Old Kent Bank & Trust Co. v. United States (232 F. Supp. 970, 1964)

FOX, District Judge.

By dint of stipulation between the parties, the sole issue to be determined by the Court in this case is the amount to be allowed as a marital deduction under Section 812(e) of the Internal Revenue Code of 1939, as amended.

,, ,, ,. , More specifically, the parties have stipulated that in the event the Court should find the amount to be allowed as a marital deduction is $173,771.81, or some lesser amount, a judgment would be entered in favor of defendant, and this cause would be dismissed forthwith with' prejudice; but if, on the other hand, the Court should find that the amount to be aii0Wed as a marital deduction is in excess of $173,771.81, the parties would endeavor to agree upon the amount of the judgment to be entered in favor of plaintiff; provided, however, that there should be taken into account in computing the judgment such further deduction as allowed by law for reasonable attorney fees and expenses incurred by plaintiffs in the prosecution of this action; and provided further, that if they should be unable so to agree, the amount of the judgment would be submitted to the Court.

The dispute over the amount to be allowed as a marital deduction arises out of these facts:

Kenneth H. Campbell, a resident of Ottawa County, Michigan, died testate on May 18, 1954. The plaintiff Old Kent Bank and Trust Company, of Grand Rapids, Kent County, Michigan, the successor by consolidation and merger to "Pb® Michigan Trust Company, and the plaintiffs Mildred M. ^ Campbell and Charles R. Sligh, Jr., citizens of Ottawa County, Michigan, were duly appointed as Co-Executors of Kenneth H. Campbell’s estate by tbe Probate Court for Ottawa County, Michigan.

The will and codicils, in pertinent part, are set out in the footnote below.

On June 8, 1943, Kenneth H. Campbell entered into a Trust Agreement with The Superior National Bank and Trust Company, of Hancock, Michigan, as Trustee which agreement was subsequently amended on May 15, 1948.

On March 4, 1955, The Michigan Trust Company replaced the Superior National Bank and Trust Company, of Hancock, ^Michigan, as Trustee of the Trust. The Trust, in pertinent parts, is set out in the footnote below.

At the time of his death, the testator left surviving him his wife, Mildred M. Campbell, a brother, Malcolm G. Campbell, a brother, Holly E. Campbell, and five nieces and nephews; namely, Nancy Y. Campbell, Carol J. Campbell, Gordon H. Campbell and Sally Jo Campbell, all being children of Malcolm G. Campbell, and Mary Lou DuSold, being the child of Holly E. Campbell.

Plaintiffs filed a timely federal estate tax return for the estate of Kenneth H. Campbell, with the District Director of Internal Revenue at Grand Rapids, Michigan, on August 16, 1955. The federal estate tax of $77,821.77 shown to be due, was paid on August 16, 1955. Included as a part of the gross estate shown on the federal estate tax return were the assets of the inter vivos trust, which at the death of Kenneth H. Campbell amounted to $341,176.60. A federal estate tax deficiency in the sum of $38,527.36, plus interest of $6,952.92, for a total of $45,-481.28, was paid to the District Director of Internal Revenue on September 23, 1958.

The plaintiffs filed a claim for a refund on December 23, 1958, seeking a refund of $38,358.40, or such greater amount, plus interest, as provided by law. By letter of March 17, 1960, the defendant proposed to deny the claim for the refund and by letter of April 28, 1960, the defendant denied that same claim.

On August 28, 1956, plaintiffs, as Co-Executors of the estate of Kenneth H. Campbell, filed a petition in the Ottawa County Probate Court for the construction of the decedent’s will. Waivers of notice and consents to the petition were filed by Malcolm G. Campbell, Holly E. Campbell, and The Kenneth H. Campbell Foundation for Neurological Research. The waiver of notice and consent filed on behalf of The Kenneth H. Campbell Foundation for Neurological Research was executed by Siegel W. Judd, who was a member of the law firm which represented the estate of Kenneth H. Campbell. On October 17, 1956, the Ottawa County Probate Court entered an order construing the will of the decedent.

The question placed before that court for construction was whether or not the word “estate” as used in Paragraph V of said will was intended to include assets held by the Superior National Bank and Trust Company under a Trust Agreement with said deceased. The court realized that if the word “estate” as used in said Paragraph V was construed to include said trust assets, nothing would pass under Paragraph VI of said will to the residuary legatees, Malcolm G. Campbell, Holly E. Campbell, and The Kenneth H. Campbell Foundation for Neurological Research. Upon this question, the court determined that the correct construction of said will, in light of the circumstances set forth in the petition, required “that the word ‘estate’ as used in Paragraph V of said will include said trust assets.”

The court’s order was never appealed, and the time for any appeal therefrom has expired.

On August 17, 1955, The Michigan Trust Company, as successor Trustee of the trust described above, paid over to the estate of Kenneth H. Campbell the sum of $72,610.44. The first annual account of The Michigan Trust Company states that this sum represented the trust’s “share of the federal estate tax assessed against the above estate on account of inclusion of the assets of this ■ trust in the federal estate tax return.” On or about August 27, 1956, The Michigan Trust Company as successor trustee of the Trust, filed with the Circuit .Court of Kent County, Michigan, its first annual account for the period March 4,1955 to March 4, 1956. Included in the account was the payment of the sum of $72,610.44 to the estate of Kenneth H. Campbell. Waivers of notice and consents to the allowance of the account were filed by Malcolm G. Campbell, Mary Lou DuSold, Nancy Campbell Dickinson and Walter K. Schmidt, Jr., as guardian ad litem appointed by the Kent County Circuit Court to act on behalf of Carol J. Campbell, Gordon H. Campbell and Sally Jo Campbell, minors.

On October 5, 1956, the Circuit Court for Kent County, Michigan, entered an order allowing the Trustee’s first annual account. This order was never appealed, and the time for any appeal therefrom has expired.

Plaintiffs, as Co-Executors of the estate of Kenneth H. Campbell, have filed with the Ottawa County Probate Court five annual accounts and a final account. All the necessary waivers of notice and consents thereto, have been filed and the orders of the Ottawa County Probate Court allowing the annual accounts and approving the final account have been entered. The orders of the Ottawa County Probate Court have never been appealed, and the time for any appeal therefrom has expired.

The Old Kent Bank and Trust Company, successor by consolidation and merger to The Michigan Trust Company, filed annual accountings for the trust referred to above, with the Circuit Court for Kent County, Michigan. All of those documents have been allowed by the court. No appeals have been taken, and the time for any appeal therefrom has expired.

On December 28, 1960, all of the assets, of the estate of Kenneth H. Campbell, as shown by the final account of May 20, 1960, plus all income therefrom from May 20, 1960 to December 28, 1960, were distributed to the decedent’s widow, Mildred M. Campbell, with the exception of $3,-410.77, which was paid to the Internal Revenue Service on account of federal income taxes of said estate for the year ended April 30, 1960, $440.22 which was paid to the Michigan Department of Revenue on account of Michigan Intangibles Tax for the period from May 17, 1959 to May 20, 1960, and $6,649.81 cash which was withheld and retained as an asset of the estate.

Upon all these facts, there is predicated the single question in this case as to the amount to be allowed as a marital deduction under Section 812(e) of the Internal Revenue Code of 1939, as amended. For the purpose of this discussion, that single question can be subdivided into two issues, the first concerning the computation of the amount of property passing to the decedent’s surviving widow under Paragraph V of the will, and the second concerning the question of whether the property so passing to the decedent’s widow under Paragraph Y is to be reduced by the death taxes assessed against the estate.

I.

I shall deal initially with the first issue concerning the computation of the amount of property passing to the decedent’s surviving widow under Paragraph V of the will.

The provisions of Paragraph V, as the plaintiffs admit in their brief, may conceivably be subject to more than one interpretation. For although the widow’s legacy is to be satisfied out of the probate assets, the question arises as to whether the amount of the legacy is to be computed by reference to the probate assets alone, or by reference to other assets of the decedent as well. If the amount of the bequest is computed by reference to the probate assets alone, the sum passing to the widow under Paragraph V is $117,688.85. If the amount of the widow’s legacy is computed by reference to both the probate assets and the trust assets, the sum passing to the widow under Paragraph V is $254,159.49.

The construction placed upon Paragraph V, therefore, makes an enormous difference not only in the amount of the probate assets passing to the widow, but also in the amount of the residue, if any, available for distribution to the residual beneficiaries under Paragraph VI of the decedent’s will.

When, on August 28, 1956, plaintiffs, as Co-Executors of the decedent’s estate, filed a petition in the Ottawa County Probate Court for construction of Paragraph V of the will, Malcolm G. Campbell, Holly E. Campbell, and The Kenneth H. Campbell Foundation for Neurological Research were all of the residual beneficiaries under Paragraph VI of the will, and thus were all of the persons interested in said petition and adversely affected thereby. All of these persons waived notice of the hearing and consented in writing to the granting of the petition.

The Ottawa County Probate Court, as I have said in the recitation of facts, construed the will to mean that the word “estate” as used in Paragraph V of said will, included the trust assets, and, therefore, the sum of $254,159.49 passed to the widow by reason of the legacy of Paragraph V.

Paragraph V itself merely prescribes a formula by which the amount of a general legacy to the surviving widow can be determined. So, even though the widow’s legacy is to be satisfied out of the probate assets, there is still a question of whether or not the amount of legacy is to be computed by reference to the amount of the probate assets alone, or by reference to other assets of the decedent as well. This precise question, however, was answered when the Ottawa County Probate Court decided that the word “estate” as used in Paragraph V of the decedent’s will should include the non-probate, or trust assets. It now becomes a question for this court to decide whether or not the decrees of the Ottawa County Probate Court and the Kent County Circuit Court have any effect in determining this federal tax question.

That the construction of a will is a matter of state law to be determined by the state courts is a proposition not open to serious dispute. On this point the plaintiffs rely on two cases, Uterhart v. U. S., 240 U.S. 598, 36 S.Ct. 417, 60 L.Ed. 819 (1916), and Blair v. Commissioner, 300 U.S. 5, 57 S.Ct. 330, 81 L.Ed. 465 (1937).

In Uterhart v. U. S., supra, the court said:

“The right to succeed to the property of the decedent depends upon and is regulated by state law * *, and it is obvious that a judicial construction * * * determines not only legally but practically the extent and character of the interests taken by the legatees.” At 418 of 36 S.Ct.

In Blair v. Commissioner, supra, where the taxpayer had made assignment of his beneficial interest in a trust, the court said:

“The question of the validity of the assignment is a question of local law. The donor was a resident of Illinois and his disposition of the property in that State was subject to its law. By that law the character of the trust, the nature and extent of the interest of the beneficiary, and the power of the beneficiary to assign that interest in whole or in part, are to be determined. The decision of the state court upon these questions is final. * * * It matters not that the decision was by an intermediate appellate court. * * * In this instance, it is not necessary to go beyond the obvious point that the decision was in a suit between the trustees and the beneficiary and his assignees, and the decree which was entered in pursuance of the decision determined as between these parties the validity of the particular assignment. Nor is there any basis for a charge that the suit was collusive and the decree inoperative. * * The trustees were entitled to seek the instructions of the court having supervision of the trust. * * * To derogate from the authority of that conclusion and of the decree it commanded, so far as the question is one of state law, would be wholly unwarranted in the exercise of federal jurisdiction.” 57 S.Ct. at 332. •

To these authorities may be added another Supreme Court decision on the question of whether or not a federal statute (in this case, the General Maximum Price Regulations of the United States Price Administrator) must be so interpreted that it will have a uniform operation in all states, irrespective of local law, in matters normally within the state power. Justice Jackson, speaking for the majority in Davies Warehouse Co. v. Bowles, 321 U.S. 144, 64 S.Ct. 474, 88 L.Ed. 635, had this to say:

“The great body of law in this country which controls acquisition, transmission and transfer of property, and defines the rights of its owners in relation to the state or to private parties, is found in the statutes and decisions of the state. The custom of resorting to them to give meaning and content to federal statutes is too old and its use too diversified to permit us to say that considerations of nationwide uniformity must prevail in a particular case over our judgment that it is out of harmony with other objectives more important to the legislative purpose.” Id. at 643.

The line of authorities upon which the plaintiffs rely in making their argument that the decree of a state court is conclusive in matters like those presented in this case to this court does not end here. Plaintiffs rely upon, and argue, that the instant case is governed by The Nashville Trust Co. v. Commissioner, (CCA6, 1943) 136 F.2d 148.

In Nashville, supra, the issue was whether the language in the decedent’s will created a legacy subject to estate taxes, or whether this was merely the recognition of a claim against the estate for services rendered and was thus a deductible item for estate tax purposes. The executors of the estate, having petitioned the chancery court for construction of the will, and after a hearing of the case upon depositions which were in no . way controverted, the chancery court held that this language was a recognition bf a claim against the estate for services rendered. The Circuit Court of Appeals held that the state court decree was conclusive with respect to the construction of the will and thus controlling for estate tax purposes. The Court, however, indicating that it might have reached a different conclusion from the one reached by the state court, decided that it was nevertheless obliged to follow the state court’s decree.

“But however these considerations might appeal to the trier of the facts, [said the Court] we are not authorized, and we think the board was not authorized, to interfere with the conclusions of the tribunal which heard the evidence and decided the question. The decree, which is un'reversed and binding upon the Board and upon us, specifically holds that there was a legal obligation to the amount of the whole value of the stock.” Id. at 152.

Ten years later, in the case of Goodwin’s Estate v. Commissioner, (CCA6, 1953) 201 F.2d 576, the Sixth Circuit Court of Appeals had an opportunity to discuss this same sort of question. Goodwin’s estate involved the binding effect for tax purposes of a probate court decree allowing certain claims against the decedent’s estate. The decedent’s three daughters had filed claims against the estate totalling $131,652.14. After a petition had been filed in the probate court seeking allowance of these claims, the probate court held the claims to be proper obligations of the estate. The Commissioner refused to recognize the probate court decree and consequently disallowed a deduction for tax purposes by reason of the claim. The tax court sustained the commissioner. On appeal, the Sixth Circuit Court of Appeals reversed, holding that the decree of the probate court was binding and conclusive for tax purposes.

Judge Allen, again writing for a unanimous court, took this occasion to discuss the nature of the proceedings had before the probate court:

“Clearly the Probate Court proceeding was not an active and genuine contest, for every party to the proceeding agreed that the claims were valid. However, the petitioner was a party having an interest adverse to the interests of the daughters. As widow of the decedent, petitioner was entitled to one-third of the net estate administered in the Probate Court after payment of claims against the estate. (Citations omitted.) The three daughters were entitled to share equally in the remainder of the estate. It is undisputed that the payment of the claims of the daughters reduced the distributive share of the widow over $30,000. The amounts paid the daughters upon their respective claims exceeded the distributive share that they would otherwise have received by varying amounts, by far the largest excess over her distributive share having been received by Frances G. Gustafson. The other two daughters therefore had an interest adverse to the allowance of the claim of Frances G. Gustafson. As the estate was solvent, the widow and daughters were the only interested parties in the proceedings with reference to the allowance of claims.

“The decree of the Probate Court was rendered after a hearing of which all parties had notice, and in which oral testimony was taken. While consent to the entry of the decree was given, it was given ‘by all parties having an interest adverse to the claimant.’ (Citation omitted.) Under the Regulations it is therefore presumed that such consent was a bona fide recognition of the validity of the claim, not a mere cloak for the gift, and was accepted by the court as satisfactory evidence upon the merits. This presumption was not rebutted. Respondent introduced no testimony. If the Regulations are valid, the decree should have been accepted as establishing the validity and amount of the claims.” Id. at 580.

The defendant in this case contends that Nashville, supra, is distinguishable upon its facts because there was a trial on the merits in Nashville, at which testimony was taken and after which the probate court made findings of fact. Goodwin’s Estate, supra, the defendant argues, is also distinguishable on its facts because, similarly, there was a trial on the merits at which testimony was taken and findings of fact made by the court.

It is, therefore, important that the nature of the consent decree entered by the Ottawa County Probate Court be examined carefully. True, in this case, there was no active contest regarding the construction of the decedent’s will, but the consents were given by persons whose financial interests were adverse to those of the widow. The decedent’s brothers, Malcolm G. Campbell and Holly E. Campbell, and The Kenneth H. Campbell Foundation for Neurological Research were the residual beneficiaries of the decedent’s estate by virtue of Paragraph VI of the decedent’s will, and to the extent that the widow’s specific bequest under Paragraph V increased in amount, their residual shares under Paragraph VI diminished.

Upon this question of whether or not the consent decree entered by the probate court was binding upon this Court, I think the plaintiffs’ arguments must prevail, and one case amply disposes of that question, Gallagher v. Smith, (CCA 3, 1955) 223 F.2d 218. In that case, Judge Maris, over the single dissent of Judge Kalodner, thoroughly discussed the federal tax cases in which state court decisions have been refused controlling effect upon the grounds that they were not res judicata in the federal tax case, or because they were regarded as non-adversary, or as in fact consent decrees, or because they were obtained by collusion. There are, as Judge Maris pointed out, at least three types of tax cases with repect to which the effect of state decisions may be quite different.

The first type of federal tax cases refuses to give state decisions conclusive effect in situations where Congress has imposed a federal criterion with respect to the taxability of income or property, or the allowability of claimed deductions. Id. at 222. The court pointed out that there seemed to be a tendency in this first group of federal tax cases to ignore the basic fact that the state decision did not, and, as against the United States, could not determine whether the criterion laid down by the Internal Revenue Code had been met. On this point the court observed:

“Frequently the courts in rejecting the applicability of a state judgment have stressed its non-adversary or agreed character, thereby giving the unwarranted impression that if the judgment of the state court had resulted from a contested litigation it would have been conclusive on the federal question.” Id. at 222. (Emphasis supplied.)

A second type of case which Judge Maris discussed is that in which the state decision does not involve a peculiar rule of federal tax law, as in the type just discussed, or a determination of the property rights of the parties as in the type about to be discussed, but has merely made a determination of some other question of law or fact asserted to be involved in the federal tax case. Ibid. It is clear that in such cases if the United States was not a party to the state case, then the decision in the state case cannot be res judicata against the United States or entitled to full faith and credit in the federal case, even though it may be entitled to consideration as declaratory of state law. On this type of case, Judge Maris concluded:

“Whether the state proceeding was adversary or nonadversary or the judgment was obtained by consent or even by collusion is, on principle, quite immaterial in such a case.” Ibid.

The third type of federal tax case in which a state decision is sought to be given effect is that in which a state court has determined the rights of the parties to income or other property involved in the tax litigation and the tax is imposed by the Internal Revenue Code solely upon the person entitled to the income or other property under the state law, the federal law having imposed no qualification upon or criterion for the taxability thereof. “In a case of this sort,” said Judge Maris, “the state judgment must be given conclusive effect in determining federal tax liability.” Id. at 222-223 (and citations therein included.) The reason for this ruling, as Judge Maris pointed out, is that the right to the income or other property sought to be taxed is created solely by state law:

“Since by hypothesis no federal qualification or criterion has been imposed and the tax is levied solely upon those in whom the state law has vested the title, the question can only be one of state law. An adjudication of such a question of title by a court of the state must accordingly be given effect, not because it is res judicata against the United States, but because it is conclusive of the parties’ property rights which alone are to be taxed. So far as those parties are concerned the law of the state is what the state court has declared and applied in their case. If the state court’s judgment has binding final effect under the state law the rights of the parties can only be what the court has held them to be. It is for this reason that the federal court should not in a case of this kind make an independent examination and application of state law. For if it reaches a different conclusion from the state court as to what the parties’ rights should be under the state law its decision will not change those rights which will necessarily remain what the state court has declared them to be.” Id. at 223. (Emphasis supplied.)

I have dwelt at length on Judge Maris’ opinion in Gallagher v. Smith, supra, not because I think that the instant case is a mixture of those three types of cases which he discussed. For clearly, this case is a case of the third type discussed in Gallagher v. Smith, supra, in which a state decision is sought to be given effect and in which a state court has determined the rights of the parties to income or other property involved in the tax litigation and the tax is imposed by the Internal Revenue Code solely upon the person entitled to the income or other property under the state law, the federal law having imposed no qualification upon or criterion for the taxability thereof.

Plaintiffs, on page 4 of their reply brief, state that “the decree of the Ottawa County Probate Court construing Paragraph V of the decedent’s will was a decision upon the merits which directly determined the rights of the parties under state law. It, therefore, conclusively established the setting in which the Internal Revenue Code was to operate and to which it must be applied by this court.”

The defendant, on the other hand, at page 5 of defendant’s reply brief, taxes the plaintiffs with the argument that the instant case is governed by Michigan Trust Company v. Kavanagh, 284 F.2d 502, in which the Sixth Circuit Court declined to be bound by a decree of the Circuit Court for Kent County. The defendant submits that there is no distinction between the instant case and the Michigan Trust case.

As to the precise grounds why this case should be controlling, one must refer to the defendant’s brief at pages 23-24. The defendant’s argument runs as follows:

“The ultimate question which the court must decide in the instant case is whether property has passed from the decedent to the surviving spouse within the definitions and limitations set forth in Section 812(e) of the Internal Revenue Code of 1939. This of course, is a federal question which must be answered without recourse to the law of the state having jurisdiction over the decedent’s estate. While we do not dispute that the state law determines what each individual in the estate will receive from the estate, and while it is similarly true that the parties can voluntarily redistribute the assets of the estate among themselves and have that redistribution approved by the Probate Court, whether or not the property ultimately received by the surviving spouse passed to her from the decedent within the meaning of Section 812(e) of the 1939 Code is a federal question determinable only by recourse to federal law.”

To this argument the plaintiffs reply that the question is not whether the property bequeathed to the widow under Paragraph V of the will “passes or has passed from the decedent to his surviving spouse,” but the question here rather concerns the amount of property so passing from the decedent to his surviving spouse. This question, the plaintiffs argue, can be determined only by reference to the decedent’s will, and the decedent’s will has only such legal significance as given by state law.

I find myself wholly in accord with the plaintiffs’ contention in this regard.

The Government, in effect, argues that the instant case falls within what Judge Maris discussed in Gallagher v. Smith, supra, as the first type of federal tax cases, which refused to give state decisions conclusive effect in situations where Congress has imposed a federal criterion with respect to the taxability of income or property, or the allowability of claimed deductions. The state court in this case did not, and could not, make such a determination. Nor was there any attempt by the Ottawa County Probate Court to make such a determination, That the Ottawa County Probate Court’s ruling had an effect upon the ultimate application of the federal criterion is incontestable; but it is one thing to say that it had an effect upon the application of the federal criterion, while it is a wholly different thing to say that it made or attempted to make that determination itself.

The defendant also argues that there was collusion “in the sense that all parties agreed to the order and that it was apparently to their advantage from a tax standpoint to do so.” This, the defendant argues, is self-evident. Further, the defendant argues that since all the parties consented to the entry of the decrees without hearing, and since it was to their tax advantage to do so, as is apparent from the instant litigation, the only conclusion that can be drawn from this is that there was collusion in the consent decree.

The defendant seeks to mitigate this charge by explaining that “collusion” in this case does not have the pejorative connotation usually carried with that word. The Government had an opportunity to take discovery depositions to substantiate their suspicions in this regard; they chose not to do so. It is rather late now to argue that what began as suspicion, and then ripened into an allegation, wholly unsupported by any substantial evidence in this record, now supports the conclusion that there was obvious collusion between the parties.

I think that the defendant’s contention in this regard is without foundation in fact or in the evidence in this record, The mere fact that the attorney who filed the waiver of notice and consent on behalf of The Kenneth H. Campbell Foundation for Neurological Research was a member of the law firm which represent-e