Estate of William J. Thomas v. Commissioner of Revenue (November 8, 2002)

COMMONWEALTH OF MASSACHUSETTS
APPELLATE TAX BOARD

ESTATE OF WILLIAM J. THOMAS	v.    COMMISSIONER OF REVENUE



Docket No. C258512				 Promulgated:
							 November 8, 2002 
                   

	This is an appeal filed under the formal procedure pursuant to G.L. c. 62C, § 39 from the refusal of the Commissioner of Revenue to abate an estate tax.
	Commissioner Scharaffa heard the appeal and was joined in the decision for the appellee by Chairman Burns and Commissioners Gorton and Egan.
These Findings of Fact and Report are made pursuant to a request by the appellant under G.L. c. 58A, § 13 and 831 CMR 1.32.

Jeffrey B. Loeb, Esq. and Daniel W. Doherty, Esq., for the appellant.
Thomas J. Nicholas, Esq., for the appellee.


FINDINGS OF FACT AND REPORT
On August 21, 1989, William J. Thomas (the "decedent") assigned, without consideration, his ownership interest in a renewable term life insurance policy on his life (the "Policy") to his daughter, Shay Thomas.  The decedent originally purchased the Policy on May 11, 1983.  The Policy was renewable annually upon payment of the agreed-upon premium.  The face value of the Policy was $750,000.  
The decedent first tested positive for Human Immunodeficiency Virus ("HIV") in 1984 and was later diagnosed with Acquired Immune Deficiency Syndrome ("AIDS") in mid-1985.  On November 1, 1989, approximately one month after he transferred the Policy to his daughter, the decedent was admitted to the hospital for complications related to AIDS, including severe weight loss of between 45 and 50 pounds during the prior five months.  In the hospital discharge summary, it was noted that the decedent's course with AIDS was "complicated" but that he had done well "until 5/89."  The decedent died from complications of AIDS on July 18, 1990.
On or about April 17, 1991, the decedent's estate ("the appellant") filed a Massachusetts Estate Tax Return and reported a Massachusetts taxable estate of $317,929.45 and an estate tax liability of $37,004.00.  The return disclosed the existence of the $750,000 term life insurance Policy as a transfer made within three years of the date of death.  The appellant did not, however, include the Policy proceeds in the decedent's Massachusetts gross estate on the grounds that the value of the Policy was less than $10,000 at the time of the transfer and therefore it was not required to include the proceeds in the Massachusetts gross estate.  
On February 16, 1994, subsequent to a review of the return by the Estate Tax Unit, the Commissioner of Revenue ("Commissioner") issued a Notice of Intention to Assess ("NIA") additional estate tax attributable to inclusion of the Policy proceeds in the decedent's Massachusetts gross estate.  Upon receipt of the NIA, the appellant requested a hearing at the Appeal and Review Bureau ("the Bureau").  After the hearing, the Bureau concluded that the fair market value of the Policy was greater than $10,000 at the time of the transfer, and, accordingly, the proceeds of the Policy should have been included in the decedent's Massachusetts gross estate. 
On April 6, 1998 the Commissioner issued an Estate Tax Closing Letter/Notice of Assessment in the amount of $179,642.00, $115,010.12 in estate tax and $64,631.88 in interest.  On or about February 28, 1999, the appellant filed an application for abatement.  The Commissioner denied the application for abatement on July 25, 2000, and on September 20, 2000, the appellant timely filed an appeal with this Board.  On the basis of these facts, the Board found that it had jurisdiction over the subject appeal.
The appellant maintained that the Commissioner must value the Policy at its "interpolated terminal reserve" value, based on its reading of Treasury Regulation ("Tres. Reg.") § 25.2512-6(a).  The interpolated terminal reserve value of the Policy at the time of the transfer was $907.  The appellant offered no evidence, beyond its reliance on Tres. Reg. § 25.2512-6(a), to support its contention that the value of the Policy at the time of the gift was equal to the Policy's interpolated terminal reserve value.
For the reasons detailed in the Opinion which follows, the Board ruled that the value of the Policy on the date of transfer to the decedent's daughter must be its fair market.  The fair market value of the Policy, as with other property, is the price at which a willing buyer and a willing seller would agree, both having reasonable knowledge of all relevant facts concerning the property to be valued.  
In the present appeal, the appellant presented no evidence suggesting that the interpolated terminal reserve value carried on the insurance company's books would reflect the amount a willing buyer would pay for the Policy at issue.  Rather, a purchaser of the Policy is presumed to be aware of all relevant facts concerning the Policy being purchased in arriving at a purchase price.  For example, a buyer is presumed to be aware of the donor's grave medical condition and the likelihood that the Policy would mature well in advance of the standard mortality age upon which the reserve is based.  
Further, the interpolated terminal reserve value fails to capture the value of a significant component of the Policy, the right of the owner to renew the Policy upon payment of the annual premium.  Given the state of the decedent's health at the time of the transfer, it is doubtful that he would have qualified for insurance at all, let alone for a policy at the annual premiums agreed to when the Policy was first purchased and the insured was younger and his health was satisfactory.  Ownership of this valuable contract right, at a time when a replacement policy could either not be purchased at all, or could only be purchased at premiums significantly higher than those established on the original purchase of the Policy, is a component of the fair market value of the Policy for which the appellant failed to account.
Accordingly, the Board found that the appellant failed to meet its burden of proving that the value of the Policy was less than $10,000.  The Board therefore issued a decision for the appellee in this appeal.  

OPINION
G.L. c. 65C, § 2, imposes a tax on the transfer of the Massachusetts taxable estate of a deceased resident of the Commonwealth.  Massachusetts taxable estate is defined as the "Massachusetts gross estate", which in turn is based on the "federal gross estate," with certain modifications.  G.L. c. 65C, §§ 1(h) and (f).  One such modification concerns the includability in the gross estate of property transferred within three years of the decedent's date of death.  
Pursuant to the Internal Revenue Code ("Code") § 2035, a decedent's federal gross estate includes the value of property which the decedent transferred during the three years prior to his date of death only if the transfer was made in "contemplation of death."  For Massachusetts estate tax purposes, however, the federal contemplation of death standard was modified for estates of decedents dying on or after January 1, 1986 by St. 1985, c. 711, §§ 5 and 19:
Notwithstanding section two thousand and thirty-five of the Code, the value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer . . . except in case of a bona fide sale for an adequate and full consideration in money or money's worth, by trust or otherwise, during the three year period ending with the date of the decedent's death; provided, however, that the value of such property or interest therein so transferred . . . exceeds ten thousand dollars for any person during a calendar year.

G.L. c. 65C, § (1)(f) (emphasis added).
It is not disputed that the Policy was transferred within three years of the decedent's death; in fact, the decedent died approximately 11 months after the transfer.  It is also not disputed that the relevant value for purposes of determining whether property gifted within three years of death under G.L. c. 65C, § 1(f) is the value as of the date of the transfer, not the value as of the date of the decedent's death, and that if the value of the gifted property exceeds $10,000 at the time of the gift, the date-of-death value of the property is includible in the Estate.  Accordingly, the only issue is whether the Policy was worth less than $10,000 at the time of transfer and therefore excludable from the Massachusetts gross estate. 
A person who claims to be aggrieved by the refusal of the Commissioner to abate a tax in whole or in part "`has the burden of proving as a matter of law [his] right to an abatement.'"  Koch v. Commissioner of Revenue, 416 Mass. 540, 556 (1993) (quoting M&T Charters, Inc. v. Commissioner of Revenue, 404 Mass. 137, 140 (1989)).  Accordingly, the appellant has the burden of proving that the Policy was worth less than $10,000 at the time of the transfer.
Because G.L. c. 65C, § 1 (a) defines the term "Code" to be the Internal Revenue Code as in effect on January 1, 1975, which includes the estate and gift tax provisions of the Code, and because the Policy must be valued as of the date of the decedent's gift of the policy to his daughter (see, e.g., 830 CMR 65C.2.3(d)(3)), Code § 2512 and the Regulations interpreting § 2512 provide guidance on the issue of valuation.  
Code § 2512 provides that gifts of property are to be valued as of "the date of the gift."  Tres. Reg. § 25.2512-1 provides the general rule for determining the value of gifted property:
Section 2512 provides that if a gift is made in property, its value at the date of the gift shall be considered the amount of the gift.  The value of the property is the price at which such property would change hands between a willing buyer and a willing seller neither being under a compulsion to buy or to sell, and both having reasonable knowledge of relevant facts . . . . All relevant facts and elements of value as of the time of the gift shall be considered.

The Internal Revenue Service has also promulgated a regulation concerning the valuation of "certain life insurance" and annuity contracts.  Tres. Reg. § 25.2512-6 provides in pertinent part:
The value of a life insurance contract or of a contract for the payment of an annuity issued by a company regularly engaged in the selling of contracts of that character is established through the sale by the company of similar contracts.  As valuation of an insurance policy through the sale of comparable contracts is not readily ascertainable when the gift is of a contract which has been in force for some time and on which further premium payments are to be made, the value may be approximated by adding to the interpolated terminal reserve at the date of the gift the proportionate part of the gross premium last paid before the date of the gift which covers the period extending beyond that date.  If, however, because of the unusual nature of the contract such approximation is not reasonably close to the full fair value, this method may not be used.

(emphasis added).
The appellant maintains that the interpolated terminal reserve value mentioned in Tres. Reg. § 25.2512-6 is the exclusive method for valuing the Policy at issue in this appeal and that, in effect, the Commissioner must prove that there is some basis for deviating from this valuation method.  Aside from twisting the applicable burden of proof, the appellant's position is flawed in a number of respects.
First, the appellant ignores the fact that § 25.2512-6 provides a valuation method for insurance policies which is entirely consistent with the general valuation principle of "fair market value" contained in Code § 2512 and Tres. Reg. § 25.2512-1.   The primary method suggested by § 25.2512-6 for valuing insurance policies is to determine the cost of purchasing a similar contract, also known as the "replacement cost" for the policy.  See, e.g., Guggenheim v. Rasquin, 312 U.S. 254 (1941).  The Supreme Court, and later the Internal Revenue Service in § 25.2512-6, recognized that the replacement cost of the policy to be valued is an accurate method of valuing the bundle of rights held by the policy owner:
[The] cost of replacement . . . is the best available criterion of the value of the policies for the purposes of the gift tax . . . .  The cost of duplicating the policies at the dates of the gifts is, in absence of more cogent evidence, the one criterion which reflects both their insurance and investment value to the owner at that time.

United States v. Ryerson, 312 U.S. 260, 261 (1941); see also Guggenheim, 312 U.S. at 257. 
The appellant, however, focuses exclusively on the later part of § 25.2512-6 which provides that, for "certain" insurance policies, an adjusted interpolated terminal reserve value "may be" used to "approximate" the value of the policy.  First, it is unclear whether the Policy at issue is one of the "certain" policies referred to in § 25.2512-6.  The Regulation speaks of policies which have been in force for "some time" and for which further premiums are due.  Although it is clear that further premiums were due as of the date of the gift, it is not clear how long the policy must be in force to constitute the "some time" mentioned in the Regulation.
More significantly, however, the language of the Regulation upon which the appellant relies is permissive, rather than mandatory, and seeks only to "approximate" the value of the policy.  In general, the word "may" connotes a permissive, discretionary power or right rather than a mandatory duty.  See, e.g., Commonwealth v. Gordon, 354 Mass. 722, 726 (1968).  Accordingly, the interpolated terminal reserve valuation method outlined in § 25.2512-6 is a permitted, but not the exclusive, method to arrive at the overriding statutory and regulatory goal of determining the fair market value of the property at the time of the gift.
Further, the last sentence of § 25.2512-6 underscores the principle that a fair market valuation of the gifted property, and not a rigid adherence to the interpolated terminal reserve method, is the underlying purpose of the regulation.  The last sentence prohibits the use of the interpolated terminal reserve value where the "unusual nature" of the contract renders an approximation of value using the terminable reserve value "not reasonably close to the full value" of the policy.  Aside from the fact that the appellant offered no evidence concerning whether the Policy at issue was "usual" or "unusual," the fact that the interpolated terminal reserve value may not be used where that value does not approximate full value reinforces the notion that "full" or market value of the policy is the standard to be achieved.  It would be a curious reading of § 25.2512-6 to assume that a Policy which is not "unusual" must be valued at its interpolated terminal reserve value even where that value does not approximate the full value of the Policy.  
The appellant relies on a series of cases involving the simultaneous deaths of insurance policy holders to support its position that the interpolated terminal reserve value must be used to the exclusion of other evidence surrounding the imminent death of the decedent.  See, e.g., Estate of Meltzer v. Commissioner, 439 F.2d 798 (4th Cir. 1971); Estate of Wien v. Commissioner, 441 F.2d 32 (5th Cir. 1971); Old Kent Bank and Trust Company v. U.S., 430 F.2d 392 (6th Cir. 1970); Estate of Chown v. Commissioner, 428 F.2d 1395 (9th Cir. 1970).  However, these cases, which deal with various statutory fictions concerning the passage of property upon the simultaneous deaths of donors and donees, are easily distinguishable.  Consideration of the health of the donor, which is readily determinable as of the date of the transfer of the policy and is a fact of which a reasonable buyer of the policy would be aware, is considerably different than consideration of a fact, a disaster causing the simultaneous deaths of the donor and donee, which can only become known after the transfer takes place and is therefore purely speculative.  
Valuation of a life insurance policy requires that "'[a]ll of the economic benefits of a policy must be taken into consideration in determining its value for gift-tax purposes.  To single out one and to disregard the others is in effect to substitute a different property interest for the one which was the subject of the gift.'"  Wien, 441 F.2d at 37 (quoting Guggenheim v. Rasquin, 312 U.S. 254, 257 (1941)).  Valuation of the Policy at issue without reference to the health, insurability, and age of the donor at the time of the transfer would ignore major components of the Policy's value.  See Pritchard v. Commissioner, 4 T.C. 204, 208 (1941) where the Tax Court ruled:
The question before us is made to seem more complicated because of the several rights which make up the total valuable chose in action evidenced by the policy.  The investment value of life insurance, attaching to the right to hold the policy for its investment qualities, is very greatly affected by the life expectancy of the insured, and the value rises in inverse ratio to the length of that life expectancy.  One of the important elements to be considered in determining a value of a life insurance policy is its collectibility.  The nearer the insured approaches death, which is the event of collectibility, the nearer its value approaches to the face amount for which it was issued.  In the instant case, the insured's health was in a desperate and hopeless, or at least a dangerous, condition, and death was known to be relatively imminent, i.e., his life expectancy was much less than that shown on the mortality tables as the life expectancy of an insurable man of his age.  The investment feature of the policies was, therefore, at that time, their most valuable attribute.

See also, DuPont v. Commissioner, 233 F.2d 210, 213 (3rd Cir 1956)("If the named insured were advanced in years and in precarious health , it might well be that the actual value, as a practical matter, is far more than the cash surrender value"); Lauer, "estate Taxation of Life Insurance Transfers: The Impact of the Tax Reform Act of 1976 Still Ignored Twelve Years Later," Tax Lawyer, Vol. 41 No. 3, n. 42 ("When an individual's life expectancy declines, the policy appreciates for two reasons.  First, the length of time until policy payout decreases.  This raises the present value of that payout.  Second, the remaining premiums to be paid on the policy decline.  This lowers the cost of maintaining the policy to maturity."). 
Moreover, valuation of the Policy at its interpolated terminal reserve value would ignore the significant value component represented by the Policy owner's ability to maintain insurance on the life of an insured under circumstance where it is doubtful that the insured could have qualified for insurance at all, let alone for a policy at the annual premiums agreed to when the Policy was first purchased, he was younger and his health was satisfactory.  See Estate of Cavenaugh v. Commissioner, 51 F.3rd 597, 604, n. 11 (5th Cir. 1995)("To illustrate in the term insurance context, consider a policy 'worthless' as measured by cash surrender or interpolated reserve value.  If the insured could no longer obtain insurance for health or other eligibility reasons, the right to renewal at a set annual premium would suddenly represent considerable value.").
On the basis of the foregoing, the Board ruled that the appellant failed to prove that the interpolated terminal reserve value of the Policy reasonably reflected the fair market value of the Policy on the date of transfer.  Because the appellant offered no other evidence of value, it failed to meet its burden of proving that the value of the policy was less than $10,000.  Moreover, the evidence of record suggested that the value of the Policy, transferred just 11 months prior to the decedent's death at a time when the decedent was in a serious and declining condition, was closer to the face value of the Policy than the Policy's interpolated terminable reserve value.  Accordingly, because the appellant failed to prove that the value of the Policy was less than $10,000 at the time of the gift, the Board issued a decision for the appellee in this appeal.


					      APPELLATE TAX BOARD	

							
By:____________________________
					    Frank J. Scharaffa, Member




A true copy:



Attest: _____________________
	    Clerk of the Board
						

   The "interpolated terminal reserve value" essentially represents the reserve value which the insurance company maintains on its books against its liability under the contract, based on standard mortality tables.  See, e.g., DuPont v. Commissioner, 233 F.2d. 210, 212 (3rd Cir. 1956).

ATB 2002-572