## Facts

- Bert B. Rapp (a California decedent) died in 1988, survived by his wife, Laura, and two sons, Richard and David; the sons served as trustees under his will, and Richard served as executor.
- Bert’s will (prepared in 1978) placed his one-half share of community property into a trust for Laura.
- The trust authorized the trustees, in their “absolute discretion,” to distribute principal and income to Laura for her health, education, and support, or as they deemed necessary or advisable for her use and benefit.
- The trust, as drafted, did not require that all trust income be paid to Laura at least annually.
- After Bert’s death, Laura petitioned a California probate court to reform the will so the trust would qualify for the federal estate tax marital deduction as “qualified terminable interest property” (QTIP) under 26 U.S.C. § 2056(b)(7).
- The probate court reformed the will to require payment of all trust income to Laura at least annually and to authorize the executor to make a QTIP election; the proceeding occurred without notice to the IRS and without testimony or documentary evidence.
- The Estate filed a federal estate tax return claiming a marital deduction for the trust as reformed; the IRS disallowed the deduction for the trust and issued a deficiency notice.
- The Tax Court held the probate reformation was not binding for federal tax purposes and was erroneous under California law; it concluded the trust did not qualify as QTIP and denied the marital deduction for the trust.
- The Estate appealed to the Ninth Circuit.

## Issues

1. Whether a state probate court’s post-death reformation intended to secure QTIP treatment is binding on the IRS and federal courts in determining federal estate tax liability when the decree is not from the state’s highest court and is inconsistent with state law.
2. Whether the trust created by the original will (without reformation) satisfied QTIP requirements so that its value qualified for the federal estate tax marital deduction.

## Decision

- The Ninth Circuit affirmed the Tax Court.
- The court held that the probate court’s reformation was not controlling for federal estate tax purposes because it did not reflect California law as the state’s highest court would apply it.
- The court held the original trust failed QTIP because Laura was not entitled to all trust income for life payable at least annually; the trustees’ discretion over distributions prevented a “qualifying income interest for life.”
- The IRS properly disallowed the marital deduction for the trust property.

## Legal Principles

- Property interests are generally defined by state law, but federal law determines the federal tax consequences of those interests.
- A federal court determining estate tax liability is not bound by a state trial-court probate decree if the decree is inconsistent with state law and lacks confirmation by the state’s highest court.
- The marital deduction under 26 U.S.C. § 2056 generally disallows deductions for terminable interests, subject to the QTIP exception in § 2056(b)(7).
- QTIP requires, among other conditions, that the surviving spouse have a “qualifying income interest for life,” including entitlement to all income from the property payable at least annually.
- A post-death state-court reformation aimed at changing tax results does not control federal tax treatment when the reformation is not supported by applicable state-law grounds (such as ambiguity or mistake) sufficient to rewrite the dispositive terms.

## Conclusion

The Ninth Circuit sustained the estate tax deficiency because the original trust’s discretionary distribution scheme did not give the surviving spouse an enforceable right to all income for life as required for QTIP, and the post-death probate reformation was not binding on federal tax authorities where it was not a reliable statement of state law.


Estate of Rapp v. Commissioner, 140 F.3d 1211 (9th Cir. 1998)