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A Modest Dynasty: Considering the Roth IRA
How can an individual capture a slice of immortality despite having only a modest estate? Longer planning is constrained by transfer taxes and the rule against perpetuities. Let's review several options that are available to the average client who dreams of creating a dynasty. For some estates, the Roth IRA offers an impressive new strategy.
The Long Haul
How can an estate make a lasting impression? Whether an estate is $1 million or $5 million, it can still be whittled away and vanish within one generation. How does one take a modest collection of stocks, realty, etc. and shape those assets into something more meaningful than the sum of their parts? Time. The answer is simply to grow assets over time.
There are two major obstacles to the accumulation of wealth over time, transfer taxes and the rule against perpetuities. A long-term trust can accumulate assets and distribute living expenses for many future generations without exposing the entire estate to transfer taxes, not to mention creditors and other pitfalls. Yet the rule against perpetuities has long stood as the ultimate time limit on financial arrangements. Short of a perpetual dynasty, a number of arrangements can protect assets for an exceptionally long period of time. Moreover, in recent years, a growing number of jurisdictions have carved out exceptions to the rule against perpetuities.
Perpetuity Parameters
As a public policy matter, the free alienability of property is to be encouraged. Property that is held in perpetuity is taken out of economic circulation and avoids transfer taxation. Yet society encourages good public works and allows charitable trusts and foundations to continue indefinitely.(1)
Non-charitable gifts and devises have traditionally been constrained by the rule against perpetuities. An interest can qualify if it must become vested within 21 years of a life in being at the time of the transfer. That roughly adds up to a measuring life (let's say 100 years) plus 21 years = 121 years.(2) So, with the proper techniques, an interest might be held in trust for about 121 years before vesting in an individual who, in turn, might live another 80 years before transferring the assets. That's a lot of time for assets to accumulate and 200 years isn't too shabby as dynasties go.(3)
Perpetually Problematic
The rule against perpetuities has become idiomatic of the archaic abstractions of legal academia.(4) Taken, as it is, to illogical conclusions, the rule gives rise to such unlikely results as measuring lives including a child en ventre sa mere (an unborn child during gestation), the fertile octogenarian, or the incongruous case of the unborn widow -e.g., a 68-year-old trust beneficiary unexpectedly marries a much younger spouse who was not a life in being at the creation of the interest and you've got a perpetuity problem. One legendary practitioner escaped a penalty for malpractice of the rule because results were too obscure to be foreseen.
Perpetuity Havens
The exponential growth of assets that can escape the 55% transfer tax for an indefinite number of generations is phenomenal. The rule against perpetuities had long stood in the way, an unbroken blanket over estate planning throughout the states. With states such as South Dakota (and others that followed) eliminating or establishing broader exceptions to the rule, the "blanket" is getting a bit tattered. What has resulted may become a competition among the states to keep assets from migrating over state lines to take advantage of more attractive tax laws.(5)
Long-Term Perspectives
Irrevocable Trusts
Someone with a relatively small estate could design a truly effective trust that combines several planning techniques. For example, an irrevocable living trust that is equipped with Crummey trust provisions can be funded with contributions that qualify for the annual gift tax exclusion. The trust might be empowered to use the unclaimed contributions to purchase and pay premiums on a life insurance policy.
Funding such a trust with insurance proceeds guarantees the future appreciation of the amounts originally contributed to the trust. Yet such appreciation comes after the transfer to the irrevocable trust and remains outside of the grantor's taxable estate. The significance of this combination of elements makes it possible for a very modest estate to create an instant pool of assets upon death which is not diminished by transfer taxes and which can be accumulated under carefully supervised trust conditions for a considerable period of time.
The FLP Legacy
The family limited partnership is another device that can be useful for accumulating and transferring wealth. Ideally, the partnership shares can be distributed before the business grows and while the family is young.(7)
Roth IRA: The poor man's dynasty
No self-respecting dynasty can get started without a large pool of assets. A fortunate few members of society will launch successful dot com IPOs and become billionaires overnight. The rest of us, resigned to conventional investments growing over time, constantly seek an edge. Compare, therefore, the huge disparity among taxable, tax-deferred, and tax-free investment models with regard to income taxation. The ceiling on income for establishing a Roth IRA is an indication of the size of an estate in which a Roth IRA is likely to be found. However, even a small tax-free Roth IRA may grow extremely rapidly. That rapid growth is coupled with another unique attribute of the Roth IRA. Unlike the conventional qualified retirement plans that must commence mandatory distributions during the participant's lifetime, the Roth IRA has no required beginning date for distributions. §§408A(c)(5).
In fact, the assets can retain sheltered status for the duration of the participant's lifetime, then be rolled over to a spouse's Roth IRA where they can remain for the duration of the spouse's lifetime. Reg. §§1.408A-6, Q&A-14. Upon the spouse's death, assets would pass to beneficiaries and distributions would be based on the life expectancies of the beneficiaries.(8)
Example: Lex, Rex, and Tex each have $100,000 that is invested with an annual return of 10% over 50 years. Lex has his funds in a taxable account. Assuming an income tax rate of 40%, Lex has an effective return of only 6% and ends up with about $1.8 million. Rex, with a tax-deferred account, pays tax upon distribution. Allowing distribution to be delayed 50 years for the sake of argument, Rex would end up with about $7 million. Meanwhile, Tex's tax-free fund will end up with $11.7 million. Even allowing for Tex's paying $40,000 of income tax up front to establish his Roth IRA's tax-free status, he comes out way ahead.
Exponential Growth
While the disparity in results is significant after 50 years, a longer period of accumulation creates an astonishing opportunity. As the chart below indicates, there is about a tenfold increase in the tax-free assets every 25 years. As the tax-free Roth IRA assets mature to 75 years or 100 years, they are leaving conventional assets far behind.
|
|
TAXABLE
|
TAX DEFERRED
|
TAX FREE
|
|
10 years
|
$179,084
|
$155,624 v
|
$259,374
|
|
25 years
|
$429,186
|
$650,083
|
$1,083,470
|
|
50 years
|
$1.84 million
|
[$7.04 million]*
|
$11.74 million
|
|
75 years
|
$7.91 million
|
[$76.31 million]*
|
$127.19 million
|
|
100 years
|
$33.93 million
|
[$827 million]*
|
$1.38 billion
|
* Brackets indicate tax deferred plans would be distributed earlier.
Example: How long can a Roth IRA remain in effect? In the previous example, suppose Tex establishes his Roth IRA when he is 30 years old. He lives to be 90. At the time of his death, his 60-year-old-widow rolls the Roth IRA over and then lives to be 100. The Roth IRA needn't distribute assets for 60 years of Tex's life, and 40 years of his surviving spouse's life. Even after that, distributions would be spread over the life expectancies of the beneficiaries.
Even though tax-deferred assets also grow exponentially, they will be taxed at distribution. More saliently, here the tax-deferred arrangements will undergo mandatory distributions long before the Roth IRA. Realistically, by 50 years the traditional IRA has probably been distributed.
Duly Noted
The need for dynasties could be partially eliminated if there were no transfer taxes as currently proposed. However, trusts would still be useful for asset protection, centralized administration and forced conservation of assets. In the final analysis, no monument can be as worthwhile as an arrangement that provides guidance and funds for many future generations.
References
1 Over time, even the large foundations established by industrialists can dwindle and come to an end. A branch of the Astor estate recently gave out the last $25 million it had and closed up shop after 38 years. David Packard's foundation held his 9% share of a technology company and therefore skyrocketed to become the 11th largest foundation with $1.5 billion by December 1994, and then reached third place on the list with $8.9 billion by the end of 1997; it had 271% growth in 1997 alone. By comparison, older foundations with stabilized portfolios have begun to slide down the list.
2 Generally, the measuring lives are lifetime beneficiaries, but any living person can be so designated. Thus, a valid bequest was made to descendants who were alive 21 years after the death of all 120 lineal descendants of Queen Victoria who were lives in being. In re Villar, 1 Ch. 243 (1926).
3 If a generation is 25 years, a 200-year period of asset accumulation overlaps eight generations. All things being relative, the Chicago Bulls were a sports dynasty by pulling a double three-peat during a single decade while the Ming dynasty in China lasted for 276 years after the expulsion of the Mongols in 1368. Many might consider the Kennedy family an American dynasty, yet that family fortune was only formed during the past century.
4 Once again: No interest shall fail to vest sooner than 21 years after a life in being. Another definition: "A limitation, whether executory or by way of remainder, of either real or personal property, which is not to vest until after the expiration of, or will not necessarily vest within, the period fixed and prescribed by law for the creation of future estates and interests." And one more: "The rule which prohibits the creation of future interests or estates which by possibility may not become vested within a life or lives in being at the time of the testator's death or the effective date of the instrument creating the future interest, and twenty-one years thereafter, together with the period of gestation when the inclusion of the latter is necessary to cover cases of posthumous birth." 41 Am J1st Perp §§3, cited in Ballentine's Law Dictionary (3rd Ed, 1969). Perpetuities were mentioned in English records as early as 1595. In 1664 the question of remoteness of vesting arose and the Duke of Norfolk's Case, 3 Ch. Cas. 1 (1685), linked the validity of a future interest to the remoteness of vesting. The rule, as we know it today, was first stated in 1833 in Cadell v. Palmer, 1 Cl. & F. 372.
5 Perpetuity havens include: Alaska, Delaware (with respect to personal property), possibly Idaho, South Dakota, and Wisconsin.
6In search of the perfect trust, The Estate Analyst (June, 1993).
7Estate planning with FLPs, The Estate Analyst (March, 1999).
8The Roth IRA estate, The Estate Analyst (Jan., 1999).
9Supreme Court Upholds Tax Lien Despite Disclaimer
Rohn Drye owed $325,000 of unpaid tax assessments to the Federal government when he suddenly became the sole heir of his mother's $233,000 estate. In an attempt to circumvent the tax liens that applied to his "property and rights to property" under 26 USC §6321, Drye filed a timely disclaimer.
State Laws Conflict: Under State law (Arkansas), a legal fiction was established that Drye predeceased his mother. As a result, his mother's intestate estate passed by operation of State law to Drye's daughter. The daughter then established a spendthrift trust that would shield assets from creditors under State law yet benefit herself and her parents.
This theory was rejected by the 8th Circuit Court of Appeals and set up a conflict with the 5th and 9th Circuits. Drye Family 1995 Trust v. U.S., 152 F3d 892 (CA-8, 1998). Some states apply an "acceptance-rejection" theory and say a property interest vests only when the beneficiary accepts the devise, in which case the Federal tax lien is defeated.
Other states apply a "transfer theory" and say the interest vests in the beneficiary immediately upon the death of the testator or intestate, in which case the tax lien prevails. See, Leggett v. U.S., 120 F3d 592 (CA-5, 1997); Mapes v. U.S., 15 F3d 138 (CA-9, 1994). The conflict among the Circuits established the jurisdictional criteria for the Supreme Court to settle the issue.
The Court's Opinion: Writing for the Court, Justice Ginsburg noted that the Court has recognized that a Federal lien on property is intended by the Legislature to reach "every species of right or interest protected by law and having an exchangeable value." Jewett v. Comm'r, 455 U.S. 305, 309 (1982) (quoting Congressional reports from 1932).
The disclaimer under state law did not defeat the Federal tax lien because State law only created the inheritance or property interest. Federal law controlled on the issue of whether Rohn had property rights within the meaning of §6321. U.S. v. Bess, 357 U.S. 51 (1958); U.S. v. National Bank of Commerce, 472 U.S. 713 (1985).
Thus, where a liquor license was not property and could not be reached by creditors under State law, it was property subject to a federal tax lien. 21 West Lancaster Corp. v. Main Line Restaurant, Inc., 790 F2d 354 (CA-3, 1986). State law created an equitable income interest in a spendthrift trust, but Federal law determined whether the interest was "property" for purposes of §6321. Bank One Ohio Trust Co. v. U.S., 80 F3d 173 (CA-6, 1996).
In passing, it may be noted that a disclaimer is not a property interest per se. In the course of establishing that a disclaimer must be executed within a reasonable time after the disclaimant learns of a transfer, Jewett determined that taxpayers did not have a "right" to disclaim assets, so the enactment of disclaimer legislation did not deprive taxpayers of property rights.
A Disclaimant's Dominion: Control over the disposition of assets is a critical factor. Thus, a taxpayer's right to withdraw all funds from a joint account would subject the property to levy for unpaid federal taxes. The right to compel an insurer to pay a cash surrender value for a policy is also a property interest that is subject to Federal tax liens. U.S. v. Bess, 357 U.S. 51 (1958). The right to retroactively renounce an interest under State law did not affect a wife's Federal tax liability. U.S. v. Mitchell, 403 U.S. 190 (1971). In short, Federal tax law "is not struck blind by a disclaimer." Irvine v. U.S., 511 U.S. 224 (1994).
The fact that §6334(a) lists specific exemptions corroborates this conclusion in that it demonstrates that Congress did not intend to recognize further exemptions. State-law disclaimers recognized under §2518(a) are therefore effective only for purposes of Federal transfer taxes; Federal tax liens apply to inheritable interests as of the moment of a decedent's death.
Power Over Status Quo: Justice Ginsburg addressed one final argument analogizing the disclaimer to a rejected gift by pointing out a crucial distinction:
A donee who declines an inter vivos gift generally restores the status quo ante, leaving the donor to do with the gift what she will. The disclaiming heir or devisee, in contrast, does not restore the status quo, for the decedent cannot be revived. Thus the heir inevitably exercises dominion over the property. He determines who will receive the property-himself if he does not disclaim, a known other if he does. *** This power to channel the estate's assets warrants the conclusion that Drye held 'property' or a 'righ[t] to property' subject to the Government's liens.
Held: Affirmed. The disclaimed interest was property under §6321 and was subject to federal tax liens. Drye v. U.S., U.S. Sup. Ct., (Dec., 1999).
Rohn F. Drye, Jr., et al. v. United States, Supreme Court of the United States, No. 98-1101, December 7, 1999, Affirming CA-8, 98-2 USTC On Writ of Certiorari to the United States Court of Appeals for the Eighth Circuit.
References
1
Matter of Olsten, New York Journal, July 8, 1993, p. 28, was a Surrogate Court case that involved a QTIP trust worth $53 million. In 1995, when the trust was worth $75 million, it was proposed that the surviving spouse purchase the remainder interest of the QTIP using a promissory note. Once the spouse got the QTIP assets, she could sell them to satisfy the note. In the process, the remainder interest, which would have been taxed in the surviving spouse's estate, would be removed from the estate without incurring transfer tax. As hopeful as this was, a fair amount of skepticism is warranted whenever tax alchemists propose turning a taxable interest worth $50 million (i.e., 66.6% of the trust's present value) into a paid debt that escapes taxation. This year, the remainder-purchase approach was repudiated by Rev. Rul. 98-8, 1998-7, IRB 24, in which the IRS confirmed that such a maneuver results in a disposal of assets...a taxable transfer under §2519.
2
Under §2056(b)(7) all income from a QTIP must be paid to the surviving spouse at least annually and no one may appoint any portion of the trust to any person other than the surviving spouse.
3
Hodgman and Stetter, Drafting for the marital deduction in light of the new family-owned business exclusion, 25 EP 5, p. 229 (June, 1998). However, the authors note the uncertainty that exists on whether §2033A excludes a particular asset from the estate. Hopefully, the statute will be interpreted to exclude value in general, making it irrelevant which assets are allocated to which trust. This issue will warrant ongoing supervision.
4
New §§1014(a)(4), 2031(c), and 2032A(c)(18), added by §508 of the Taxpayer Relief Act of 1997. Conservation easements after TRA '97, The Estate Analyst (Feb., 1998).
5
Tiernan, What powers over a credit shelter thrust can the spouse possess?, 23 EP 9, p. 424 (Nov., 1996).
6
IRC §§2041 and 2514. Tiernan, How to draft invasion clauses for marital and credit shelter trusts, 25 EP 6, p. 259(July, 1998).
7
Clayton v. Comm'r., 976 F2d 1486 (5th Cir., 1992); Estate of Robertson v. Comm'r., 15 F3d 779 (8th Cir. 1994); Estate of Spencer v. Comm'r., 43 F2d 226 (6th Cir. 1995); Estate of Clack, 106TC 131(1996); T.D. 8714, 62 Fed. Reg. 7156 (Feb. 18, 1997). For discussion, see, Newman and Kalter, New regulations approve use of contingent QTIPs, 24 EP 6, p. 265 (July, 1997); and, Blattmachr and Zaritsky, Coping with the new Clayton QTIP regulations, 136 T&E 6, p. 41 (May, 1997).
8
Talavera, Mobley, and Johnson, What are a spouse's rights in retirement plans and IRAs?, 23 EP 3, p. 109 (march, 1996); Moore, Interaction of the estate tax marital deduction and qualified plan and IRA benefits, 23 EP 2, p. 86 (Feb., 1996); and Holding, Getting QTIP treatment for IRAs and qualified retirement plans, 131 T&E 2, p. 26 (Feb., 1992).
9
Nudelman and Panos, Choosing the most appropriate marital deduction formula clause, 22 EP 6, p. 256 (July, 1996).
A Modest Dynasty: Considering the Roth IRA
How can an individual capture a slice of immortality despite having only a modest estate? Longer planning is constrained by transfer taxes and the rule against perpetuities. Let's review several options that are available to the average client who dreams of creating a dynasty. For some estates, the Roth IRA offers an impressive new strategy.
The long haul
How can an estate make a lasting impression? Whether an estate is $1 million or $5 million, it can still be whittled away and vanish within one generation. How does one take a modest collection of stocks, realty, etc. and shape those assets into something more meaningful than the sum of their parts? Time. The answer is simply to grow assets over time.
There are two major obstacles to the accumulation of wealth over time, transfer taxes and the rule against perpetuities. A long-term trust can accumulate assets and distribute living expenses for many future generations without exposing the entire estate to transfer taxes, not to mention creditors and other pitfalls. Yet the rule against perpetuities has long stood as the ultimate time limit on financial arrangements. Short of a perpetual dynasty, a number of arrangements can protect assets for an exceptionally long period of time. Moreover, in recent years, a growing number of jurisdictions have carved out exceptions to the rule against perpetuities.
Perpetuity parameters
As a public policy matter, the free alienability of property is to be encouraged. Property that is held in perpetuity is taken out of economic circulation and avoids transfer taxation. Yet society encourages good public works and allows charitable trusts and foundations to continue indefinitely.(1)
Non-charitable gifts and devises have traditionally been constrained by the rule against perpetuities. An interest can qualify if it must become vested within 21 years of a life in being at the time of the transfer. That roughly adds up to a measuring life (let's say 100 years) plus 21 years = 121 years.(2) So, with the proper techniques, an interest might be held in trust for about 121 years before vesting in an individual who, in turn, might live another 80 years before transferring the assets. That's a lot of time for assets to accumulate and 200 years isn't too shabby as dynasties go.(3)
Perpetually problematic
The rule against perpetuities has become idiomatic of the archaic abstractions of legal academia.(4) Taken, as it is, to illogical conclusions, the rule gives rise to such unlikely results as measuring lives including a child en ventre sa mere (an unborn child during gestation), the fertile octogenarian, or the incongruous case of the unborn widow -e.g., a 68-year-old trust beneficiary unexpectedly marries a much younger spouse who was not a life in being at the creation of the interest and you've got a perpetuity problem. One legendary practitioner escaped a penalty for malpractice of the rule because results were too obscure to be foreseen.
Perpetuity Havens: The exponential growth of assets that can escape the 55% transfer tax for an indefinite number of generations is phenomenal. The rule against perpetuities had long stood in the way, an unbroken blanket over estate planning throughout the states. With states such as South Dakota (and others that followed) eliminating or establishing broader exceptions to the rule, the "blanket" is getting a bit tattered. What has resulted may become a competition among the states to keep assets from migrating over state lines to take advantage of more attractive tax laws.(5)
Long-term perspectives
Irrevocable Trusts: Someone with a relatively small estate could design a truly effective trust that combines several planning techniques. For example, an irrevocable living trust that is equipped with Crummey trust provisions can be funded with contributions that qualify for the annual gift tax exclusion. The trust might be empowered to use the unclaimed contributions to purchase and pay premiums on a life insurance policy.
Funding such a trust with insurance proceeds guarantees the future appreciation of the amounts originally contributed to the trust. Yet such appreciation comes after the transfer to the irrevocable trust and remains outside of the grantor's taxable estate. The significance of this combination of elements makes it possible for a very modest estate to create an instant pool of assets upon death which is not diminished by transfer taxes and which can be accumulated under carefully supervised trust conditions for a considerable period of time.
The FLP Legacy: The family limited partnership is another device that can be useful for accumulating and transferring wealth. Ideally, the partnership shares can be distributed before the business grows and while the family is young.(7)
Roth IRA: The poor man's dynasty
No self-respecting dynasty can get started without a large pool of assets. A fortunate few members of society will launch successful dot com IPOs and become billionaires overnight. The rest of us, resigned to conventional investments growing over time, constantly seek an edge. Compare, therefore, the huge disparity among taxable, tax-deferred, and tax-free investment models with regard to income taxation. The ceiling on income for establishing a Roth IRA is an indication of the size of an estate in which a Roth IRA is likely to be found. However, even a small tax-free Roth IRA may grow extremely rapidly. That rapid growth is coupled with another unique attribute of the Roth IRA. Unlike the conventional qualified retirement plans that must commence mandatory distributions during the participant's lifetime, the Roth IRA has no required beginning date for distributions. §§408A(c)(5).
In fact, the assets can retain sheltered status for the duration of the participant's lifetime, then be rolled over to a spouse's Roth IRA where they can remain for the duration of the spouse's lifetime. Reg. §§1.408A-6, Q&A-14. Upon the spouse's death, assets would pass to beneficiaries and distributions would be based on the life expectancies of the beneficiaries.(8)
Example: Lex, Rex, and Tex each have $100,000 that is invested with an annual return of 10% over 50 years. Lex has his funds in a taxable account. Assuming an income tax rate of 40%, Lex has an effective return of only 6% and ends up with about $1.8 million. Rex, with a tax-deferred account, pays tax upon distribution. Allowing distribution to be delayed 50 years for the sake of argument, Rex would end up with about $7 million. Meanwhile, Tex's tax-free fund will end up with $11.7 million. Even allowing for Tex's paying $40,000 of income tax up front to establish his Roth IRA's tax-free status, he comes out way ahead.
Exponential Growth: While the disparity in results is significant after 50 years, a longer period of accumulation creates an astonishing opportunity. As the chart below indicates, there is about a tenfold increase in the tax-free assets every 25 years. As the tax-free Roth IRA assets mature to 75 years or 100 years, they are leaving conventional assets far behind.
$100,000 INVESTED AT 10% PRODUCES:
TAXABLE
TAX DEFERRED
TAX FREE
10 years
$179,084
$155,624 v
$259,374
25 years
$429,186
$650,083
$1,083,470
50 years
$1.84 million
[$7.04 million]*
$11.74 million
75 years
$7.91 million
[$76.31 million]*
$127.19 million
100 years
$33.93 million
[$827 million]*
$1.38 billion
* Brackets indicate tax deferred plans would be distributed earlier.
Example: How long can a Roth IRA remain in effect? In the previous example, suppose Tex establishes his Roth IRA when he is 30 years old. He lives to be 90. At the time of his death, his 60-year-old-widow rolls the Roth IRA over and then lives to be 100. The Roth IRA needn't distribute assets for 60 years of Tex's life, and 40 years of his surviving spouse's life. Even after that, distributions would be spread over the life expectancies of the beneficiaries.
Even though tax-deferred assets also grow exponentially, they will be taxed at distribution. More saliently, here the tax-deferred arrangements will undergo mandatory distributions long before the Roth IRA. Realistically, by 50 years the traditional IRA has probably been distributed.
Duly noted
The need for dynasties could be partially eliminated if there were no transfer taxes as currently proposed. However, trusts would still be useful for asset protection, centralized administration and forced conservation of assets. In the final analysis, no monument can be as worthwhile as an arrangement that provides guidance and funds for many future generations.
A Modest Dynasty: Considering the Roth IRA
How can an individual capture a slice of immortality despite having only a modest estate? Longer planning is constrained by transfer taxes and the rule against perpetuities. Let's review several options that are available to the average client who dreams of creating a dynasty. For some estates, the Roth IRA offers an impressive new strategy.
The long haul
How can an estate make a lasting impression? Whether an estate is $1 million or $5 million, it can still be whittled away and vanish within one generation. How does one take a modest collection of stocks, realty, etc. and shape those assets into something more meaningful than the sum of their parts? Time. The answer is simply to grow assets over time.
There are two major obstacles to the accumulation of wealth over time, transfer taxes and the rule against perpetuities. A long-term trust can accumulate assets and distribute living expenses for many future generations without exposing the entire estate to transfer taxes, not to mention creditors and other pitfalls. Yet the rule against perpetuities has long stood as the ultimate time limit on financial arrangements. Short of a perpetual dynasty, a number of arrangements can protect assets for an exceptionally long period of time. Moreover, in recent years, a growing number of jurisdictions have carved out exceptions to the rule against perpetuities.
Perpetuity parameters
As a public policy matter, the free alienability of property is to be encouraged. Property that is held in perpetuity is taken out of economic circulation and avoids transfer taxation. Yet society encourages good public works and allows charitable trusts and foundations to continue indefinitely.(1)
Non-charitable gifts and devises have traditionally been constrained by the rule against perpetuities. An interest can qualify if it must become vested within 21 years of a life in being at the time of the transfer. That roughly adds up to a measuring life (let's say 100 years) plus 21 years = 121 years.(2) So, with the proper techniques, an interest might be held in trust for about 121 years before vesting in an individual who, in turn, might live another 80 years before transferring the assets. That's a lot of time for assets to accumulate and 200 years isn't too shabby as dynasties go.(3)
Perpetually problematic
The rule against perpetuities has become idiomatic of the archaic abstractions of legal academia.(4) Taken, as it is, to illogical conclusions, the rule gives rise to such unlikely results as measuring lives including a child en ventre sa mere (an unborn child during gestation), the fertile octogenarian, or the incongruous case of the unborn widow -e.g., a 68-year-old trust beneficiary unexpectedly marries a much younger spouse who was not a life in being at the creation of the interest and you've got a perpetuity problem. One legendary practitioner escaped a penalty for malpractice of the rule because results were too obscure to be foreseen.
Perpetuity Havens: The exponential growth of assets that can escape the 55% transfer tax for an indefinite number of generations is phenomenal. The rule against perpetuities had long stood in the way, an unbroken blanket over estate planning throughout the states. With states such as South Dakota (and others that followed) eliminating or establishing broader exceptions to the rule, the "blanket" is getting a bit tattered. What has resulted may become a competition among the states to keep assets from migrating over state lines to take advantage of more attractive tax laws.(5)
Long-term perspectives
Irrevocable Trusts: Someone with a relatively small estate could design a truly effective trust that combines several planning techniques. For example, an irrevocable living trust that is equipped with Crummey trust provisions can be funded with contributions that qualify for the annual gift tax exclusion. The trust might be empowered to use the unclaimed contributions to purchase and pay premiums on a life insurance policy.
Funding such a trust with insurance proceeds guarantees the future appreciation of the amounts originally contributed to the trust. Yet such appreciation comes after the transfer to the irrevocable trust and remains outside of the grantor's taxable estate. The significance of this combination of elements makes it possible for a very modest estate to create an instant pool of assets upon death which is not diminished by transfer taxes and which can be accumulated under carefully supervised trust conditions for a considerable period of time.
The FLP Legacy: The family limited partnership is another device that can be useful for accumulating and transferring wealth. Ideally, the partnership shares can be distributed before the business grows and while the family is young.(7)
Roth IRA: The poor man's dynasty
No self-respecting dynasty can get started without a large pool of assets. A fortunate few members of society will launch successful dot com IPOs and become billionaires overnight. The rest of us, resigned to conventional investments growing over time, constantly seek an edge. Compare, therefore, the huge disparity among taxable, tax-deferred, and tax-free investment models with regard to income taxation. The ceiling on income for establishing a Roth IRA is an indication of the size of an estate in which a Roth IRA is likely to be found. However, even a small tax-free Roth IRA may grow extremely rapidly. That rapid growth is coupled with another unique attribute of the Roth IRA. Unlike the conventional qualified retirement plans that must commence mandatory distributions during the participant's lifetime, the Roth IRA has no required beginning date for distributions. §§408A(c)(5).
In fact, the assets can retain sheltered status for the duration of the participant's lifetime, then be rolled over to a spouse's Roth IRA where they can remain for the duration of the spouse's lifetime. Reg. §§1.408A-6, Q&A-14. Upon the spouse's death, assets would pass to beneficiaries and distributions would be based on the life expectancies of the beneficiaries.(8)
Example: Lex, Rex, and Tex each have $100,000 that is invested with an annual return of 10% over 50 years. Lex has his funds in a taxable account. Assuming an income tax rate of 40%, Lex has an effective return of only 6% and ends up with about $1.8 million. Rex, with a tax-deferred account, pays tax upon distribution. Allowing distribution to be delayed 50 years for the sake of argument, Rex would end up with about $7 million. Meanwhile, Tex's tax-free fund will end up with $11.7 million. Even allowing for Tex's paying $40,000 of income tax up front to establish his Roth IRA's tax-free status, he comes out way ahead.
Exponential Growth: While the disparity in results is significant after 50 years, a longer period of accumulation creates an astonishing opportunity. As the chart below indicates, there is about a tenfold increase in the tax-free assets every 25 years. As the tax-free Roth IRA assets mature to 75 years or 100 years, they are leaving conventional assets far behind.
$100,000 INVESTED AT 10% PRODUCES:
TAXABLE
TAX DEFERRED
TAX FREE
10 years
$179,084
$155,624 v
$259,374
25 years
$429,186
$650,083
$1,083,470
50 years
$1.84 million
[$7.04 million]*
$11.74 million
75 years
$7.91 million
[$76.31 million]*
$127.19 million
100 years
$33.93 million
[$827 million]*
$1.38 billion
* Brackets indicate tax deferred plans would be distributed earlier.
Example: How long can a Roth IRA remain in effect? In the previous example, suppose Tex establishes his Roth IRA when he is 30 years old. He lives to be 90. At the time of his death, his 60-year-old-widow rolls the Roth IRA over and then lives to be 100. The Roth IRA needn't distribute assets for 60 years of Tex's life, and 40 years of his surviving spouse's life. Even after that, distributions would be spread over the life expectancies of the beneficiaries.
Even though tax-deferred assets also grow exponentially, they will be taxed at distribution. More saliently, here the tax-deferred arrangements will undergo mandatory distributions long before the Roth IRA. Realistically, by 50 years the traditional IRA has probably been distributed.
Duly noted
The need for dynasties could be partially eliminated if there were no transfer taxes as currently proposed. However, trusts would still be useful for asset protection, centralized administration and forced conservation of assets. In the final analysis, no monument can be as worthwhile as an arrangement that provides guidance and funds for many future generations.
Rohn Drye owed $325,000 of unpaid tax assessments to the Federal government when he suddenly became the sole heir of his mother's $233,000 estate. In an attempt to circumvent the tax liens that applied to his "property and rights to property" under 26 USC §6321, Drye filed a timely disclaimer.
State Laws Conflict: Under State law (Arkansas), a legal fiction was established that Drye predeceased his mother. As a result, his mother's intestate estate passed by operation of State law to Drye's daughter. The daughter then established a spendthrift trust that would shield assets from creditors under State law yet benefit herself and her parents.
This theory was rejected by the 8th Circuit Court of Appeals and set up a conflict with the 5th and 9th Circuits. Drye Family 1995 Trust v. U.S., 152 F3d 892 (CA-8, 1998). Some states apply an "acceptance-rejection" theory and say a property interest vests only when the beneficiary accepts the devise, in which case the Federal tax lien is defeated.
Other states apply a "transfer theory" and say the interest vests in the beneficiary immediately upon the death of the testator or intestate, in which case the tax lien prevails. See, Leggett v. U.S., 120 F3d 592 (CA-5, 1997); Mapes v. U.S., 15 F3d 138 (CA-9, 1994). The conflict among the Circuits established the jurisdictional criteria for the Supreme Court to settle the issue.
The Court's Opinion: Writing for the Court, Justice Ginsburg noted that the Court has recognized that a Federal lien on property is intended by the Legislature to reach "every species of right or interest protected by law and having an exchangeable value." Jewett v. Comm'r, 455 U.S. 305, 309 (1982) (quoting Congressional reports from 1932).
The disclaimer under state law did not defeat the Federal tax lien because State law only created the inheritance or property interest. Federal law controlled on the issue of whether Rohn had property rights within the meaning of §6321. U.S. v. Bess, 357 U.S. 51 (1958); U.S. v. National Bank of Commerce, 472 U.S. 713 (1985).
Thus, where a liquor license was not property and could not be reached by creditors under State law, it was property subject to a federal tax lien. 21 West Lancaster Corp. v. Main Line Restaurant, Inc., 790 F2d 354 (CA-3, 1986). State law created an equitable income interest in a spendthrift trust, but Federal law determined whether the interest was "property" for purposes of §6321. Bank One Ohio Trust Co. v. U.S., 80 F3d 173 (CA-6, 1996).
In passing, it may be noted that a disclaimer is not a property interest per se. In the course of establishing that a disclaimer must be executed within a reasonable time after the disclaimant learns of a transfer, Jewett determined that taxpayers did not have a "right" to disclaim assets, so the enactment of disclaimer legislation did not deprive taxpayers of property rights.
A Disclaimant's Dominion: Control over the disposition of assets is a critical factor. Thus, a taxpayer's right to withdraw all funds from a joint account would subject the property to levy for unpaid federal taxes. The right to compel an insurer to pay a cash surrender value for a policy is also a property interest that is subject to Federal tax liens. U.S. v. Bess, 357 U.S. 51 (1958). The right to retroactively renounce an interest under State law did not affect a wife's Federal tax liability. U.S. v. Mitchell, 403 U.S. 190 (1971). In short, Federal tax law "is not struck blind by a disclaimer." Irvine v. U.S., 511 U.S. 224 (1994).
The fact that §6334(a) lists specific exemptions corroborates this conclusion in that it demonstrates that Congress did not intend to recognize further exemptions. State-law disclaimers recognized under §2518(a) are therefore effective only for purposes of Federal transfer taxes; Federal tax liens apply to inheritable interests as of the moment of a decedent's death.
Power Over Status Quo: Justice Ginsburg addressed one final argument analogizing the disclaimer to a rejected gift by pointing out a crucial distinction:
A donee who declines an inter vivos gift generally restores the status quo ante, leaving the donor to do with the gift what she will. The disclaiming heir or devisee, in contrast, does not restore the status quo, for the decedent cannot be revived. Thus the heir inevitably exercises dominion over the property. He determines who will receive the property-himself if he does not disclaim, a known other if he does. *** This power to channel the estate's assets warrants the conclusion that Drye held 'property' or a 'righ[t] to property' subject to the Government's liens.
Held: Affirmed. The disclaimed interest was property under §6321 and was subject to federal tax liens. Drye v. U.S., U.S. Sup. Ct., (Dec., 1999).
Rohn F. Drye, Jr., et al. v. United States, Supreme Court of the United States, No. 98-1101, December 7, 1999, Affirming CA-8, 98-2 USTC On Writ of Certiorari to the United States Court of Appeals for the Eighth Circuit.
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SYLLABUS
In 1994, Irma Drye died intestate, leaving a $233,000 estate in Pulaski County, Arkansas. Petitioner Rohn Drye, her son, was sole heir to the estate under Arkansas law. Drye was insolvent at the time of his mother's death and owed the Federal Government some $325,000 on unpaid tax assessments. The Internal Revenue Service (IRS) had valid tax liens against all of Drye's "property and rights to property" pursuant to 26 U.S.C. §6321. Drye petitioned the Pulaski County Probate Court for appointment as administrator of his mother's estate and was so appointed. Several months after his mother's death, Drye resigned as administrator after filing in the Probate Court and county land records a written disclaimer of all interests in the estate. Under Arkansas law, such a disclaimer creates the legal fiction that the disclaimant predeceased the decedent, consequently, the disclaimant's share of the estate passes to the person next in line to receive that share. The disavowing heir's creditors, Arkansas law provides, may not reach property thus disclaimed. Here, Drye's disclaimer caused the estate to pass to his daughter, Theresa Drye, who succeeded her father as administrator and promptly established the Drye Family 1995 Trust (Trust). The Probate Court declared Drye's disclaimer valid and accordingly ordered final distribution of the estate to Theresa, who then used the estate's proceeds to fund the Trust, of which she and, during their lifetimes, her parents are the beneficiaries. Under the Trust's terms, distributions are at the discretion of the trustee, Drye's counsel, and may be made only for the health, maintenance, and support of the beneficiaries. The Trust is spendthrift, and under state law, its assets are therefore shielded from creditors seeking to satisfy the debts of the Trust's beneficiaries. After Drye revealed to the IRS his beneficial interest in the Trust, the IRS filed with the county a notice of federal tax lien against the Trust as Drye's nominee, served a notice of levy on accounts held in the Trust's name by an investment bank, and notified the Trust of the levy. The Trust filed a wrongful levy action against the United States in the United States District Court for the Eastern District of Arkansas. The Government counterclaimed against the Trust, the trustee, and the trust beneficiaries, seeking to reduce to judgment the tax assessments against Drye, confirm its right to seize the Trust's assets in collection of those debts, foreclose on its liens, and sell the Trust property. On cross-motions for summary judgment, the District Court ruled in the Government's favor. The Court of Appeals for the Eighth Circuit affirmed, reading this Court's precedents to convey that state law determines whether a given set of circumstances creates a right or interest, but federal law dictates whether that right or interest constitutes "property" or the "right[t] to property" under §6321.
Held: Drye's disclaimer did not defeat the federal tax liens. The Internal Revenue Code's prescriptions are most sensibly read to look to state law for delineation of the taxpayer's rights or interests in the property the Government seeks to reach, but to leave to federal law the determination whether those rights or interests constitute "property" or "rights to property" under §6321. Once it has been determined that state law creates sufficient interests in the taxpayer to satisfy the requirements of the federal tax lien provision, state law is inoperative to prevent the attachment of the federal liens. United States v. Bess, 357 U.S. 51, 56-57, pp. 5-11.
(a) To satisfy a tax deficiency, the Government may impose a lien on any "property" or "rights to property" belonging to the taxpayer. §§6321, 6331(a). When Congress so broadly uses the term "property" this Court recognizes that the Legislature aims to reach every species of right or interest protected by law and having an exchangeable value. E.g., Jewett v. Commissioner [82-1 USTC 13,453], 455 U.S. 305, 309. Section 6334(a), which lists items exempt from levy, is corroborative. Section 6334(a)'s list is rendered exclusive by §6334(c), which provides that no other "property or rights to property shall be exempt." Inheritances or devises disclaimed under state law are not included in §6334(a)'s catalog of exempt property. See, e.g., Bess, 357 U.S., at 57. The absence of any recognition of disclaimers in §§6321, 6322, 6331(a), and 6334(a) and (c), the relevant tax collection provisions, contrasts with §2518(a), which renders qualifying state-law disclaimers "with respect to any interest in property" effective for federal wealth-transfer tax purposes and for those purposes only. Although this Court's decisions in point have not been phrased so meticulously as to preclude the argument that state law is the proper guide to the critical determination whether Drye's interest constituted "property" or "rights to property" under §6321, the Court is satisfied that the Code and interpretive case law place under federal, not state, control the ultimate issue whether a taxpayer has a beneficial interest in any property subject to levy for unpaid federal taxes. Pp. 5-7.
(b) The question whether a state-law right constitutes "property" or "rights to property" under §6321 is a matter of federal law. United States v. National Bank of Commerce, 472 U.S. 713, 727. This Court looks initially to state law to determine what rights the taxpayer has in the property the Government seeks to reach, then to federal law to determine whether the taxpayer's state-delineated rights qualify as "property" or "rights to property" within the compass of the federal tax lien legislation. Cf. Morgan v. Commissioner, 309 U.S. 78, 80. Just as exempt status under state law does not bind the federal collector, United States v. Mitchell, 403 U.S. 190, 204, so federal tax law is not struck blind by a disclaimer, United States v. Irvine [94-1 USTC 60,163], 511 U.S. 224, 240, pp. 7-9.
(c) The Eighth Circuit, with fidelity to the relevant Code provisions and this Court's case law, determined first what rights state law accorded Drye in his mother's estate. The Court of Appeals observed that under Arkansas law Drye had, at his mother's death, a valuable, transferable, legally protected right to the property at issue, and noted, for example, that a prospective heir may effectively assign his expectancy in an estate under Arkansas law, and the assignment will be enforced when the expectancy ripens into a present estate. Drye emphasizes his undoubted right under Arkansas law to disclaim the inheritance, a right that is indeed personal and not marketable. But Arkansas law primarily gave him a right of considerable value--the right either to inherit or to channel the inheritance to a close family member (the next lineal descendant). That right simply cannot be written off as a mere personal right to accept or reject a gift. In pressing the analogy to a rejected gift, Drye overlooks this crucial distinction. A donee who declines an inter vivos gift restores the status quo ante, leaving the donor to do with the gift what she will. The disclaiming heir or devisee, in contrast, does not restore the status quo, for the decedent cannot be revived. Thus the heir inevitably exercises dominion over the property. He determines who will receive the property--himself if he does not disclaim, a known other if he does. This power to channel the estate's assets warrants the conclusion that Drye held "property" or a "righ[t] to property" subject to the Government's liens under §6321, pp. 9-11.
152 F.3d 892, affirmed.
JUSTICE GINSBURG
delivered the opinion of the Court.
This case concerns the respective provinces of state and federal law in determining what is property for purposes of federal tax lien legislation. At the time of his mother's death, petitioner Rohn F. Drye, Jr., was insolvent and owed the Federal Government some $325,000 on unpaid tax assessments for which notices of federal tax liens had been filed. His mother died intestate, leaving an estate with a total value of approximately $233,000 to which he was sole heir. After the passage of several months, Drye disclaimed his interest in his mother's estate, which then passed by operation of state law to his daughter. This case presents the question whether Drye's interest as heir to his mother's estate constituted "property" or a "righ[t] to property" to which the federal tax liens attached under 26 U.S.C. §6321, despite Drye's exercise of the prerogative state law accorded him to disclaim the interest retroactively.
We hold that the disclaimer did not defeat the federal tax liens. The Internal Revenue Code's prescriptions are most sensibly read to look to state law for delineation of the taxpayer's rights or interests, but to leave to federal law the determination whether those rights or interests constitute "property" or "rights to property" within the meaning of §6321. "[O]nce it has been determined that state law creates sufficient interests in the [taxpayer] to satisfy the requirements of [the federal tax lien provision], state law is inoperative to prevent the attachment of liens created by federal statutes in favor of the United States." United States v. Bess, 357 U.S. 51, 56-57 (1958).
I
A
The relevant facts are not in dispute. On August 3, 1994, Irma Deliah Drye died intestate, leaving an estate worth approximately $233,000, of which $158,000 was personalty and $75,000 was realty located in Pulaski County, Arkansas. Petitioner Rohn F. Drye, Jr., her son, was sole heir to the estate under Arkansas law. See Ark. Code Ann. §28-9-214 (1987) (intestate interest passes "[f]irst, to the children of the intestate"). On the date of his mother's death, Drye was insolvent and owed the Government approximately $325,000, representing assessments for tax deficiencies in years 1988, 1989, and 1990. The Internal Revenue Service (IRS or Service) had made assessments against Drye in November 1990 and May 1991 and had valid tax liens against all of Drye's "property and rights to property" pursuant to 26 U.S.C. §6321.
Drye petitioned the Pulaski County Probate Court for appointment as administrator of his mother's estate and was so appointed on August 17, 1994. Almost six months later, on February 4, 1995, Drye filed in the Probate Court and land records of Pulaski County a written disclaimer of all interests in his mother's estate. Two days later, Drye resigned as administrator of the estate.
Under Arkansas law, an heir may disavow his inheritance by filing a written disclaimer no later than nine months after the death of the decedent. Ark. Code Ann. §§28-2-101, 28-2-107 (1987). The disclaimer creates the legal fiction that the disclaimant predeceased the decedent; consequently, the disclaimant's share of the estate passes to the person next in line to receive that share. The disavowing heir's creditors, Arkansas law provides, may not reach property thus disclaimed. §28-2-108. In the case at hand, Drye's disclaimer caused the estate to pass to his daughter, Theresa Drye, who succeeded her father as administrator and promptly established the Drye Family 1995 Trust (Trust).
On March 10, 1995, the Probate Court declared valid Drye's disclaimer of all interest in his mother's estate and accordingly ordered final distribution of the estate to Theresa Drye. Theresa Drye then used the estate's proceeds to fund the Trust, of which she and, during their lifetimes, her parents are the beneficiaries. Under the Trust's terms, distributions are at the discretion of the trustee, Drye's counsel Daniel M. Traylor, and may be made only for the health, maintenance, and support of the beneficiaries. The Trust is spendthrift, and under state law, its assets are therefore shielded from creditors seeking to satisfy the debts of the Trust's beneficiaries.
Also in 1995, the IRS and Drye began negotiations regarding Drye's tax liabilities. During the course of the negotiations, Drye revealed to the Service his beneficial interest in the Trust. Thereafter, on April 11, 1996, the IRS filed with the Pulaski County Circuit Clerk and Recorder a notice of federal tax lien against the Trust as Drye's nominee. The Service also served a notice of levy on accounts held in the Trust's name by an investment bank and notified the Trust of the levy.
B
On May 1, 1996, invoking 26 U.S.C. §7426(a)(1), the Trust filed a wrongful levy action against the United States in the United States District Court for the Eastern District of Arkansas. The Government counterclaimed against the Trust, the trustee, and the trust beneficiaries, seeking to reduce to judgment the tax assessments against Drye, confirm its right to seize the Trust's assets in collection of those debts, foreclose on its liens, and sell the Trust property. On cross-motions for summary judgment, the District Court ruled in the Government's favor.
The United States Court of Appeals for the Eighth Circuit affirmed the District Court's judgment. Drye Family 1995 Trust v. United States [98-2 USTC 50,651], 152 F.3d 892 (1998). The Court of Appeals understood our precedents to convey that "state law determines whether a given set of circumstances creates a right or interest; federal law then dictates whether that right or interest constitutes 'property' or the 'right to property' under §6321." Id., at 898.
We granted certiorari, 526 U.S.†(1999), to resolve a conflict between the Eighth Circuit's holding and decisions of the Fifth and Ninth Circuits. 1 We now affirm.
II
Under the relevant provisions of the Internal Revenue Code, to satisfy a tax deficiency, the Government may impose a lien on any "property" or "rights to property" belonging to the taxpayer. Section 6321 provides: "If any person liable to pay any tax neglects or refuses to pay the same after demand, the amount . . . shall be a lien in favor of the United States upon all property and rights to property, whether real or personal, belonging to such person." 26 U.S.C. §6321. A complementary provision, §6331(a), states:
"If any person liable to pay any tax neglects or refuses to pay the same within 10 days after notice and demand, it shall be lawful for the Secretary to collect such tax . . . by levy upon all property and rights to property (except such property as is exempt under section 6334) belonging to such person or on which there is a lien provided in this chapter for the payment of such tax." (2)
The language in §§6321 and 6331(a), this Court has observed, "is broad and reveals on its face that Congress meant to reach every interest in property that a taxpayer might have." United States v. National Bank of Commerce, 472 U.S. 713, 719-720 (1985) (citing 4 B. Bittker, Federal Taxation of Income, Estates and Gifts 111.5.4, p. 111-100 (1981)); see also Glass City Bank v. United States, 326 U.S. 265, 267 (1945) ("Stronger language could hardly have been selected to reveal a purpose to assure the collection of taxes."). When Congress so broadly uses the term "property," we recognize, as we did in the context of the gift tax, that the Legislature aims to reach " 'every species of right or interest protected by law and having an exchangeable value.' " Jewett v. Commissioner [82-1 USTC 13,453], 455 U.S. 305, 309 (1982) (quoting S. Rep. No. 665, 72d Cong., 1st Sess., 39 (1932); H.R. Rep. No. 708, 72d Cong., 1st Sess., 27 (1932)).
Section 6334(a) of the Code is corroborative. That provision lists property exempt from levy. The list includes 13 categories of items; among the enumerated exemptions are certain items necessary to clothe and care for one's family, unemployment compensation, and workers' compensation benefits. §§6334(a)(1), (2), (4), (7). The enumeration contained in §6334(a), Congress directed, is exclusive: "Notwithstanding any other law of the United States . . ., no property or rights to property shall be exempt from levy other than the property specifically made exempt by subsection (a)." §6334(c). Inheritances or devises disclaimed under state law are not included in §6334(a)'s catalog of property exempt from levy. See Bess, 357 U.S., at 57 ("The fact that . . . Congress provided specific exemptions from distraint is evidence that Congress did not intend to recognize further exemptions which would prevent attachment of [federal tax] liens[.]"); United States v. Mitchell, 403 U.S. 190, 205 (1971) ("Th[e] language [of §6334] is specific and it is clear and there is no room in it for automatic exemption of property that happens to be exempt from state levy under state law."). The absence of any recognition of disclaimers in §§6321, 6322, 6331(a), and 6334(a) and (c), the relevant tax collection provisions, contrasts with §2518(a) of the Code, which renders qualifying state-law disclaimers "with respect to any interest in property" effective for federal wealth-transfer tax purposes and for those purposes only.(3)
Drye nevertheless refers to cases indicating that state law is the proper guide to the critical determination whether his interest in his mother's estate constituted "property" or "rights to property" under §6321. His position draws support from two recent appellate opinions: Leggett v. United States [97-2 USTC 60,286; 97-2 USTC 50,635], 120 F.3d 592, 597 (CA5 1997) ("Section 6321 adopts the state's definition of property interest."); and Mapes v. United States, 15 F.3d 138, 140 (CA9 1994) ("For the answer to th[e] question [whether taxpayer had the requisite interest in property], we must look to state law, not federal law."). Although our decisions in point have not been phrased so meticulously as to preclude Drye's argument, 4 we are satisfied that the Code and interpretive case law place under federal, not state, control the ultimate issue whether a taxpayer has a beneficial interest in any property subject to levy for unpaid federal taxes.
III
As restated in National Bank of Commerce: "The question whether a state-law right constitutes 'property' or 'rights to property' is a matter of federal law." 472 U.S., at 727. We look initially to state law to determine what rights the taxpayer has in the property the Government seeks to reach, then to federal law to determine whether the taxpayer's state-delineated rights qualify as "property" or "rights to property" within the compass of the federal tax lien legislation. Cf. Morgan v. Commissioner, 309 U.S. 78, 80 (1940) ("State law creates legal interests and rights. The federal revenue acts designate what interests or rights, so created, shall be taxed.").
In line with this division of competence, we held that a taxpayer's right under state law to withdraw the whole of the proceeds from a joint bank account constitutes "property" or the "righ[t] to property" subject to levy for unpaid federal taxes, although state law would not allow ordinary creditors similarly to deplete the account. National Bank of Commerce, 472 U.S., at 723-727. And we earlier held that a taxpayer's right under a life insurance policy to compel his insurer to pay him the cash surrender value qualifies as "property" or a "righ[t] to property" subject to attachment for unpaid federal taxes, although state law shielded the cash surrender value from creditors' liens. Bess, 357 U.S., at 56-57. 5 By contrast, we also concluded, again as a matter of federal law, that no federal tax lien could attach to policy proceeds unavailable to the insured in his lifetime. Id., at 55-56 ("It would be anomalous to view as 'property' subject to lien proceeds never within the insured's reach to enjoy."). (6)
Just as "exempt status under state law does not bind the federal collector," Mitchell, 403 U.S., at 204, so federal tax law "is not struck blind by a disclaimer," United States v. Irvine [94-1 USTC 60,163], 511 U.S. 224, 240 (1994). Thus, in Mitchell, the Court held that, although a wife's renunciation of a marital interest was treated as retroactive under state law, that state-law disclaimer did not determine the wife's liability for federal tax on her share of the community income realized before the renunciation. See 403 U.S., at 204 (right to renounce does not indicate that taxpayer never had a right to property).
IV
The Eighth Circuit, with fidelity to the relevant Code provisions and our case law, determined first what rights state law accorded Drye in his mother's estate. It is beyond debate, the Court of Appeals observed, that under Arkansas law Drye had, at his mother's death, a valuable, transferable, legally protected right to the property at issue. See 152 F.3d, at 895 (although Code does not define "property" or "rights to property," appellate courts read those terms to encompass "state-law rights or interests that have pecuniary value and are transferable"). The court noted, for example, that a prospective heir may effectively assign his expectancy in an estate under Arkansas law, and the assignment will be enforced when the expectancy ripens into a present estate. See id., at 895-896 (citing several Arkansas Supreme Court decisions, including: Clark v. Rutherford, 227 Ark. 270, 270-271, 298 SW2d 327, 330 (1957); Bradley Lumber Co. of Ark. v. Burbridge, 213 Ark. 165, 172, 210 SW2d 284, 288 (1948); Leggett v. Martin, 203 Ark. 88, 94, 156 SW2d 71, 74-75 (1941)). (7)
Drye emphasizes his undoubted right under Arkansas law to disclaim the inheritance, see Ark. Code Ann. §28-2-101 (1987), a right that is indeed personal and not marketable. See Brief for Petitioners 13 (right to disclaim is not transferable and has no pecuniary value). But Arkansas law primarily gave Drye a right of considerable value--the right either to inherit or to channel the inheritance to a close family member (the next lineal descendant). That right simply cannot be written off as a mere "personal right . . . to accept or reject [a] gift." Brief for Petitioners (13)
In pressing the analogy to a rejected gift, Drye overlooks this crucial distinction. A donee who declines an inter vivos gift generally restores the status quo ante, leaving the donor to do with the gift what she will. The disclaiming heir or devisee, in contrast, does not restore the status quo, for the decedent cannot be revived. Thus the heir inevitably exercises dominion over the property. He determines who will receive the property--himself if he does not disclaim, a known other if he does. See Hirsch, The Problem of the Insolvent Heir, 74 Cornell L. Rev. 587, 607-608 (1989). This power to channel the estate's assets warrants the conclusion that Drye held "property" or a "righ[t] to property" subject to the Government's liens.
***
In sum, in determining whether a federal taxpayer's state-law rights constitute "property" or "rights to property," "[t]he important consideration is the breadth of the control the [taxpayer] could exercise over the property." Morgan, 309 U.S., at 83. Drye had the unqualified right to receive the entire value of his mother's estate (less administrative expenses), see National Bank of Commerce, 472 U.S., at 725 (confirming that unqualified "right to receive property is itself a property right" subject to the tax collector's levy), or to channel that value to his daughter. The control rein he held under state law, we hold, rendered the inheritance "property" or "rights to property" belonging to him within the meaning of §6321, and hence subject to the federal tax liens that sparked this controversy.
For the reasons stated, the judgment of the Court of Appeals for the Eighth Circuit is Affirmed.
1. In the view of those courts, state law holds sway. Under their approach, in a State adhering to an acceptance-rejection theory, under which a property interest vests only when the beneficiary accepts the inheritance or devise, the disclaiming taxpayer prevails and the federal liens do not attach. If, instead, the State holds to a transfer theory, under which the property is deemed to vest in the beneficiary immediately upon the death of the testator or intestate, the taxpayer loses and the federal lien runs with the property. See Leggett v. United States [97-2 USTC 60,286; 97-2 USTC 50,635], 120 F.3d 592, 594 (CA5 1997); Mapes v. United States, 15 F.3d 138, 140 (CA9 1994); accord, United States v. Davidson, 55 F. Supp. 2d 1152, 1155 (Colo. 1999). Drye maintains that Arkansas adheres to the acceptance-rejection theory.
2. The Code further provides:
"Unless another date is specifically fixed by law, the lien imposed by section 6321 shall arise at the time the assessment is made and shall continue until the liability for the amount so assessed (or a judgment against the taxpayer arising out of such liability) is satisfied or becomes unenforceable by reason of lapse of time." 26 U.S.C. §6322.
3. See Pennell, Recent Wealth Transfer Tax Developments, in Sophisticated Estate Planning Techniques 69, 117-118 (ALI-ABA Continuing Legal Ed. 1997) ("The fact that a qualified disclaimer by an estate beneficiary is deemed to relate back to the decedent's death for state property law or federal gift tax purposes is not sufficient to preclude a federal tax lien for the disclaimant's delinquent taxes from attaching to the disclaimed property as of the moment of the decedent's death . . . . [T]he qualified disclaimer provision in §2518 only applies for purposes of Subtitle B and the lien provisions are in Subtitle F.").
4. See, e.g., United States v. National Bank of Commerce, 472 U.S. 713, 722 (1985) ("[T]he federal statute 'creates no property rights but merely attaches consequences, federally defined, to rights created under state law.' ") (quoting United States v. Bess, 357 U.S. 51, 55 (1958)).
5. Accord, Bank One Ohio Trust Co. v. United States, 80 F.3d 173, 176 (CA6 1996) ("Federal law did not create [the taxpayer's] equitable income interest [in a spendthrift trust], but federal law must be applied in determining whether the interest constitutes 'property' for purposes of §6321."); 21 West Lancaster Corp. v. Main Line Restaurant, Inc., 790 F.2d 354, 357-358 (CA3 1986) (although a liquor license did not constitute "property" and could not be reached by creditors under state law, it was nevertheless "property" subject to federal tax lien); W. Plumb, Federal Tax Liens 27 (3d ed. 1972) ("[I]t is not material that the economic benefit to which the [taxpayer's local law property] right pertains is not characterized as 'property' by local law.").
6. Compatibly, in Aquilino v. United States, 363 U.S. 509 (1960), we held that courts should look first to state law to determine " 'the nature of the legal interest' " a taxpayer has in the property the Government seeks to reach under its tax lien. Id., at 513 (quoting Morgan v. Commissioner, 309 U.S. 78, 82 (1940)). We then reaffirmed that federal law determines whether the taxpayer's interests are sufficient to constitute "property" or "rights to property" subject to the Government's lien. Id., at 513-514. We remanded in Aquilino for a determination whether the contractor-taxpayer held any beneficial interest, as opposed to "bare legal title," in the funds at issue. Id., at 515-516; see also Note, Property Subject to the Federal Tax Lien, 77 Harv. L. Rev. 1485, 1491 (1964) ("Aquilino supports the view that the Court has chosen to apply a federal test of classification, for the contractor concededly had legal title to the funds and yet in remanding the Court indicated that this state-created incident of ownership was not a sufficient 'right to property' in the contract proceeds to allow the tax lien to attach. In this sense Aquilino follows Bess in requiring that the taxpayer must have a beneficial interest in any property subject to the lien." (footnote omitted)).
7. In recognizing that state-law rights that have pecuniary value and are transferable fall within §6321, we do not mean to suggest that transferability is essential to the existence of "property" or "rights to property" under that section. For example, although we do not here decide the matter, we note that an interest in a spendthrift trust has been held to constitute " 'property' for purposes of §6321" even though the beneficiary may not transfer that interest to third parties. See Bank One, 80 F.3d, at 176. Nor do we mean to suggest that an expectancy that has pecuniary value and is transferable under state law would fall within §6321 prior to the time it ripens into a present estate.
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TECHNICAL REFERENCES
1. Over time, even the large foundations established by industrialists can dwindle and come to an end. A branch of the Astor estate recently gave out the last $25 million it had and closed up shop after 38 years. David Packard's foundation held his 9% share of a technology company and therefore skyrocketed to become the 11th largest foundation with $1.5 billion by December 1994, and then reached third place on the list with $8.9 billion by the end of 1997; it had 271% growth in 1997 alone. By comparison, older foundations with stabilized portfolios have begun to slide down the list.
2. Generally, the measuring lives are lifetime beneficiaries, but any living person can be so designated. Thus, a valid bequest was made to descendants who were alive 21 years after the death of all 120 lineal descendants of Queen Victoria who were lives in being. In re Villar, 1 Ch. 243 (1926).
3. If a generation is 25 years, a 200-year period of asset accumulation overlaps eight generations. All things being relative, the Chicago Bulls were a sports dynasty by pulling a double three-peat during a single decade while the Ming dynasty in China lasted for 276 years after the expulsion of the Mongols in 1368. Many might consider the Kennedy family an American dynasty, yet that family fortune was only formed during the past century.
4. Once again: No interest shall fail to vest sooner than 21 years after a life in being. Another definition: "A limitation, whether executory or by way of remainder, of either real or personal property, which is not to vest until after the expiration of, or will not necessarily vest within, the period fixed and prescribed by law for the creation of future estates and interests." And one more: "The rule which prohibits the creation of future interests or estates which by possibility may not become vested within a life or lives in being at the time of the testator's death or the effective date of the instrument creating the future interest, and twenty-one years thereafter, together with the period of gestation when the inclusion of the latter is necessary to cover cases of posthumous birth." 41 Am J1st Perp §§3, cited in Ballentine's Law Dictionary (3rd Ed, 1969). Perpetuities were mentioned in English records as early as 1595. In 1664 the question of remoteness of vesting arose and the Duke of Norfolk's Case, 3 Ch. Cas. 1 (1685), linked the validity of a future interest to the remoteness of vesting. The rule, as we know it today, was first stated in 1833 in Cadell v. Palmer, 1 Cl. & F. 372.
5. Perpetuity havens include: Alaska, Delaware (with respect to personal property), possibly Idaho, South Dakota, and Wisconsin.
6. In search of the perfect trust, The Estate Analyst (June, 1993).
7. Estate planning with FLPs, The Estate Analyst (March, 1999).
8. The Roth IRA estate, The Estate Analyst (Jan., 1999).
9. Supreme Court Upholds Tax Lien Despite Disclaimer
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