Rev. Rul. 76-199

Advice has been requested whether the cash payment made to the surviving spouse pursuant to a compromise settlement agreement, conditioned on a favorable determination by the Internal Revenue Service, qualifies for the Federal estate tax marital deduction authorized under section 2056(a) of the Internal Revenue Code of 1954, or whether it fails to qualify on the basis that it is a "terminable interest" within the meaning of section 2056(b)(1).

The decedent died testate and directed the payment of all debts and expenses. Under decedent's will, $100,000 was bequeathed to decedent's surviving spouse and the residue of decedent's estate ($900,000) was bequeathed to A, a child of the decedent by a previous spouse. The residuary estate was charged with the payment of all death taxes. The will stated that the bequest to the surviving spouse was intended to satisfy the obligations of an antenuptial agreement that the decedent and the surviving spouse had entered into three years before decedent's death, at the time of their prospective marriage.

The surviving spouse objected to the probate of the decedent's will and, in good faith, the spouse started legal proceedings to have the antenuptial agreement declared void or voidable so that the spouse could elect to take a dower interest in the decedent's property. Under the law of the state where the decedent was domiciled at the time of death and where the decedent's property was located, dower is the absolute right to take one-half of a decedent's property when a decedent is survived by a surviving spouse and one child.

Before the surviving spouse's suit was judicially decided on its merits, the representatives of decedent's estate and the decedent's child recognized the bona fide nature of the surviving spouse's claim and, at arm's-length, they negotiated a compromise agreement in settlement of the spouse's rights. The spouse agreed to drop the suit and consented to the probate of the will in exchange for the immediate payment of $400,000. The compromise agreement further provided that the estate would claim a marital deduction in the amount of $400,000 on the decedent's Federal estate tax return, and that the spouse would keep only the original $100,000 bequest and return $300,000 if a determination were made by the Internal Revenue Service that the $400,000 payment failed to qualify for the marital deduction under section 2056 of the Internal Revenue Code of 1954.

Section 2056(a) of the Code provides that the value of the taxable estate shall be determined by deducting from the value of the gross estate an amount equal to the value of any interest in property which passes from the decedent to the decedent's surviving spouse. For purposes of this provision, section 2056(e)(3) provides that an interest in property shall be considered as passing from the decedent to the surviving spouse if such interest is the dower or curtesy interest, or the statutory interest in lieu thereof, of such person. Under section 20.2056(e)-2(c) of the Estate Tax Regulations, where a surviving spouse elects dower or his or her statutory share in the decedent's estate instead of the interest which the spouse was bequeathed under the decedent's will, the interest which the surviving spouse takes, rather than the renounced interest, is regarded as passing from the decedent. Section 20.2056(e)-2(d) of the regulations provides the same result where the surviving spouse takes her interest in settlement of a will controversy.

Section 2056(b)(1) of the Code provides that no marital deduction is allowable with respect to certain property interests, referred to generally as "terminable interests," passing from a decedent to a surviving spouse if: (1) on the occurrence of an event or contingency or on the failure of an event or contingency to occur, the interest will terminate or fail; (2) an interest in such property passes (but not for consideration) to a person other than the surviving spouse; (3) by reason of such passing such third person may possess or enjoy any part of the property after failure of the surviving spouse's interest, or (4) such interest is acquired for the surviving spouse by the estate's representative or the trustee of a trust pursuant to directions of the decedent.

Where a surviving spouse receives a full ownership interest in property under a compromise agreement in lieu of her (or his) claimed dower interest, the interest in property which passes to the surviving spouse is deemed to have the same character as property received through enforcement of the spouse's dower interest (or statutory equivalent), which qualifies for the marital deduction by virtue of section 2056(e) of the Code. See Rev. Rul. 66-139, 1966-1 C.B. 225. Therefore, the property interest received under a compromise agreement in such a case qualifies for the marital deduction under section 2056(a) as an interest in property which passes from the decedent to the surviving spouse.

A condition inserted in a compromise agreement with a surviving spouse to the effect that the Service must make a favorable Federal estate tax marital deduction determination, before the payment received as the settlement of a bona fide right to take against the decedent's will and obtain the spouse's dower is to become final, neither adds to nor detracts from the otherwise unquestionably qualified nature of the spouse's interest under the marital deduction provisions of the Code. This situation is distinguishable from the mala fide circumstances present in the condition subsequent type of savings clauses considered in Rev. Rul. 65-144, 1965-1 C.B. 442, and Commissioner v. Proctor, 142 F. 2d 842 (4th Cir. 1944), where savings clauses were used to negate questionable powers or transfers in the event of adverse action by the Internal Revenue Service occasioned by such powers or transfers.

Furthermore, this is not the type of condition that Congress intended to result in the surviving spouse's interest being terminable within the meaning of section 2056(b)(1) of the Code. See Sen. Rep. No. 1013 (Part 2), 80th Cong., 2d Sess. 7 (1948) and compare those cases in which it is held that an otherwise deductible nonterminable interest is not made terminable simply because it is contingent upon the enforcement of those vested rights by an order of the probate courts. Estate of Gertrude P. Barrett, 22 T.C. 606 (1954), acq., 1954-2 C.B. 3 (will settlement agreement); Hamilton National Bank of Knoxville v. United States, 353 F. 2d 930 (6th Cir. 1966), cert. denied, 384 U.S. 939 (1966) (compensation in lieu of dower); and Estate of Green v. United States, 441 F. 2d 303 (6th Cir. 1971) (widow's allowance vested under state law). Hence, if it otherwise qualifies in every respect for the deduction under section 2056(a) of the Code, property received under such a compromise agreement does not fail to so qualify by virtue of the terminable interest provisions of section 2056(b)(1) because a stipulation is inserted in the agreement that the spouse's right to the property received is not final until the estate tax marital deduction is allowed by the Service.

Accordingly, in the instant case, the full amount of the settlement payment to the surviving spouse ($400,000) qualifies for the marital deduction under section 2056(a) of the Code.

Rev. Rul. 65-144 is distinguished.