “the decedent intended that the transfers take effect in her daughters' possession and enjoyment immediately as made, and not that such possession and enjoyment be delayed to take effect at or after her death.” The court based this finding on inferences drawn from stipulated facts. The parties stipulated that the frequent and regular instances of control over the trust assets by the daughters during decedent's life were “consistent with the decedent's intentions in creating the trusts in the first instance.” The entire history of the trusts' operations and the decedent's complete disinterest in them bears out this intention. After having made the transfers, she let the entire property pass into the total and complete de facto control of her daughters who sold the El Monte acreage and invested, sold and reinvested the proceeds. The fact that bare legal title was held by a trustee is not controlling where the factual issue of intent is resolved in favor of the right of immediate possession and enjoyment in the transferees. The trial court properly found on the facts presented that the corpus was not includable in the estate of Edwina Butler under section 13643.

The State Controller further contends that Edwina Butler made a transfer and received from the transferees in exchange a promise to make to her payments which did not constitute an adequate and full consideration in money or money's worth and this renders the transfer subject to inheritance tax under section 13645.³

The State Controller argues that the transfers of the trust remainders and the transfers of the life income interests cannot be separated but constitute an indivisible transaction relying on Estate of Stevens (1958) 163 Cal.App.2d 255, 329 P.2d 337, and Estate of Corda (1976) 57 Cal.App.3d 903, 129 Cal.Rptr. 328. The four transfers (two transfers of remainders under the 1964 and 1965 trusts and two transfers of life income interests, one to each daughter) according to this logic constitute one indivisible single transaction accompanied by promises of the transferees to make inadequate annuity payments.

In the Stevens case the decedent during her life deeded 3 parcels of income producing real property worth $155,000 to her daughter. She and her daughter contemporaneously executed a second agreement in which the daughter promised to make payments on the $34,000 mortgage and annuity payments of $600 per month to her mother for life. The present value of the annuity at the time of the transfer was $75,000. The separate agreement between the parties classified the difference between $75,000 and the $121,000 net value of the real property as a gift. The court, however, viewed these transfers as constituting a single transaction and held that the transferor could not alter the situation by her declaration expressing an intention that the portion of the transferred property exceeding the value of the consideration was intended as a gift. The court found that the consideration for the transfer was inadequate “since the value of the annuity at the time of the transfer was not in excess of $75,000 and the mortgage indebtedness assumed only amounted to $34,000 making the total of the consideration given $109,000 for transferred property having a value of $155,000 at the time of the transfer.” (Estate of Stevens, supra, 163 Cal.App.2d 255, 268-269, 329 P.2d 337, 344.) The transfer was held taxable under section 13645.

The facts and holding in Corda were similar and the court applied the Stevens principles, stating that there was nothing to distinguish Corda. The decedent in Corda had transferred to his son Ernest and wife real property and farm equipment and to his other 2 children cash and securities, for a total transfer valued at $267,326, in exchange for the promises of the 3 children to make to him for life payments totalling $14,000 per year. The present value of the total annuity promises was $72,576 at the time of the transfer. The court “looking realistically at what economic benefits are in fact shifted by the questioned transfer” (Estate of Corda, supra, 57 Cal.App.3d 903, 910, 917, 129 Cal.Rptr. 328, 333) found that the decedent engaged in a single transaction in which he transferred property in exchange for an annuity. The court found the transfer taxable under section 13645 because after the date of the transfer, the income from the real property and farm equipment was at least equal to the annual annuity and the cash and securities also produced interest and dividend income.

The principle of Stevens and Corda does not demand that we fuse together what is in the present case a transaction involving essentially two separate items of property, i. e., the trust remainders and the trust life estates. The applicable principle is derived from Estate of Thurston, supra, 36 Cal.2d 207, 223 P.2d 12, which appears to be controlling under these circumstances. In Thurston the decedent conveyed two parcels of real property to his children and reserved to himself a life estate in each. A year later he relinquished to his children his life estate in one of the two parcels for a consideration paid by them in the amount of $10,000. The State Controller conceded this to constitute adequate consideration for the transfer of the life estate, but argued in effect that the transfer of the remainder interest could not be separated from the sale of the life estate. The court held to the contrary that transfers of the trust remainders could properly be separated from the transfers of the life estate.

The propriety of this result was acknowledged by the court in Stevens which, reviewing Thurston, observed: “(I)t merely means that a transferor might in a single transaction make an outright gift of real property; or, where he first makes a gift but reserves a life estate in the real property, he may later make a relinquishment (an outright transfer) of his retained interest in said real property. Accordingly, it may very well have been that the decedent herein could have made a relinquishment of her interest in the annuity, but she did not do so.” (Estate of Stevens, supra, 163 Cal.App.2d 255, 269, 329 P.2d 337, 344.) The Thurston court found the transfer of real property coupled with a later outright transfer of decedent's retained life estate in the same real property constituted a separate and distinct transaction. Accordingly, the transfer of the life estate for which adequate consideration was received was not taxable under inheritance tax laws by section 13641.

Because in the present case the remainder interests were transferred separately from the life estates and were free of any promises by the transferees to make payments to the decedent, there is no basis for including the transfer of the remainder interests in the estate of Edwina Butler for inheritance taxation under section 13645. The remainder interests were clearly gifts and the gift tax was declared and paid on the transfers in each instance (e. g., for the 1964 and the 1965 trusts, respectively).

Decedent subsequently transferred her retained life estates to respondents in return for their promises to make annuity payments to her which together totalled $442.20 monthly. Plainly, the promises by the daughters to make annuity payments in this amount to the decedent for life constituted consideration in money or money's worth at the time of the transfer. The parties stipulated that at the date of the transfers the value of the total life estate reserved by Edwina Butler, then age 71, was.$40,384.56. The present value of the annuities, computed from table 1 of the federal estate and gift tax regulations then in effect and made in exchange for the transfer of the life estate was an equivalent.$40,384.56.

The adequacy of the consideration given for an inter vivos transfer under the inheritance tax law is determined as of the date of the transfer. “ It is, of course, the established rule in the law of contracts that the adequacy of consideration must be determined as of the date of the agreement. (Citations.) (P) There is no reason why the same rule should not apply in determining the adequacy of the consideration given for an Inter vivos transfer under the inheritance tax law. Indeed if the adequacy of consideration for annuity contracts were to be determined as of the date of the annuitant's death many such transactions, not otherwise taxable, would be rendered so by the fortuitous circumstance that the annuitant died before the payments received equaled the consideration paid for the contract.” (Estate of Stevens, supra, 163 Cal.App.2d 255, 266, 329 P.2d 337, 342.) In the present case on the date of transfer the present value of the annuity promises equaled the value of the total life estate. The transfer of the life estate interests was therefore made for an adequate and full consideration and is not taxable under section 13645.

It is not claimed that the two outright transfers of undivided interests in the El Monte acreage are taxable.

DISPOSITION

The first appeal is dismissed; the order fixing inheritance tax is affirmed.

FOOTNOTES

1.  This figure appearing in the order is apparently inaccurate. The State Controller notes that the amount of tax was incorrectly mathematically computed and the correct amount should have been $32,856.

2.  Unless otherwise indicated, all statutory references are to the Revenue and Taxation Code.Section 13643 provides as follows:“A transfer conforming to Section 13641 and made with the intention that it take effect in possession or enjoyment at or after the death of the transferor is a transfer subject to this part.”Section 13641 in substance subjects to inheritance tax inter vivos transfers lacking adequate consideration.

3.  Section 13645 provides as follows:“A transfer conforming to Section 13641 and under which the transferee promises to make payments to or care for the transferor is a transfer subject to this part.”

HANSON, Associate Justice.

LILLIE, Acting P. J., and KAUFMANN (Assigned by the Chairperson of the Judicial Council), J., concur.