Removing the Scaffolding: the Qtip Provisions and the Ownership Fiction

• Publication year: 2021

84 Nebraska L. Rev. 571. Removing the Scaffolding: The QTIP Provisions and the Ownership Fiction

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Dana R. Irwin*

Removing the Scaffolding: The QTIP Provisions and the Ownership Fiction

TABLE OF CONTENTS

I. Introduction ...................................................... 572
II. Legal Fictions ................................................... 574
A. The Elements of a Legal Fiction ............................... 575
B. The Dangers of a Legal Fiction ................................ 576
III. The Marital Deduction, the Terminable Interest Rule, and the QTIP Provisions ......................................... 577
A. The Marital Deduction ........................................ 578
B. The Terminable Interest Rule ................................. 581
C. The QTIP Provisions .......................................... 583
IV. The Ownership Fiction ............................................ 586
A. The Ownership Fiction's Falsity and Utility ................... 586
B. The Ownership Fiction's Potential Dangers ..................... 588
V. The QTIP Taxing Provisions ........................................ 589
A. Section 2044: Taxing QTIP Property at the Surviving Spouse's Death ....................................... 590
B. Section 2519: Taxing QTIP Property at the Earlier Transfer of a Qualifying Income Interest ....................... 591
VI. The QTIP Rulings ................................................. 596
A. Taxing QTIP Property at the Transfer of a Remainder Interest ............................................ 596
1. Sale of a QTIP Remainder Interest .......................... 596
2. Gift of a QTIP Remainder Interest .......................... 598
B. Dropping the Ownership Fiction ................................ 600
VII. Conclusion ...................................................... 604

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I. INTRODUCTION

"The fiction is like a scaffolding in that it can be removed with ease."(fn1)

Pursuant to the federal estate and gift tax unlimited marital deduction, married individuals can transfer property to each other taxfree during life or at death.(fn2) The marital deduction is based on the theory that a married couple is a single taxpaying unit and that transfers within this unit should be disregarded.(fn3) As a general rule, a transfer of property will only qualify for the marital deduction if it grants the surviving spouse (or donee spouse(fn4)) outright ownership or an equivalent thereof ("Terminable Interest Rule").(fn5) This ensures that the transferred property will be included in the surviving spouse's transfer tax base. Transfer taxes will be deferred but not escaped.(fn6)

An exception to the Terminable Interest Rule allows a donor spouse to receive the marital deduction for the full value of property in which he(fn7) grants a surviving spouse nothing more than an income interest if the property meets the requirements of qualified terminable interest property ("QTIP Property"),(fn8) set forth in section 2056(b)(7) of the Internal Revenue Code ("Code"). The donor spouse then receives

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the marital deduction without surrendering control over the ultimate disposition of the property.(fn9)

Since the enactment in 1981 of the provisions of the Code that created this exception ("QTIP Provisions"),(fn10) many articles have analyzed and critiqued the requirements for qualification for the initial marital deduction.(fn11) Far fewer have addressed the subsequent taxation of QTIP Property in the hands of the surviving spouse.(fn12) This second component of the QTIP Provisions, arguably more significant because it justifies the first, is the subject of this Article.

The taxation of QTIP Property can occur at three different points in time: at the surviving spouse's death;(fn13) at the surviving spouse's lifetime disposition of her income interest;(fn14) and at a remainderman's disposition of a QTIP remainder interest.(fn15) The first two situations are addressed by sections 2044 and 2519 of the Code ("QTIP Taxing Provisions"), respectively. The third is addressed by various rulings ("QTIP Rulings")(fn16) of the Internal Revenue Service ("Service").

This Article evaluates the QTIP Taxing Provisions and the QTIP Rulings. Part II explains that in doing so, it relies on the theory of legal fictions. This theory provides a conceptual tool by which to understand all aspects of the QTIP Provisions. Part III provides background for the analysis that follows by reviewing the marital deduction provisions, the Terminable Interest Rule, and the QTIP Provisions. Part IV demonstrates that the decision to grant the marital deduction for QTIP Property can be explained by means of a legal fiction that treats QTIP Property as passing in its entirety to the surviving spouse ("Ownership Fiction"). The Ownership Fiction ensures that the QTIP Property will ultimately be taxed in the surviving spouse's transfer tax base. This taxation is the topic of Parts V and

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VI, which address the QTIP Taxing Provisions and the QTIP Rulings, respectively. This Article concludes that the QTIP Taxing Provisions lead to equitable results when applied by their terms, but inequitable and inconsistent results when extended beyond their terms by the QTIP Rulings.

II. LEGAL FICTIONS

In the nineteenth and early twentieth centuries, legal fictions were the topic of great interest to academics. Prominent writers such as Bentham, Blackstone, Maine, and Fuller debated the question of whether fictions had a role in the law and, if so, the nature of that role.(fn17) Today, legal fictions are widespread throughout all areas of law, but they receive little attention from academics.(fn18) One recent commentator remarked,

The legal fiction used to be a hot topic on the jurisprudential agenda. It was written and talked about passionately by those who wrote and talked about such things in the nineteenth and early twentieth centuries. Then interest in the subject withered and died, and virtually fell off the vine.(fn19)

The same commentator posed the following logical question: "Why would anyone want to write, or read for that matter, an article about a formerly hot topic?"(fn20) The answer is that a discussion of legal fictions is necessary to a thorough discussion of the QTIP Provisions. The Ownership Fiction provides the theoretical basis for granting the marital deduction at the death of the first spouse to die(fn21) and for taxing the QTIP Property at a later point in time.(fn22) Understanding legal fictions in general, and the Ownership Fiction in particular, is therefore critical to understanding and justifying the taxation of QTIP Property.

In using the theory of legal fictions to examine and critique current law regarding QTIP Property, this Article does not seek to revive the debate over the merits of legal fictions or over their proper definition. It assumes that legal fictions are an inescapable part of the law and takes as its starting point the definition of a legal fiction set forth by Lon L. Fuller, whose 1930 and 1931 articles on legal fictions are still relied upon as the most comprehensive discussion on the topic to

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date.(fn23) The remainder of this Part reviews Fuller's thoughts on (i) the elements of a legal fiction and (ii) the potential dangers of a legal fiction.(fn24)

A. The Elements of a Legal Fiction

A legal fiction is a conceptual tool, a "device of legal thought and expression" that places a new legal result into a pre-existing conceptual structure.(fn25) In so doing, it explains and justifies the result. Fuller compares a legal fiction to scaffolding, in that it supports a given legal result but can be "removed with ease" when need be.(fn26)

A legal fiction is an apparent falsehood, but it is neither a lie nor an erroneous conclusion.(fn27) Fuller distinguishes a legal fiction from a lie in that a fiction is not intended to deceive,(fn28) and from an erroneous conclusion in that a fiction is adopted with knowledge of its falsity.(fn29) The author of the legal fiction "either positively disbelieves it, or is partially conscious of its untruth or inadequacy."(fn30)

An author uses a legal fiction precisely because of its falsity, which counterintuitively serves as "a metaphorical way of expressing a truth."(fn31) The fiction's underlying analogy re-characterizes the form of a given situation to express what is perceived to be its substantive reality. For example, "the doctrine of constructive receipt is based on the [analogy] that once a taxpayer has an unrestricted right to a sum of money that has actually been set aside for her," though not yet delivered to the taxpayer, "the situation is more akin to the taxpayer's having possession of the money" than it is to not having possession of the money.(fn32) The doctrine's falsity, that a taxpayer is in possession of money that she has not yet received, is thought to represent the economic reality of the situation.(fn33)

This re-characterization brings a new situation within, or excludes a new situation from, the scope of an existing rule.(fn34) And this process

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of inclusion or exclusion, in turn, justifies a legal result that would otherwise seem incorrect or unfair.(fn35) The doctrine of constructive receipt brings sums of money set aside for, though not yet delivered to, a taxpayer within the scope of pre-existing tax laws that operate on money received by taxpayers.(fn36) Initially, it appears unfair to tax an individual on sums of money that she has not yet received. It appears more acceptable, however, when the situation is likened to actual receipt and the individual is characterized as being in the same economic situation as if she had received it.(fn37) Fuller explains that "[i]f we can create the impression of a similarity (in fact and not simply in legal effect). . . we will have...