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Nance v. Iowa Department of Revenue

Supreme Court of Iowa

February 23, 2018


          On review from the Iowa Court of Appeals.

         Appeal from the Iowa District Court for Polk County, Michael D. Huppert, Judge.

         The Iowa Department of Revenue seeks further review of decision of court of appeals that allowed taxpayer to avoid state inheritance tax through a postmortem family settlement agreement. DECISION OF COURT OF APPEALS VACATED; DISTRICT COURT JUDGMENT AFFIRMED.

          David M. Repp and F. Richard Lyford of Dickinson, Mackaman, Tyler & Hagen, P.C., Des Moines, for appellant.

          Thomas J. Miller, Attorney General, Donald D. Stanley Jr., Special Assistant Attorney General, and Hristo Chaprazov, Assistant Attorney General, for appellee.

          WATERMAN, Justice.

         In this appeal, we must decide whether the court of appeals correctly held a taxpayer avoided an Iowa inheritance tax through a private postmortem family settlement agreement (FSA). The taxpayer's father-in-law, over five years before his death, signed a beneficiary form listing her as a contingent beneficiary of his brokerage account. That account transferred to her alone upon his death, and the Iowa Department of Revenue (IDOR) determined the estate owed the inheritance tax on the full account value. The decedent's grandchildren from his son's prior marriage sued the taxpayer, claiming they were entitled to the brokerage account under their grandfather's will. They alleged their grandfather had dementia and lacked the mental capacity to execute an enforceable beneficiary designation for his brokerage account. The taxpayer settled the lawsuit by transferring half the account value to the grandchildren under an FSA without any judicial determination of incapacity. She then sought a refund of part of the inheritance tax already paid. The IDOR denied the refund and determined the taxpayer failed to meet her burden to establish incapacity. The district court affirmed. The taxpayer appealed, and we transferred the case to the court of appeals, which reversed and held the FSA controlled the tax issue. We granted the IDOR's application for further review.

         For the reasons explained below, we hold that the IDOR correctly denied the taxpayer's refund, and its refusal to give effect to the FSA was not irrational, illogical, or wholly unjustifiable. Without an adjudication of incapacity, the beneficiary designation transferred the brokerage account to the decedent's daughter-in-law upon his death, and the postmortem FSA was not binding on the IDOR and could not avoid the inheritance tax when the taxpayer failed to prove incapacity in the IDOR's contested case proceeding. The contrary holding of the court of appeals would allow parties to evade inheritance taxes without an adjudication defeating facially valid beneficiary designations. We vacate the decision of the court of appeals and affirm the district court judgment that upheld the IDOR decision.

         I. Background Facts and Proceedings.

         On August 17, 2003, Lester D. Gardiner Sr. and his wife, Mildred M. Gardiner, executed a transfer on death (TOD) agreement naming their only son, Lester Gardiner Jr., as the sole primary beneficiary of their brokerage accounts at Edward D. Jones. The TOD agreement designated their son's wife, Beverly Gardiner (now Beverly Gardiner Nance), as the sole contingent beneficiary. Lester Sr. was nearly age 92 when he signed the beneficiary designation. James Gibbons, a broker for Edward D. Jones, was present when the TOD agreement was executed and later testified that Lester Sr. and Mildred were mentally alert when they signed it. Beverly was not informed of her contingent designation at that time.

         Lester Jr. had been married and divorced before he married Beverly in 1979. Lester Jr.'s three children from his prior marriage- Donald Gardiner, Donitta Gardiner, and Dianne Gardiner Green-are Lester Sr.'s only grandchildren. Donald, Donitta, and Dianne were the beneficiaries of Lester Sr.'s will, which he executed on November 22, 1988, nearly five years before he executed the TOD agreement.

         Lester Sr. and Mildred moved into the Rowley Masonic Home in Perry in 2000 and resided in that nursing home until their deaths. Mildred died in 2004, and Lester Jr. died in 2007. On August 3, 2007- almost four years after Lester Sr. executed the TOD agreement-Beverly and Dianne filed an involuntary petition seeking the appointment of a guardian and conservator for Lester Sr. One of his treating physicians opined in a signed statement that Lester Sr.'s "mental condition makes him incapable of caring for his own personal safety or provid[ing] for the necessities of life such as food, shelter, clothing and continuing medical care." Lester Sr. was declared unfit to manage his affairs on September 11, and Beverly and Dianne were appointed coguardians and coconservators. Lester Sr. died testate on January 31, 2009, at the age of 97.

         After Lester Sr.'s death, his grandchildren, as coexecutors of his estate, sued Beverly, challenging the validity of the beneficiary designation form. They alleged that Lester Sr. lacked the requisite capacity to execute the form in August 2003 due to his dementia. Beverly denied the allegations, claiming Lester Sr. was competent when he and his wife signed the beneficiary designation over five years before his death.

         While the lawsuit was pending, the estate timely filed an inheritance tax return on October 20, 2009. The estate paid the required inheritance tax of $18, 988 based on the fact that Beverly received the full balance of the TOD brokerage accounts.

         With the grandchildren's lawsuit pending, counsel for the estate retained Dr. Robert Bender to review the medical and nursing home records of Lester Sr. and his wife. Dr. Bender had never examined or seen Lester Sr. Dr. Bender opined in a June 21, 2010 letter that both Lester Sr. and his wife suffered from dementia. He noted that the records showed Lester Sr. "was found to have impairment in decision-making skills" by June 2002, and by November of that year, Lester Sr. "was often confused[] and unable to manage his own affairs." Based on his review of the records, Dr. Bender concluded that Lester Sr. was incapable of understanding his finances and "was very vulnerable to undue influence being exerted on him by those around him." Lester Sr.'s grandchildren used Dr. Bender's opinion to support their claim that Lester Sr. lacked the requisite mental capacity to execute the beneficiary designation form in August 2003. Beverly found no expert who would opine to the contrary. However, Gibbons, the broker who was present when the TOD agreement was executed in 2003, testified at a deposition that he believed both Lester Sr. and Mildred to be mentally alert at the time.

         On July 27, the grandchildren and Beverly settled their dispute in mediation and entered into an FSA. The IDOR was not a party to the FSA. The FSA provided that the brokerage accounts would be liquidated and the proceeds divided equally between Beverly and the estate. The proceeds had already been reduced by the inheritance tax payment, and the parties agreed that any tax refund would be divided equally between the estate and Beverly. The probate court approved the FSA on September 3 without any adjudication of Lester Sr.'s incapacity in 2003.

         The estate filed an amended inheritance tax return on October 28. The estate requested a refund of $10, 034 based on the FSA providing that half of the brokerage accounts were paid to Lester Sr.'s grandchildren. The estate claimed the proceeds passing by operation of the FSA to the grandchildren were exempt from inheritance tax under Iowa Code section 450.9 (2009) as property passing to Lester Sr.'s lineal descendants. The IDOR denied the refund on November 3. The estate protested the denial on December 29. The estate transferred any refund claim to Beverly. The estate was closed.

         On June 26, 2013, the IDOR received a letter from Beverly's counsel requesting an informal conference. On July 24, 2014, Beverly filed a formal written demand to initiate a contested case, and the IDOR filed an answer denying her right to a refund.

         On November 24, a contested case hearing was held before an administrative law judge (ALJ). Beverly argued that the beneficiary designation was invalid, relying on Dr. Bender's letter opining that Lester Sr. was incompetent in August 2003 because he suffered from dementia.[1] Dr. Bender-who had not personally examined Lester Sr.- was not called as a witness at the contested case hearing. Beverly testified that she visited her father-in-law during the weekends at the nursing home. But she did not testify regarding her personal observations of Lester Sr.'s mental state at the time he executed the TOD agreement or at any other time.

         The ALJ issued a proposed order on February 3, 2015. The ALJ found that the IDOR had subject matter jurisdiction over the issue of Lester Sr.'s competency to execute the TOD agreement because such determination would be necessary to decide whether a taxable event occurred. The ALJ concluded that the FSA, executed after the transfer of the accounts to Beverly through the TOD agreement, "ha[d] no bearing on whether a taxable event occurred when the Accounts passed to [Beverly]." The ALJ also determined that Beverly failed to prove by clear, convincing, and satisfactory evidence that Lester Sr. lacked sufficient mental capacity to execute the beneficiary designation. The ALJ concluded that upon Lester Sr.'s death the TOD accounts passed directly to Beverly and that the IDOR, therefore, properly denied the refund request.

          Beverly appealed to the director of the IDOR. She filed a motion to allow witness testimony and a supporting brief, requesting the opportunity to present the oral testimony of Dr. Bender. The IDOR filed a resistance. The director granted Beverly's motion to allow witness testimony.

         The director held an evidentiary hearing on January 14, 2016. Dr. Bender testified. He described the "mini-mental status examinations" used to evaluate a patient's cognitive abilities and elaborated on how Lester Sr.'s performance on such tests demonstrated his severe dementia. Dr. Bender concluded his direct testimony by stating, "My opinion is that [Lester Sr.] was cognitively incapable of understanding the document that he signed in August of '03, and that shouldn't have happened from the medical perspective." On cross-examination, Dr. Bender admitted that he did not remember ever personally examining Lester Sr. or Mildred or speaking to any of the treating physicians.

         The director found that In re Estate of Bliven, 236 N.W.2d 366 (Iowa 1975), was controlling and, therefore, agreed with the ALJ that the FSA had no bearing on whether a taxable event occurred when the TOD accounts passed to Beverly. The director rejected Beverly's claim that In re Estate of Van Duzer, 369 N.W.2d 407 (Iowa 1985) (involving a spousal election against the will), controlled. The director noted that "the portion of the TOD that [Beverly] agreed to give to Decedent's beneficiaries under the Family Settlement Agreement passed not from Decedent's estate to the beneficiaries but from [Beverly] to the beneficiaries."

         The director also determined the IDOR had subject matter jurisdiction over the issue of Lester Sr.'s competency and that Beverly failed to meet her burden of proof on the issue of her father-in-law's alleged lack of capacity. The director reasoned,

No physician or other medical practitioner who provided care to the decedent at the time that he executed the TOD testified at either the Administrative Law Judge or the Director hearing. In fact, no witness testified regarding any personal observations of the Decedent at the time he executed the TOD.
At the hearing before the Director, Dr. Bender testified to explain his opinion regarding the significance of the Decedent's mini-mental status examination results. He also testified, based on his review of the mini-mental status examination results, it was his opinion that Decedent was not competent when he executed the TOD. However, Dr. Bender did not ever personally examine the Decedent. The oral testimony was consistent with the information provided to the Administrative Law Judge, however, it did not rise to the level of clear and convincing evidence that the contract should be set aside.
Based on the foregoing evidence, the Protester has not met her burden to prove by clear, convincing, and satisfactory evidence that the Decedent was incompetent when he executed the TOD.

         Beverly filed a timely petition for judicial review in the district court. The district court agreed with the director that Bliven controlled and that the postmortem FSA had no effect on the amount of inheritance tax owed. The district court concluded that the assets covered by the TOD agreement passed to Beverly at the moment of Lester Sr.'s death, and "any entitlement to those assets by his grandchildren was created after his death by virtue of the family settlement agreement." The district court affirmed the decision of the IDOR denying Beverly's request for a refund of inheritance tax.

         Beverly appealed, and we transferred the case to the court of appeals. The court of appeals concluded that Van Duzer-not Bliven- controlled and that the FSA changed how half of Lester Sr.'s brokerage accounts passed upon his death. As a result, the court determined that the settlement proceeds paid to the grandchildren under the FSA were exempt from inheritance tax. The IDOR filed an application for further review, which we granted.

         II. Standard of Review.

         "Our review is governed by the standards set forth in Iowa's Administrative Procedure Act, chapter 17A." Lange v. Iowa Dep't of Revenue, 710 N.W.2d 242, 246 (Iowa 2006). "In exercising its judicial review power, the district court acts in an appellate capacity." Iowa Ag Constr. Co. v. Iowa State Bd. of Tax Review, 723 N.W.2d 167, 172 (Iowa 2006) (quoting Mycogen Seeds v. Sands, 686 N.W.2d 457, 463 (Iowa 2004), superseded by statute on other grounds, 2004 Iowa Acts 1st Extraordinary Sess. ch. 1001, §§ 12, 20, as recognized in JBS Swift & Co. v. Ochoa, 888 N.W.2d 887, 890, 898-900 (Iowa 2016)). "When we review the district court's decision, 'we apply the standards of chapter 17A to determine whether the conclusions we reach are the same as those of the district court.' " Id. (quoting Mycogen Seeds, 686 N.W.2d at 464). If we reach the same conclusions, we affirm; if not, we reverse. Id.

         The fighting issues here turn on the IDOR's factual determinations and application of law to those facts. We may grant relief if the taxpayer's substantial rights have been prejudiced because the agency action is

[b]ased upon a determination of fact clearly vested by a provision of the law in the discretion of the agency that is not supported by substantial evidence in the record before the court when that record is viewed as a whole.

         Iowa Code § 17A.19(10)(f); see also Iowa Ag Constr. Co., 723 N.W.2d at 173 (concluding that factual determinations regarding the applicability of certain sales tax exemptions were clearly vested by a provision of law in the discretion of the agency when "[t]he case was tried as a contested case proceeding in which factual findings were made based on evidence produced"). For purposes of our review,

"Substantial evidence" means the quantity and quality of evidence that would be deemed sufficient by a neutral, detached, and reasonable person, to establish the fact at issue when the consequences resulting from the establishment of that fact are understood to be serious and of great importance.

         Iowa Code § 17A.19(10)(f)(1). "In assessing evidentiary support for the agency's factual determinations, we consider evidence that detracts from the agency's findings, as well as evidence that supports them, giving deference to the credibility determinations of the presiding officer." Lange, 710 N.W.2d at 247; see also Iowa Code § 17A.19(10)(f)(3).

         "Because factual determinations are by law clearly vested in the agency, it follows that application of the law to the facts is likewise vested by a provision of law in the discretion of the agency." Iowa Ag Constr. Co., 723 N.W.2d at 174; see also Mycogen Seeds, 686 N.W.2d at 465. We therefore can only reverse the agency's application of the law to the facts if we determine the application was "irrational, illogical, or wholly unjustifiable." Iowa Ag Constr. Co., 723 N.W.2d at 174 (quoting Iowa Code § 17A.19(10)(m) (allowing a court to reverse when the challenger's ...

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