United States District Court, Central District of Illinois, Rock Island Division
September 14, 1983
MERLE SCHUNEMAN AND ROBERT DOTY, TRUSTEES UNDER TRUST AGREEMENT DATED APRIL 10, 1977 WITH KATHRYN M. KEEFE, AS SETTLOR, PLAINTIFFS,
UNITED STATES OF AMERICA, DEFENDANT.
The opinion of the court was delivered by: Mihm, District Judge.
Plaintiffs Merle Schuneman and Robert Doty, as trustees
under a trust agreement of which Kathryn M. Keefe was settlor,
have brought this action to recover certain estate taxes paid
in connection with the estate of the decedent, Kathryn M.
Keefe. The Plaintiffs were assessed and paid (1) $144,892.36
in taxes and interest based on a denial of the special use
valuation for certain farm land of the estate and (2)
$37,930.48 based on the disallowance of the state tax credit.
Plaintiffs allege that (1) the IRS erroneously held that the
decedent's estate did not qualify for special use valuation
under § 2032A of the Internal Revenue Code; and (2) the IRS
erroneously disallowed a credit for the state death taxes paid
by the estate. (The United States has conceded that Plaintiffs
were entitled to a credit for this sum but refuses to refund
the $8,028.48 of assessed interest paid by the Plaintiffs on
The case is before the Court on cross motions for summary
A discussion of the facts will help clarify the situation
involved in this case. Most of the farm land in question had
been in the Keefe family since 1895. During the period 1895
through 1956, the farm was operated by Kathryn's parents and
following their death, by Kathryn and her brothers. Two of her
brothers predeceased her and Kathryn inherited their portion
of the farm land. Later, she acquired forty additional acres
from another source, bringing her total farm ownership to 330
During the years 1956 through 1968, Kathryn resided on the
farm and operated the farm land, hiring neighboring farmers to
use their machinery to plant and harvest the crops. In 1969,
Kathryn first entered into an oral crop-share-lease
arrangement with a neighboring farmer, Arthur Wetzell, and
continued this arrangement through 1975. Under the terms of
the crop share arrangement, Kathryn reserved the right to
decide what crops were to be planted, the number of acres
which would be planted in each crop, and the crop rotation
practices which would be used. Each winter Mr. Wetzell would
present a proposed crop plan showing the amount and location
of each crop for the coming year. During each year of the crop
share arrangement Kathryn, in consultation with Mr. Wetzell,
decided which crops would be planted and the number and the
location of the acres which would be planted in each crop.
Under the crop share arrangement, Kathryn paid 50% of the
production costs, including fertilizer, seed, and supplies and
100% of the utilities. Kathryn participated with Mr. Wetzell
in making decisions concerning the extent to which the farm
operation should participate in programs implemented by the
United States Department of Agriculture. In August, 1975,
Kathryn took out a personal liability insurance policy for the
farm operations in which she designated herself as operator
and not simply as landlord. During the planting and harvesting
season, consultations between Kathryn and Mr. Wetzell
generally occurred two or three times a week and during the
remainder of the year, generally at least once a week.
In 1976, Kathryn entered into a written lease with Mr.
Wetzell for the subject farm land. Under the terms of this
lease agreement, the tenant, Mr. Wetzell, was to pay Kathryn
cash rent in the amount of $26,240 and Kathryn was not to
participate in the operation of the farm as she had under the
previous arrangement with Mr. Wetzell. A similar agreement was
negotiated in 1977; however, this arrangement did provide that
if, at the time of harvest, the gross income derivable to Mr.
Wetzell was shown to be less than the average production of 70
bushels per acre times a price of $2.25 per bushel, then the
annual rent would be adjusted to $26,080 from the $32,600
which the 1977 lease stated as rent.
On April 23, 1977, Kathryn died and the trustees filed the
federal estate tax return. The trustees valued the farm land
on the estate tax return at its special use value under § 2032A
of the Code. Upon audit of
the return, however, the Defendant denied the estate's
election of special use valuation and determined that the real
estate did not qualify for special use valuation under § 2032A
because the Defendant determined that the real estate was not
being used for a qualified use on the date of the decedent's
death. The Defendant also disallowed the state death tax credit
in the amount of $29,902.
Later the Defendant conceded that the trustees were entitled
to a credit for the state death taxes under § 2011 of the Code.
However, the Defendant denied a refund or credit for the
$8,028.48 of assessed interest with respect to the additional
estate tax paid because of the Defendant's disallowance of the
state death tax credit.
It is with this background that the Court must examine the
26 U.S.C. § 2032A
The Plaintiffs have raised three issues with regard to §
(1) Whether § 2032A, as enacted by the 1976 Act, required the
decedent to use the farm land for a qualified use at the time
of her death;
(2) Whether § 2032A, as amended by the Economic Recovery Tax
Act (ERTA) of 1981, required the decedent to use the farm land
for a qualified use at the time of her death; and
(3) If the amendments made by the 1981 Act change the
requirements of the 1976 Act, is it a violation of due process
to apply them retroactively.
Under § 2032A the executor of an estate may elect to value
certain property based on its actual use rather than its
"highest and best use" as is typically done. However, to
qualify under § 2032A a number of requirements must be
satisfied. The portion of § 2032A as provided in the 1976 Act
which is relevant to this case provided:
"For purposes of this section, the term
`qualified real property' means real property
located in the United States which was acquired
from or passed from the decedent to a qualified
heir of the decedent and which, on the date of
the decedent's death, was being used for a
qualified use . . ."
Plaintiffs argue that this portion of § 2032A simply required
that the real property be used for a qualified use. According
to Plaintiffs, the qualified use test could be satisfied by
anyone using the property for a qualified use.
On the other hand, the Government argues that the
Plaintiffs' interpretation of the statute is incorrect and
that § 2032A required that the decedent be using the property
for a qualified use at the time of death.
Plaintiffs' argument focuses on two areas. First, the
absence of the words "by the decedent" following ". . . was
being used for a qualified use . . ." in the section. Their
argument is simply that, if Congress had intended that only a
qualified use by the decedent would satisfy the requirement,
they would have added those words to the section. They then go
on to cite other portions of § 2032A where these words were
added, thereby limiting the requirement to a specific person
(See § 2032A(b)(1)(A)(ii), § 2032A(b)(1)(C)(i) and (ii)).
However, these provisions do not provide the necessary
guidance. Each of the provisions would be meaningless without
the proviso "by the decedent or a member of the decedent's
family". Accordingly, an examination of these sections is not
The more useful inquiry is Plaintiffs' second area of focus,
namely, the legislative history. However, a review of the
legislative history and the treasury regulations, are not as
supportive of Plaintiffs' position as they argue.
The earliest version of § 2032A was promulgated in the Senate
Finance Committee and was basically a land use provision. That
is, the Committee felt that land used for farming, woodlands,
scenic or historic purposes should not be valued at its
"highest and best use" but at its value as actually used. The
Plaintiffs rely on the Committee
report to support their argument that the Committee was
concerned only with the use of the property and not the use of
the property by the decedent.
While it is true that the report dwells primarily on the use
of the land, there is a sentence dealing with the
beneficiary's use of the property which contradicts
Plaintiffs' position. The report states that:
"It would be a windfall to the beneficiaries of
an estate to allow such a property to be valued
for estate tax purposes at a value other than its
highest and best use value unless the
beneficiaries continue to use the property for a
reasonable period as the decedent did before
death." (emphasis added).
Clearly the Committee assumed that it would be the decedent
who was "using" the property for a qualified use and that the
beneficiary must continue that use.
Nevertheless, § 2032A, as passed, was not in the same form as
the Committee version. Shortly after the Committee's version
was presented, the House developed a similar § 2032A. The House
version differed from the Senate's in that it limited the
"qualified use" definition and added the "material
participation" requirement. The Joint Conference Committee
considered the only significant difference in the two versions
to be the limited definition of "qualified use". Based on the
Joint Committee's report of what the difference in the versions
was, Plaintiffs argue that the section as then passed adopted
the Senate's position, namely a focus on use rather than who
was using the property. However, as noted above, Plaintiffs'
interpretation of the Senate's version is not fully supported
in the Senate Finance Committee report.
House Report No. 94-1380, U.S.Code Cong. & Admin.News 1976,
p. 2897 is the report which discussed the text of § 2032A as it
was finally adopted. This report, in discussing the qualified
use requirement, stated that "there must be a trade or business
use. The mere passive rental of property will not qualify".
The Court finds that § 2032A, as passed in 1976, required the
decedent to be "using" the property at the time of death.
Because it is the decedent's estate which would benefit from
the special use valuation, it is logical that the section would
so require. To rule otherwise, would allow a decedent's estate
to elect the special use valuation for land to which he no
longer had any involvement, except as owner.
The Plaintiffs argue that it was the material participation
requirement that was intended to involve the decedent in the
operation of the farm or other business, not the qualified use
requirement. The material participation requirement requires
that the decedent or a member of the decedent's family
materially participate in the operation of the farm or other
business in five of the eight years preceding decedent's
death. While both requirements insure that the decedent (or a
member of his family in the case of material participation) is
connected with the property, they are separate requirements.
This can be illustrated by a simple example. Suppose the
decedent owned property which he farmed himself in years one
through five. Then, in years six and seven, he leased the farm
to his son, who farmed the land, on strictly a cash-rent
basis. If the decedent died at the end of the seventh year, he
would have satisfied the material participation requirement
because he or a member of his family materially participated
in the operation of the farm in all seven years. However, the
qualified use requirement would be satisfied only in years one
through five when the decedent was "using" the property. In
years six and seven, the qualified use requirement would not
be fulfilled because the decedent was involved in the "mere
passive rental" of the property. It was the son who was using
This interpretation is supported in both the House and
Senate reports discussing the amendments added by the ERTA of
1981. Those amendments, relevant here, changed § 2032A(b)(1) to
"For purposes of this section, the term
`qualified real property' means real property
located in the United States which
was acquired from or passed from the decedent to
a qualified heir of the decedent and which, on
the date of the decedent's death, was being used
for a qualified use by the decedent or a member of
the decedent's family . . ." (emphasis added).
Both reports state that the amendments made numerous
technical changes in the current use valuation provision. The
reports explain the reason for the change as follows:
"When real property is actually used for farming
purposes or in other closely held businesses by
members of a family (both before and after the
death of the owner of the property), the
committee believes that it is inappropriate to
value the property for estate tax purposes based
on a market value that does not reflect its value
in its current use."
The House report goes on to state:
"To facilitate the orderly transfer of
responsibility for farming operations before
death, the bill provides that the qualified use
requirement of present law, applicable to periods
on and before the date of the decedent's death
(§ 2032A(b)(1)), may be satisfied if either the
decedent or a member of the decedent's family uses
real property otherwise eligible for current use
valuation as a farm for farming purposes, in a
timber operation, or in another trade of business.
As stated above, the bill does not change the
present law requirements that this use be an active
trade or business use as opposed to a passive, or
The Senate report gives the following example for the
qualified use requirement:
". . . if a decedent has leased otherwise
qualified real property to a son pursuant to a
net cash lease, and the son conducts a farming
operation on the property, the son's business use
is attributed under the bill to the decedent for
purposes of satisfying the qualified use
requirement (§ 2032A(b)(1)). On the other hand,
during any period when the decedent leases the real
property to a non family member for use in a
qualified use pursuant to a lease under which the
rental is not substantially dependent upon
production, the qualified use requirement is not
These reports and examples therein indicate that both the
House and Senate felt that the addition of "by the decedent or
a member of the decedent's family" in § 2032A was intended to
broaden the application of the section rather than narrow it.
Congress was attempting to make clear that the use, at the time
of death, did not have to be performed by the decedent so long
as it was performed by a member of the decedent's family.
Accordingly, in the example on page 8 of this Order, the
decedent's estate would be entitled to the special use
valuation under the 1981 amendments (assuming the property was
otherwise eligible) since the decedent's son was using the
land for farming purposes.
Based on the foregoing analysis, it is the Court's ruling
that the decedent, Kathryn Keefe, or a member of her family,
must have been using the property at the time of her death.
Under the facts of this case, it is undisputed that the
decedent had leased the farm to Arthur Wetzell in 1976 and
1977. Mr. Wetzell was to pay cash rent of $26,240 under the
1976 lease and $32,600 under the 1977 lease; however, the 1977
lease also contained a provision whereby the rent would be
reduced to $26,080 if a certain income level was not realized.
While there are no issues of fact with regard to the terms of
the 1977 lease, the Court will reserve ruling on whether the
1977 lease is "substantially based on production".
In addition, there may be disputed issues of fact relevant to
the decedent's participation in the operation of the farm. If
it can be shown that the decedent did materially participate in
the operation of the farm in 1977, then she would be considered
as having "used" the property in that year, regardless of
whether the lease was substantially based on production.
Accordingly, the Court is not in a position to
rule on this portion of the summary judgment motions at this
Based on the previous finding that Kathryn had to be using
the property under either the 1976 Act or the 1981 Amendment,
the retroactive effect of the 1981 amendments, as raised in
Part VI of Plaintiff's memorandum in support of their motion
for summary judgment, is not relevant and need not be decided.
State Death Tax Credit
The final issue that must be discussed is whether Plaintiffs
are entitled to the interest assessed and paid in connection
with the state death tax credit. The Defendant argues that
§ 2011(c) of the Code prohibits the payment of any interest on
a refund for state death tax credit. The section provides in
"The credit allowed by this section shall include
only such taxes as were actually paid and credit
therefor claimed . . .
Refund based on the credit [for state death taxes
actually paid] may (despite the provisions of
sections 6511 and 6512) be made if claim therefor
is filed within the period above provided. Any
such refund shall be made without interest."
The Defendant seeks to apply § 2011(c) too broadly.
Undoubtedly, the statute was designed to prohibit interest
being paid on the tax that was to be refunded. The case cited
by Defendant, Edinburg v. U.S., 617 F.2d 206 (Ct.Cl. 1980), did
state that any refund that was "based upon" the credit to which
the estate was entitled for death taxes paid, would be made
without interest. However, later in the opinion the Court
concluded that the assessed interest paid by taxpayers on a tax
deficiency was part of the tax. (See Edinburg, at 210-211;
26 U.S.C. § 6601(e)(1) [Interest Treated as Tax]). As a result, §
2011(c) which prohibits interest on a refund based on the
credit, does not apply. Here the assessed interest paid by the
estate was part of the credit and should be refunded.
The Court's ruling may be summarized as follows:
(1) Under the 1976 Act, § 2032A required the
decedent to be using the property at the time
(2) The 1981 Amendments expanded § 2032A by
allowing the decedent or a member of the
decedent's family to be using the property at
the time of death.
(3) In this case, the decedent would be
considered as using the property at the time of
her death, if:
a) The 1977 lease was substantially based on
b) The decedent materially participated in the
operation of the farm.
(4) The Plaintiffs are entitled to a refund of
the assessed interest ($8,028.48) paid by
Plaintiffs in connection with the state death
IT IS ORDERED that:
(1) The Plaintiff's Motion for Summary Judgment
is DENIED in part and GRANTED in part.
(2) The Defendant's Motion for Summary Judgment
is DENIED in part and GRANTED in part.
(3) The issue of whether the decedent was using
the property at the time of her death is taken
(4) Plaintiffs be refunded the assessed interest
of $8,028.48 which they paid in connection with
the state death tax credit.
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