No. 95-1402

COMMISSIONER OF INTERNAL REVENUE, PETITIONER v. estate of OTIS C. HUBERT, deceased, C & S SOVERAN TRUST COMPANY (GEORGIA) N. A., co executor

on writ of certiorari to the united states court of appeals for the eleventh circuit

[March 18, 1997]

Justice Breyer, dissenting.

I join Justice Scalia's dissent. This case turns on whether a payment of administration expenses out of income generated by estate assets constitutes a "material limitation" on the right to receive income from those assets. 26 CFR § 20.2056(b)-4(a) (1996). The Commissioner has long, and consistently, argued that such a payment does reduce the value of the marital deduction. See, e.g., Ballantine v. Tomlinson, 293 F. 2d 311 (CA5 1961); Alston v. United States, 349 F. 2d 87 (CA5 1965); Estate of Street v. Commissioner of Internal Revenue, 974 F. 2d 723 (CA6 1992); Estate of Roney, 33 T. C. 801 (1960), aff'd per curiam, 294 F. 2d 774 (CA5 1961); Reply Brief for United States 15. Justice Scalia explains why the Commissioner's interpretation is consistent with the regulation's language and the statute it interprets. I add a brief explanation as to why I believe that it is consistent with basic statutory and regulatory tax law objectives as well.

The regulation, which speaks of the "net value" of what passes to the spouse, requires a realistic valuation of the interest left to the spouse as of the date of the decedent's death. Assume, for example, that a decedent leaves his entire estate to his wife in trust, with the proviso that the administrator pay 25% of the income earned by the estate assets during the period of administration to the decedent's son. Assume that the period of administration lasts several years and that the estate generates several million dollars in income during that time. On these assumptions, the son will have received an important asset (included in the estate's date of death value) that the surviving spouse did not receive, namely, the right to a portion of the estate's income over a period of several years. Were estate tax law to fail to take account of this fact (that the son, not the wife, received that asset), it would permit a valuable asset (the right to that income) to pass to the son without estate tax. But estate tax law does seem realistically to appraise the "net value" of what passes to the wife in such circumstances. See 26 CFR §§ 20.2056(b)-5(f)(9), 20.2056(b)-4(a) (1996); 4 A. Casner & J. Pennell, Estate Planning §13.11, pp. 138-139, and §13.14.6, n. 18 (5th ed. 1988); cf. Estate of Friedberg, 63 TCM 3080 (1992), ¶92, 310 P-H Memo TC (delay in payment of a specific bequest to a surviving spouse reduces its marital deduction value). And that being so, why would it not take account of the similar limitation on the right to income at issue here? The fact that the administrator uses estate income to pay administration expenses, rather than to make a bequest to the son, makes no difference from a marital deduction perspective, for, as the regulations state, the marital deduction focuses upon the "net value" of the "interest which passed from the decedent to his surviving spouse." §20.2056(b)-4(a) (1996); see United States v. Stapf, 375 U.S. 118, 125 (1963).

The Commissioner's position also treats economic equals as equal. The time when the administrator writes the relevant checks, and not the account to which he debits them, determines economic impact. Thus $100,000 in administration expenses incurred by a $1 million estate open for one year, paid by check on the year's last day will (assuming 10% simple interest and assuming away here irrelevant complexities) leave $1 million for the spouse at year's end, whether the administrator pays the expenses out of estate principal or from income. On these same assumptions, a commitment to pay, say, $100,000 in administration expenses out of income will reduce the value of principal by an amount identical to the reduction in value that would flow from a commitment to pay a similar amount out of principal. This economic similarity argues for similar estate tax treatment.

I recognize that the statute permits estates to deduct administration and certain other expenses either from the estate tax or from the estate's income tax. 26 U.S.C. § 642(g); cf. ante, at 2 (O'Connor, J., concur ring in judgment). But I do not read that statute as allowing a spouse to escape payment both of the estate tax (through a greater marital deduction) and also of income tax (through the deduction of the administration expenses from income). One can easily read the provision's language as simply granting the estate the advantage of whichever of the two tax rates is the more favorable, while continuing to require the estate to pay at least one of the two potential taxes. To read the "election" provision in this way makes of it a less dramatic departure from a Tax Code that otherwise sees what passes to heirs not as the full value of what the testator left, but, rather, as that value minus a set of permitted deductions. 26 U.S.C. § 2053(a) (specifying deductions).

Although respondents argue that the Commissioner's interpretation will sometimes produce an unjustified "shrinking" of the marital deduction, I do not see how that is so. I concede that unfairness could occur were the Commissioner to readjust the marital deduction every time the administrator deducted from the estate's income tax every expense necessary to produce that income. But regulations guard against her doing so. Those regulations distinguish between (a) "expenditures . . . essential to the proper settlement of the estate," and (b) expenses "incurred for the individual benefit of the heirs, legatees, or devisees." 26 CFR § 20.2053-3(a) (1996). The former are "administration expenses;" the latter are not. Deducting expenses in the latter category from the estate's income tax should not affect the marital deduction; and, as long as that is so, the Commissioner's interpretation will simply permit estates to use their administration expense deductions to best tax advantage. It will not lead to a marital deduction that to the spouse's overall disadvantage somehow shrinks, or disappears.

The Commissioner's insistence upon reducing the date of death value of the trust dollar for dollar poses a more serious problem. Payment of $100,000 in administration expenses from future income should reduce the date of death value of assets left to a wife in trust not by $100,000, but by $100,000 discounted to reflect the fact that the $100,000 will be paid in the future, earning interest in the meantime. (Assuming a 10% interest rate and payment one year after death, the reduction in value would be about $91,000, not $100,000.) Nonetheless, the Commissioner's practice of reducing the marital deduction dollar for dollar might reflect the simplifying assumption that discount calculations do not make a sufficiently large difference sufficiently often to warrant the administrative burden of authorizing them. Or it might reflect the fact that when administration expenses are taken as a deduction against the estate tax, their value is not discounted. Were the Commissioner to defend the dollar for dollar position in some such way, her approach might prove reasonable. And this Court will defer to longstanding interpretations of the Code and Treasury Regulations, see supra, at 1, that reasonably "implement the congressional mandate." United States v. Correll, 389 U.S. 299, 307 (1967); see National Muffler Dealers Assn., Inc. v. United States, 440 U.S. 472, 488 (1979). Regardless, I would not decide this matter now, for it has not been argued to us.

Finally, although I agree with much that Justice O'Connor has written, I cannot agree that the amount at issue--almost $1.5 million of administration expenses deducted from income--is insignificant hence immaterial; and I can find no concession to that effect in the courts below.

For these reasons and those set forth by Justice Scalia, I would reverse the Court of Appeals.