## Facts

- Charles J. Wyly, Sr. and his wife, Flora E. Wyly, lived in Texas, a community-property state.
- The couple owned certain shares of stock as community property.
- Charles and Flora created a trust and transferred some of those community-property shares to the trust.
- Flora was entitled to the trust’s income for life, and the remainder was to pass to the couple’s grandchildren.
- Under Texas law, Charles’s transfer of his one-half community interest in the shares to Flora was treated as a gift to his spouse, converting that half to Flora’s separate property.
- Texas community-property rules generally treat income produced by a spouse’s separate property (such as dividends) as community income, which would be shared by both spouses.
- After Charles died, his estate did not include the transferred shares in Charles’s gross estate.
- The IRS determined an estate-tax deficiency, asserting that Charles had retained an interest (or right to income) for life in the transferred shares because Texas law would still give him a share of income attributable to the gifted property.
- The U.S. Tax Court ruled for the IRS and sustained inclusion under 26 U.S.C. § 2036(a)(1).
- The estate appealed to the Fifth Circuit; the court decided the appeal in a consolidated opinion with two related Texas cases presenting the same § 2036(a)(1) question.

## Issues

1. Does 26 U.S.C. § 2036(a)(1) apply automatically to a Texas spouse’s gift of community property to the other spouse, solely because Texas law leaves the donor spouse with a residual community interest in income generated by the gifted property?

## Decision

- No. Section 2036(a)(1) does not automatically require gross-estate inclusion of property gifted by one Texas spouse to the other solely due to Texas community-property income rules.
- The Fifth Circuit reversed and remanded the Tax Court’s judgment in *Estate of Wyly v. Commissioner* for further proceedings consistent with its opinion.

## Legal Principles

- Section 2036(a)(1) generally includes in a decedent’s gross estate property the decedent transferred while retaining for life (or for a period not ending before death) the possession or enjoyment of the property, or the right to the income from it.
- The statute is not triggered by a retained interest that arises only by operation of state marital-property rules, without a retained right to income or enjoyment tied to the transfer itself.
- State law determines what property rights exist (including community-property consequences), but federal law determines whether those rights amount to a retained interest that causes inclusion under § 2036(a)(1).
- A per se rule that treats every interspousal gift of Texas community property as a retained-life-interest transfer under § 2036(a)(1) is not consistent with the statute as applied by the Fifth Circuit.

## Conclusion

The Fifth Circuit held that § 2036(a)(1) does not automatically bring interspousal gifts of Texas community property back into the donor spouse’s gross estate merely because Texas law may give the donor spouse a continuing share of income generated by the gifted property; instead, inclusion requires more than a state-law residual income interest and turns on whether the decedent actually retained a qualifying right to possession, enjoyment, or income under § 2036(a)(1).


Estate of Wyly v. Commissioner, 610 F.2d 1282 (1980)