Estate of Bracken v. State

175 Wash.2d 549

290 P.3d 99

In the Matter of the Estate of Sharon M. Bracken,

Carol B. CLEMENCY, Laura B. Clough, and John L. Bracken, Personal Representatives of the Estate of Sharon M. Bracken, Appellants,

v.STATE of Washington, Department of Revenue, Respondent.

In the Matter of the Estate of Barbara J. Nelson,

William C. Nelson, Brian S. Nelson and Janet McCann, Personal Representatives of the Estate of Barbara J. Nelson, Appellants,

v.State of Washington, Department of Revenue, Respondent.

In the Matter of the Estate of John T. Toland,

Nancy Toland Richards and Catherine Toland Lile, Personal Representatives of the Estate of John T. Toland, Appellants,

v.State of Washington, Department of Revenue, Respondent.

Nos. 84114–4, 85075–5.

Supreme Court of Washington, En Banc.

Argued May 19, 2011.

Decided Oct. 18, 2012.

Douglas C. Lawrence, Scott A.W. Johnson, Rosemary Reed, Stokes Lawrence P.S., Seattle, WA, Rhys Matthew Farren, Malcolm A. Moore, Richard A. Klobucher, Davis Wright Tremaine LLP, Bellevue, WA, Jessica Anne Skelton, Pacifica Law Group LLP, Seattle, WA, Philip Albert Talmadge, Talmadge/Fitzpatrick, Tukwila, WA, Mark Wilcox Roberts, Luke Evan Thomas, K & L Gates LLP, for Appellants.

David M. Hankins, Donald F. Cofer, Office of the Attorney General, Charles E. Zalesky, Attorney General of Washington, Olympia, WA, for Respondent.

Mark Wilcox Roberts, K & L Gates LLP, Seattle, WA, Taki V. Flevaris, Washington State Supreme Court, Olympia, WA, for Amicus

Curiae on behalf of Estate of Barbara Hagyard Mesdag.

SIDDOWAY, J.^*

[175 Wash.2d 553]¶ 1 The Estates of Barbara J. Nelson and Sharon M. Bracken (the Estates) challenge the efforts of the Washington State Department of Revenue (DOR) to treat them as having engaged in a present taxable transfer of assets that were actually transferred years ago by Ms. Nelson's and Ms. Bracken's late husbands' estates. As authority for finding and taxing fictional present transfers, DOR relies on the legislature's adoption in 2005 of definitions from the federal estate tax regime. For federal estate tax purposes, the United States Treasury's authority to presently tax fictional transfers by the wives' estates of what is referred to as “qualified terminable interest property” (QTIP) was based on earlier consent to federal tax deferral and is clear.

¶ 2 We hold that DOR exceeded its authority in enacting regulations that allow it to treat transfers completed by William Nelson and Jim Bracken years ago as if the estates had elected to defer state estate tax on the transfers, to be paid by their wives' estates. DOR stands on a different footing than the United States Treasury. The treasury can rely on Congress's enactment, in advance, of a taxation choice and the predecessor Nelson and Bracken estates' informed and affirmative election to defer federal taxation. DOR must rely on the asserted authority of our legislature to tax transfers years after the fact absent any deferral agreement by the taxpayer. We reject DOR's interpretation of chapter 83.100 RCW and reverse the trial court. Summary judgment should be entered in favor of the Estates.

FACTS AND PROCEDURAL BACKGROUND

¶ 3 The complication for Washington estate tax collections that gives rise to these cases has its genesis in the coupling and later decoupling of federal and state estate taxes. To explain the effect of the taxation changes, we begin with the estates of Ms. Nelson's and Ms. Bracken's late husbands, William Nelson and Jim Bracken.

Creation of “QTIP” by the William Nelson and Jim Bracken Estates

¶ 4 Jim Bracken died a Washington resident in 1984. William Nelson died a Washington resident in 2004. At the time they died, federal tax law allowed their estates an unlimited marital deduction for property passed outright to a surviving spouse or in certain other ways giving the surviving spouse control over the transferred property. Federal law had also been liberalized by the Economic Recovery Tax Act of 1981 (ERTA), Pub.L. No. 97–34, 95 Stat. 172, to permit certain transfers of “terminable interests” to qualify for the marital deduction. See H.R.Rep. No. 97–201, at 263 (1981), reprinted in 1981–2 C.B. 352. For federal estate tax purposes, “terminable interests” are interests such as life estates that will terminate or fail on the lapse of time, on the occurrence of an event or contingency, or on the failure of an event or contingency to occur. SeeI.R.C. § 2056(b)(1).

¶ 5 For the most part, terminable interests are not eligible for the marital deduction. Id. But in ERTA, Congress saw it as desirable to allow estate plans that provide for the lifetime needs of a surviving spouse and ensure that whatever property remaining will pass to the first spouse's children to claim the marital deduction. It recognized that

unless certain interests which do not grant the spouse total control are eligible for the unlimited marital deduction, a decedent would be forced to choose between surrendering control of the entire estate to avoid imposition of estate tax at his death or reducing his tax benefits at his death to insure inheritance by the children.

H.R.Rep. No. 97–201, at 160. Congress created QTIP as an interest that could be transferred tax free without granting the surviving spouse total control. As further explained in the house report, if certain conditions are met, a life interest granted to the surviving spouse will not be treated as a terminable interest. The entire property subject to such interest will be treated as passing to such spouse and no interest in such property will be considered to pass to any person other than the spouse. Accordingly, the entire interest will qualify for marital deduction.

Id. at 161.

[175 Wash.2d 556]¶ 6 Advantages of the QTIP option are many. The spouse who dies first controls the final disposition of the property, while allowing the surviving spouse to use the property or receive the income it generates, unreduced by front-end estate taxation. The personal representative of the first spouse elects whether to treat the property as QTIP and claim the marital deduction, thereby maximizing flexibility. If the QTIP election is made, the transfer of the property is not taxed in the estate of the first spouse even though it is he or she who makes the actual transfer. But the statutorily required quid pro quo is that the property is deemed for federal estate tax purposes to have been transferred to the surviving spouse at the first spouse's death and is deemed to be transferred to the residuary beneficiaries from the surviving spouse upon the surviving spouse's later death. The result is to draw the property into the estate of the surviving spouse; in this way, the estate of the first spouse gets a full marital deduction, yet the property does not escape ultimate taxation.

¶ 7 Mr. Bracken and Mr. Nelson established marital trusts in their wills, naming their wives as lifetime beneficiaries. The estates made the elections required to qualify the trusts as QTIP trusts for the federal estate tax marital deduction under I.R.C. § 2056(b)(7). They claimed corresponding marital deductions for the QTIP included in the trusts.

¶ 8 No election was made to qualify Jim Bracken's or William Nelson's QTIP trusts for a Washington marital deduction and state tax deferral. No such election or deduction existed under state estate tax law in 1984 or 2004. Between 1981 and 2004, Washington imposed an estate tax in the amount of federal estate tax that the treasury would share with a state through a credit claimed on a decedent's federal estate tax return. State estate taxes taking advantage of this federal tax sharing were called “pickup” taxes. Some history on the pickup tax will help explain later developments.

[175 Wash.2d 557]¶ 9 In the 1920s, the states, which had historically been more dependent on death taxes ¹ for their revenue needs than had the federal government, became engaged in a “race to the bottom” after Florida abolished its death tax. Florida reasoned that other state revenues derived from attracting wealthy Americans to live out their retirement years in Florida would more than offset lost death taxes. As Alabama followed suit and more states were forced to consider eliminating death taxes in order to compete for wealthy residents, the national solution arrived at was for states to set aside their historical objection to federal death taxes in exchange for the federal government becoming the principal death tax collector and sharing a generous percentage of the amount collected. Sharing was accomplished through a federally set credit for state death taxes. The states could share the federally collected taxes or not; if they did not, the taxes stayed with the federal government. With states able to opt into a credit that was pain-free to their residents, the change had the intended effect of eliminating state tax competition. Even Florida, after unsuccessfully challenging the federal tax, adopted its own pickup tax rather than pass up the generous credit. See Jeffrey A. Cooper, Interstate Competition and State Death Taxes: A Modern Crisis in Historical Perspective, 33 Pepp. L.Rev. 835 (2006).

¶ 10 At the time of Mr. Bracken's and Mr. Nelson's deaths, Washington relied on a pickup tax (or, as discussed below, a tax designed to mirror a pickup tax) codified at chapter 83.100 RCW. Again, at the time of the deaths of Mr. Bracken and Mr. Nelson, Washington law made no provision for a QTIP or other election to defer state estate taxes.

Enactment of EGTRRA and the Washington Response

¶ 11 In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), Pub.L. No. 107–16, 115 Stat. 38, providing for the gradual elimination of federal estate taxes between 2001 and 2010 and for their return in 2011. EGTRRA also provided for the elimination of the state death tax credit over a period of four years. As the state death tax credit was eliminated, so too was the state...