                        T.C. Memo. 1997-443



                      UNITED STATES TAX COURT



ESTATE OF ARTHUR C. EDWARDS, DECEASED, KENNETH EDWARDS, EDWARD
EDWARDS AND JAMES EDWARDS, AS TRUSTEES OF THE ARTHUR C. EDWARDS
SETTLEMENT TRUST, PERSONAL REPRESENTATIVE, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 8214-93.                Filed September 29, 1997.



     Owen G. Fiore and Glenn M. Alperstein, for petitioner.

     Debra Lynn Reale and S. Katy Lin, for respondent.



                        MEMORANDUM OPINION


     FAY, Judge:   This case is before us on petitioner's motion

for summary judgment pursuant to Rule 121.1     Respondent filed a

     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect as of the date of decedent’s
                                                   (continued...)
                               - 2 -

response in opposition to petitioner's motion.   Both petitioner

and respondent submitted memoranda in support of their positions.

     Respondent determined a deficiency in petitioner's Federal

estate tax of $14,107,060.   The deficiency was due primarily to

respondent's increased valuation of decedent's stock in his

closely held corporations, as well as respondent's disallowance

of certain deductions for claims against the estate.   The parties

have resolved the valuation issues.

     The disallowed deductions relate to various claims on dece-

dent's closely held stock.   Specifically, Ann Goss, decedent's

former wife, holds a claim to the income from the stock for her

life, and his three children hold a claim to the remainder

interest in the stock.   Respondent has conceded that the estate

is entitled to a deduction for Ann Goss' interest in the stock.

Therefore, the issue for decision is whether petitioner is

entitled to deduct the value of the decedent's children's

remainder interest in the stock as a claim against the estate

under section 2053(a)(3).

     We may grant a motion for summary judgment under Rule 121

"if the pleadings, answers to interrogatories, depositions,

admissions, and any other acceptable materials, together with the

affidavits, if any, show that there is no genuine issue as to any


     1
      (...continued)
death, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
                               - 3 -

material fact and that a decision may be rendered as a matter of

law."   Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C.

518, 520 (1992), affd. 17 F.3d 965 (7th Cir. 1994).   The moving

party bears the burden of proving that there is no genuine issue

of material fact and that a decision may be rendered as a matter

of law.   Celotex Corp. v. Catrett, 477 U.S. 317, 322-323 (1986);

Preece v. Commissioner, 95 T.C. 594, 597 (1990).

     The facts presented below are stated solely for the purpose

of deciding petitioner's motion for summary judgment.

Background

     Some of the facts have been stipulated by the parties.     The

stipulation of facts and the attached exhibits are incorporated

herein by this reference.   A hearing on petitioner's motion for

summary judgment was held on June 16, 1997, in Washington, D.C.

     The decedent died on November 6, 1988.   He was a resident of

California at that time.

     Decedent was survived by his three children and his former

wife, Ann Goss.   Decedent married Ann Goss in 1927, and they

resided in California at all times during the marriage.   Decedent

and Ann Goss separated in 1967, and formal divorce proceedings

commenced on September 11, 1969.   At the time of the divorce

proceedings, decedent and Ann Goss jointly owned 61.6 percent of

the stock in Dunn-Edwards Corporation (the Company) and 40

percent of the stock in Highland Properties, Inc. (Highland

Properties).
                                - 4 -

     Decedent, at the time of the divorce, desired to maintain

control of the Company.    Ann Goss was not opposed to decedent's

desire to run the Company, because she recognized that the

Company had prospered under his stewardship.    However, in return,

Ann Goss demanded certain property rights that she may not have

otherwise received in a dissolution proceeding, such as alimony

that would continue after her remarriage.    On March 6, 1970, in

order to meet these goals, decedent and Ann Goss entered into a

written property settlement agreement (the 1970 PSA) incident to

the divorce proceedings.   Pursuant to the 1970 PSA, Ann Goss

received one-half of the jointly owned stock.   In addition, she

agreed to place her shares of stock in trust (the voting trust),

and then execute a voting trust agreement in favor of decedent.

Pursuant to the terms of the voting trust, decedent would be

entitled to vote her shares of stock in the Company and Highland

Properties for 21 years or until his death, if sooner.   In

return, decedent agreed to pay alimony that would not terminate

upon her remarriage.   Further, decedent and Ann Goss agreed to

maintain their reciprocal will provisions.   At that time, each of

their wills provided that the stock in the Company and Highland

Properties would pass, in trust, to the surviving spouse for

life, with the remainder to the three children.

     On March 10, 1970, decedent's marriage to Ann Goss was

dissolved by a Los Angeles County Superior Court interlocutory

order.   The Los Angeles County Superior Court entered a final
                               - 5 -

judgment of dissolution of marriage on March 12, 1970 (the final

judgment).   The 1970 PSA was incorporated into the final judg-

ment.   At the time the final judgment was entered, each of the

Edwards children was over 21 years old.

     A disagreement between Ann Goss and decedent arose concern-

ing some of the terms of the 1970 PSA.    In order to resolve the

disagreement, decedent, Ann Goss, their three children, and the

Company entered into a second property settlement agreement on

January 20, 1984 (the 1984 PSA).   On June 6, 1984, a stipulation

for modification of judgment and order thereon was entered by the

California Superior Court (the 1984 court order).   The 1984 court

order incorporated the 1984 PSA into the final judgment in place

of paragraph 14 of the 1970 PSA.   Paragraph 14 had dealt with the

reciprocal will provisions of petitioner and Ann Goss.   In the

1984 court order, decedent was prohibited from modifying, without

prior approval of the court, the Arthur C. Edwards settlement

trust (settlement trust), a revocable living trust that he had

created in 1981.   Under the terms of the settlement trust,

decedent was to receive the income from his stock in the Company

and Highland Properties during his life; at his death, Ann Goss

was to receive such income for life; and, at her death, the trust

property was to be distributed to the three children.

     On November 6, 1988, the date of decedent's death, the fair

market values of decedent's interests in the Company and Highland

Properties, respectively, were $18,113,960 and $106,184.   Pur-
                                 - 6 -

suant to the terms of the settlement trust, outlined supra, Ann

Goss possessed an income interest in this property for her life.

The parties have agreed that the fair market value of that income

interest was $6,741,453.

     After decedent's death, a Federal estate tax return was

filed by the executors of decedent's estate.    In the return, the

executors claimed deductions for the value of Ann Goss' life

interest in decedent's stock and the value of the Edwards

children's remainder interest.    Respondent, in the notice of

deficiency, disallowed both deductions.    Respondent has subse-

quently conceded that the claim of Ann Goss is deductible.     The

deductibility of the remainder interest of the Edwards children,

however, is still in dispute.

Discussion

     Section 2053(a)(3) provides that the value of the gross

estate is determined by deducting the amount of claims against

the estate.   Section 2053(c)(1)(A) limits the deduction for

claims founded on a promise or agreement to the amount of claims

that were contracted for full and adequate consideration.    One

purpose of this consideration requirement is to prevent decedents

from reducing their gross estate through contractually arranged

transfers that serve a "donative or testamentary intent."      Estate

of Huntington v. Commissioner, 100 T.C. 313, 316 (1993), affd. 16

F.3d 462 (1st Cir. 1994); see also United States v. Stapf, 375

U.S. 118, 130-133 (1963).   However, liabilities imposed by law
                               - 7 -

and not founded on a promise or agreement are deductible from the

gross estate regardless of the ability to show consideration.

Sec. 20.2053-4, Estate Tax Regs.

     A claim founded on a divorce decree is a liability imposed

by law and deductible without regard to the limitations of

section 2053(c)(1)(A).   See Harris v. Commissioner, 340 U.S. 106

(1950); Estate of Robinson v. Commissioner, 63 T.C. 717 (1975).

Petitioner asserts that the claim of the Edwards children is

founded on the divorce decree and is therefore deductible as a

claim imposed by law.2   Respondent disagrees, arguing that the

claim is founded on the 1970 PSA, not the divorce decree.

     In order for the claim to be imposed at law, the divorce

decree, rather than the agreement between the parties, must be

the "operative element" of a claim.     Estate of Satz v. Commis-

sioner, 78 T.C. 1172, 1179 (1982).     Whether the divorce decree is

the "operative element" depends upon whether the divorce court

has the power to vary the terms of the agreement between the

parties--here the rights of the Edwards children vis-a-vis the

stock.   Harris v. Commissioner, supra at 109-110; Estate of

Fenton v. Commissioner, 70 T.C. 263, 271-274 (1978).     If the

divorce court has the power to prescribe a property settlement

     2
      Petitioner also asserts that the Edwards children's claim
is supported by full and adequate consideration. At the hearing,
the parties indicated that more facts needed to be developed
before this alternative theory would be ripe for summary judg-
ment. Consequently, we offer no opinion as to whether the
Edwards children's claim is supported by adequate consideration.
                                - 8 -

with terms different from those agreed to by the spouses, then it

is the decree that fixes the right of the spouses, and, under the

rationale of Harris v. Commissioner, supra, any subsequent claim

by a spouse is founded on that decree.    Estate of Fenton v.

Commissioner, supra at 272.    The fact that a property settlement

agreement is incorporated into the divorce decree is not

determinative in ascertaining whether the decree is the operative

element of a claim.     Id.

     Petitioner argues that the claim of decedent's children is

based upon the final judgment because the 1984 PSA was

incorporated into it.    Petitioner notes that, where a marriage

settlement agreement3 is incorporated into a divorce decree, the

Court of Appeals for the Ninth Circuit has stated:    "A marriage

settlement agreement loses its status as an independent contract

when it is incorporated into a final divorce decree."    Spirtos v.

Moreno, 56 F.3d 1007, 1008 (9th Cir. 1995).    Because the 1984 PSA

was incorporated into the final judgment, under California law,

the parties can only enforce the terms of the agreement through

actions on the judgment, and not by actions on the 1984 PSA.    See

Hough v. Hough, 160 P.2d 15 (Cal. 1945); In re Marriage of

Umphrey, 267 Cal. Rptr. 218 (Ct. App. 1990).    Therefore,




     3
      For the purposes of this opinion, the terms "marriage
settlement agreement" and "property settlement agreement" are
used interchangeably.
                               - 9 -

petitioner concludes that the claim of the Edwards children is

imposed by law and deductible under section 2053(a)(3).

      Petitioner's argument in this regard does not carry the day.

The fact that the 1984 PSA was merged, or incorporated, into the

final judgment is not dispositive of the critical issue before

us.   Our inquiry must focus on the extent of the California

divorce court's power to modify the terms of the 1984 PSA before

incorporating it into the final judgment.

      In this regard, our examination of California law indicates

that, absent exceptional circumstances, a California divorce

court lacks the power to modify a property settlement agreement

before incorporating it into a divorce decree.   See Flynn v.

Flynn, 265 P.2d 865 (Cal. 1954); Adams v. Adams, 177 P.2d 265

(Cal. 1947).   The Court of Appeals for the Ninth Circuit has

addressed this question in Gray v. United States, 541 F.2d 228

(9th Cir. 1976).   In Gray, the decedent husband and his wife had

entered into a property settlement agreement, whereby the husband

agreed to maintain an insurance policy on his life, designating

his wife as the beneficiary.   Id. at 230.   The husband died in a

plane crash shortly after the divorce court had entered a divorce

decree, wherein the court   approved the property settlement

agreement and ordered the parties to carry out its provisions.

Id.   The proceeds of the policy were paid directly to the wife;

the executor included the proceeds in the gross estate and

claimed a deduction for that same amount.    Id. at 231.   The
                                 - 10 -

District Court held that the claim was founded on a divorce

decree and thereby deductible under section 2053, and the

Government appealed.    Id.

       The Court of Appeals for the Ninth Circuit reversed the

District Court.    The Court of Appeals for the Ninth Circuit

agreed with the Government's position that a claim is founded on

the court decree only where "the court entering the decree had

the power to modify or alter the terms of the agreement."       Id. at

231.    The Court of Appeals, in concluding that the wife's claim

was founded on the marriage settlement agreement, observed that

"under California law a California court entering a divorce

decree, in the absence of fraud, has no power to modify or alter

the property agreement".      Id. at 232.   According to the Ninth

Circuit, the fact that the divorce court ordered the parties to

carry out the terms of the agreement only imposed an additional

method for enforcing its terms and did not change the conclusion

that the wife's claim was founded on the agreement.

       Petitioner attempts to distinguish the present case by

noting that the law relating to property settlement agreements

has changed since the Ninth Circuit decided Gray v. United

States, supra, and cites a number of cases where the divorce

court altered the terms of a marriage settlement agreement.      See

Adkins v. Adkins, 186 Cal. Rptr. 818 (Ct. App. 1983); Brennan v.

Brennan, 177 Cal. Rptr. 520 (Ct. App. 1981); Moore v. Moore, 169

Cal. Rptr. 619 (Ct. App. 1980).     Petitioner's attempts to
                              - 11 -

distinguish the case at bar from Gray v. United States, supra,

fall short.

     In each of the above cases, the presence of exceptional

circumstances, such as fraud or overreaching, gave the court

grounds to set aside the agreements.    See Adkins v. Adkins, supra

at 822 (sufficient showing of extrinsic fraud for the court to

set aside a marital settlement agreement where the husband,

unable to read or write, signed the agreement based on his wife's

misleading representations); Brennan v. Brennan, supra at 525

(sufficient showing of extrinsic fraud for the court to set aside

a marriage settlement agreement where the wife, unrepresented by

counsel, relied to her detriment on the advice of her husband and

his attorney); Moore v. Moore, supra at 624 (wife's waiver of her

interest in the community property set aside where she was not

represented by counsel and spoke only limited English).   More-

over, in each of these cases, the court set aside a property

settlement agreement after a divorce decree had been previously

entered.   None of the cases involves a court's power to modify an

agreement prior to entering the decree.

     Petitioner makes the assertion that the property settlement

agreement in Gray v. United States, supra, was based on the pre-

1967 California law, which is not applicable to decedent.

Specifically, petitioner claims that the agreement in Gray was a

"pre-1967 Integrated Property Settlement Agreement" that was not

incorporated into the divorce decree.   However, petitioner has
                               - 12 -

not shown that any change in California law endowed the divorce

court with power to alter the 1984 PSA prior to accepting it and

incorporating it into the final judgment.   According to a leading

treatise, the law in California regarding a divorce court's power

to modify a property settlement agreement before entering a

decree has not substantially changed from the time Gray v. United

States, supra, was decided.    See 11 Witkin, Summary of Cal. Law,

ch. XVI, sec. 296 (9th ed. 1990) (citing Adams v. Adams, 177 P.2d

265 (Cal. 1947)).   We conclude that the California divorce court

lacked sufficient power to modify the 1970 PSA and the 1984 PSA,

and therefore the Edwards children's claim is founded on those

agreements.

     Petitioner has not demonstrated that it is entitled to

judgment as a matter of law.   Courts have often expressed

reservations about extending the rationale of Harris v.

Commissioner, 340 U.S. 106 (1950), to encompass transfers to the

children of a decedent.   See Rosenthal v. Commissioner, 205 F.2d

505 (2d Cir. 1953), revg. 17 T.C. 1047 (1951); Spruance v.

Commissioner, 60 T.C. 141 (1973), affd. without published opinion

505 F.2d 731 (3d Cir. 1974); Estate of Hartshorne v.

Commissioner, 48 T.C. 882 (1967), affd. 402 F.2d 592 (2d Cir.

1968); Estate of Keller v. Commissioner, 44 T.C. 851 (1965).     In

Rosenthal v. Commissioner, supra at 508, the Court of Appeals for

the Second Circuit opined:
                              - 13 -

          The rationale of both the Harris and Converse
     decisions rests basically on the divorce court's power,
     if not duty, to settle property rights as between the
     parties, either by adopting their own agreement as in
     the Harris case, or by having the matter litigated as
     in the Converse case. We do not find this rationale
     applicable to a decree ordering payments to adult
     offspring of the parties or to minors beyond their
     needs for support--the only payments with which we are
     now concerned, since that part of the taxpayer's
     undertakings necessary for the support of his children
     during their minority is concededly not taxable.
     [Citations omitted]. While neither the Nevada statute,
     Nev. Comp. Laws secs. 9462, 9463 (Supp. 1931-1941),
     [Fn. ref. omitted.] nor interpretive decisions indicate
     the precise limits of the divorce court's authority in
     this area, courts of other jurisdictions operating
     under similar statutes have been restricted in their
     power to make awards of property to children to amounts
     appropriate merely for the maintenance of minor
     children. [Citations omitted.] * * *. But since such
     a decree provision depends for its validity wholly upon
     the consent of the party to be charged with the
     obligation and thus cannot be the product of litigation
     in the divorce court, we do not consider the rationale
     of the Harris decision applicable to the present case.
     We therefore conclude that the arrangements here made
     for the taxpayer's daughters beyond their support
     during minority do not obtain exemption from the
     federal gift tax by simply receiving the court's
     imprimatur. * * *

Rosenthal v. Commissioner, supra at 508.     Like the taxpayer in

Rosenthal, petitioner has not demonstrated that the California

divorce court had the power to modify the provisions of the

property settlement agreements that dealt with the agreed-upon

transfers to the Edwards children.     Further, significant policy

concerns are raised by expanding the rule in Harris v. Commis-

sioner, supra, to cover transfers made to a spouse's children.

As we have noted:   "To construe the statute as suggested by

petitioner would open a means for a divorcing parent to transfer
                                - 14 -

property to his adult children free of both gift tax and estate

tax".    Estate of Hartshorne v. Commissioner, supra at 895

(quoting Estate of Keller v. Commissioner, 44 T.C. 851, 860

(1965).

        Petitioner has not cited a case wherein we have expanded the

rationale of Harris v. Commissioner, supra, and applied it to

property transfers to children on the theory that the transfers

were founded on a divorce decree.       In fact, when faced with the

contrary authority cited above, petitioner merely puts forth an

argument that it is up to the legislature, not the courts, to

cure any abuse of the laws.     This argument does not persuade us

that petitioner is entitled to judgment as a matter of law.

Accordingly, we conclude petitioner is not entitled to summary

judgment.

        To reflect the foregoing,

                                         An order denying petitioner's

                                    motion for summary judgment will be

                                    issued.
