THE INDISPENSABLE ROLE OF STATE LAW IN RESOLVING FEDERAL TAX QUESTIONS: ONE ASPECT OF FEDERALISM1

JONATHAN S. INGBER CPA, LL.B & MST2 (305-577-4333) jsi@kwalandoliva.com

What were the Framers talking about, that two governments give you more freedom than one? I mean, how does this work? How do you get more freedom if you have two governments than if you have one? And federalism is one of the neglected subjects of the American political discourse. But every generation has to learn it alloveragain. Democracy isnt inherited. Its not something in your genes. U. S. Supreme Court Justice Anthony Kennedy to students visiting the U.S. Supreme Court, recorded December 14, 1999, aired on C-SPANs America and The Courts program, August 25, 2001.
2

The author is a member of the tax department at Kwal + Oliva, a full service downtown Miami public accounting firm representing a large, diverse, and select clientele.

INTRODUCTION
Accountants routinely interpret the federal law in both the preparation of all kinds of tax returns (closed-fact-compliance mode) and the creation of a multiplicity of tax shelters 3 (open-fact-tax-planning mode). It is absolutely impossible to perform either function without performing the indispensable lawyer-like tasks of statutory interpretation and judicial case reconciliation.4 This process is decidedly aggravated by what the Framers 5 created at the birth of the republic. Much more frequently than the average tax practitioner might suspect the resolution of an admittedly federal tax question must be temporarily delayed until an underlying issue of state law is first resolved. Under what circumstances is such state law applicable (itself a federal question) and by what methodology does such practitioner determine what the state law actually is? Both questions are addressed in the material that follows. Just as any good federal tax regulation is admirably served by an explanatory preamble, these two questions are more appropriately addressed after a brief excursion into the part of our constitutional fabric denominated by the simple word federalism. 6

I-BACKGROUND: A--QUEST-CE QUE CEST QUE LE GOVERNEMENT FEDERAL, ALEXIS?7

Divided government raises a host of issues. It sounds a bit inefficient, but then totalitarian government is the quintessence of efficiency. Remembering that ultimate sovereignty rests with the people 8, how shall their agents be organized? To what extent
3

The term is used in its most innocuous, non-pejorative sense to include any scenario that will reduce contributions to the fisc. 4 To be drawn into the question of whether such work constitutes the unauthorized practice of law (in an era of multidisciplinary practices) would necessitate a dilatory detour into a quagmire that the author has neither the space nor patience to pursue. Note that the Conference Report to the IRS Restructuring and Reform Act of 1998, discussing the new confidentiality privilege relating to taxpayer communications for federally authorized tax practitioners, states that [n]o inference is intended as to whether aspects of federal tax practice covered by the new privilege constitute the authorized or unauthorized practice of law under various State laws. 5 I refer with reverence and genuine affection to the fifty-five delegates who endured a stifling summer in Philadelphia (the worst summer since 1750.Miracle at Philadelphia: The Story of the Constitutional Convention-May to September 1787 by Catherine Drinker Bowen). 6 As an adjunct professor at Florida International University the author has more than once posed to his students the following question: Looking at the statutory designation P.L. 98-369, when was the Deficit Reduction Act of 1984 {Who pray tell is buried in Grants tomb?} enacted? The answer to the riddle demands a certain familiarity with American constitutional history. Worded slightly differently one could just as well ask when the Articles of Confederation were formally trashed. 7 Blessed federalism! See Democracy In America by Alexis De Tocqueville. The author gratefully acknowledges the lifting of these thoughts examining our constitutional structure from Federalism: A View From A Not So Swift Train by Jonathan S. Ingber 8 We the People [not the several states constituting the confederation] of the United States, in Order to form a more perfect [more perfect than its immediate predecessor] Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of

shall the federal government be superior to all the separate governments of the states; over which specific areas shall this limited government reign supreme? Professor Belz 9 has expressed the following salient thoughts on the concept of federalism: If sovereignty was supreme authority, it was by definition destroyed when divided. It was illogical and irrational to contemplate a government within a government 10-an imperium in imperio-as Americans did in suggesting that within the empire, side by side with Parliaments power over commerce and other general matters, the colonial assemblies possessed sovereignty in local affairs. Novelties, whether in political theory, music, art, or mathematics 11 are not readily accepted by the cognoscenti of any generation. As divorced from reality as either non-Euclidean geometry or federalism may appear to be it may be instructive to observe two historical facts: Almost a century ago Albert Einstein utilized a branch of mathematics, now referred to as Riemannian geometry (one kind of non-Euclidean), to describe gravitation in his theory of general relativity not by a force, but by the curvature of space-time.12 So too the founding fathers13, looking to the political theories of John Locke and Charles Montesquieu, constructed a governmental edifice that to this day is still the subject of heated debate. The development of federalism is a continuous, unending process.14 Now that the reader has been fully apprised of the ever brooding omnipresence of federalism, it is time to move forward to the next step in the saga depicting the
Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America. The father of all preambles. 9 Kelly, Harbison & Belz. The American Constitution: Its Origins and Development, 7th Ed., New York: W.W. Norton & Company, 1991. 10 That is a brief description of the relationship of 50 independently percolating laboratories to the supreme federal authority with limited powers. 11 A modern verbalization of Euclids parallel postulate runs as follows: For every line l and for every point P that does not lie on I there exists a unique line m through P that is parallel to l. More succinctly, two intersecting lines are not both parallel to the same line. Was it Pogo who defined two parallel lines as two lines that never intersect unless you bend one of them? The hyperbolic axiom, in one version of nonEuclidean geometry, proclaims that there exists a line l and a point P not on such l such that at least two distinct lines parallel to l pass through P. See M. Greenberg, Euclidean and Non-Euclidean Geometries: Development and History, 3d Edition (Freeman 1993) In his Relativity: The Special and the General Theory (Three River Press 1961), Professor Einstein credited the German mathematician, Georg Riemann, an early adherent to non-Euclidean geometry, with helping him to envision the possibility of a finite and yet unbounded universe. Is federalism more or less plausible than such a startlingly different geometry? 12 www.physics.syr.edu. 13 Elbridge Gerry, Oliver Ellsworth, Alexander Hamilton, Gouverneur Morris, Benjamin Franklin, George Washington, James Madison, George Mason, Charles Pinckney, et al. 14 For a taste of the division within the current United States Supreme Court on the essence of federalism the reader is referred to one of many articles authored by the New York Times current beat reporter, Linda Greenhouse (winner of the 2002 Pulitzer Prize). See her report on the Courts 5 to 4 decision stating that a state agency (Port of Charleston, South Carolina) was constitutionally immune, under the 11th Amendment, from having to defend its actions before the Federal Maritime Commission as a private cruise line sought relief under the federal Shipping Act. Ms. Greenhouse is presently a Senior Research Scholar in Law, the Knight Distinguished Journalist in Residence and Joseph Goldstein Lecturer in Law at Yale Law School. On the subject of sovereign immunity in the context of federalism, Judge John T. Noonan, Jr. of the United States Court of Appeals [9th Circuit] has written a highly critical volume on this aspect of United States Supreme Court jurisprudence, entitled, Narrowing The Nations Power: The Supreme Court Sides With The States [University of California Press (2002)].

intertwining of two distinct sets of laws. While the tale is one focusing on the federal courts15 jurisdiction over citizens of different states16, it starts the reader on a quest for elusive certainty in interpreting federal tax law in an environment where a huge repository of residual law making authority is entrusted, within the confines of federalism, to the states.

B--RATIO ET AUCTORITAS 17: SWIFT TO ERIE TO BOSCH18

Having decided on that small speck of federalism exemplified by the diversity of citizenship jurisdiction of the federal courts, the author now proceeds to examine two United States Supreme Court cases that wrestled with the issue of which sovereigns law, state or federal, applied in resolving disputes between citizens of different states. Believing that the second of the two cases got it right, the paper then turns, in the next segment, to a specialized area of the substantive law19 to show the existence of constant tension between state and federal law in resolving some of that specialtys most basic questions.20 Should the reader hesitate and not move on for fear that her interest will not be sufficiently stimulated, the author can only say that an English don from Cambridge, head bowed so that his fleshy pate reflected a blinding light from the television cameras, reading from the book that lay in his hands, delivered a fascinating lecture on Supreme Court litigation during the three decades prior to the Civil War. The final line has been cast off. The not so swift train is underway. 21

C--SWIFT v. TYSON, 16 PET. (41 U.S.) 1 (1842)

So Adams man Marshall is out, and Jacksons man Taney is in. Whats a man like Story to do?22 The former with his national supremacy outlook had no difficulty in declaring statutes in more than a mere minority of the states unconstitutional. The latter with his
15

In the Federalist Papers (No. 78 by Hamilton) Publius stated: Whoever attentively considers the different departments of power must perceive that, in a government in which they are separated from each other, the judiciary, from the nature of its functions, will always be the least dangerous to the political rights of the Constitution. 16 See Article III, Section 2 of the Constitution of the United States. 17 Reason and authority (are the two most shining lights in the world). From Sir Edward Cokes Commentary Upon Littleton. 18 Regrettably the Supreme Courts decisional process moved infinitely slower than the Hall of Fame World Series Chicago Cubs trio of Tinker to Evers to Chance. 19 The patience of the tax practitioner may yet be rewarded. 20 The requisite analysis is summarily described as follows; State law creates legal interests and rights. The federal revenue acts designate which interests or rights so created shall be taxed. See Morgan v. Commissioner, 309 U.S. 78 (1940). 21 Again this portion of the paper has borrowed liberally from the source cited in footnote 7. 22 The characterization of Marshalls and Taneys (Chief Justice Rehnquists pronunciation is Tawney) judicial postures comes from the triptych-authored text cited in footnote 9.

dual federalism gave the states the courage to test come of the less extreme tenets of Calhouns nullification theory.23 Answer: Take another look at the Rules of Decisions Act. The story24 begins with a prosaic case in commercial law. Keith and Norton, the scoundrels, 25 negotiate a bill of exchange, previously obtained from Tyson, to one Swift. Tyson had originally given the instrument to the dynamic duo to purchase real estate. Unfortunately the sellers did not have marketable title. 26 Keith and Norton transferred the note because they had incurred an obligation to Swift on a prior occasion. The narrow legal issue between the litigating parties, both innocent of any wrongdoing, centered on the definition of a holder in due course. Namely, does a pre-existing debt constitute value?27 But the universal question, the one of greater significance for future litigants as the federal courts exercise their diversity of citizenship jurisdiction, is which law to apply in deciding the case. This ordinary case becomes an extraordinary one on this issue of federalism. Justice Story looked to Section 34 of the Judiciary Act of 1789 and concluded that state case law does not constitute laws of the states and accordingly are not rules of decision. 28 Ergo, if the subject matter of the lawsuit in the federal court is one that would decidedly benefit from uniform treatment throughout the several states of the Union, then maybe it was time to commence the development of federal common law.29

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that one day the state of Alabama, whose governors lips are presently dripping with the words of interposition and nullification (dual federalism), will be transformed . Speech delivered by Dr. King on the steps of the Lincoln Memorial in Washington D.C. on August 28, 1963. 24 No pun intended. 25 The characterization of the two unindicted co-conspirators is from Villanova Law Schools website: www.law.vill.edu/Fed.-Ct/SCT 26 As in no title whatsoever. 27 A holder in due course is a holder who takes the instrument for value, in good faith, and without notice that it is overdue or has been dishonored or of any other defense against or claim to it on the part of any person. UCC Section 3-302(1)(a, b & c). 28 That section provides that the laws of the several states, except where the constitution, treaties or statutes of the United States shall otherwise require or provide, shall be regarded as rules of decision, in trials at common law, in the courts of the United States, in cases where they apply. Swift v. Tyson, 41 U.S. (16 Pet.) 1, as Justice Story quoted from what today is found in 28 U.S.C. 1652. 29 First as understood after Swift: Federal Common Law is a body of decisional law developed by the federal courts untrammeled by state court decisions. Blacks Law Dictionary Deluxe Fourth Edition (1951) purchased at the bookstore in the fall of 1964. One would hardly view state law as enunciated by the state judiciary as a hindrance. Second as understood today: Federal Common Law is a body of decisional law developed by the federal courts. The application of this body of common law is limited by the Erie doctrine and by the Rules of Decision Act, which provides that except for cases governed by the Constitution, the treaties of the United States, or acts of Congress, federal courts are to apply state law. Areas in which federal common law has been developed include federal propriety interests, admiralty and foreign relations. Erie R.R. v. Tompkins, 304 U.S. 64, 58 S. Ct. 817, 82 L.Ed. 1188 (1938). See also Swift v. Tyson Case. Blacks Law Dictionary 6th Edition plucked off the Internet: www.alaska.net?~winter/federal-common-law.html Now thats a little more up to date!

Story was no legal lightweight.30 Nevertheless at first blush it is difficult to believe that a legal system heavily influenced if not actually derived from the English statutory and common law, would hold that case law, judge made law, does not constitute an integral part of state law. Assuming Justice Story to have correctly interpreted the federal choice of law statute, an inquiring mind wants to know how federal common law could possibly result in uniform contract law throughout the federal republic? Why should an elected state judge bow to the wisdom of the life appointed federal judge in deciding lawsuits between two citizens who reside in the same state? With no inclination to do so, what uniformity will ever be achieved through the glacial like development of a federal common law? Reading the case one is tempted, from a natural law point of view, to believe that the ascertainment of general common law principles of law is similar to a scientific determination of the melting point of lead. The law exists in fixed form simply waiting to be discovered. 31 As the proverbial Monday morning quarterback I would assert that uniform legislation promulgated by a national, disinterested, professionally competent organization and subsequently adopted by the individual state legislatures throughout the nation is more likely to develop uniform state law. 32 One unknown commentator asked the hardly rhetorical question: [I]f federal courts were to be courts at all in the true sense then would they have to be able to shape the law just as much as state courts did? From the viewpoint of todays federal question jurisdiction, responding to a plethora of federal legislation, such as Title 26, the question no longer seems relevant. Before we consider [t]he demise of Old Swifty, 33 one should look at an opinion of the Great Dissenter.34 The failure to promote uniformity is tolerable; a perversion of the rationale for diversity jurisdiction is not. Unable to find the justification for such

30

Justice Story had already authored a three-volume treatise entitled Commentaries on the Constitution (1833). In fairness to the Justice the decision in Swift was unanimous for a court that then included Taney. See Oxford Companion to the Supreme Court of the United States, edited by Kermit L. Hall (1992). 31 Let Storys words in Swift speak for him: It never has been supposed by us, that the section [of the Judiciary Act of 1789] did apply, or was designed to apply, to questions of a more general nature, not at all dependent upon local statutes or local usages of a fixed and permanent operation, as, for example, to the construction of ordinary contracts or other written instruments, and especially to questions of general commercial law, where the state tribunals are called upon to perform the like functions as ourselves (So who performs the ultimate correction function?), that is, to ascertain, upon general reasoning and legal analogies (Solving a mathematical problem?), what is the true exposition of the contract or instrument, or what is the just rule furnished by the principles of commercial law to govern the case. 32 The greater the need for uniform rules the more likely it is that the separate state legislatures are prone to adopt the legislation proposed by the National Commissioners On Uniform State Laws with minimum or minor modifications. Presumably the Uniform Commercial Code would be a good example. When the subject is more provincial, the parochial interests of the local bar may even prevent the adoption of such kind of legislation. The Uniform Probate Code would seem to illustrate the latter. 33 I have stolen that appellation from A March of Liberty: A Constitutional History of the United States by Melvin I. Urofsky (1988). 34 The expression is used by Catherine Drinker Bowen in her biography of Oliver Wendell Holmes titled Yankee From Olympus. Somewhat reminiscent of Eisenhowers appointments of Warren and Brennan, President Theodore Roosevelt got more than he bargained for in the common law craftsman. Such is the beauty of a lifetime appointment.

jurisdiction in the Federalist Papers,35 resort is made to Chief Justice Marshalls opinion in Bank of United States v. Deveaux,36 where he asserts that fear of local bias against an out of state party is the reason for its inclusion in the judicial power. In the egregious case of Black & White Taxicab & Transfer Co. v. Brown & Yellow Taxicab & Transfer Co. (Holmes dissenting) 37, a Kentucky corporation reincorporated in the state of Tennessee so that it could sue a Kentucky defendant in the federal district court of Kentucky. A better legal result flowed from an application of federal common law rather than that of Kentucky state law. 38 This kind of forum shopping in a federal system is not exactly what had motivated Justice Story who apparently envisioned that the Swift approach would promote nationwide uniformity in the common law by establishing persuasive federal decisional law for adoption by state courts, but in practice this never developed.39

D--ERIE R.R. v. TOMPKINS, 304 U.S. 64 (1938)

It is now time to touch upon the final part of this general federal tale before examining how federal substantive tax law is still very much a product of divided government. In a letter (one of hundreds spanning three decades) to Professor Frankfurter, Justice Brandeis said on May 3, 1938 that [w]ith Swift v. Tyson removed, wont it be possible now to go further in limiting diversity jurisdiction? 40 Eight days earlier the United States Supreme Court, Justice Louis D. Brandeis writing the majority opinion, overruled Swift. The author remembers it almost as if it were yesterday. Vice Dean Bischoff, formerly a student of Frankfurters at Harvard, entered the class and announced, Fellows (it was a different time and place), we are going to make a minor detour in our study of torts. Todays case is Erie Railroad. When the decision was handed down, despite its very

35

The Federalist Papers seem strangely silent on this type of federal court jurisdiction. (The 80ths reference to all those [cases] in which the State tribunals cannot be supposed to be impartial and unbiased turns out not to be concerned with such jurisdiction.) 36 9 U.S. (5 Cranch) 61, 87 (1809) reveals the rationale supporting diversity jurisdiction: However true the fact may be, that the tribunals of the states will administer justice as impartially as those of the nation, to parties of every description, it is not less true that the constitution itself either entertains apprehensions on this subject, or views with such indulgence the possible fears and apprehensions of suitors, that it has established national tribunals for the decision of controversies between aliens and a citizen, or between citizens of different states. 37 276 U.S. 518, 532 (1928). 38 Possibly an early example of what today is referred to as a type F reorganization under current tax law. See I.R.C. 368(a)(1)(F) (1986). All references to section numbers, hereinafter cited, are to the Internal Revenue Code of 1986, as amended, unless otherwise indicated. 39 See American Constitutional Law 2d Edition, Lawrence K. Tribe. Why a lawyer who acquired his legal education at a Birmingham night school would want to aspire to a federal model is difficult to contemplate in todays terms. Holmes dissent is powerfully expressed: The common law so far as it is enforced in a State, whether called common law or not, is not the common law generally but the law of that State existing by the authority of the State without regard to what it may have been in England or anywhere else. Supra footnote 37 at 533. Brandeis opinion in Erie was just below the horizon. 40 Half Brother, Half Son: The Letters of Louis D. Brandeis to Felix Frankfurter (Edited by Melvin I. Urofsky and David W. Levy, University of Oklahoma Press, 1991).

ordinary facts, the New York Times believed it warranted discussion on the editorial page.41 The petitioner railroad maintained that the 2nd Circuit Court of Appeals affirmance of the Federal District Courts judgment entered on a jury verdict for respondent (plaintiff) should be reversed. Brandeis phrased the issue as follows: The question for decision is whether the oft-challenged doctrine of Swift v. Tyson shall now be disapproved.42 Tompkins, domiciled in Pennsylvania, had been strolling on a pathway parallel to the Eries right of way when a door projecting from the moving train struck him. The defendant was a New York citizen having been incorporated under the statutes of that jurisdiction. The law of the site of the accident, as enunciated by Pennsylvanias highest court, did not require the railroad to exercise due care with respect to a trespasser. The federal common law, however, viewed Tompkins to be a licensee rightfully using a beaten footpath alongside the tracks, and accordingly was owed a duty of care. Being a Swift devotee, the Pennsylvanian sued the New Yorker in lower Manhattan. Theodore Kiendl43, not wanting Swift overruled, sought to preserve the advantage of continuing federal jurisdiction for his multistate client by finding an exception to the applicability of its doctrine. Believing that Pennsylvania law was well settled in a much litigated area of tort law, he urged that where the evidence in the form of state decisions is sufficiently conclusive Swift stood for the proposition that the federal courts are bound to recognize an asserted rule of state law. 44 But Brandeis, years earlier, had already decisively declared the corrective action warranted by a case such as Swift.45 This landmark decision states three reasons for overruling Justice Story and his brethren. First, recent46 historical scholarship had discovered that an earlier hand written draft of the federal statute in question had stated that the Statute law of the several States in force for the time being and their unwritten or common law now in use, whether by
41

I have only partly been able to verify this possibly apocryphal tale by resorting to the microfilm collection at the library of Florida International University. 42 The litigation in the lower courts was not pursued as a vehicle for overturning such a hoary precedent. Had there been any doubts about the Courts purpose in granting certiorari, the oral argument on January 31, 1938, quickly dispelled them. Mr. Kiendl (the railroads attorney), [Brandeis] asked, do you think Swift v. Tyson was rightly decided? Brandeis and the Progressive Constitution: Erie, the Judicial Power, and the Politics of the Federal Courts in Twentieth-Century America by Edward A. Purcell, Jr., Yale University Press, 2000. 43 Partner in John W. Davis well regarded New York law firm. 44 Id footnote 42 at 97. The tactic used in the appellate brief was viewed as an exercise in virtuosity and a tour de force. 45 Stare decisis is not, liked the rule of res judicata, [a] universal inexorable command. The rule of stare decisis, though one tending to consistency and uniformity of decision, in not inflexible. Whether it shall be followed or departed form is a question entirely within the discretion of the court, which is again called upon to consider a question once decided. Stare decisis is usually the wise policy, because in most matters it is more important that the applicable rule of law be settled than that it be settled right. Burnet v. Colorado Oil & Gas, 285 U.S. 393, 405-6 (Brandeis, J. dissenting). In this regard it would be equally profitable to recall Justice Felix Frankfurters dissenting opinion in an estate tax case denying a charitable contribution deduction: Wisdom too often never comes, and so one ought not to reject it merely because it comes late. Henslee v. Union Planters Natl. Bank & Trust, 336 U.S. 915, 918 (1949). 46 Professor Charles Warrens article preceded the litigation by fifteen years: New Light on the History of the Federal Judiciary Act of 1789, 37 Harv. L. Rev. 49 (1923).

adoption from the common law of England, the ancient statutes of the same or otherwiseshall be regarded as the rules of decision in the trials at common law in the courts of the United States in cases where they apply. Hardly persuasive. As Judge Henry Friendly has stated: If ever Congress reenactment of a statute or failure to alter it could be fairly taken as approving a prior judicial interpretation, the unchanged 47 existence of Section 34 for a century after Storys construction was such a case. 48 The deleted provision could just have easily been interpreted to mean that the federal courts were to apply the common law of the states until such courts had developed their own brand of decisional law.49 Second, what had originally been intended to protect the out of state plaintiff had been converted into a legal weapon inflicted upon the local citizenry with Black & White Taxicab being a relevant illustration. Uniformity of law in two different forums had not come to pass resulting in the acceptable legal technique of forum shopping. Wrestling with the distinction between general versus local law as a threshold question on the applicability of Swift also added a degree of uncertainty to federal court litigation. Criticism of the aged case also centered on its philosophical underpinning. As Justice Frankfurter stated in Guaranty Trust Co. v. York: The overruling [of] Swift v. Tysondid not merely overrule a venerable case. It overruled a particular way of looking at law that dominated the judicial process long after its inadequacies had been laid bare. Law was conceived as a brooding omnipresence of Reason, of which decisions were merely evidence and not themselves the controlling formulations. 50 Third, and clearly the ratio decidendi of the case, Swift was not just a case of federal statutory construction, rather it was plainly constitutionally wrong. The federal courts can only develop case law in the legal areas allocated to the federal government by the constitution. Confessing his own error in citing Swift in prior litigation, allow the good justice to speak for himself: But notwithstanding the great names which may be cited in favor of the doctrine, and notwithstanding the frequency with which the doctrine has been reiterated, there stands, as a perpetual protest against its repetition the constitution of the United States, which recognizes and preserves the autonomy and independence of the states, independence in their legislative and independence in their judicial departments. Supervision over either the legislative or the judicial action of the states is in no case permissible except as to matters by the constitution specifically authorized or delegated to the United States. Any interference with either, except as thus permitted, is an invasion of the authority of the state, and, to that extent, a denial of its independence. Blessed federalism at its finest.51

47 48

The only minor modification was to replace trials at common law with civil actions. Friendly, In Praise of Erie: And of the New Federal Common Law, 39 N.Y.U. L. Rev. 383, 390 (1964). 49 Federal Jurisdiction, Erwin Chemerinsky, Little Brown and Company (1989) at p. 263. 50 326 U.S. 99, 101-102 (1945). 51 What if Congress has constitutionally granted legislative power but has chosen not to exercise it. Will state law prevail in such a federal vacuum? The dormant commerce clause and its effect on the constitutionality of state taxation is certainly grist for another federal tax adventure sometime in the future.

E--C.I.R. v. Estate of Bosch, 387 U.S. 456 (1967)

And now the author is ready to cross the bridge of semi-esoteric concepts of choice of law in diversity cases to the equally obfuscated tenets of the tax law. The latter area of law has been chosen to illustrate some of the problems associated with the interdependence of federal and state law in a substantive specialty where Congress clearly has constitutional power to legislate. Accordingly, another Supreme Court decision has been selected to accomplish the task. Professor Philip Heckerling first brought the case of C.I.R. v. Estate of Bosch52 to the authors attention in a well-remembered course on federal estate and gift taxation. 53 In a majority opinion authored by Justice Clark, accompanied by separate dissenting opinions from Justices Douglas, Harlan, and Fortas, the Court cited Erie for the proposition that only a decision of the particular states highest court should be controlling on litigation in the federal courts where a matter of state law was at issue in such litigation. 54 Let the reader see if she can follow the interplay of state and federal law in that particular case. In Bosch a New York resident originally created a revocable trust granting his spouse a testamentary general power of appointment over the corpus. In 195155, prior to the grantors death in 1957, the spouse executed an instrument for the purpose of releasing her general power of appointment and converting it into a special power. Following the husbands death, in the Tax Court proceeding, the surviving wife maintained that her attempt to release the general power of appointment over her husbands trust was ineffective, entitling the estate to a marital deduction for federal estate tax purposes.56 In the spirit of federalism the Tax Court refrained from rendering a decision on the federal tax issue until the Supreme Court of New York (a court of original jurisdiction) could entertain a proceeding to settle the trustees account and simultaneously rule on the validity of the release under state law. 57 Once the state court
52 53

387 U.S. 456 (1967). Professor Charles W. Kingsfield, Jr. of Paper Chase fame (actor John Houseman) bore more than a passing resemblance to the very fine professor in the Graduate Law School program at the University of Miami. 54 Presumably the support for that assertion may be found in Justice Brandeis words: And whether the law of the state shall be declared by its Legislature in a statute or by its highest court in a decision is not a matter of federal concern. 304 U.S. 64, 78 (1938). 55 A Florida public accountant was subjected to a malpractice claim based on the Powers of Appointment Act of 1951 (P.L. 58-82). The federal legislation provided a transitional rule for a brief period of time during the Truman administration (a so-called window of opportunity {See Danny Devito in Renaissance Man [1984]}) with no untoward consequences attaching to a release of a general power of appointment resulting in a special power instead. 56 A terminable interest generally does not qualify for the federal estate tax marital deduction. The general power of appointment trust was probably the most frequently utilized form for a marital deduction clause other than an outright devise or bequest prior to the appearance of the qualified terminable interest property trust (QTIP with apologies to Cheeseborough Ponds). See I.R.C. 2056(b)(5). 57 In a reversal of court roles a circuit court judge in Miami-Dade County, Florida refused to proceed in a malpractice case against a certified public accountant until the plaintiff obtained a private letter ruling from the Internal Revenue Service stating that disability payments from an insurance company were taxable under Treas. Reg. 1.105-1(d)(1)(1964). While such referrals are appealing for allowing an expert to make the technically determinative decision, they fly in the face of common practice where trial courts, both

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had held the release to be a nullity, the Tax Court then held that the estate qualified for the marital deduction because of the general power of appointment trust, concluding that the state court judgment constituted an authoritative exposition of New York law and adjudication of the {local} property rights involved. On a fine distinction, a divided 2 nd Circuit Court of Appeals affirmed not on the point as to whether or not a federal court is bound by the decision of the state tribunal, but whether or not a state tribunal has authoritatively determined the rights under state law of a party to the federal action. 58 Examining a Senate Finance Committee report for guidance on the meaning of the marital deduction provision of the federal tax statute, the Supreme Court held in Bosch that a federal court should give proper regard59 to a lower state court decision on the state law issue but would not necessarily be bound by it, that only the states highest court is the best authority on its own law, and finally in attempting to ascertain what the state law is a federal court may be said to be, in effect, sitting as a state court.60 One asks somewhat rhetorically is that not genuine respect for federalism? 61&62

II-CONTROLLING FACTORS:

AIMPORTANCE OF STATE LAW IN FEDERAL TAX CONTROVERSIES63

Now the time has come to move more aggressively into the mind-numbing thicket of the federal tax law with the goal of illustrating the brooding omnipresence 64 of federalism.
federal and state, must of necessity rule in a wide range of legal subjects without first seeking guidance from such acknowledged experts. 58 Two of the dissenting opinions in Bosch at the Supreme Court level focused on whether the state trial court proceeding was a genuine adversarial contest. Justice Douglas, in dissent, noted that the Commissioner of Internal Revenue was not a party to the state court proceeding and therefore was not bound in the sense of res judicata. 59 Hardly a ringing endorsement for finality on the state law issue. 60 Clearly, the federal judiciary has come a long way from the days when Swift v. Tyson held sway, after Erie stated the constitutional defect of attempting to create new decisional law where Congress had no constitutional authority for making law or had not yet attempted to exercise its authority in an area admittedly one of federal legislative competence. 61 Justice Clark cited West v. AT&T, 311 U.S. 223 (1940) for the proposition that an intermediate appellate state court is a datum for ascertaining state law which is not to be disregarded by a federal court unless it is convinced by other persuasive data that the highest court of the state would decide otherwise. A fortiori the decision of a state trial court should not be controlling. In a rather persuasive dissent Justice Harlan, noted that [t]he relationship between the state and federal judicial systems is simply too delicate and important to be reduced to any single standard. Accordingly, although the Rules of Decision Act and the Erie doctrine plainly offer relevant guidance to the appropriate result here, they can scarcely be said to demand any single conclusion. 62 Second Natl. Bank of New Haven v. United States, 387 U.S. 456 (1967), the companion case to Bosch, also required an interpretation of a testamentary provision that affected the magnitude of a marital deduction, namely the applicability of a state estate tax apportionment statute for determining whether a marital residuary provision would bear a portion of the federal levy. 63 A classic law review article by Professors Stephens and Freeland heavily influences this portion of the exposition: The Role of Local Law and Local Adjudication in Federal Tax Controversies, 46 Minn. L. Rev. 223 (1961). 64 The phrase is appropriated from a footnote in Professor Tribes discussion of Swifts critics; only the reference was to the common law.

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Harking back to the opening paragraphs comment on the accountants role in federal tax compliance and planning, the author postulates, perhaps in self-deception, that most accountants would acknowledge that their participation in the federal tax process necessarily requires them to routinely resolve questions of tax law. 65 However, I also believe that only a few federally authorized tax practitioners fully appreciate the extent to which the resolution of federal tax questions is so heavily dependent at times on a resolution of underlying state law issues. 66 After decades steeped in federalism67 that statement seems innocent enough. But heres the Shakespearean rub.68 Fifty independent laboratories percolating different versions of state law is a thing to behold. One perhaps may state with some certainty that the citizens of these several states would like to have a federal tax law that applies uniformly throughout these United States. So the question then becomes, in interpreting the Internal Revenue Code, when did Congress prefer uniformity and preempt the subject, and when did it choose to let federalism run rampant by allowing state law to effect the incidence of a federal tax? The structure of federalism embodied in the nations constitution is founded upon a central government possessing certain enumerated powers contained in section 8 of Article I. While the list is not terribly short and includes some fairly extensive powers, the federal government is clearly one of limited powers as so enumerated. 69 Amendment X, as subsequently adopted shortly thereafter, again emphasizes that the great residual
65

An uncooperative payroll department of a state utility company refused to verify in advance whether a large qualified plan distribution constituted a lump-sum distribution eligible for favorable ten year forward averaging treatment. We do not render legal opinions. Very well. Let us reword the question. On or before January 31 of next year when the corporation issues the mandatory Form 1099R, what letter, if any, will the issuer enter in box 7 of such form. 66 Despite the protestations made in footnote 4, the reader is referred to an excellent article by Dr. James R. Hamill entitled CPAs and the Unauthorized Practice of Law, The CPA Journal (August 1998) where the author, discussing the historical anachronism found in I.R.C. 1014(b)(6) for stepping up the entire basis of community property in the hands of a surviving spouse, states that [t]he determination of community property is a strictly legal issue, albeit one with tax consequences, and must be resolved by an attorney. The author respectfully disagrees. First, the practice of federal tax law necessarily involves the resolution of state law issues on a frequently occurring basis. Second, it moves to the ludicrous to suggest that a nonlawyer accountant may investigate the most excruciatingly complex concepts of the federal tax law in the legislative regulations governing the preparation of consolidated income tax returns following a tax-free reorganization that constitutes an equity structure shift resulting in a change of ownership causing a reduction in the utilization of the net operating loss carryforward attribute, but must step aside if a client professes not to know whether her common law marriage qualifies for the filing of a joint individual income tax return. Third, permit Stanley Kowalski (an immortal character created by Tennessee Williams in his classic play, A Streetcar Named Desire) to speak for the laity: Ill wait till [Blanche DuBois] gets through soaking in a hot tub and then Ill inquire if she is acquainted with the Napoleonic code. It looks to me like you have been swindled, baby, and when youre swindled under the Napoleonic code Im swindled too. And I dont like to be swindled. There is such a thing in this state of Louisiana as the Napoleonic code, according to which whatever belongs to my wife is also mineand vice versa. 67 After the passage of 35 years Hart and Wechslers The Federal Courts and The Federal System, 5th edition (Fallon, Meltzer & Shapiro 2003) again rests comfortably in my Soliman-like office in the home tax library. 68 Hamlet, Act 3, scene 1, line 66. How many representatives, unsuccessful in the House Way and Means Committee, have resorted to a soliloquy on the House floor to inject a little Congressional intent into the federal tax statute? 69 The last clause, number 18, containing the necessary and proper phrase, aids in the expansion of such limited powers.

12

law making function remains with the several States. 70 Thus it surely comes as no surprise that the words of a federal taxing statute, a statute capable of invading almost any endeavor that humans pursue, absent a specific definition found in such statute itself, may require an interpretation derived from state law. The ultimate question, of course, is when must such state law be resorted to in order to properly apply the tax provision in the manner that Congress intended. A good starting point is the terribly succinct statement made by Justice Roberts in Morgan v. C.I.R.71: State law creates legal interests and rights. The federal revenue acts designate what interests or rights, so created, shall be taxed. Such a statement should not lead to the conclusion that the resolution of federal tax controversies would be entirely dependent on state law pronouncements. The Supreme Court recognized the delicate part that such state law plays by stating further: Our duty is to ascertain the meaning of the words used to specify the thing taxed. If it is found in a given case that an interest or right created by local law was the object intended to be taxed, the federal law must prevail no matter what name is given to the interest or right by state law. Six of the Courts prior opinions are cited to support these pithy but accurate statements, including Lyeth v. Hoey.72 The latter Supreme Court case dealt with the income tax treatment received by a Massachusetts heirs challenge to his ancestors will. The taxpayer received property as a result of a compromise to litigation approved by the local probate court. The federal tax issue concerned the availability of an exemption for an inheritance under the income tax statute. As noted earlier in this paper, the meaning of the words found in a federal tax statute enacted by Congress is always a federal question. To what extent, however, should such meaning be dependent upon state law? Clearly the federal taxing statute does not determine the status of a plaintiff as an heir. Such status is determined by resort to that great repository of state law envisioned under our federal system with so ever a gentle reminder from the axiomatic statement contained within the Constitutions 10th amendment. The mere fact that the taxpayer had standing to challenge the decedents last will and testament on the grounds of lack of testamentary capacity and undue influence clearly demonstrates the status of such litigant under state law. Once that essential legal conclusion was established by such law, the characterization of the heirs law suit by compromise in settlement of the litigation as not constituting an inheritance under that same state law is irrelevant in determining the availability of the income tax exemption for an inheritance under the federal tax law. The characterization of the compromise by the Massachusetts courts was rejected once the one issue of status, determinable solely by state law, had been resolved. 73
70

Some constitutional commentators would, casting aspersion on the efficacy of the amendment, say that the provision states nothing of consequence as it merely expresses a truism. At this very moment [11/13/03] Chief Justice Roy Moore of the Alabama Supreme Court is testing the efficacy of Article VIs supremacy clause somewhat reminiscent of another day of defiance at the doors to the schoolhouse of the University of Alabama in 1963. Governor George Corley Wallace said: Segregation now! Segregation tomorrow! Segregation forever! 71 309 U.S. 78 (1940). The importance of that statement warrants its repetition. 72 305 U.S. 188, 193 (1938) 73 The author was alerted to a more recent case that demonstrated a heavy reliance on state concepts of property law. In Estate of Forrest, TC Memo 1990-464, the Tax Court looked to Texas law to determine whether the decedent was a life tenant whose interest expired at death or a fee simple owner, requiring

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BEXPLICIT REFERENCE TO STATE LAW

The question remains, however, under which circumstances is resort to state law required for the resolution of federal tax controversies. What are some of the controlling criteria? This question has a multifaceted response. An initial answer focuses on whether the federal tax statute makes an explicit reference to state law. Such a reference is the exception, not the usual situation, but the Internal Revenue Code has illustrations of such definitive cross-references. It is rare but occasionally it happens. Congress explicitly provides in the federal tax provision that state law controls. For example, one is entitled to a dependency exemption for an unrelated individual who was a member of the taxpayers household unless the relationship between such individual and the taxpayer is in violation of local law.74 Presumably a state criminal statute penalizing fornication would prevent utilization of the deduction. However, would an arbitrary exercise of state prosecutorial discretion raise a federal constitutional issue of due process if an indictment under the states penal law had not been sought since the last century? Could the heavier federal constitutional consideration be avoided by resorting to a possible state law doctrine of desuetude?75 Has the hard working reader been following the bouncing federal/state ball? A better illustration of such explicitness may be found in subchapter J (Estates, Trusts, Beneficiaries, and Decedents76) of chapter 1 (Normal Taxes and Surtaxes) of subtitle A (Income Taxes), specifically section 643(b). Here, the Internal Revenue Code defines plain vanilla, garden variety income in the following manner: For purposes of this subpart and subparts B, C, and D, the term income, when not preceded by the words taxable, distributable net, undistributed net, or gross, means the amount of income of the estate or trust for the taxable year determined under the terms of the governing
inclusion in the federal gross estate. The deed from the decedents grandparents contained the following language: with remainder over, as to said grandso[n], to [his] respective bodily heirs. The technical property question under Texas law was the applicability of the Rule in Shelleys Case which states that the phrase bodily heirs are words of purchase as opposed to limitation, i.e., the remainder interest is a future interest of the decedents children rather than an expression implying a long line of succession by an indefinite reference to the whole line of heirs. Confessedly, this particular cases appeal to the authors fancy is attributable to a Proustian memory of Professor Means property lectures of a time so long ago that the memory of man goeth back not that far. 74 I.R.C. 152(b)(5) (1986). Congress loves morality. A more recent example, a product of the Taxpayer Relief Act of 1997, as enacted in new I.R.C. 25A, is denial of the Hope Scholarship Credit if the scholar is convicted of a felony drug offense. See I.R.C. 25A(b)(2)(D). The companion Lifetime Learning Credit has no such limitation. Congressional intent in the ever-popular morality play? Drug use by un tudiant vieux is more socially acceptable. 75 See Justices Frankfurters and Douglas opinions in Poe v. Ullman, 367 U.S. 497 (1961), which preceded Griswold v. Connecticut, 381 U.S. 479 (1965). In footnote 3 of the latters dissenting opinion regarding the non-justiciability expressed in the formers plurality decision of the Supreme Court, Justice Douglas quotes T. F. Plucknetts Concise History of the Common Law (5th ed. 1956), pp 337-338: On the continent there was some speculation during the middle ages as to whether a law could become inoperative through longcontinued desuetude. In England, however, the idea of prescription and the acquisition or loss of rights merely by the lapse of a particular length of time found little favour.There was consequently no room for any theory that statutes might become obsolete. 76 An area heavily freighted with locally provincial concerns.

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instrument and applicable local law (emphasis added).77 And what pray tell did the State of Florida78 have to say about that. Floridas former version of the Revised Uniform Principal and Income Act 79 provided in Section 738.02(1) for priority to the instrument, the statute, and equity in that order. Assume the narrow issue requiring resolution concerns the availability of the depreciation deduction for fiduciary accounting purposes. Referring the reader to the footnotes for relevant authority, here is the somewhat labyrinthine argument. For federal tax purposes the taxable income of a trust is determined in the same manner as in the case of an individual except as modified by part I of subchapter J.80 A trust shall be allowed a depreciation deduction at the entity level to the extent not allowable to beneficiaries under I.R.C. 167(d). That subsection states that the depreciation deduction follows the income (in the state fiduciary principal and income accounting sense) in order not to waste such deduction at the entity level to the extent the trust receives a deduction for distribution to beneficiaries, unless the governing instrument creating the trust provides otherwise. Assume that the trust agreement is silent on the issue but the trustee has been establishing an annual reserve for depreciation for rental real estate transferred into the trust prior to January 1, 1976 81 Under state law a reasonable reserve for depreciation deducted at the trust level will reduce fiduciary accounting income that is distributable and potentially taxable to the beneficiaries. More recently, in the context of the delicate balance of federalism, the Treasury Department has responded to the modification of state law concerning accounting for principal and income. The Revised Uniform Principal and Income Act (1997) has been adopted in a majority of the states. Through two provisions, one to permit a trustee the power to adjust between principal and income82 and a second to permit a total return unitrust, state fiduciary accounting now adopts the total positive return investment strategy (arithmetic sum of ordinary dividend, interest, and royalty income and capital gains appreciation) under a statutory prudent investor standard. It is not surprising, therefore, that Prop. Reg. 1.643(b)-1 was promulgated in the Federal Register on February 15, 2001.83 Having expressly adopted state law decades ago in this area of federal income tax law, any change in such state law must naturally produce a concomitant change in such federal tax law.

77

I.R.C. 643(b). Occasionally a tax preparer (usually an accountant) attempts to prepare a fiduciary income tax return without examining the last will and testament or the trust agreement. Now there is the making of a malpractice special. 78 The author has practiced accounting and law in the State of Florida since leaving the United States Navy on August 3, 1970. 79 The new Florida Uniform Principal and Income Act, effective January 1, 2003, will be referred to shortly. 80 I.R.C. 641(b). Most of the differences are contained in I.R.C. 642. 81 Florida Statutes Section 738.13(1)(b) (prior to 01/01/03). If the rental real estate operation were considered a trade or business operated by a sole proprietor or partner, section 738.08(1) would also require a depreciation charge against accounting income. 82 One cannot help but be reminded of the medieval and renaissance search for the transmutation of the baser metals (lead, for example) into gold. 83 Finalized by Treasury Decision 9102 on December 30, 2003.

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CBY NECESSARY IMPLICATION

Noting that explicit reference to state law is the exception rather than the rule, what second rule guides the relevancy of underlying state law to resolve federal tax controversies? At first the answer almost seems simplistically obvious. Remembering the nature of our federal system, in a part of the legal fabric left to the states with no federal intrusion, it would seem that the relevance of state law as the controlling factor occurs by necessary implication. Having thus stated the obvious, the inherent nature of federal law, be it tax legislation or some other federal bailiwick such as bankruptcy, foreign commerce, immigration, copyright, or national defense, demands its uniform application throughout the United States. It is this expectation of uniformity that places limits on allowing the determination of state law as an underlying issue to control the application of federal tax law. The expression necessary implication appears in Burnet v. Harmel, 287 U.S. 107 (1932). That particular case involved the issue of whether the receipt of a bonus payment under gas and oil leases gave rise to a capital gain. Such characterization of the taxable amount was dependent on the existence of a sale or exchange. Texas law, as applied to the bonus payment, operated immediately upon its execution to pass the title of the oil and gas rather than at the subsequent time of severance. The court posed the present issue in the following language: [I]n the absence of language evidencing a different purpose, [the federal statute] is to be interpreted so as to give a uniform application to a nation-wide scheme of taxation. State law may control only when the operation of the federal taxing act, by express language or necessary implication (emphasis added) makes its own operation dependent upon state law. The court held that the state law was not determinative of the federal tax controversy because regardless of state characterization, Congress desire to give more favorable tax treatment to long term capital investments was not implicated by any discernible difference between payments of royalties or bonus payments, whether title to the underlying mineral changed on consummation of the agreement or severance of such mineral from the property subject to exploration. 84 Freuler v Helvering85 is a good example clarifying this concept of necessary implication. In that case the trustee, while failing to reduce income distributable to the beneficiaries by a depreciation charge, had reduced the entitys taxable income by such a charge. Both state law and the governing instrument were silent on the issue. A California court, in a trust accounting proceeding, determined that the amounts distributable during a quarter of a century should have been reduced by depreciation, and, accordingly, the life income beneficiaries had received excessive distributions in the amount of $622,440.90, which, by agreement of all the parties to the litigation, was
84

A case of somewhat more recent vintage, Corn Products Refining Co. v. C.I.R., 350 U.S. 46 (1955), discussed the quality of income in hedging transactions designed to insure both the price and quantity of corn inventory. The court, citing the Harmel case with approval, stated that everyday transactions were not intended to generate favorable capital gains. While Corn Products did not concern a possibly determinative state law issue, the case surely stands for the proposition that the meaning of a federal tax statute is essentially a federal tax question that presumptively requires uniform application throughout the country. 85 291 U.S. 35 (1934)

16

payable with promissory notes accruing no interest payable at the termination of the trust to whoever should be the remaindermen at that point in time. The case stands for the proposition that nothing in the federal tax statute purports to ascertain the amounts properly distributable to the income beneficiaries. That of necessity is determinable under state law as enunciated in the trust accounting proceeding in the local court. 86 Another Supreme Court decision, Blair v. C.I.R.,87 states that the validity of an assignment of a life tenants interest in a testamentary trust was a question of state law. 88 Whether or not such an equitable interest in property was assignable in the case of a spendthrift trust had to be determined under the law of Illinois. To derogate from the authority of that conclusion [reached by an intermediate state appellate court] 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.89 The court properly distinguished this initial issue from the one that naturally follows from the determinative state conclusion on the validity of the assignment, namely, will a valid assignment permit the shifting of the incidence of the federal income tax. That second question, involving the meaning of the federal taxing statute, remains a federal question. 90 Perhaps one more relatively simple illustration of the concept of by necessary implication is appropriate prior to exploring the final part of this rather extended preamble. If one as a taxpayer has survived numerous tax preparation sessions with the author, such taxpayer comes bearing a computer-generated label. So it is not necessary to ascertain the taxpayers name, address, and social security number. Typically, the next question91 concerns filing status. Is the taxpayer married? Most taxpayers do not hesitate in responding to that deceptively simple interrogatory. Given the pertinent facts, where does the answer to this legal question repose? State law (statutory or case law) or the Good Book92, all three thousand pages or so? While the Internal Revenue Code frequently refers to the marital state (as in married filing separately for applying many provisions) it really does not attempt to define the constituent elements of a valid

86

A more recent case following the reasoning of the Supreme Court in Freuler, reversed the Federal District Courts decision that had approved the governments motion for summary judgment. While an estate prior to receiving probate court approval had made distributions, such courts approval of the final accounting was required to demonstrate that the amounts distributed to the beneficiaries were properly paid under the federal tax provision. The federal statute does not purport to determine the issue of propriety that is, of necessity, left to state law. 87 300 U.S. 5 (1937). 88 Lucas v. Earl, 281 U.S. 111 (1930), involving an anticipatory assignment of income earned by the assignor (sweated labor), was not apposite. 89 Supra footnote 86 at 7. 90 Blair is cited favorably in Meisner v. United States, 133 F. 3d 654 (8th Cir. 1998), where the transfer of royalty rights associated with intellectual property in the context of a divorce was properly submitted to a jury as to whether the fruit or the tree itself was the subject of the assignment. 91 If one follows the order prescribed on page 1 of the standard Form 1040 for the individual income tax. 92 Having lectured on a wide variety of federal subjects in 43 states and the District of Columbia, the author yearns for the day when every hotel room will provide not only Bibles from the Gideon Society and the Church of Jesus Christ of Latter-Day Saints, but also the most recent version of the Internal Revenue Code published by the Research Institute of America.

17

marriage. That, by necessary implication, in a federal system, is left to state law. 93 So if the taxpayer and her partner have been co-habiting since July 4, 1967 without benefit of clergy or other official ceremony or state license, are they validly married? Is a common law marriage still recognized by the couples state of residence? 94 Try it from the opposite perspective. If the wife gets on board, without baggage, a train heading for Boise, Idaho, remains there for the requisite period of time to establish residency, and then returns to the Empire State after the Idaho court has exercised its jurisdiction in a divorce proceeding, has a valid divorce occurred? If the initial state court had jurisdiction, in the quasi in rem sense, then a court in a different state could not permit relitigation of the issue of the severance of the marital res. This result is not an application of general federalism, but is dictated by the full faith and credit clause of Article IV, section 1 of the Constitution. However, when a taxpayer resorts to a quickie holiday divorce in the Dominican Republic followed by remarriage to the same person in early January on returning to the mainland, the Internal Revenue Service has not felt compelled by the concept of comity to recognize the divorce. So much for reference to state law by necessary implication.

DThe Penumbra9596
The last issue to be considered before an attempt is made to review a host of federal tax cases to see whether or not the foregoing principles in a federal system are observed is one that suggests that the by necessary implication principle does indeed have its limitations. Put more directly, when will state law as the underlying determinant be ignored in favor of an overriding federal principle dictating the ultimate federal tax result? Helvering v. Clifford97, in the context of a progressive income tax system, ignores the property interest of an income beneficiary in a short-term trust on the ground that to do otherwise would defeat the overall Congressional plan for a progressive income tax system. Needless to say the facts are an essential underpinning for a conclusion that
93

The above statement fails to take into account the enactment of the Defense of Marriage Act [DOMA] on September 21, 1996. [P.L. 104-199] 94 No common-law marriage entered into after January 1, 1968, shall be valid, except that nothing contained in this section shall affect any marriage which, though otherwise defective, was entered into by the party asserting such marriage in good faith and in substantial compliance with this chapter. Florida Statutes Section 741.211 [History.s. 1, ch. 67-571.] 95 As stated previously in footnote 63 the analysis pursued here draws considerable inspiration from Professors Stephens and Freeland, who, with M. Carr Ferguson, produced a marvelous treatise on Federal Income Taxation of Estates and Beneficiaries. The last of the three authors is a former Assistant Secretary of the Treasury for Tax Policy who subsequently represented a shareholder of American Telephone & Telegraph, challenging an Internal Revenue Service determination that the famous corporate division (technically not a divisive type D reorganization) was partially taxable as it related to Pacific Telesis. See Dunn Trust v. C.I.R., 86 T.C. 745 (1986).
96

The expression brings to mind Justice Goldbergs concurring opinion in Griswold v. Connecticut, 381 U.S. 479 (1965): In reaching the conclusion that the right of marital privacy is protected as being within the protected penumbra of specific guarantees of the Bill of Rights, the Court refers to the Ninth Amendment. (Emphasis added). 97 309 U.S. 331 (1940).

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ignores state law despite the federal system in which the tax law operates. In Justice Douglas words: The broad sweep of this [statutory] language indicates the purpose of Congress to use the full measure of its tax power within those definable categories. Technical considerations, niceties of the law of trusts or conveyances, or the legal paraphernalia which inventive genius may construct as a refuge from surtaxes should not obscure the basic issue. That issue is whether the grantor after the trust has been established may still be treated, under this statutory scheme as the owner of the corpus. Given the operative facts, specifically, the short five-year duration of the trust, the settlors wife was the income beneficiary, and the husbands considerable control over the trusts corpus, all supported the legal conclusion that such taxpayer continued to be the owner of the property producing the trust income. In the context of a single economic unit the Supreme Court could not hold as a matter of law that the respondent ceased to be the owner of the corpus after the trust was created.98 Continuing application of the holding in Clifford is uncertain. Federalism and its influence on the federal tax law is not scientifically determinable science. An example of current relevancy in this huge legal reservoir may be found in todays political rhetoric: The time has to come to eliminate the marriage penalty. Now how could one be against such a noble objective? 99 And what does federalism have to do with such an irresistible political platform? Return with us now to those thrilling days of yesteryear! How about 1948? The warriors have returned and Goldie Hawn and the other factory surrogates have been told to go home. With rationing, double daylight savings, and lack of consumer goods, the home front was producing a store of taxable income requiring the implementation of the income tax withholding mechanism. They said that the class tax became a mass tax. 100 In an earlier decision an opportunity to insure uniform application of a progressive income tax system with the concomitant rejection of state law as the conclusive determinant was rejected. The significance of the Supreme Courts holding in Poe v. Seaborn101now hits home in the proverbial pocket book. Despite the desirability of a
98

Interestingly, Robert H. Jackson, as attorney general, in the Clifford litigation, represented the government. In reading an entertaining book of considerable legal scholarship by Professor Bernard Schwartz, Super Chief Earl Warren and His Supreme Court-A Judicial Biography (New York: New York University Press 1983), the author first became aware of Justice Robert Jacksons pithy description of the Supreme Courts role in the legal hierarchy: However, reversal by a higher court is not proof that justice is thereby better done. There is no doubt that if there were a super-Supreme Court, a substantial proportion of our reversals of state courts would also be reversed. We are not final because we are infallible, but we are infallible only because we are final. (Emphasis added) Brown v. Allen, 344 U.S. 443, 540 (1953). 99 Congress frequently attempts to use the tax system to foster any number of worthy objectives. Econometric models designed to measure the efficacy of tax policy might suggest more efficient methods to accomplish such social objectives. And just how accurate are the budget projections of the Congressional Budget Office let alone the Office of Management and Budget? 100 That turn of phrase appears in The Greedy Hand by Amity Shlaes, a senior columnist on political economy for the Financial Times. Her title comes from Thomas Paines Rights of Man: If, from the more wretched parts of the old world, we look at those which are in an advanced stage of improvement, we still find the greedy hand of government thrusting itself into every corner and crevice of industry, and grasping the spoil of the multitude. 101 282 U.S. 101 (1930)

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uniform individual income tax for all of the then forty-eight states and pertinent territories, the Court held community income earned by one spouse is taxable one half to each spouse.102 Referring to state law property notions first to resolve the second issue of the incidence of the federal income tax liability, the constitutional concept of federalism raised its familiar head. Clearly such an interpretation favored community property states over common law jurisdictions in a progressive tax environment.103 To prevent the wholesale conversion to a distinctly different state property regime Congress came to the rescue with appropriate federal tax legislation. The Revenue Act of 1948 said that in the context of federalism and uniform federal tax law, the former must give way to the latter with respect to the following four issues: [a] Married couples will be permitted to elect to file a joint income tax return.104 [b] & [c] Married donors and decedents will be allowed a marital deduction equal to one half the value of the transfer or one half the adjusted gross estate, respectively. 105 [d] Gifts by either spouse to a third party are eligible for the election to split gifts.106

102

The community income at stake comprised Seaborns salary, interest on bank deposits and on bonds, dividends, and profits on sales of real and personal property. One wonders why Lucas v. Earl, 281 U.S. 111 (1930) was not decisive on income attributable to labor as opposed to property. While it is true that case was decided more than eight months prior to Seaborn (see Justice Holmes comments in Lucas v. Earl: we think that no distinction can be taken according to the motives leading to the arrangement by which the fruits are attributed to a different tree from that on which they grew. (Emphasis added)), it should be noted that the Lucas case involved joint property with right of survivorship as opposed to community property. In addition, the Poe case, recognizing that the community property regime is not monolithic with no differences among the eight states adhering to that property regime, observed that California law, as interpreted by its courts, gave the wife a mere expectancy and that the property rights of the husband during the life of the community were so complete that he was in fact the owner. 103 More than one Florida domiciliary undergoing the throes of a divorce, on exposure to the doctrine of equitable distribution, would be hard pressed to distinguish between community property and common law jurisdictions. 104 Sen. Rep. No. 1013, 80th Cong. 2d Sess. (1948), 1948-1 C.B. 326: Under the provisionsthe combined normal tax and surtax that would be determined if the net income and the applicable creditswere reduced by one-half. 105 One should take one more look at the Economic Recovery Tax Act of 1981. In a non-Code provision of that early Reagan tax legislation, section 403(e)(3) gave the individual states an opportunity to interpret the expression contained in a will executed or a trust created before September 12, 1981, its date of enactment. If a formula pecuniary amount or fractional share clause provided that the spouse is to receive the maximum amount of property qualifying for the marital deduction allowable by federal law, state legislation could treat such a clause as referring to the subsequent federal tax law change. Florida responded to the invitation. 106 Last comment on this ancient legislation. Every tax accountant in Phoenix, Houston, Albuquerque, and Shreveport knows the answer to the following query: Is property which represents the surviving spouses one-half share of community property treated as acquired from or to have passed from the decedent and thus entitled to a complete step up in basis? When Goldie Hawn went back to the kitchen, the contribution rule for including jointly owned property in the federal gross estate of a deceased husband favored the surviving wife in a common law jurisdiction. Accordingly, the 1948 Revenue Act enacted, to insure parity, a provision in the 1939 Code (now section 1014(b)(6) of the 1986 Code). But this provision has clearly become an historical anachronism with the unlimited marital deduction of ERTA and the qualified joint interest as enacted by the Tax Reform Act of 1976 (see I.R.C. 2040(b) (1986)). The author submits that federalism demands its repeal. Tell that to Senator Breaux on the Senate Finance Committee. See I.R.C. 1022(d)(1)(B)(iv)(1986) which will become effective after December 31, 2009

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ECRUCIBLE107
It would nice if stare decisis solved all the problems. While it is true that structurally the Constitution implicitly reflects the relationship between the central government and the several states denominated as federalism, the resolution of federal tax problems rarely raise questions having a constitutional dimension.108 That being the case adherence to precedents is more likely. If Congress does not like the results of the statutory interpretative process it may readily amend the law to override the erroneous judicial decision. But the reality is that federalism isnt easy. Accordingly, prior decisions, over time, might not be as authoritative as would otherwise be the case. The countervailing thought, however, is that an economy needs a predictive legal base in order to participate in a highly competitive global economy. Having struggled through the preceding preamble to acquire a knowledge and rudimentary understanding of the process, it now becomes the immediate task of examining a sufficient number of illustrative specimens of the quantitatively voluminous case law to begin the process of mastering the technique of divining the relevancy of state law for the ultimate resolution of federal tax controversies. 109

III--THE CASES [VARIATIONS ON A THEME]:

ADRYE v. UNTIED STATES, 120 S. CT. 474 (1999) 110

Taxpayer was the sole heir of his mothers intestate estate. Following a valid disclaimer under Arkansas law, Rohn Drye resigned his position as administrator. His daughter, the next lineal descendant who succeeded to the decedents property, established a family spendthrift trust with her parents having a life estate permitting discretionary distributions for their health, maintenance, and support. The disclaimer was motivated by the insolvency of the taxpayer attributable to a large federal lien for unpaid tax assessments.111

107 108

Or trial by fire. Only to the extent that the Constitution so requires may this Court interfere with the exercise of this plenary power [police power over the health, safety, morals or welfare] of government. But precisely because it is the Constitution alone which warrants judicial interference in sovereign operations of the State, the basis of judgment as to the Constitutionality of state action must be a rational one, approaching the text which is the only commission for our power not in a literalistic way, as if we had a tax statute before us, but as the basic charter of our society, setting out in spare but meaningful terms the principles of government. Poe v. Ullman, 367 U.S. 497, 540 (1961) (J. Harlan, dissenting) (Emphasis added). 109 Judicial interpretation always insures that every legal instrument, statute, or constitution will have its own gloss. Interstitial legislation is a phenomenon to the laity. It is standard operating procedure for the lawyer. In the age of Erie federal question jurisdiction ensures an infinite supply of federal common law. 110 The choice of potential cases available to demonstrate the principles previously enunciated appear at first blush to be almost unlimited. Consequently, the decisions authoritativeness, the area of substantive tax law illustrated, and the sheer interest inherent in both its facts and law have influenced the authors selection mode. 111 Asset protection techniques are a legitimate aspect of estate planning which goes beyond the mere reduction of federal income and transfer taxes.

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Initially one might think that the inability of a general creditor to defeat the disclaimer technique under state law would determine the litigations end result. But such a conclusion would show a lack of sensitivity to the true meaning of Morgan.112 While state law typically creates a property interest, such law is not allowed to characterize such state created interest or to dictate subsequent results that might flow therefrom. Instead the federal system next looks to federal law for the ultimate consequence. Justice Ginsburgs opinion draws attention to the language in I.R.C. 6321 which states that the amount [of the tax] shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person. (Emphasis added). Citing prior decisions of the Supreme Court and quotations therefrom, the statutory language is broad and reveals on its face that Congress meant to reach every interest in property that a taxpayer might have, and that [s]tronger language could hardly have been selected to reveal a purpose to assure the collection of taxes. (Citations omitted). Further, by referring to I.R.C. 6334 (Property exempt from levy), more specifically subsection (c) which states that [n]otwithstanding any other law of the United States no property or rights to property shall be exempt from levy other than the property specifically made exempt by subsection (a), it seems quite evident that inheritances and devises disclaimed under state law are not among the transactions that qualify for exemption from enforcement of the federal tax lien. The mere fact that the disclaimer was effective for transfer tax purposes under subtitle B of the Internal Revenue Code does not automatically assure it was effective for procedure and administration purposes under subtitle F. Interestingly, stating that certiorari was granted because of conflicts between the Eighth Circuits holding below and decisions of the Fifth and Ninth Circuits (as evidenced by petitioners reliance thereon), the Supreme Court made an honest admission: Although our decisions in point have not been phrased so meticulously as to preclude Dryes argument, we are satisfied that the Code and interpretive case law under federal, not state, law control the ultimate issue whether a taxpayer has a beneficial interest in any property subject to levy for unpaid federal taxes. In deciding that the taxpayer had something of value that would constitute property under the lien provision (federal question), the Court looked to see what the taxpayer was able to do under state law (state question). In pressing the analogy to a rejected gift, Drye overlooks this crucial distinction. A donee that declines an inter vivos gift generally restores the status quo ante, leaving the donor to do with the gift what she will. The disclaiming heir or devisee, in contrast, does not restore the status quo, for the decedent could not be revived. Thus the heir inevitably exercises dominion over the property. He determines who will receive the property himself if he does not disclaim, a known other if he does. In terms of the prior preamble analysis, the decision clearly seems to stand on the settled principles espoused by the Morgan case. While the need for a broad federal collection statute is fundamental to the ultimate decision, the result does not appear to fall within the penumbra. The need to interpret Arkansas law was not overcome by some larger federal concern. The federal question, the meaning of the words contained in the
112

The reader is referred to footnote 71 above.

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federal statute, became pertinent only when the nature of the state property interest had been determined.

BUNITED STATES v. CRAFT, 122 S.Ct. 1414 (2002) 113

In this non-unanimous decision the efficacy of the federal tax lien, in the context of state property rights, again occupies the Supreme Courts attention. Despite two dissenting opinions, the six to three majority opinion certainly does not seem to be inconsistent with the Drye decision, although admittedly the fact pattern was quite distinctive and, taking Justice Thomas forceful dissent as an accurate reflection of prior understanding of federal practitioners on the efficacy of property ownership in the form of tenancy by the entireties against the attachment of a federal tax lien, the decision certainly may be viewed as a somewhat unexpected extension of such federal lien law. Before considering the persuasiveness of the dissent, however, it is advisable to examine the majority opinion, which, of course, represents the controlling law. Procedurally, in the first taste of appellate jurisdiction, the Sixth Circuit Court of Appeals reversed the federal district court trial judges decision to grant the governments motion for summary judgment. The appellate courts decision, based on Michigan law, held that the husband had no separate property interest to which the income tax lien could attach.114 On remand the district court held that the quitclaim deed (from husband to wife), executed after the lien arose, could not be a fraudulent transfer since the subject of the deed was exempt property under state law, but also held that the husbands payments on the underlying mortgage constituted fraudulent transfers to that extent. On the second appeal to the Sixth Circuit, not reconsidering the interrelationship between state and federal law, the district courts opinion was affirmed, followed by a writ of certiorari. 115 Having described the above procedural events, Justice OConnors majority opinion immediately asserts the recurrent theme of the present paper, namely, that the interpretation of the federal tax statute, assuredly a question of federal law, is heavily dependent on a underlying issue of state law, namely, the nature of the property or rights to property possessed by the taxpayer.116 Understandably, an early citation to the Drye litigation is made. Alluding to a metaphor attributed to Benjamin Cardozo 117, lawyers are more inclined to view real property less in terms of its tangible nature (terra
113 114

A second lien case was selected to prevent the reader from becoming cocky. Don Crafts failure to file federal income tax returns for taxable years 1979 through 1986, inclusive, had resulted in an assessment of $482,446. 115 The opinion of the three-judge panel in the first appeal was clearly held to be the law of the case on the meaning of I.R.C. 6321 on the second appeal. 116 Sandra Craft had instituted the litigation to quiet title to funds held in an escrow account that was a condition for releasing the federal tax lien and permitting the sale of the property then owned solely by the wife as a result of the prior quitclaim deed. 117 Presumably in Paradoxes of Legal Science 129 (1928). I say presumably because, not being as popular as his The Nature of the Judicial Process, the former work does not seem to be readily obtainable from www.barnesandnoble.com. Ah, but the author has subsequently acquired a copy of it.

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firma: firm or solid earth) and more in terms of intangible rights with respect to the property. Somewhat in mathematical terms, once the accumulation of sticks reaches a sufficiently quantifiable level (critical mass), then, presumably, state law recognizes the kind of property or rights in property that will satisfy the federal meaning contained within the Internal Revenue Code tax lien provision. Briefly summarizing the different kinds of concurrent ownership 118, and then reviewing Michigan law, state law gave the following sticks to the plaintiffs husband prior to the execution of the quitclaim deed: [T]he right to use the property, the right to exclude third parties from it, the right to a share of income produced from it, the right of survivorship, the right to become a tenant in common with equal shares upon divorce, the right to sell the property with the respondents [wifes] consent and to receive half the proceeds from such a sale, the right to place an encumbrance on the property with the respondents consent, and the right to block respondent from selling or encumbering the property unilaterally. Admittedly, such a laundry list 119 is impressive and lends support to the courts decision, and the fact that community property frequently is not alienable without the consent of both spouses, and yet is recognized as property under federal tax lien law, negates the significance of the distinction between joint property with right of survivorship where the owners are not necessarily united in bonds of matrimony and property held by husband and wife as tenants by the entirety. Two more points are worth noting. First, if the husband did not have a sufficient proprietary interest then neither did the wife. Thus a tenancy by the entirety would enter a no mans land where no taxpayer had either property or rights in property for purposes of an efficacious federal tax lien statute. The logic appears to be impeccable but should not be allowed to overcome the lack of a sufficient property interest under state law, assuming such to be the case. From the majoritys perspective, the so-called laundry list of particular rights refutes the non-existence of property rights to support a federal tax lien. Second, legislative history in 1954 shows a Senate rejection of an amendment that would have added the parenthetical language of including the interest of such person as tenant by the entirety after the phrase property or rights to property. The court is quite correct in not resting statutory interpretation on a failed modification as one could just as easily have inferred that the rejection of the amendment was premised on the redundancy of the additional statutory language. Before moving forward to additional illustrative cases, Justice Thomas dissent is worthy of consideration. 120 The opinion certainly demonstrates that an appraisal of elements
118

Resorting to the authors own home office library, the distinctions among tenancy in common, joint tenancy with right of survivorship, tenancy by the entirety, and tenancy in coparcenary are well explained by Professor Cornelius Moynihans An Historical Background of the Common Law of Real Property and Its Modern Application. The opinion notes the unilateral control that the husband had under the common law and the extent to which the Married Womens Property Acts of the latter 19th century significantly increased the wifes rights with respect to such property. 119 Justice Thomas description found in a dissent joined by Justices Scalia and Stevens. 120 Justice Scalias short dissenting opinion has the following sociological comment: [T]he Court nullifies (insofar as federal taxes are concerned, at least) a form of property ownership that was of particular benefit to the stay-at-home spouse or mother. She is overwhelmingly likely to be the survivor that obtains title to

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constituting property rights and the characterizations and consequences that flow from such appraisal are not so easily distinguishable. He believes the unfortunate utilization of the Cardozean metaphor amounts to an amorphous construct that tends to eliminate the distinction between property and rights to property contained within the statute. It is one thing to prevent a state law fiction of retroactivity with respect to a valid disclaimer treating the ungrateful donee as having predeceased the donor, but by [e]xtending this Courts state law fiction jurisprudence to determine whether property or rights to property exist under state law in the first place works a sea change in the role States have traditionally played in creating and defining property interests. (Emphasis added) By asserting that every federal court for over 50 years has held the same position as that of the Michigan courts, i.e., a federal tax lien does not attach to tenancy by the entirety property in the enforcement of an individual spouses income tax liability, Justice Thomas relies to some degree on the common law distinction between such tenancies and those of joint tenancy between property owners who are not married to each other.121 Professor Moynihan stated, by referring to William Blackstones Commentaries on the Laws of England that jointly held property has a four fold unity: the unity of interest, the unity of title, the unity of time and the unity of possession. The tenancy by the entirety featured the fifth unity of the marital relationship, the oneness of husband and wife.122 Further, according to Professor Moynihan: Yet the manner of holding the estate was said to be differentjoint tenants were seised of a share and of the whole (per my et per tout), but tenants by the entirety were seised of the whole and not of a share (per tout et non per my). Once the possibility of such a single unity exists, it is an easy step to treat such an entirety as a distinct entity in the same way that a partnership may be an aggregate of individuals but for many purposes, including creditor rights, a partnership is viewed as an entity, similar to a corporation, that is distinct from its owners. Twice citing the treatise by Professors Bittker and McMahon, the Internal Revenue Service is said to step into the shoes of the taxpayer, no more no less. Since a creditor of an individual limited partner, for example, is unable to reach the partnerships asset through legal process, by analogy, the Internal Revenue Service is unable to reach the assets of the marital entity. The Craft case certainly demonstrates that the easily recited holding in Morgan is not easily applied.

the unencumbered property; and she (as opposed to her business-worldly husband) is overwhelmingly unlikely to be the source of the individual indebtedness against which a tenancy by the entirety protects. The authors earlier reference to the Goldie Hawn movie speaks for itself. His sons response to the Scalia quote would undeniably be more succinct: Hello? 121 In his ultimate footnote 9, the Justice quite appropriately cites the Internal Revenue Manual at 5.8.4.2.3 which distinguishes between [a]ssets or income that are available to the taxpayer but not available to IRS that includes assets outside the country, or property owned as tenancy by the entirety. (Emphasis added) 122 Neither owns a separate distinct interest in the fee; rather each and both as an entity own the entire interest (Emphasis added). Neither takes anything by survivorship; there is nothing to pass because the survivor always had the entirety. To me the conception is quite incomprehensible. (Chief Justice Weintraub in his dissenting opinion in King v. Greene, 153 A.2d 49, 60 (1959).)

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CBOGGS v. BOGGS, 520 U.S. 833 (1997) 123

Two of three siblings of a first marriage of the decedent, brought a state action for an accounting against the surviving second spouse of their father. Their mother, who died before the father had retired, bequeathed one third of her estate to her surviving husband124 as well as a usufruct125 in the remaining two-thirds balance. Justice Kennedys majority opinion states that the three children had the naked ownership of the remaining two-thirds. 126 The surviving spouse, responding to the state litigation for an accounting, brought suit in the federal district court seeking a declaratory judgment that the federal statute, the Employee Retirement Income Security Act of 1974, preempts the application of Louisianas community property and succession laws to the extent the such state law recognizes the sons claim to an interest in the disputed retirement benefits.127 A divided panel of the 5th Circuit Court of Appeals affirmed the summary judgment against the complainant-surviving spouse, and, despite six dissenting members, the appellate court refused to grant a rehearing en banc. Citing a conflict with the 9th Circuit Court of Appeals, the Supreme Court granted a writ of certiorari. 128 The Court found it unnecessary to determine the presence of field pre-emption, that is whether Congress, by its enactment of ERISA, had sought to give itself exclusive jurisdiction over the regulation of employee benefit plans, both pension and welfare. 129 A bit surprisingly the Court also found it not necessary to interpret the applicability or

123

This is another case whose application is of utmost importance. However, the Morgan doctrine has no relevance if, in a slightly different aspect of federalism, the federal legislation is held to preempt the field. In addition, the case is even more interesting since it arose in the context of community property law as practiced in the state of Louisiana. Admittedly, the case is not one concerned with the resolution of a federal tax question. Nevertheless, deciding whether state-law claims are pre-empted by federal legislation, answers the preliminary question of who is the appropriate taxpayer. 124 [T]he maximum (share of her estate) permitted under the law according to Justice Breyers dissenting opinion. 125 The usufruct is no stranger to the development of the law of eligibility for subchapter S status. More recently, P.L 105-34 amended the qualified domestic trust provision of I.R.C. 2056A(c)(3)(1986) which provides the following definition of a trust: To the extent provided in regulations prescribed by the Secretary, the term trust includes other arrangements which have substantially the same effect as a trust. 126 In modern civil law, the owner of the usufruct is similar to a life tenant, and the owner of the thing burdened is the naked owner. (Italics in original) See Blacks Law Dictionary, 7th Edition (West Group, Minneapolis 1999). 127 Are you listening, Stanley Kowalski? 128 The high importance of the question submitted for review influenced the Supreme Court to exercise its appellate jurisdiction. Citing a brief from the Estate Planning, Trust and Probate Law Section of the State Bar of California as amicus curiae, the nine community property states are reported to have eighty million residents with one trillion in retirement assets. More succinctly, the importance of the question raised in Boggs was clearly recognized by the Supreme Court: Given the pervasive significance of pension plans in the national economy, the congressional mandate for their uniform and comprehensive regulation, and the fundamental importance of community property law in defining the marital partnership in a number of States, the question is of undoubted importance. 129 Professor Tribe tells the reader a failure of Congress to regulate at the national level will not typically lead to a conclusion forbidding local regulation. [S]uch an inference does not follow logically, and would result in an undesirable regulatory vacuum. American Constitutional Law, Second Edition, Lawrence H. Tribe (1988 Foundation Press).

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dimensions of ERISAs own express pre-emption clause.130 Quite simply the case may be adjudicated on the basis of whether or not a community property regime either conflicts with the provisions of ERISA or operates to frustrate its objects. In deciding this narrower issue the Court first looked to the survivors annuity payable to the second spouse on the death of the retired employee participant. 131 The statute has an antialienation provision with two explicit exceptions. The testamentary provisions under Louisianas community property statute could, given a particular factual scenario, defeat the exception providing for the survivor annuity, which may not be less than 50 per cent of the annuity payable during the joint lives of the participant and spouse. With respect to the surviving childrens additional claims to the monthly annuity payments made during the participants lifetime, the decedents individual retirement account created by the rollover of his interest in the employers tax deferred savings plan, and the retired employees distributive share of the employers stock ownership plans shares of employer stock, ERISA confers beneficiary status on the nonparticipant spouse or dependent beneficiary. Besides the survivor annuity, the only other exception to the antialienation provision is the qualified domestic relations order. In fact 1056(d)(3)(B)(ii) of the statute defines such an order as one that relates to the provision of child support, alimony payments, or marital property rights to a spouse, former spouse, child, or other dependent of a participant made pursuant to a State domestic relations law (including a community property law) (italics added). This ultimately, given specific exceptions for the survivor annuity and the qualified domestic relations order that recognize the potential for a community property regime context, give[s] rise to the strong implication that other community property claims are not consistent with the statutory scheme. To reinforce its conclusion, the Court hypothesized a worst-case scenario under a contrary ruling. An accounting, itself a burden of significant proportions, might be required years after the death of a nonparticipant spouse. Worse still, if the married couple had lived in several states, only some of which were community states, the accounting could entail complex, expensive, and time consuming litigation. Congress could not have intended that pension benefits from pension plans would be given to accountants and attorneys for this purpose.132
130

29 U.S.C. 1144(a): Except as provided in subsection (b) of this section, the provisions of this subchapter and subchapter III of this chapter shall supersede any and all State laws insofar as they may now or hereafter relate to any employee benefit plan described in section 1003(a) of this title and not exempt under section 1003(b) of this title. (Italics added). Justice Breyer, in dissent, addressed the relevance of the quoted provision. In order for the relevant Louisiana statute to relate to an employee benefit plan it must specifically refer to such a plan. Here the state statute merely states that any property that comprises a part of the community property regime (property acquired during the existence of the legal regime through the effort, skill, or industry of either spouse) is community property. La. Civ. Code Ann., Art. 2338 (West 1985). 131 Tax aficionados will recognize the qualified joint and survivor annuity requirement of I.R.C. 401(a)(13). All employee benefit plans must comply with diverse reporting, disclosure, and fiduciary requirements, whereas pension plans must also adhere to participation, vesting, and funding requirements found both in ERISA and a number of tax sections in the Internal Revenue Code. 132 Such a semi-pejorative assertion reinforces the authors decision to include this case as a fine example to illustrate the tensions naturally occurring in the federalism environment. Justice Breyer, in dissent, finds it somewhat disconcerting, if not downright incredulous, that the statute, as interpreted by the majority, expresses greater solicitude for a second spouse of ten years than a first spouse (and the progeny of the first

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DDeutsch v. C.I.R., 1997 T.C.M. (R.I.A.) 97470

This case is very much concerned with the somewhat esoteric aspects of subchapter J, which treats of estates, trusts, beneficiaries, and decedents. The function of this well structured part of the Internal Revenue Code is to determine who shall bear the burden of taxation, the hybrid133 entity, either a trust or an estate, or the beneficiaries of such entity. But this tax court decisions great attraction is the human conflict that it describes when the children of a first marriage square off against the surviving second wife of a deceased parent. The legal issue may be stated quite simply: Does the distribution of a surviving spouses elective share portion of an estate carry with it taxable distributable net income? A simplistic approach would equate the forced share with property that is acquired by gift, bequest, devise, or inheritance 134 as opposed to income from such property. As clean an incision as the statute first appears to produce, hoped for ease of application is summarily dealt a deathblow with the second sentence of the flush language that follows the delineation of income.135 Allow the facts of this case to illustrate the drama that not infrequently accompanies litigation. The personal representative was a son of the decedent, while the attorney advising the estate was a nephew of the decedent. There is no need to resort to physical violence when one, with a deftly timed distribution of the elective share portion, can shift the entire taxable portion of distributable net income 136 to the surviving spouse by making residuary distributions to the surviving progeny of the decedent in the succeeding taxable year while the surviving spouse receives an exceedingly large distribution in the immediately preceding taxable year.137
relationship) of three decades duration who sought to leave a community property interest that she possessed prior to her death to such progeny. This is especially true, acknowledging that the case lies at the intersection of ERISA pension law and state community property law, and that a community property regime represents a commitment to the equality of a wife and a husband in a real life partnership inherent in the marital relationship. And for further emphasis the dissent continued: State community property laws, many of ancient lineage, must have continued to exist through such lengths of time because of their manifold excellences and are not lightly to be abrogated or tossed aside. Nevertheless, despite such cautionary assertions, the majority opinion, in response, simply states that [t]he fairness of the distinction might be debated, but Congress had decided to favor the living over the dead and we must respect its policy. 133 Neither a separate and discrete taxable entity such as a subchapter C corporation nor a pure pass through entity such as a partnership or an S corporation (ignoring the entity level taxes that may occur because of a prior subchapter C history and its concomitant accumulation of earnings and profits). 134 I.R.C. 102(a). 135 I.R.C. 102(b)(2): Any amount included in the gross income of a beneficiary under subchapter J shall be treated for purposes of paragraph (2) as a gift, bequest, devise, or inheritance of income from such property. Thus the answer lies somewhere in the bowels of subchapter J. 136 Known to practitioners as DNI (not to be confused with the DNA of criminal law), this concept is defined as taxable income with an array of modifications found in I.R.C. 643(a), particularly the distribution deduction found in paragraph one thereof. 137 He who steps up to the trough alone will be nourished by the taxable victuals found therein. Such nonpartial treatment, that is, a rule oblivious to the identity of the distributee, precipitated subsequent litigation by the surviving spouse against the estates personal representative. The role played by a personal representative in probate proceedings makes such personal representative a fiduciary. The widow ultimately settled her claim to surcharge the personal representative for breach of his fiduciary obligation

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One would think that the resolution of this federal tax question, the taxability of the elective share as a distribution, is by necessary implication dependent upon the initial application of underlying state law. As well stated by the tax court: Inasmuch as State law is the source of legal rights and interests in property and income, we must first ascertain the legal and economic characteristics of the Florida elective share under the Florida Probate Code as compared with Florida statutory dower. 138 Dutifully bowing to the East by specifically citing the Morgan and Bosch cases, the court proceeded to examine the Florida statutes, decisional law, as well as well-recognized secondary authorities. Perhaps the most revealing part of the exposition is footnote 5 in the courts opinion that acknowledges the foremost treatise on the subject of the income taxation of estates and trusts.139 Most tax practitioners in this semi-arcane area of fiduciary income tax preparation have considerable familiarity with the concept of the federal gross estate under the existing transfer tax system and how such statutory construct differs from the state probatable estate.140 The cited textbook refers to something denominated as the subchapter J estate. Obviously joint tenancies or tenancies by the entireties, prior transfers to inter vivos trusts retaining prohibited interests,141 annuities, powers of appointment, life insurance policies payable to designated beneficiaries other than the insureds estate, and qualified terminal interest property all are not part of an estate
by accepting an additional payment of $50,000 that the Tax Court in its opinion characterized as the establishment of a war chest to do battle with the federal government in subsequent litigation. Apparently, Florida case law (Williams v. Harrington, 460 So. 2d 533 (Fla. 2d D.C.A. 1984)) would not require an equitable adjustment to compensate the surviving spouse for the income tax liability attributable to the planned attempt to shift federal tax consequences to the unlucky distributee. Accepting Kenneth M. Harts (not to be confused with Kenneth R. Hart, counsel to the Florida Institute of CPAs; see Florida Bar Journal issue of February 1999, footnote 8) characterization of the Florida case law, such a holding certainly does little to uphold what the then Judge Cardozo classically defined as the duties of a fiduciary in Meinhard v. Salmon, 249 N.Y. 458 (1928): Many forms of conduct permissible in a workaday world for those acting at arms length, are forbidden to those bound by fiduciary ties. A trustee is held to something stricter than the morals of the market place. Not honestly alone, but the punctilio of an honor the most sensitive, is then the standard of behavior. As to this there has developed a tradition that is unbending and inveterate. Uncompromising rigidity has been the attitude of courts of equity when petitioned to undermine the rule of undivided loyalty by the disintegrating erosion of particular exceptions. Only thus has the level of conduct for fiduciaries been kept at a level higher than that trodden by the crowd. It will not consciously be lowered by any judgment of this court. 138 The comparison is relevant because the Commissioner of Internal Revenue had previously stated in Rev. Rul. 64-101that the historical antecedent known as dower, originally enacted by the Florida legislature in 1933 until its repeal in 1975, was governed by the general exclusionary provisions of I.R.C. 102 as opposed to the provisions of subchapter J, I.R.C. 661 and 662, which, by utilization of the concept of distributable net income, shifts taxability from the hybrid entity to the distributee spouse. 139 Federal Income Taxation of Estates and Beneficiaries, Ferguson, Freeland, & Stephens (1970). Professor Ascher has replaced the deceased Professor Stephens in the two subsequent editions. 140 The author never ceases to marvel at the average layman who understandably but mistakenly believes that her last will and testament governs the disposition of her real and personal property, most of which is held in joint tenancy with right of survivorship. 141 See I.R.C. 2035-2038, inclusive.

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subject to administration by the local probate court. Dower, including the male counterpart of curtesy, and a statutory elective share in lieu of such common law interest, are, however, a part of such probate estate.142 Thus the reference to non-probatable assets is not terribly persuasive. Citing the income tax regulations 143 the tax court made a telling observation by analogizing to the instance of devised real estate that is not needed to pay the decedents debts and consequently is not considered to be part of the administration process despite the fact that the decedent died owning the real property in her own name alone. Florida Statutes 732.514 provides that [t]he death of the testator is the event that vests the right to devises unless the testator in the will has provided that some other event must happen before a devise vests.144 Comparing the current statutory elective share with the repealed common law relic produces a favorable result in that the former unlike its predecessor does not share in income of the estate, or mesne profits, nor is entitled to interest from the estate prior to the date distribution is ordered by the Probate Court. The 1995 version of Florida Statute 732.207 just simply provided a fractional share calculated on date of death values without any other express statutory provision for income to accrue.145 Not being treated as a typical income beneficiary suggests that the distribution rules apportioning tax liability between the estate and its beneficiaries are inapplicable. From the governments perspective, the obverse side of the coin in this side by side comparison of state statutory provisions, is the exposure of the elective share (calculated net of all liens, mortgages, and unsecured claims) to creditor claims while the dower interest was originally free from all liability for the debts of the decedent and all costs, charges and expenses of administration.146 After undergoing this arduous exercise in the determination of state law, Judge Beghe, finally reaching a feverish pitch in this ever increasing crescendo, comes down on the side of the petitioner wife: The fact that the surviving spouse who elects the Florida elective share incurs no similar income tax liability because she is not entitled to enjoy any portion of estate income only confirms
142

Immediately following the probatable estate inclusion (property in which the decedent had an interest), I.R.C. 2034 provides: The value of the gross estate shall include the value of all property to the extent of any interest therein of the surviving spouse, existing at the time of the decedents death as dower or curtesy, or by virtue of a statute creating an estate in lieu of dower or curtesy. Note well that the Florida legislature amended the surviving spouses elective share provision, effective on October 1, 1999, for all decedents dying on or after October 1, 2001. The amended provision is far more akin to the federal gross estate than it is to the state probatable estate. 143 See Treas. Reg. 1.663(a)-1(c)(1)(ii) (1999). 144 In forty years of practice the author has yet to see a tax preparer exclude rental real estate from the fiduciary income tax return, reporting the results of operations on the individual income tax returns of the devisees immediately following the moment of death. No doubt Justice Holmes would remind advisers to the laity that the reason for such a somewhat surprising statutory provision is grounded in history. Professor Moynihan, in his freshman law students gem of a textbook, cited supra footnote 118, would presumably assert that the feudal system of land tenure insisted on such instantaneous vesting of a devise in order to prevent an abeyance of seisin. The potential crusader always had to know who owed him knights service. 145 Reiterating my comments that appear at footnote 66, it is absurd to suggest that the tax accountant must await resolution of this state law issue before being permitted to complete the fiduciary income tax return of the estate. 146 A subsequent modification in 1939 made the widows interest in personal property subject to such claims.

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that the payment of the Florida elective share is not a subchapter J distribution (emphasis added).147&148

EGUARANTY TRUST CO. v. YORK, 326 U.S. 99 (1945) 149

Recalling the teachings of the first case discussed in the preamble portion of the instant paper, to what extent are the federal courts, exercising their diversity jurisdiction, as well as their Congressional granted authority to administer equitable remedies, required to follow states statutes and decisions concerning those remedies. To what extent is Erie relevant on that issue? The Second Circuit Court of Appeals had reversed a summary judgment in favor of the defendant. Petitioner, as trustee for note holders, had been sued in a class action for breach of its fiduciary obligations to note holders that had not accepted an exchange offer made by the debtor. Such a suit would have been barred in state court because of the statute of limitations. Since the case involved state created rights, the starting point for analysis is the relevance of Eries federal jurisdictional teachings. Justice Frankfurter reminded the followers of Supreme Court constitutional jurisprudence that Brandeis opinion rejected an approach to looking at the law as constituting a brooding omnipresence of Reason, of which decisions were merely evidence and not themselves the controlling formulations, i.e., a transcendental body of law outside of any particular state but obligatory within it unless and until changed by statute. The states may not dictate the remedies available in the federal courts nor may such courts be prohibited from providing an appropriate remedy to enforce a state right. Substantive versus procedural law are not necessarily two distinct categories whose content are always readily discernible, however, providing no talismanic solution. To the extent that a substantive right is unenforceable under existing procedural mechanisms, the right in essence is nonexistent. The federal court sitting in diversity is performing merely as another state court. Under the teachings of Erie a
147

An appeal to the First Circuit Court of Appeals (Brigham v. United States, 160 F. 3d 759 (1998)) was underway at the time of the Deutsch decision on exactly the same issue under New Hampshire law. In the article cited in footnote 137, Kenneth Hart, the widow Deutschs white knight, optimistically hopes that the federal appellate court, hav[ing] the benefit of the thorough analysis performed by the U.S. Tax Court in Deutsch. carefully analyze New Hampshire law to determine whether its attributes warrant the same conclusion of law. And here, shortly thereafter, is said appellate courts response relating to the holding in Deutsch: Passing the fact that $800,000 is a good deal of protection, the proposition that, simply by fiat, a state may preserve its citizens from federal taxes is absurd [Do we have a penumbrist in our midst?]. The list of exclusions in 26 U.S.C section 663 [bequest of a specific sum of money or property] clearly does not exclude an elective share, and we note that the Treasury Regulations expressly deny exclusion even to a widows temporary allowance [Florida Statutes 732.403 has a family allowance provision]. Knowing when state law controls is not the proverbial piece of cake. 148 In passing the author notes that by issuing a notice of deficiency two days prior to the expiration of the statute of limitations on assessment the government failed to issue a similar notice to the decedents estate, setting itself up for a potential whipsaw, ignoring the relevancy of I.R.C. 1311-1314 (mitigation of effect of limitations) and 6901 (transferee liability). 149 While not a federal tax case, in the context of federalism, Justice Frankfurters majority opinion elucidates the applicability of the Erie precedent to enforcing state-created obligations utilizing the equitable remedies and procedures of the federal courts exercising their diversity jurisdiction. It is interesting to note that the same counsel, Messieurs Davis and Kinedl, that had secured victory for their client in the Erie litigation, represented the petitioner.

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district court may not enforce a state created right that would not be enforceable in a state court.150

FESTATE OF DELAUNE v. UNITED STATES, 143 F. 3d 995 (5 th Cir. 1998)151

This is not just another community property case arising out of the bayou. While it did take place in Louisiana, the case centers about the effectiveness of an attempted disclaimer. The 5th Circuit Court of Appeals reversal of the lower federal district courts disallowance of the attempted disclaimer by the heirs of the successor surviving spouse who expired before exercising her right to disclaim a portion of her predeceased husbands estate. The Tax Reform Act of 1976152 enacted I.R.C. 2518, according to the House Report explaining the legislation, to create a uniform Federal standard so that a disclaimer could be effective for Federal estate and gift tax purposes whether or not valid under local law. However, because of the fourth requirement of subsection (b) 153 state law is still pertinent in determining federal estate tax consequences. The amendment made by the Economic Recovery Tax Act of 1981, namely subsection c(3), validates attempts which is to a person or persons who would have received the property had the transferor made a qualified disclaimer (within the meaning of subsection (b)). Reading the case one wonders how the requirement that such refusal is in writing 154 was satisfied given the fact that the surviving spouse died after orally directing her attorneys to draft the renunciation plan. It is here where state law comes to the rescue. 155
150

Justice Rutledge, in dissent, would not have reached a decision on a premature constitutional issue caused by the lower appellate courts assumption that the state statute of limitations had in fact barred the instant suit. Having to decide the case, he would hold that the statute of limitations is merely remedial (after all the exercise of equitable jurisdiction may be predicated on the different standard of laches). Note that Klaxon Co. v. Stentor Electric Manufacturing Co., 313 U.S. 487 (1941) had previously held that choice of law rules are substantive in nature and are subject to the holding in Erie. The constitutionally based decision of Brandeis was designed to eliminate forum shopping, [a] policy so important to our federalism must be kept free from entanglements with analytical or terminological niceties. Thus the rule enunciated by Justice Frankfurter is essentially an outcome test. Frankfurter decided Guaranty Trust, with such references to forum shopping and jurisprudential outlook (a particular way of looking at law) that were designed to remake Eries doctrinal foundation. Brandeis decision, [Frankfurter] taught, was solely on the policy of ending forum shopping and a changed jurisprudential climate, not on the Constitution. [A] policy of federal jurisdiction is not one of constitutional dimension. See Brandeis and the Progressive Constitution by Edward A. Purcell, Jr. (Yale University Press 2000). But the author would maintain that to the extent Eries real foundation is federalism, it most definitively has a constitutional underpinning. 151 Again the author has carte blanche relative to case selection. It should become manifestly clear why this particular case from the 5th Circuit Court of Appeals was selected. Judges Wisdom and Higginbotham were part of the three-judge panel considering the appeal with their colleague Judge Jolly assigned the task of drafting the opinion. 152 P.L. 94-455, Sec. 2009(b)(1). 153 [A]s a result of such refusal, the interest passes [effective transfer of title under local law] without any direction on the part of the person making the disclaimer. 154 I.R.C. 2518(b)(1).

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The federal district court had held that the disclaimer was invalid under state law because the Louisiana Civil Code plainly does not provide for the renunciation of a succession by the heirs [the litigants seeking an estate tax refund] of a dead heir [the surviving spouse] on her behalf [again, the surviving spouse]. Judge Jolly was ready for the challenge of determining just what state law permits. 156 The widow essentially had a choice between redrafting her will to prevent an intestacy (almost her entire estate was bequeathed to her predeceased husband), with her husbands heirs receiving nothing, or, by renouncing the bequest under her husbands will, allow his heirs to succeed to his property. Having directed her counsel to adopt the latter alternative, but before the documents had been drafted, she shuffled off this mortal coil. 157 While the deceased wife could not be reanimated for a limited amount of post-hoc estate planning, at a state court hearing an agreed judgment was signed by all interested parties (other than Sammies estate) [whereby] Sammies heirs purported to renounce, in her name and on her behalf, a portion of [husband] Jacks succession equal to two-sevenths of the combined estates. In a rather dazzling display of interpretation of Louisiana law, Judge Jolly, complimenting his fellow panel member, Judge Wisdom, stated that civil code interpretation [unlike the common law tradition] is a bit unique: In this there is no mere reliance upon the holdings of prior decisions. Indeed, the code civil expressly forbids decisions to be made so as to form a general rule of law, and anyone who examines Dalloz and Sirey will not find reference to authoritative materials other than the code texts. There is no stare decisis of interpretation. Furthermore, the interpretative process is not confined to the judges alone. The chief reliance is rather upon the theoretician as he has indicated his opinions in doctrinal writing. Interpretation of statutory texts is not the esoteric job of judges. It is an intellectual process in which law teachers have played a greater part than judges. Such an unfamiliar methodology to common law jurisdictions speaks volumes for federalism. Viewing a relevant article of the current Louisiana Civil Code (of 1870), an exact copy of the English text of the Code of 1825, as well as French texts, 158 despite the omission of the words to renounce, based on such prior history, the appellate court held that the renunciation by the heirs, in behalf of the decedent, was effective under state law. Taking the government to task for failing to properly apply its own regulations 159 the court held that the requirements of I.R.C. 2518(b)(3) were satisfied because utilization of
155

Or as Judge Jolly put it with a little more flair: This case will demonstrate how, under the Louisiana Law Civil, the past is not dead; how the past will not die; and how, indeed, the past is not even past. 156 [T]he Law Civil will not let us stop with a plain reading of the current Code. Because, under the Law Civil, the Code Napoleon [Stanley Kowalskis authoritative source] of 1804 adds clarity to the work of Louisianas subsequent Digesters and Redactors, and hence to the Code we read today. 157 Judge Jolly, citing the same Shakespearean source, put it slightly differently: The Fell Sergeant [cruel sheriffs officer] who commands our last days waits not for the orderlies, however, and before the renunciation could be completed and executed, Sammie [Barman Delaune] lapsed into a coma. 158 [W]hen he to whom a succession has fallen has died without having repudiated it or without having accepted it expressly or tacitly, his heirs may accept it or repudiate it under his authority. En francais: Lorsque celui a qui une succession est echue, est decede sans lavoir repudiee ou sans lavoir acceptee expressement ou tacitement, ses heritiers peuvent laccepter ou la repudier de son chef. 159 Treas. Reg. 25.2518-2(d) (1997).

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community property funds in an amount less than the income produced by the decedents portion did not constitute an affirmative act of accepting the benefits of the disclaimed property. Accordingly, the federal statute was satisfied as well.

GKERR v. C.I.R., 292 F. 3d 490 (5th Cir. 2002)160

The taxpayers made capital contributions to two limited partnerships formed under Texas statutory law. The general partner in the second family limited partnership was the first family limited partnership. The gifts that were the subject of an Internal Revenue Service gift tax deficiency of $1,416,850 for gratuitous transfers of limited partnership interests in the second partnership to the taxpayers children and for gratuitous transfers of interests in the first partnership to an irrevocable grantor retained annuity trust with the remainder beneficiaries consisting of children and grandchildren. The donors applied a valuation discount for lack of marketability and lack of control of twenty-five percent. The legal issue resolved by the appellate court161 was whether the partnership agreements contained restrictions greater than those provided by the Texas statute. Such an applicable restriction would be disregarded under the special valuation rule contained in the previously cited Code section. The partnership agreements contained provisions on dissolution and liquidation on the earlier of the passage of thirty years time, or, by agreement of all partners, on the happening of certain events constituting acts of dissolution. In addition, no limited partner had the right to withdraw from the partnership prior to dissolution or liquidation. Shrewdly conceived or not, the Kerrs had previously given some of the limited partnership interests in both partnerships to the University of Texas. While the University, as an appreciative donee and the only non-family partner, had indicated that it would not have opposed removal of the restrictions, the court held that the federal tax statute at issue specifically stated [T]he transferor or any member of the transferors family, either alone or collectively, has the right after such transfer to remove, in whole or in part, the restriction.
Additional Cases162&163

160

This case rather narrowly involves an express reference to state law in an exception to the definition of an applicable restriction. I.R.C. 2704 is one of four special valuation rules found in chapter 14 as enacted by P.L. 101-508 (Revenue Reconciliation Act of 1990) which retroactively repealed an attempt by former I.R.C. 2036(c), an estate tax provision enacted by the Revenue Act of 1987, to curb abuses in an estate planning technique known as an estate freeze. Frankly, the author was attracted to the case because the taxpayer, Baine P. Kerr, Sr., as former president of Pennzoil, had received a ten million dollar bonus in 1989 for his work prosecuting the case against Texaco for its tortious interference with the economic relations established with Getty Oil. An eleven billion dollar jury verdict was settled for three billion dollars (See Houston Business Journal, January 17, 2000), announcing the taxpayers victory in the Tax Court litigation. The author, attempting to catch an airplane in Houston, was told by a taxi cab driver (a divinity student from Nigeria), pointing to a bank building, that the settlement funds had been transferred electronically to the indicated bank. 161 In deciding whether a partial summary judgment should have been decided in favor of the taxpayers, the appellate court may review de novo a valuation question turning on a pure question of law. 162 With great reluctance a review of the hundreds of cases illustrating the thematic material of this paper is foreclosed by the time restraints of publication. Oral presentation of the materials was previously scheduled in Orlando, Florida at the Florida Institute of Federal Taxation, on November 14, 2003 at 11:35

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IVCONCLUSION:

DENOUEMENT164
The tax law is but one of many areas of the law affected by the delicate relationship between a supreme central government with limited powers and the several states exercising considerable jurisdiction in the regulation and the preservation of public order and tranquillity, the promotion of the public health, safety, and morals, and the prevention, detection, and punishment of crimes.165 The founding fathers had trashed the eighteenth-century notion of federalism that focused on independent and coequal sovereign states, replacing it with far more subtle and amorphous arrangements. James Madison referred to the new political creation as the compound government of the United States[that] is without a model, and to be explained by itself, not by similitude or analogies.166 Remembering the earlier comments found herein concerning nonEuclidean geometry, opponents of this novel political construct emphasized the absolute and indivisible nature of sovereignty stating that the successor to the Articles of Confederation was a solecism in politics for two coordinate sovereignties to exist together.167 As the two incidents of Elian Gonzalez and Bush v. Gore illustrate, the definitional lines for marking the separate spheres of federal and state action is as difficult to draw today despite more than two centuries of distillation by the Supreme Court as it was when the Kentucky and Virginia Resolutions were drafted by Thomas Jefferson and James Madison, respectively. Admittedly, no one quotes Patrick Henrys
A.M. Now that the paper is scheduled again for presentation before the South Dade Chapter of the Florida Institute of Certified Public Accountants on August 18, 2010 at 7:10 P.M., time permitting, the author hopes to discuss a few more recent cases. 163 The author has attempted to portray all of the cases discussed herein with as much accuracy as possible. Differences in opinion must commence after the operative facts have been provided in an exacting manner. Archibald Cox, of Saturday Night Massacre fame, told the following story of a judges reverence for case law: Why do people support constitutionalism and the rule of law, and as their instrument, the courts?[T]he fragile faith that law has a separate existence not merely because it applies to all men equally but because it binds the judges as well as the judged, not just today but yesterday and tomorrow. Learned Hand, one of the great federal judges who never reached the Supreme Court, once put the matter to me, a young law clerk, from a judges perspective. Sonny, he asked, to whom am I responsible? No one can fire me. No one can dock my pay. Even those nine bozos in Washington, who sometimes reverse me, cant make me decide as they wish. Everyone should be responsible to someone. To whom am I responsible? Then the Judge turned and pointed to the shelves of his law library. To those books about us. Thats to whom Im responsible. That kind of attitude of course lays a strong foundation for the federal tax system. 164 It is fair to say that the good citizens of South Florida, in the summer and fall of the first year of the millennium received two unsolicited civics lesson on the essence of federalism. One, agents of the Immigration and Naturalization Service (of the Justice Department; now a part of the Department of Homeland Security) seized Elian Gonzalez in the early morning hours of April 22, 2000. Two, the United States Supreme Court held that the Florida Supreme Courts order for a manual recount of the ballots cast by Floridians in the presidential election would be violative of the equal protection clause of the fourteenth amendment to the United States constitution. Some would assert that the opaque theories of historians, political scientists, and lawyers have become grist for federalisms mill. 165 Blacks Law Dictionary, 4th Edition, (West Publishing Co. 1951). 166 David M. OBrien, Constitutional Law and Politics, Vol. One, 4th Edition, (W.W. Norton 2000) citing Rufas S. Davis, The Federal Principle (Berkeley: University of California Press, 1978), 118. 167 Again the quote is from Professor OBrien, citing Herbert J. Storing, What the Anti-Federalists Were For (Chicago: University of Chicago Press, 1987), 250.

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remarks at the Virginia ratifying convention: what right had they to say, We, the People?[W]ho authorized them to speak the language of, We, the People, instead of We, the States? States are the characteristics, and the soul of a confederation. If the States are not the agents of this compact, it must be one great consolidated National Government of the people of all the States.168 Thus, while the substantive specialty of the federal tax law was employed to demonstrate the interplay of federal and state law in a federal republic, after first dealing with the issue of federalism in the more general context of choice of law issues in diversity of citizenship jurisdiction, I now choose to make my limited summary remarks by dealing with federalism in a broader sense. I like divided government! Regardless of its manifestations, whether federal and state governments, the three separate branches of the federal government, 169 or the political parties that vie for control, I prefer such division. Why? Because where most of lifes problems, whether economic, social, political, or personal, do not have readily determinable answers, the theories and opinions of all contending sides is conducive to providing solutions. Full exploration, in a free society, by educated citizens will ultimately determine whether such theories and opinions survive. 170
168

Patrick Henry, in The Complete Anti-Federalist, Vol. 5, ed. Herbert J. Storing (Chicago: University of Chicago Press, 1981), 211. The federal judge and author cited in footnote 14 provides an instructive excerpt from a letter from Alexander Hamilton to George Washington on August 18, 1792: There are somethings which the General Government has clearly a right to dothere are others which it has clearly no right to meddle with, and there is a good deal of middle ground, about which honest & well disposed men may differ. The most that can be said is that some of this middle ground may have been occupied by the National Legislature; and this surely is no evidence of a disposition to get rid of the limitations in the constitution; nor can it be viewed in that light by men of candor. 169 Once the 11th circuit court in Miami-Dade county, Florida had dismissed the great-uncles, (Lazaro Gonzalez) petition for custody of Elian [See In re the Matter of Lazaro Gonzalez, No. 00-00479-FC-28 (Fla. 11th Cir. Ct. 2000], the case was no longer an issue of federalism {immigration law within the exclusive jurisdiction of the federal government (but see Senate Bill 1070, amending Arizona Revised Statutes (2010)) in contra distinction to a child custody issue which is presumably within the exclusive jurisdiction of the state government}, but rather became of one attempting to apply the doctrine of the separation of powers embedded in the constitution. As the presiding judge of the three-judge panel, James Edmondson, stated: This case, at first sight, seems to be about little more than a child and his father. But, for this Court, the case is mainly about the separation of powers under our constitutional system of government: a statute enacted by Congress, the permissible scope of executive discretion under the statute, and the limits of judicial review of the exercise of executive discretion. Interestingly, this tripartite governmental structure is completely exemplified by an administrative agency (once the nine old men made a judicious choice for resolving the delegation controversy). Take the Internal Revenue Service, for example. As a promulgator of regulations it takes on the role of a legislator. As an issuer of private letter rulings it bears more than a passing resemblance to a court exercising a judicial function. And finally as a local sheriff padlocking the door for failure to remit payroll taxes, it surely performs in an executive manner. 170 It should come as no surprise then that the author not only likes 5 to 4 decisions by this nations highest court, but relishes plurality decisions with as many different concurring and dissenting opinions as the exigencies of the litigation demands. I am reminded of a story that my father was fond of repeating. His clients would ask: Mr. Ingber are you sure? His response, which I frequently find myself quoting, was:

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It is not easy to determine when state law will have a substantial influence on the application of federal law, whether taxation, immigration, securities, employee benefits, or the regulation of interstate commerce. Why should it be easy? Law is as every bit as complex as the human affairs it regulates. When Swift v. Tyson ultimately turned out to be an unsatisfactory constitutional solution, it took a flexible judicial response as evidenced by Erie R. R. Co. v. Tompkins to provide a more viable alternative. In Poe v. Seaborn171, despite the desirability of a uniform individual income tax for all the then forty-eight states and pertinent territories, the Supreme Court held community income earned by one spouse is taxable one half to each spouse. Referring to state law property notions first to resolve the second issue of the incidence of the federal income tax liability, the constitutional concept of federalism raised its familiar head. Clearly such an interpretation favored community property states over common law jurisdictions in a progressive tax environment. To prevent the wholesale conversion to a distinctly different property regime Congress came to the rescue with appropriate federal tax legislation. The Revenue Act of 1948 172 said that in the context of federalism and uniform federal tax law, the former must give way to the latter with respect to the following four issues: [a] Married couples will be permitted to elect to file a joint income tax return.173 [b] & [c] Married donors and decedents will be allowed a marital deduction equal to one half the value of the transfer or one half the adjusted gross estate, respectively. 174 [d] Gifts by either spouse to a third party are eligible for the election to split gifts. Recalling the 1940 Supreme Court case cited a few pages back, namely Morgan v. Commissioner, one might be tempted to rely on state law to determine the person to be taxed by inquiring into who owns the income. Sounds like a simple property law question to me, which by necessary implication is usually resolved by reviewing the huge residual lawmaking authorityleft with the states. However, in a progressive federal
The Supreme Court splits five to four and you are asking me if I am sure? Frankly, an ideal Supreme Court would be chosen from the following categories: law professor, United States senator, federal appellate judge, federal district court judge, state governor, state appellate judge, private civil litigator, public interest litigator, and public prosecutor (one from each category only). To put it in a slightly different manner, Justices Thurgood Marshall and Lewis Powell brought unique qualities to the rarefied bench because of their contrasting backgrounds. Presumably somewhat tongue in cheek Juan Williams has quoted the great civil rights litigator on the subject of his rumored retirement: I have a lifetime appointment and I intend to serve it. I expect to die at 110 shot by a jealous husband. 171 282 U.S. 101 (1930) 172 The current tax oratorical exhortations on the subject of the marital penalty never include a reference to this relevant legislation. 173 Sen. Rep. No. 1013, 80th Cong. 2d Sess. (1948), 1948-1 C.B. 326: Under the provisionsthe combined normal tax and surtax that would be determined if the net income and the applicable creditswere reduced by one-half. 174 In a non-Code provision of the Economic Recovery Tax Act of 1981, enacted early in the first Reagan administration, section 403(e)(3) gave the individual states an opportunity to interpret the expression contained in a will executed or a trust created before September 12, 1981. If a formula pecuniary amount or a fractional share clause provided that the spouse is to receive the maximum amount of property qualifying for the marital deduction allowable by Federal law, state legislation could treat such a clause as referring to the subsequent federal tax law change. Florida responded to the invitation.

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income tax system, reliance on state law may defeat the federal purpose of progressivity. In Lucas v. Earl175 the same Supreme Court had earlier declared that in the case of income produced by sweated labor, the tax fell on the producer of such income, not on a subsequent proprietary assignee. And so it never ends. This penumbra only insures that federalism simply demands a careful examination of all issues before the appropriate law can be ascertained. It would be nice if it were simple. But federalism, a living organism, like life itself, insists on constant reexamination in a changing environment before a tentative solution may be obtained. Like the bard from Stratford-on-Avon, it gets better with each reading.176&177

FEDERALISM EXHIBIT A
Jonathan S. Ingber 2544 Jardin Lane Weston, Florida 33327

APRIL 1, 2000178

175 176

281 U.S. 111 (1930). The ultimate footnote. Did Federalist Paper #62 (probably Madison) anticipate the federal tax law according to Congress? Judge for yourself: The internal effects of a mutable policy are still more calamitous. It poisons the blessings of liberty. It will be of little avail to the people that the laws are made by men of their own choice if the laws be so voluminous that they cannot be read, or so incoherent that they cannot be understood; if they be repealed or revised before they are promulgated, or undergo such incessant changes that no man, who knows what the law is today, can guess what it will be tomorrow. Law is defined to be a rule of action; but how can that be a rule, which is little known and less fixed? 177 Those seeking a set of principles whose truths may be proved with absolute certainty need not apply for employment in the vineyards where federalism propagates. Today the burden of proof in tax litigation is placed on the broad shoulders of the federal government by virtue of the politically popular [presumably not practically useless] requirements of I.R.C. 7491. The inconclusiveness of legal proof was made abundantly clear by the comments of Jimmy Hoffa (prior to his untimely termination) who was fond of proclaiming his innocence: The federal government aint proved nothin against me, yet. Applying state law to resolve federal tax controversies is an art not a science. For those who find such uncertainly disconcerting the author would recommend a different field of study, such as mathematics. There the inherent beauty of that ancient subject lies in its precise irrefutable proofs. There, utilization of rules of logic, itself a tightly constructed subject (see B. Russell, The Principles of Mathematics, (1902)), in conjunction with undefined terms (e.g.. point or line), definitions (see the precision brought to the calculus concept of limit by Augustin Cauchy {undreamed of by Leibniz and Newton}), postulates (the previously cited Euclidean parallel postulate being one of the more famous ones), and theorems, have led to proofs with a certainty that far transcends the demonstrations encountered in the typical courthouse. 178 Written one Saturday morning in the throes of the tax season, three weeks prior to the little boys seizure by agents of the Immigration and Naturalization Service.

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Madison J. Johns, Esq.179 One Main Manor Miami, Florida Hi Professor, Time for a few interrogatories on this Saturday morning? Federalisms finest hour? Does the dynamic duo (1) demonstrate the continuing validity of Hamiltons assertion? Perhaps process ultimately elevates to the level of substance? Rhetorically: Justice Kennedy, can the concept of federalism ever be adequately explained to Joe Six-pack? (2) As it was difficult, if not foolhardy, to argue the constitutional merits of an integrated society on the back roads of Philadelphia, Mississippi; it is hard, but necessary, to defend federalism in the presence of a childs angelic face.

Never losing the (constitutional) faith,

Jonathan

ENDNOTES
1. Do Alex & Joe believe that an elected judiciary is even less dangerous?180&181

179

Believing the original addressee would prefer anonymity (never having responded to the authors letter); I have modified the name and address. 180 I recognize today that my responsibility when I was standing there was not to express my personal feelings about the issue, but I should have expressed the position as the mayor of Miami-Dade County. Thats where I went wrong. St. Petersburg Times, August 31, 2003. Thurgood Marshall is reputed to have said that he preferred Senator Stennis to Lyndon Johnson because he knew exactly where the former stood. Perhaps Floridas new senatorial candidate is a lover of biography: I do understand power, whatever else may be said about me. I know where to look for it, and how to use it. [Lyndon Baines Johnson] 181 To my mind the Elian Gonzalez litigation was never a case of family law (in loco parentis). Rather it was one that demonstrated principles of federalism and separation of powers among the branches as well

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2. One wonders. Mon professeur: And what was the purpose of the Gulf of Tonkin resolution? Etudiant (in a class on American constitutional history): It was before my time. (A) ENDNOTE TO ENDNOTES A. I refer her to Dr. Kings self-eulogy weeks before his death in Memphis: I want you to say that day, that I tried to be right on the war question. say that I was a drum major for peace Je me souviens. dont know much about history dont know much about science books dont know much about the French I took

SUBLIMINAL INFLUENCES182 1. Dean Robert McKay: A Midwesterner, I believe. Taught me and a hundred others in the fall of 1965 and the spring of 1966 about constitutional law. Was it Whitney North Seymour, Jr. who characterized this subject as akin to the sounds of a hand dryer found in the mens bathroom? If so, he obviously never sat in on one of the good professors lectures. Reconciling the irreconcilable or plainly stating why he believed the Supreme Court was wrong, he made it all sound so deceptively easy but at the same time extremely interesting. Following Baker v. Carr, the New York State legislature sought his help in solving their reapportionment problem. I believe he may be the only posthumous recipient of the American Bar Associations Liberty Bell Award. Professor Bernard Schwartz. Talk about a fountain of information. His lectures on administrative law made it abundantly clear, crystal in fact, that the separation of powers doctrine had undergone a major case of radical surgery in an increasingly and technically complex society. [Take the Internal Revenue Service, please.183 In padlocking the door for failure to remit escrow funds to the federal depositary, the revenuers are executing the law. In assisting the Treasury Department in promulgating estate tax regulations, the agency is assuming the role of lawgiver. Finally, in issuing private letter rulings, the agency performs a quasi-judicial function.] Professor Schwartz has written an entertaining judicial biography about Earl Warren. In Super Chief I first became aware of Justice Robert Jacksons pithy description of the Supreme Courts role in the legal hierarchy.

2.

(the respect given to administrative decisions by the judiciary). The emotions generated by the case and the legal positions presented by the boys attorneys may have obfuscated the underlying principles. 182 Three years of law school and three years of service in the United States Navy constituted a most fertile period for the authors education. In these somewhat troubling times the speech of Douglas MacArthur at West Point comes to mind: Today marks my final roll call with you. But I want you to know that when I cross the river, my last conscious thoughts will be of the Corps, and the Corps, and the Corps. I bid you farewell. 183 Apologies to Henny Youngman.

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3.

4.

Dean Robert J. Pitofsky. At first blush the subject of federal jurisdiction gave the impression of being as dry as the proverbial toast. Far from it as our federal government is not necessarily omniscient and omnipresent. To comprehend the limits of federal judicial power one must explore the nature of both federal question and diversity of citizenship jurisdiction. I believe the professors expertise in anti-trust law quite naturally led him to consider the legal issues relevant to the exercise of that power by the federal courts. LCDR Jesse H. De Loach {USS Adroit (MSO-509)}. Taught a young naval officer the meaning of eternal vigilance184, loyalty up and loyalty down, and concern for ones men. Four months after my departure, he had a rendezvous along the Mekong Delta [Tran Hung Dao-26]. George Gerson Ingber. My father had an education that included instruction in Latin. He read more books than I can ever hope to read.

5.

184

The lesson came home, unfortunately, once again when CDR Waddle, commanding officer of USS Greeneville (SSN-772), failed to avoid collision with the Japanese M/V Ehime Maru.

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42