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Estate of Arthur S. Kraus v. Commissioner of Internal Revenue

decided: May 22, 1989.


On Appeal from the United States Tax Court, No. 45576-85 -- Mary Ann Cohen, Judge.

Wood, Jr., Coffey, and Kanne, Circuit Judges.

Author: Wood

WOOD, JR., Circuit Judge.

After disallowing a marital deduction under section 2056 of the Internal Revenue Code of 1954 (as amended prior to decedent's death), the Commissioner of Internal Revenue (Commissioner) increased by $152,279.37 the estate tax assessment against the Estate of Arthur S. Kraus (Estate).*fn1 The Estate petitioned the Tax Court for review of the assessment and after trial the Tax Court upheld the deficiency determination. The Estate then moved for reconsideration based on newly discovered evidence. Tax Ct.R. 161. The Tax Court denied the motion. We affirm the Tax Court's ruling on the assessment, reverse the Tax Court's denial of the motion for reconsideration, and remand the case for reevaluation in light of the newly discovered evidence.


Arthur S. Kraus, a certified public accountant, created the Arthur Kraus Insurance Trust in 1970. The insurance trust provided for the creation of a marital trust fund upon Arthur's death. As created, the terms of the marital trust satisfied the requirements of section 2056 and would have entitled the Estate to a marital deduction after Arthur's death. However, Arthur amended the insurance trust on June 6, 1977. Certain changes wrought by the Estate and Gift Tax Reform Act of 1976*fn2 were the catalysts for the amendment. The 1977 amendment failed to provide Arthur's surviving spouse a general power of appointment over the marital trust. Without the general power of appointment, the Estate is not entitled to a marital deduction. Arthur made no further changes to the insurance trust before his death on October 17, 1981.

Based on the failure of the amended trust to provide Arthur's surviving spouse with a general power of appointment, the Commissioner disallowed the Estate's claimed marital deduction and on October 11, 1985, increased by $152,279.37 the estate tax assessment against the Estate. Contending that the general power contained in the original trust was unintentionally converted to a limited power as a result of a scrivener's error in the 1977 amendment, the Estate petitioned the chancery division of the Cook County Circuit Court for reformation of the amended trust on October 18, 1985. The Estate argued that based on changes effected by the Tax Reform Act of 1976, Michael Rotman, the attorney who drafted the initial trust, sent letters to all of his clients, including Arthur Kraus, and suggested amendments to their trusts. Altering the power of appointment was not one of the suggested changes. Attorney Rotman, who prepared the amendment, provided an affidavit to the Illinois court stating that the error in the appointment clause resulted from the inadvertent omission of certain key words when the amendment was transcribed from a standard form to his word processor.*fn3 Rotman was Arthur's cousin and is an experienced tax attorney. He worked for the Internal Revenue Service from 1962 to 1965 and then entered private practice. Since 1965, he has concentrated his practice in estate planning and probate matters. On December 3, 1985, the Illinois court accepted the Estate's evidence and reformed the amended trust to grant Arthur's surviving spouse a general power of appointment.

After the Commissioner refused to withdraw the $152,279.37 assessment, the Estate petitioned the Tax Court to review the Commissioner's assessment. The Tax Court judge heard testimony, reviewed documentary evidence, and upheld the assessment. Among its many findings, the Tax Court found that Arthur Kraus "was aware of the language required to provide for a general power of appointment to qualify under section 2056," the Illinois court's order was not binding for federal tax purposes, the amended trust not only omitted language necessary to create a general power but also included language necessary to create a special power, and the Estate provided no evidence "to corroborate any of Rotman's testimony." The Tax Court upheld the deficiency assessment.

The Estate, in its motion for reconsideration, alleged that it had newly discovered evidence that would corroborate Rotman's testimony. Rotman had testified that the error contained in the 1977 amendment was also reflected in several other trusts amended during the same time frame. Rotman's excuse for failing to produce any of the other documents during trial was that when he discovered the error, he corrected the trusts and then destroyed the erroneous amendments to avoid confusion. In his affidavit supporting the Estate's motion for reconsideration, Rotman alleges that he diligently searched his files prior to trial but was unable to find other trusts with similar errors. Only after trial when he was working on an unrelated matter did he find another trust with the same error. Rotman claims that this erroneous trust was not destroyed and had not been found previously because it had been misfiled. The Commissioner opposed the Estate's motion for reconsideration and the Tax Court denied the motion. The Estate appeals the deficiency assessment and the Tax Court's denial of the motion for reconsideration.


A. Deficiency Assessment

1. Standard of Review

We review the Tax Court's findings of fact and application of law to the facts using a "clearly erroneous" standard of review. See Yosha v. Commissioner, 861 F.2d 494, 499 (7th Cir. 1988); Eli Lilly & Co. v. Commissioner, 856 F.2d 855, 861 (7th Cir. 1988); Levin v. Commissioner, 832 F.2d 403, 405 (7th Cir. 1987); Standard Office Bldg. Corp. v. United States, 819 F.2d 1371, 1373-74 (7th Cir. 1987); Wright v. United States, 809 F.2d 425, 428 (7th Cir. 1987); Illinois Power Co. v. Commissioner, 792 F.2d 683, 685, 687 (7th Cir. 1986); Mucha v. King, 792 F.2d 602, 604-06 (7th Cir. 1986). For the reasons stated in Mucha, 792 F.2d at 604-06, and subsequent cases, we reject the taxpayer's argument that we should employ a de novo standard when we review the Tax Court's application of law to the facts. But cf. Walter v. Commissioner, 753 F.2d 35, 38 (6th Cir. 1985); Manocchio v. Commissioner, 710 F.2d 1400, 1402 (9th Cir. 1983). The overwhelming authority of Mucha and its progeny mandates use of the "clearly erroneous" standard in the Seventh Circuit. Under this standard, we first review the Tax Court's choice of applicable law de novo and then, in light of the evidence admitted, we determine whether the result reached was clearly erroneous.

The taxpayer argues that there are two methods of employing the clearly erroneous standard -- broad and narrow. Under the broad method, appellate courts show little deference to district court findings of fact that are based only on undisputed testimony or documentary evidence. See, e.g., Flowers v. Crouch-Walker Corp., 552 F.2d 1277 (7th Cir. 1977); Wigginton v. Order of United Commercial Travelers of Am., 126 F.2d 659 (7th Cir.), cert. denied, 317 U.S. 636, 87 L. Ed. 513, 63 S. Ct. 28 (1942); see also Orvis v. Higgins, 180 F.2d 537 (2d Cir.), cert. denied, 340 U.S. 810, 95 L. Ed. 595, 71 S. Ct. 37 (1950). The rationale for broad review is that appellate courts sit in just as good a position as trial courts when it comes to evaluating uncontradicted evidence. Flowers, 557 F.2d at 1284; Orvis, 180 F.2d at 539. Findings based on disputed evidence or involving credibility determinations, on the other hand, necessitate more deference to the trial court and appellate courts thus review these findings more narrowly. Orvis, 180 F.2d at 539-40. The taxpayer argues that we should employ the broad method of review. The Supreme Court expressly rejected varying methods of clearly erroneous review in Anderson v. City of Bessemer, 470 U.S. 564, 84 L. Ed. 2d 518, 105 S. Ct. 1504 (1985). See also Eli Lilly, 856 F.2d at 861; Ginsu Prod., Inc. v. Dart Indus., Inc., 786 F.2d 260, 262-64 (7th Cir. 1986). The Supreme Court held that there was no principled ...

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