Appeal from the United States District Court for the Central District of Illinois, Danville Division. No. 85 C 2431--Harold A. Baker, Judge.
Wood, Jr. and Ripple, Circuit Judges, and Fairchild, Senior Circuit Judge.
FAIRCHILD, Senior Circuit Judge.
For purposes of determining federal estate tax, the Internal Revenue Code allows farms to be valued according to use as farms, rather than at their fair market value, so long as the farm passes to a "qualified heir of the decedent," that is, a member of the decedent's family and, in certain circumstances, a member of the qualified heir's family. 28 U.S.C. § 2032A (1979).*fn1 In order to confine this tax benefit to cases where farm use and family ownership continue for a period of years, § 2032A(c)(1) imposes an additional estate tax (sometimes called a "recapture tax") if, within fifteen years (later changed to ten) and "before the death of the qualified heir," the "qualified heir" disposes of an interest other than to a member of his or her family, or ceases to use the property as a farm.
In this case, an executor elected special use valuation, but the Internal Revenue Service, relying on a Treasury Regulation interpreting the statute, rejected the election. The estate paid the additional tax assessed, and filed suit in district court seeking a refund. The district court held the Treasury Regulation unreasonable in light of Congressional intent, and ordered the IRS to refund $46,638.28, including interest. The IRS appeals.*fn2
The decedent, Ruth M. Smoot, died on November 19, 1980. She was survived by her husband, Laverne Smoot, who was then sixty-seven years old, and by three sons and four grandchildren. At the time she died, Mrs. Smoot owned interests in four tracts of farmland located in Vermilion County, Illinois. Mrs. Smoot devised her real estate to Mr. Smoot during his life, with power to appoint by his will to anyone except himself, his estate, or his creditors. If Mr. Smoot does not exercise his power, the remainder will be divided among Mrs. Smoot's then surviving children and descendants of any deceased children. If no descendant of hers survives Mr. Smoot, one half will be distributed among Mr. Smoot's heirs and one half among hers, the heirs being determined as of that time. Thus, it is possible that Mr. Smoot could die within fifteen years of Mrs. Smoot's death, having exercised his power of appointment in favor of persons who were not members of the family of either Mr. or Mrs. Smoot.
Mr. Smoot, as executor, claimed a special use valuation for the farmland on the estate's tax return. The IRS disallowed special use valuation because Mrs. Smoot's will, as written, left two possibilities that the farmland would pass out of her family members' hands within fifteen years of her death. This could happen if Mr. Smoot dies within fifteen years and (1) exercises his testamentary power in favor of a nonfamily member, or (2) does not exercise the power and none of Mrs. Smoot's descendants survive Mr. Smoot, since the remainder interest will pass under the will to persons who might not be qualified heirs (family members) under § 2032A(e) (1979). The IRS argued that special use valuation was not available because both possibilities violated a Treasury Regulation requiring that where the decedent had created successive interests, all such interests must be received by qualified heirs. 20 C.F.R. § 20.2032A-8(a)(2).
The district court first held that because the probability was so minuscule that, within fifteen years of Mrs. Smoot's death, part of the farmland would pass to non-qualified heirs by way of the will's default clause,*fn3 it was not a reasonable basis for denying special use valuation. The IRS does not challenge this ruling on appeal.
The IRS also defended its denial of special use valuation based on the portion of Treasury Regulation § 20.2032A-8(a)(2) which says that remainder interests of qualified heirs which are subject to divestment in favor of non-qualified heirs are not treated as being received by qualified heirs. Since the remainder interests left to Mrs. Smoot's descendants are subject to divestment by Mr. Smoot's power of appointment, the farmland does not meet the regulation's requirement that all successive interests be received by "qualified heirs." The IRS argued that because Mr. Smoot might appoint a non-qualified heir within fifteen years of Mrs. Smoot's death, the regulation reasonably advanced the purposes of § 2032A by denying special use elections when such a possibility exists.
The district court decided that Congress intended a "wait and see" approach to the situation presented by Mrs. Smoot's will, instead of denying the special use valuation based on a contingency:
Given the legislative history indicating a Congressional intent to aid family operated farms and the specific inclusion of a recapture provision, the court believes that Congress intended that special use valuation be allowed as long as the property of the deceased remains in the hands of a qualified heir. Only when the property passes to a nonqualified heir should the IRS exercise its power granted under the recapture agreement in order to collect the additional tax from a qualified heir.
Laverne Smoot, Executor v. United States, 88-1 U.S.T.C. para. 13,748, 1987 WL 49387 (C.D.Ill. 1987). The ...