Lyeth v. Hoey
Headline: Heirs’ estate settlement ruled exempt from federal income tax; Court held that property received in a will-contest compromise counts as inheritance, affecting heirs nationwide.
Holding: The Court held that property an heir receives through a compromise settling a will contest is "acquired by inheritance" under the Revenue Act of 1932 and therefore exempt from federal income tax.
- Settlements of will contests received by heirs generally exempt from federal income tax.
- Creates a uniform federal rule instead of differing state characterizations.
- Reduces risk of double taxation on estate distributions.
Summary
Background
The dispute involves a grandson who challenged his grandmother’s 1931 will. The will left a large residuary estate to an Endowment Trust for a religious foundation. The heirs, including the grandson, contested the will alleging lack of capacity and undue influence. The parties reached a court-approved compromise in Massachusetts dividing the residuary estate between the heirs and the trust, with heirs receiving stock units and a small cash distribution paid through a family corporation. The Internal Revenue Service treated the heir’s distributed share as taxable income for 1933 and assessed an additional tax, which the heir paid and then sued to recover.
Reasoning
The Court asked whether property an heir receives from an estate as part of a compromise of a will contest is “acquired by inheritance” under the Revenue Act of 1932 and therefore exempt from federal income tax. The Court held that federal law, not varying state characterizations, controls the meaning of the statutory exemption and that Congress intended a uniform rule. Because the heir received the property by virtue of his status as an heir and to remove an obstacle to his inheritance, the transfer was within the statute’s exemption for property acquired by bequest, devise, or inheritance. The Court reversed the Court of Appeals and affirmed the District Court judgment for the taxpayer.
Real world impact
The decision means heirs who receive property through court-approved compromises that settle will contests may avoid federal income tax on those distributions. It establishes a national rule rather than leaving the question to differing state characterizations, reducing the chance of double taxation on estate transfers.
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