Commissioner of Internal Revenue v. Procter
154 A.L.R. 1215, 142 F. 2d 824, 32 A.F.T.R. (P-H) 750 (1944)
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Rule of Law:
A condition subsequent in a gift instrument that purports to revoke the gift if a court determines it is subject to federal gift tax is void because it is contrary to public policy.
Facts:
- Frederic W. Procter was indebted to his mother for $686,300.03, secured by his interest in four trusts created by his grandfather.
- On January 13, 1939, Procter and his mother agreed to waive future interest on the debt and limit the security to his remainder interests in only two of the trusts.
- On the same day, Procter executed a new trust indenture, transferring his remainder interests in those two trusts to trustees.
- The new trust provided that upon his mother's death, the trustees would first pay any remaining debt owed to her from the trust property.
- The trust then directed that the income from the remaining property be paid to Procter for his life, with the principal passing to his children upon his death.
- The trust indenture included a clause stating that if a court of last resort determined any part of the transfer was subject to gift tax, that part of the property would be automatically excluded from the gift and remain Procter's sole property.
Procedural Posture:
- The Commissioner of Internal Revenue assessed a gift tax against Frederic W. Procter for the transfer of remainder interests into a trust.
- Procter petitioned the U.S. Tax Court to contest the tax assessment.
- The Tax Court held that no gift tax could be assessed, ruling in favor of Procter on valuation grounds.
- The Commissioner, as petitioner, sought review of the Tax Court's decision in the United States Court of Appeals for the Fourth Circuit.
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Issue:
Does a provision in a trust agreement that purports to void a gift transfer if a court determines it is subject to federal gift tax violate public policy?
Opinions:
Majority - Parker, Circuit Judge.
Yes. A condition subsequent that purports to void a gift if it is found to be taxable is contrary to public policy and therefore invalid. The court reasoned that such a clause is void for three primary reasons. First, it has a tendency to discourage the collection of tax by public officials, because any attempt to enforce the tax would only serve to defeat the gift, rendering the effort moot. Second, it obstructs the administration of justice by requiring courts to pass upon a moot case; if the court were to find the gift taxable, the condition would retroactively nullify the gift, leaving no actual controversy for the court to decide. Third, the condition attempts to render a final court judgment for naught, as it would only become operative after a final judgment has been entered, which is an impermissible attempt to trifle with the judicial process.
Analysis:
This decision established the foundational 'Procter doctrine,' which invalidates savings clauses that attempt to retroactively nullify a gift or transaction based on a final court determination of taxability. The ruling prevents taxpayers from obtaining what would essentially be a free declaratory judgment from the courts on tax matters without any risk. It ensures the finality of gifts for tax purposes and deters taxpayers from using such clauses to discourage tax audits and litigation. The principles from this case remain central to tax and estate planning, influencing how practitioners draft documents to avoid clauses that are contingent on a future court ruling.
