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Comptroller of Treasury v. Taylor

Court of Appeals of Maryland

July 29, 2019

COMPTROLLER OF THE TREASURY
v.
RICHARD REEVES TAYLOR

          Argued: April 8, 2019

          Circuit Court for Washington County Case No. 21-C-15-055059

          Barbera, C.J., [*] Greene, McDonald, Watts, Hotten, Getty, Raker, Irma S. (Senior Judge, Specially Assigned) JJ.

          OPINION

          HOTTEN, J.

         This case arises from the Comptroller of the Treasury's ("Comptroller") assessment of estate tax and penalties against a Maryland estate that included the value of a particular type of marital trust. The marital trust, which was created in Michigan, consisted of qualified terminable interest property or "QTIP" that was reported on the decedent's federal estate tax return, but was omitted from the Estate's corresponding Maryland estate tax return.

         In a reported opinion, Comptroller of the Treasury v. Taylor, 238 Md.App. 139, 152, 189 A.3d 799, 807 (2018), the Court of Special Appeals held that "the Comptroller lack[ed] the authority to tax the [trust assets] as part of [the] Maryland estate." The Court also held that "[g]iven no tax was authorized under the statute, no penalty could be properly charged against the Estate." Id.

         On appeal, the Comptroller presents the following questions for our review:

1. Is the value of a surviving spouse's interest in a QTIP trust created in another state properly included in the surviving spouse's Maryland estate, and therefore subject to the Maryland estate tax?
2. Did the Tax Court improperly waive a late-filing penalty when waiver must be supported by affirmative evidence and the only basis cited for the waiver was the personal representative's erroneous interpretation of the tax laws?

         The personal representative filed a cross-petition with the following issues:

1. Is [the Comptroller's] taxation of the QTIP trust in the [E]state unconstitutional?
2. Is the fact that an issue was raised before the Tax Court, but not expressly decided by that agency, sufficient to permit review of that issue on appeal from the agency ruling?

         For reasons discussed infra, we reverse the judgment of the Court of Special Appeals on the first issue. We conclude that, upon the death of decedent's surviving spouse, Margaret Beale Taylor ("Ms. Taylor"), the QTIP trust assets were deemed to be transferred upon her death and that transfer was taxable by Maryland. As to issue two, we answer in the negative, concluding that the Tax Court properly waived the late-filing penalty.

         With respect to the cross-petition, we consider the second issue first, concluding that this Court's review is limited to the Tax Court's findings and to the reasons for those findings. Because the Tax Court did not expressly address a constitutionality argument in its written opinion, we decline to review the personal representative's first issue in the cross-petition.

         BACKGROUND

         Factual Background

         The instant tax dispute arose from events that were triggered by the death of Ms. Taylor's husband, John Wilson Taylor ("Mr. Taylor"). Mr. Taylor predeceased Ms. Taylor on December 1, 1989. At the time of Mr. Taylor's death, Mr. and Ms. Taylor were residents of Wayne County, Michigan.

         Mr. Taylor died with a valid Will dated September 1, 1982. The Will directed the creation of a "residuary marital trust," consisting of a portfolio of eleven different parcels of stocks and bonds valued on Mr. Taylor's date of death at $2, 299, 893.20. Mr. Taylor's Will directed that the net income from the residuary marital trust be paid to Ms. Taylor at least annually for and during her lifetime and that upon Ms. Taylor's death, the trust assets would be dispersed to the trust beneficiaries, Mr. Taylor's son and grandchildren.

         Upon the death of Mr. Taylor, the personal representative for his estate filed a timely federal tax return with the Internal Revenue Service in which the estate claimed a deduction for the marital trust, known as a qualified terminable interest property ("QTIP") election. Election of the QTIP deduction enables a married couple to defer payment of any estate tax on the transfer of the QTIP until the death of the surviving spouse. The marital deduction is allowed for the entire value of the QTIP. See 26 U.S.C. §§ 2044(a), (c); 2056(b)(7)(B).

         Following Mr. Taylor's death, Ms. Taylor continued to reside in Michigan until 1993, when she moved to Washington County, Maryland. She died testate on January 15, 2013.

         The personal representative filed a federal Estate (and Generation-Skipping Transfer) Tax Return with the Internal Revenue Service, which included the value of the property in the marital trust. On the federal estate tax return, the personal representative reported an Estate value of $5, 582, 245. The personal representative also filed a Maryland estate tax return, in which he excluded the value of the marital trust, decreasing the reported value of Ms. Taylor's federal gross estate by $4, 108, 048.02.

         The personal representative explained his deduction of Ms. Taylor's interest in the marital trust in a statement attached to the Maryland return. It stated:

In reliance on Section 7-309(b)(6)(i)[1] of the Maryland Tax-General Code Annotated, the marital trust created under the Last Will and Testament of decedent's deceased spouse, John Wilson Taylor, in which decedent had an income interest for life and which is reported on Schedule F of decedent's Federal Estate Tax Return, Form 706, has been excluded from the federal gross estate (line 1, federal Form 706) reported on line 1 of Section IV of the MET-1. John Wilson Taylor died on December 1, 1989, and was a resident of the State of Michigan on the date of his death. No Maryland estate tax return was filed for Mr. Taylor, and thus no "marital deduction qualified terminable interest property election was made for the decedent's predeceased spouse on a timely filed Maryland estate tax return."

         After examining the Maryland estate tax return, the Comptroller disallowed the claimed exclusion of Ms. Taylor's interest in the marital trust, adding back the value to the federal gross estate and the corresponding Maryland estate. The Comptroller then sent the personal representative a Deficiency Notice, which added interest, a 10% late penalty, and imposed a 25% penalty "due on underpayment attributable to substantial estate tax valuation."

         In a letter to the Comptroller dated January 20, 2014, the personal representative protested the Deficiency Notice and objected to the Comptroller's demands. The personal representative asserted that Maryland had no taxable interest in the trust assets, citing to Maryland Code, Tax-General ("Tax-Gen.") §§ 7-309(b)(6)(i), 7-302, and 26 U.S.C § 2044, discussed infra.

         On May 28, 2014, the Comptroller sent a revised Deficiency Notice, waiving the 25% penalty, but retaining the 10% late penalty. On June 24, 2014, the personal representative filed a Petition of Appeal.

         Procedural Background

         1. Maryland Tax Court Proceeding

         The Tax Court held a hearing on May 6, 2015, followed by a written opinion, Taylor v. Comptroller of the Treasury, Maryland Tax Court, Case No. 14-EL-OO-0691, Memorandum and Order of the Court dated Sept. 2, 2015 ("Tax Court Proceeding"), which affirmed the estate tax assessed on the trust assets, as well as the assessed interest. In an amendment to the memorandum and order, the Court waived and abated the 10% late penalty fee, citing Tax-Gen. §13-714 and Frey v. Comptroller, 422 Md. 111, 29 A.3d 475 (2011), as relevant authority.[2]

         The Tax Court found that, at the time of Ms. Taylor's death, she possessed a federal gross estate, consisting entirely of personal property, valued at $5, 582, 245. In considering this State's authority to tax the trust's assets, the Tax Court concluded that:

[T]he Maryland estate tax is directly linked to the federal estate tax, and completely integrated with it. The linkage and integration is accomplished by adopting, at the outset, the federal definition of "gross estate." Tax-Gen. § 7-301(b). (The term "'estate' means the federal gross estate of the decedent as determined by Subtitle B of the Internal Revenue Code . . ."). . . . Thus, the Maryland estate means the federal gross estate - as increased by any property not otherwise included in the federal gross estate that is deemed to be included pursuant to § 7-309(b)(6) of this subtitle. Tax-Gen. § 7-301(b).
Ms. Taylor's [E]state was properly reported by [the personal representative] on the Estate's federal estate tax return as $5, 582, 245 on her date of death. This value, pursuant to 26 U.S.C § 2044(a), included the value of the property in which Ms. Taylor had "a qualifying income interest for life[, ]" which was Ms. Taylor's QTIP property. There is no statute or statutory provision that authorizes [the personal representative] to subtract the value of Ms. Taylor's QTIP property from her federal gross estate for Maryland [e]state tax purposes.

Tax Court Proceeding at 4-5. The personal representative filed an appeal with the Circuit Court for Washington County on September 17, 2015. The Comptroller filed a cross-petition for review of the Tax Court's decision to abate the late penalty payment.

         2. Circuit Court Proceeding

         The circuit court reversed the Tax Court's assessment of taxes and interest against the Estate. In the Matter of Richard Reeves Taylor, Case No. 21-C-15-055059; Memorandum Opinion of the Court dated Nov. 23, 2016.

         The circuit court indicated that the Tax Court erred in concluding that Ms. Taylor's federal gross estate consisted entirely of personal property, because the trust assets "were not and never were" the property of Ms. Taylor. According to the circuit court, Ms. Taylor never had legal title to the trust assets because legal title was transferred to the trust beneficiaries. That property right vested in the beneficiaries at the time of Mr. Taylor's death in 1989.

         The circuit court held that the federal QTIP election simply enabled the trust assets to be taxable as part of the federal estate; the election did not convert the trust assets into Ms. Taylor's personal property which could be subjected to Maryland estate tax.

         The circuit court explained that, because the trust assets were not the property of Ms. Taylor, the only way for the State to impose taxes on the assets would be through statutory authority. After conducting a statutory analysis of Tax-Gen. §§ 7-301(b) and (d), 7-302, and 7-309(b)(5) and (b)(6), the circuit court concluded that the Tax Court had erred in assessing the estate tax on the trust assets.

         The circuit court also held that imposition of a Maryland estate tax on the trust assets violated the Fourteenth Amendment to the U.S. Constitution and the Maryland Declaration of Rights, because the State had taxed property outside its jurisdiction and taxed an item from which this State had received no benefit.

         3. Court of Special Appeals Proceeding

         The Court of Special Appeals affirmed the decision of the circuit court. The Court held that "the Tax Court's decision was premised upon an erroneous conclusion of law, and the Comptroller lacks the authority to tax the [trust assets] as part of Ms. Taylor's Maryland estate." Taylor, 238 Md.App. at 152, 189 A.3d at 807. The Court of Special Appeals based this holding on its statutory analysis, which mirrored the circuit court's analysis.

         The Court also held that "[g]iven no tax was authorized under the statute, no penalty could be properly charged against the Estate." Id.

         The Court of Special Appeals did not address the circuit court's decision regarding the Fourteenth Amendment and the Maryland Declaration of Rights, "as it was not decided by the Tax Court." Id.

         STANDARD OF REVIEW

[D]ecisions of the Tax Court receive the same judicial review as other administrative agencies. In this context [. . . we] evaluate[ ] the decision of the agency. A court's role in reviewing an administrative agency
adjudicatory decision is narrow; it is limited to determining if there is substantial evidence in the record as a whole to support the agency's findings and conclusions, and to determine if the administrative decision is premised upon an erroneous conclusion of law. We cannot uphold the Tax Court's decision on grounds other than the findings and reasons set forth by the Tax Court.

Taylor, 238 Md.App. at 145, 189 A.3d at 803 (internal citations and quotations omitted).

         DISCUSSION

         A. The value of the property contained in Ms. Taylor's Maryland estate includes the value of her QTIP, and the transfer of such property at death is subject to the Maryland estate tax.

         1. Ms. Taylor was deemed to have a property interest in the marital trust that transferred upon her death, such that the entire value of the marital trust is included in her federal gross estate.

         The personal representative contends that Ms. Taylor did not own, control, or have any interest in the assets of the QTIP trust, nor was there a transfer of trust property at her death. The personal representative asserts that:

[O]n Mr. Taylor's death, legal title to the QTIP property transferred to the trustees of the trust and equitable title transferred to Mr. Taylor's son and grandchildren, the remainder beneficiaries of the trust. Accordingly, the transfer of the QTIP property occurred in Michigan in 1989 under Mr. Taylor's [W]ill, not in Maryland in 2013 when Ms. Taylor died.

         However, the personal representative fails to adequately consider the estate tax scheme and the creation of QTIP trusts. Ms. Taylor's property interest in the marital trust was deemed to have transferred upon Ms. Taylor's death. We review the general estate tax scheme and creation of QTIP trusts to explain our conclusion. Estate Taxes and QTIP Trusts

         The estate tax applies on the transfer of assets from an estate upon one's death. The federal code, however, provides an exception for married couples through the marital deduction, codified in 26 U.S.C. §2056(a). The marital deduction generally shields the outright transfer of property, from the first-to-die spouse to the surviving spouse, from estate taxes. This marital "exemption is premised on the expectation that the property will be subject to estate tax on the death of the second spouse (unless consumed during her life or transferred by gift and thus subject to gift tax)." Estate of Sommers v. Commissioner of Internal Revenue, 149 T.C. 209, 223 (2017). Pursuant to 26 U.S.C. §2056(b)(1), transfers of 'terminable' property interests are not generally eligible for the marital deduction because they are not included in the surviving spouse's estate.[3] This is known as the "terminable interest rule." Estate of Smith v. Commissioner of Internal Revenue, 565 F.2d 455, 459 (7th Cir. 1977).

         In the instant matter, Ms. Taylor had a terminable property interest because she had a qualifying terminable income interest for life, paid annually, through operation of the QTIP trust. See 26 U.S.C. § 2056(b)(7)(B)(i)(II). However, the terminable interest rule has an exception for QTIP assets to enable application of the marital deduction.

The QTIP rules provide an election under which a qualifying terminable interest can be covered by the marital deduction at the death of the first spouse with the proviso that the underlying property be included in the estate of the second spouse upon death. See secs. 2056(b)(7), 2044. In effect, the rules employ a fiction that treats the second spouse as owning the subject property outright, rather than owning merely a life or other terminable interest.

Estate of Sommers, 149 T.C. at 223 (emphasis added). The provisions creating the QTIP option, codified in 26 USC §§ 2044 and 2056, create two fictional legal transfers so that the full value of the QTIP assets is captured by the estate tax upon the surviving spouse's death. The first fictional transfer occurs upon the death of the first-to-die spouse, when QTIP assets "shall be treated as" passing from the first-to-die spouse to the surviving spouse. See §§ 2056(b)(7)(A)(i), (b)(7)(B)(i)(I). The second fictional transfer occurs when the surviving spouse dies and the QTIP assets "shall be treated as property passing from" the surviving spouse under §2044(c). This second fictional transfer triggers the estate tax, and the entire value of the QTIP assets is included in the surviving spouse's federal gross estate under §2044(a).

         Our review of the federal estate tax scheme and QTIP trusts reveals that the entire value of the marital trust was deemed to have transferred upon Ms. Taylor's death See supra; see also In re Estate of Bracken, 175 Wash.2d 549, 577-78, 290 P.3d 99, 112 (2012) (Madsen, CJ, concurring/dissenting), overturned by statute ("[U]nder federal law there are two relevant transfers where QTIP property is concerned. . . . When the surviving spouse dies, a second transfer of the entire property is deemed to occur-the transfer of the property from the surviving spouse to the third party remainder beneficiaries."); see 2006 Leg. Sess., Fiscal and Policy Note, Senate Bill 2 ("SB 2") (stating that "[t]he value of the QTIP that qualifies for the marital deduction as a result of the election is included in the surviving spouse's estate when the surviving spouse dies." (emphasis added)).

         The Comptroller did not seek to tax Mr. Taylor's property or the transfer of his property, but rather sought to tax the deemed transfer of the QTIP property upon Ms. Taylor's death as a Maryland resident.[4]

         2. The value of Ms. Taylor's Maryland estate is the same as the value of her federal gross estate.

         The "Maryland estate" is defined as "the part of an estate that this State has the power to subject to the Maryland estate tax." See Tax-Gen. § 7-301(d) (emphasis added). Furthermore, an "estate" is defined as "the federal gross estate of a decedent, as determined by . . . the Internal Revenue Code, as increased by any property not otherwise included in the federal gross estate that is deemed to be included pursuant to § 7-309(b)(6) of this subtitle." See Tax-Gen. § 7-301(b) (emphasis added). Putting these definitions together results in two parts to a Maryland decedent's estate: (1) the federal gross estate as determined by the Internal Revenue Code, plus (2) any property not otherwise in the federal gross estate that is included in Tax-Gen. § 7-309(b)(6).

         As to the first part of the Estate, the personal representative properly reported a value of $5, 582, 245 for Ms. Taylor's federal gross estate. As to the second part of the Estate, we must consider the statutory language of Tax-Gen. § 7-309(b) in the context of the definition for an "estate." Accordingly, Tax-Gen. § 7-309(b)(6) serves to increase the value of the Estate (an estate is the federal gross estate, as increased by property pursuant to ...


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