2004 WL
3396365 (U.S.Tax Ct.)
For opinion
see T.C. Memo. 2005-126
Estate
of Charles Porter SCHUTT, Deceased, Charles P. Schutt, Jr. and Henry I.
Brown,
III Co-Executors, Petitioner,
COMMISSIONER
OF INTERNAL REVENUE, Respondent.
Reply
Brief for Respondent
*i
CONTENTS
PRELIMINARY
STATEMENT ... i
RESPONDENT'S
OBJECTIONS TO PETITIONER'S PROPOSED FINDINGS OF FACT ... 2
ARGUMENT
... 13
I.
Burden of Proof ... 13
II.
I.R.C. § 2036 Does Apply ... 13
A.
General Rules and Purpose ... 13
B.
Elements 1 and 2 of § 2036 - A "Transfer" of Property to
Schutt I and Schutt II Occurred, and the Contribution of Property by Mr. Schutt
Were Not Bona Fide Sales for Full and Adequate Consideration ... 20
C.
Section 2036 (a) (1) - Mr. Schutt Did Retain the Possession or Enjoyment of, or
the Right to the Income From, the Transferred Prpoerty ... 50
D.
Section 2036 (a) (2) - Mr. Schutt Did Retain the Right to Designate the Persons
Who Would Enjoy the Property Transferred to Schutt I and Schutt II ... 55
E.
Section 2 03 8 Does Apply to Assets Contributed by Mr. Schutt to Schutt I and
Schutt II ... 67
CONCLUSION
... 70
*ii
CITATIONS
Cases
Archbald
v. Commissioner, 27 B.T.A. 837 (1933), aff'd sub nom. Helvering v. Walbridge,
70 F.2d 720 (2d Cir.), cert. denied, 293 U.S. 594 (1934) ... 28
Bischoff,
Estate of v. Commissioner, 69 T.C. 32 (1977) ... 39, 40
Boykin,
Estate of v. Commissioner, T.C. Memo. 1987-134, 53 T.C.M. (CCH) 345 ... 53, 54,
55
Byrum,
United States v., 408 U.S. 125, 136 (1972) ... 55, 59, 64
Church v.
United States, 2000 U.S. Dist. LEXIS 714 (W.D. Tex. 2000), aff'd without
published opinion, 268 F.3d 1063 (5th Cir. 2001) ... passim
Cohen,
Estate of v. Commissioner, 79 T.C. 1015 (1982) ... 57, 62
Dickman
v. Commissioner, 465 U.S. 330 (1984) ... 25, 26
Farrel,
Estate of v. United States, 553 F.2d 637 (1977) ... 59, 62
Frazee
v. Commissioner, 98 T.C. 554 (1992) ... 22
Guynn v.
United States, 437 F.2d 1148 (4th Cir. 1971) ... 51
Harper,
Estate of v. Commissioner, T.C. Memo. 2002-121, 83 T.C.M. (CCH) 1641, 1652 ...
passim
Harrison,
Estate of v. Commissioner, T.C. Memo. 1987-8, 52 T.C.M. (CCH) 1306 ... 23
Helvering
v. Helmholz, 296 U.S. 93 (1935), aff'g 75 F.2d 245 (D.C. Cir. 1934), aff'g 28
B.T.A. 165 (1933) ... 58, 61
Helvering
v. Walbridge, 70 F.2d 683 (2d Cir.), cert. denied, 293 U.S. 594 (1934) ... 27
Heyen v.
United States, 945 F.2d 359 (10th Cir. 1991), aff'g 731 F. Supp. 1488 (D. Kan.
1990) ... 22
Holmes,
Commissioner v., 326 U.S. 480 (1946) ... 64
*iii
Jennings v. Smith, 161 F.2d 74 (2d Cir. 1947) ... 57
Keller,
Estate of v. Commissioner, 44 T.C. 851 (1965) ... 26
Kimbell
v. United States,
F.3d
, 2004
U.S. App. LEXIS 9911 (5th Cir. 5/20/04), rev'g and remanding 244 F. Supp. 2d
700 (N.D. Tex. 2003) ... 28, 42
Lehman
v. Commissioner, 109 F.2d 99 (2d Cir.), cert, denied, 310 U.S. 637 (1940) ...
53
Lewis G.
Hutchens Non-Marital Trust v. Commissioner, T.C. Memo. 1993-600, 66 T.C.M.
(CCH) 345 ... 53, 55
Lockard
v. Commissioner, 166 F.2d 409 (1st Cir. 1948) ... 27
Mahoney
v. United States, 831 F.2d 641 (6th Cir. 1987), cert. denied, 486 U.S. 1054
(1988) ... 13, 14, 15
McNichol,
Estate of v. Commissioner, 265 F.2d 667 (3d Cir. 1959), aff'g 29 T.C. 1179
(1958) ... 50, 51
Michelson,
Estate of v. Commissioner, T.C. Memo. 1978-371, 37 T.C.M. (CCH) 1534 ... 23
Moir,
Estate of v. Commissioner, 47 B.T.A. 765 (1942), acq. 1942-2 C.B. 13 ... 61
Reichardt,
Estate of v. Commissioner, 114 T.C. 144 (2000) ... 43
Reynolds,
Estate of v. Commissioner, 55 T.C. 172 (1970) ... 39, 40
Schafer,
Estate of v. Commissioner, 749 F.2d 1216 (6th Cir. 1984) ... 24
Stone,
Estate of v. Commissioner, T.C. Memo. 2003-309, 86 T.C.M. (CCH) 551 ... passim
Strangi,
Estate of v. Commissioner, T.C. Memo. 2003-145, 85 T.C.M. (CCH) 1331, appeal
docketed, No. 03-60992 (5th Cir. 11/21/03) ... passim
Struthers
v. Kelm, 218 F.2d 810 (8th Cir. 1955) ... 64
Thompson,
Estate of v. Commissioner, T.C. Memo. 2002-246, 84 T.C.M. (CCH) 374, appeal
docketed, 03-3173 (3d Cir. 7/22/03) ... passim
*iv
Tully, Estate of v. United States, 528 F.2d 1401 (Ct. Cl. 1976) ... 58, 59
United
States v. Estate of Grace, 395 U.S. 316 (1969) ... 15, 52
Wells
Fargo Bank N.M., N.A. v. United States, 319 F.3d 1222 (10th Cir. 2003) ... 22
Wemyss,
Commissioner v., 324 U.S. 303 (1945), rev'g 144 F.2d 78 (6th Cir. 1944), rev'g
2 T.C. 876 (1943) ... 22
Yawkey,
Estate of v. Commissioner, 12 T.C. 1164 (1949), acq. 194 9-2 C.B. 2 ... 60
Statutes
12 DEL.
CODE ANN. § 3808 ... 62
I.R.C. §
721 ... 27, 28
I.R.C. §
2036 ... passim
I.R.C. §
2036(a) ... passim
I.R.C. §
2036(a)(1) ... passim
I.R.C. §
2036(a)(2) ... passim
I.R.C. §
2038 ... passim
I.R.C. §
2501 (a) (1)] ... 26
I.R.C. §
7482 (b) (1) (A) ... 25
Other
Authorities
H. Rep.
No. 8300, 83rd Cong., 2d Sess. (1954), U.S. Code Cong. & Ad. News 4019 ...
27
Sol. Op.
42, C.B. No. 3, 61 ... 28
Rules
Fifth
Cir. Rule 47.5.4 ... 25
Fifth
Cir. Rule 47.6 ... 25
*v
Regulations
Treas.
Reg. § 20.2036-1 (b) (3 ... 60
Treas.
Reg. § 20.2038-1 (a) (2) ... 61, 68
Treas.
Reg. § 25.2511-1 (c) (1) ... 21
Treas.
Reg. § 25.2512-1(g) ... 21
Treas.
Reg. § 25.2512-8 ... 22
Respondent objects to the following findings of fact
requested by petitioner:
16. This requested finding of fact is incomplete. Trust 2064
terminates on the earlier of the date upon which Phyllis du Pont Schutt's
youngest grandchild living at the time of her death reaches age 40 or the date
which is 21 years after the death of the last survivor of the issue of her
grandfather living on October 6, 1934. (Ex. 19-J)
18. The last sentence of this requested finding of fact is
misleading and is not supported by the record. Although the decedent over the
years expressed concern about the dissipation of the family wealth by his
heirs, he rejected any plan proposed by Mr. Dinneen to address that concern.
(Tr. 112) The decedent did not exhibit a desire to "develop a plan"
until December 1996 when he authorized Mr. Dinneen to contact Mr. Sweeney to
discuss the matter. (Tr. 112-13, 119-20)
19. A portion of this requested finding of fact is not
supported by the record. Petitioner does not cite to any evidence in the record
to support the contention that the decedent and his wife established the
irrevocable trusts "in furtherance of the preservation of the buy and hold
investment philosophy."
*3 25. A portion of this requested finding of fact is not
supported by the record. Petitioner does not cite to any evidence in the record
to support the contention that Phyllis du Pont Schutt established the
irrevocable trust "in furtherance of the preservation of the buy and hold
investment philosophy of Eugene E. duPont."
28. A portion of this requested finding of fact is not
supported by the record. Petitioner does not cite to any evidence in the record
to support the contention that Phyllis du Pont Schutt established the
irrevocable trust "in furtherance of the preservation of the buy and hold
investment philosophy of Eugene E. duPont." Rather, the record supports a
finding that she established that trust as part of her overall estate plan.
44. This requested finding of fact is not supported by the
record. Petitioner does not cite to any evidence in the record to support the
assertion that the decedent "became concerned about perpetuating the buy
and hold investment philosophy with respect to Alabama timberlands...."
48. This requested finding of fact is not supported by the
record. Petitioner does not cite to any evidence in the record to support the
assertion that the decedent was concerned about the investment philosophy of
his daughter and her children or the reason why he did not make annual
exclusion gifts to them during 1994.
*4 49. This requested finding of fact is not supported by
the record. Mr. Dinneen only testified about one meeting with the Wilmington
Trust Company's investment advisors, during which they suggested that the bank
trusts held too much stock in the Phillips Petroleum Company. (Tr. 107-08) Mr.
Dinneen further testified that the decedent rejected their recommendation to
dispose of some of the Phillips stock and invest the proceeds in other securities
because, according to the decedent, "you can't have too much of a good
thing." (Tr. 107- 08) Petitioner does not cite to any evidence in the
record to support the contention that the bank's investment advisors ever
suggested that the decedent sell any of the Exxon or DuPont stock.
53. The first sentence of this requested finding of fact is
not supported by the record. While the decedent may have wished to perpetuate
his investment philosophy, the record establishes that his dominant motivation
for forming the business trusts was to obtain the favorable tax advantages. See
pp. 95-107 of respondent's opening brief and pp. 13-20 of this brief.
57. This requested finding of fact is not supported by the
record in that the evidence establishes that there were no "arm's-length
negotiations" between the decedent and the bank concerning any material
matters affecting the formation and operation of the business trusts. See pp.
87-90 of respondent's opening brief for a discussion of this issue.
*5 58. This requested finding of fact is misleading to the
extent that it implies that there were arm's-length negotiations between the
decedent and the bank. See the objection to requested finding of fact number
57. Respondent proposes that the word "discussion" be substituted for
the word "negotiation."
60. This requested finding of fact is misleading to the
extent that it implies that there were arm's-length negotiations between the
decedent and the bank. See the objection to requested finding of fact number
57. Respondent proposes that the word "discussion" be substituted for
the word "negotiation."
61. This finding of fact is not supported by the record. The
only evidence cited to support this proposed finding of fact is the testimony
of Neal Howard, who stated that he would have recommended against the bank's
participation in the plan had the decedent not proposed to transfer some of his
assets to the business trusts as well. (Tr. 92-95) When asked why he would have
recommended against the bank's participation in the plan if the trust
beneficiaries supported funding the business trusts solely with assets held by
the bank trusts, Mr. Howard could not provide a credible explanation.
Moreover, this requested finding of fact is based on
speculation. The final decision for the bank would have been made by George W.
Helme, the head of the bank's trust department, not by Mr. Howard. (Tr. 32)
There is nothing in the record *6 indicating how Mr. Helme would have reacted
had the decedent proposed to transfer only bank trust assets to the business
trusts. [FN1] As Mr. Howard testified, the issue never came up because the plan
presented by the decedent contemplated that he would transfer some of his
assets to the business trusts. (Tr. 94)
FN1. It must be remembered that as direction advisor for
some of the bank trusts, the decedent could have directed the bank to invest
the bank trust
assets in the business trusts. He also had the ability to
remove the bank as trustee if it had not agreed to the proposal
62. This requested finding of fact is misleading to the
extent that it implies that there were arm's-length negotiations between the
decedent and the bank. See the objection to requested finding of fact number
57. Respondent proposes that the word "discussion" be substituted for
the word "negotiation."
63. This requested finding of fact is misleading to the
extent that it implies that there were arm's-length negotiations between the
decedent and the bank. See the objection to requested finding of fact number
57. Respondent proposes that the word "discussion" be substituted for
the word "negotiation."
65. This requested finding of fact is not supported by the
record. The record establishes that there were no "significant *7
negotiations" over who would be trustee of the business trusts. The bank's
representatives raised this issue early in the discussions, but immediately
agreed to have the decedent serve in that capacity when he insisted upon it.
The record suggests that the bank's representatives only expressed an interest
in having the bank serve as the trustee to preserve its fees. (Tr. 59-60)
69. This requested finding of fact is misleading to the
extent that it implies that there were arm's-length negotiations between the
decedent and the bank. See the objection to requested finding of fact number
57. Respondent proposes that the word "discussion" be substituted for
the word "negotiation."
70. This requested finding of fact is misleading to the
extent that it implies that there were arm's-length negotiations between the
decedent and the bank. See the objection to requested finding of fact number
57. Respondent proposes that the word "discussion" be substituted for
the word "negotiation."
71. This requested finding of fact is misleading to the
extent that it implies that there were arm's-length negotiations between the
decedent and the bank. See the objection to requested finding of fact number
57. Respondent proposes that the word "discussion" be substituted for
the word "negotiation."
74. This requested finding of fact is misleading to the
extent that it implies that there were arm's-length negotiations between the
decedent and the bank. See the objection to *8 requested finding of fact number
57. Respondent proposes that the word "discussion" be substituted for
the word "negotiation."
77. This requested finding of fact is not supported by the
record. There is no evidence that the decedent ever opposed the bank's request
that consents be obtained from the bank trust beneficiaries or that there were
any "negotiations" concerning the provisions of those agreements. Mr.
Sweeney and his associates drafted the consents, and the bank's representatives
simply suggested some minor changes to make the consents more informative for
the beneficiaries. Similarly, there is no evidence that the decedent ever
objected to the bank serving as custodian of the stock transferred to the
business trust. His only concern was that the bank's fees for serving as
trustee for the bank trusts and as custodian for the business trust assets not
exceed the trustee fees the bank received before the business trusts were
formed. The bank's representatives readily agreed to limit its fees as the
decedent requested. Finally, there is no evidence that the term of the trusts
was the product of negotiations between the bank and the decedent. When the
bank raised that issue, Mr. Sweeney suggested that the term be at least 40 to
50 years. (Ex. 45-J)
81. This requested finding of fact is misleading. There is
no evidence that the bank "required" that the trust agreements be
changed to provide for mandatory periodic distributions of the *9 trusts' net
cash flow, but rather Mr. Howard requested that the trust agreements so
provide. Mr. Sweeney, not Mr. Howard, decided that the distributions would be
made on a quarterly basis. (Tr. 80-81) Moreover, the decedent had no objection
to Mr. Howard's request because he had always contemplated that the trusts' net
cash flow would be distributed to the trust beneficiaries on a quarterly basis.
(Ex. 65-J)
100. This requested finding of fact is not supported by the
record. See pp. 95-107 of respondent's opening brief and pp. 13-20 of this
brief.
101. The third sentence of this requested finding of fact is
misleading. The decedent could amend the trust agreements if the bank agreed.
To clarify this requested finding of fact, respondent proposes that the word
"unilateral" be inserted before the word "right."
102. The first sentence of this requested finding of fact is
misleading. The decedent could terminate the trust agreements and liquidate the
trust assets if the bank agreed. To clarify this requested finding of fact,
respondent proposes that the word "unilateral" be inserted before the
word "right."
103. This requested finding of fact is not supported by
credible evidence. This finding of fact is based solely on Mr. Howard's
testimony. (Tr. 95-97) When asked whether the bank would have agreed to
terminate the business trusts had the *10 decedent and the trust beneficiaries
so requested, Mr. Howard stated that he would have been "appalled" by
such a request and would have recommended that the bank reject any such
proposal. Yet he could not provide any credible reason why the bank would have
reacted negatively to such a request considering that it would have been placed
in the same position vis-a-vis the stock that it enjoyed before the business
trusts were formed.
120. This finding of fact is not supported by the record.
During the period of 1995 through 1998, the decedent was being treated for
several medical problems, including coronary artery disease and congestive
heart failure. The decedent also had a history of hypertension and
hyperlipidemia (elevated cholesterol levels) and was considered a borderline
diabetic. Given the decedent's age, these conditions were life-threatening.
(Stip. å¦ 111; Exs. 99-J, 100-J)
121. This finding of fact is not supported by the record.
See the objection to requested finding of fact number 120.
126. This requested finding of fact is not supported by the
record. Mr. Sweeney and Mr. Dinneen only testified that they were not aware
that the decedent had any life-threatening illnesses during the period when the
business trusts were being formed. The decedent's medical history suggests
otherwise. (Stip. å¦ 111; Exs. 99-J, 100-J) Moreover, it is reasonable to infer
that the decedent's health was a factor in his decision to *11 form the
business trusts given his medical history and the fact that in late November of
1996, he was hospitalized for a week after complaining of chest pains. It is
likely that this event had a significant impact on the decedent since this was
the first time in 20 years he had been to the hospital for other than a routine
checkup.
132. This requested finding of fact is not supported by the
record. See pp. 90-94 of respondent's opening brief and pp. 20-52 of this
brief.
133. This requested finding of fact is not supported by the
record. See pp. 62-66 of respondent's opening brief and pp. 52-57 of this
brief.
134. This requested finding of fact is not supported by the
record. See pp. 66-79 of respondent's opening brief and pp. 57-69 of this
brief.
135. This requested finding of fact is not supported by the
record. See pp. 59-79, 83-107 of respondent's opening brief and pp. 20-69 of
this brief.
136. This requested finding of fact is not supported by the
record. See pp. 90-94 of respondent's opening brief and pp. 20-52 of this
brief.
137. This requested finding of fact is not supported by the
record. See pp. 79-83 of respondent's opening brief and pp. 69-70 of this
brief.
*12 138. This requested finding of fact is not supported by
the record. See pp. 79-107 of respondent's opening brief and pp. 20-52, 69-70
of this brief.
139. This finding of fact is only relevant if the Court
rejects respondent's position that the value of the stock the decedent, through
his revocable trust, contributed to the business trusts should be included in
the gross estate under I.R.C. §§ 2036 and/or 2038. See the
Stipulation of Settled Issues filed by the parties.
Respondent agrees that he has the burden to prove by a
preponderance of the evidence that the value of the stock the decedent, through
his revocable trust, contributed to the business trusts should be included in
the gross estate under I.R.C. §§ 2036 and/or 2038.
Respondent agrees with petitioner that as a general
proposition, § 2036 is intended to cover transactions that are
essentially testamentary in nature. However, based on a single sentence of
dicta in Mahoney v. United States, 831 F.2d 641, 646-57 (6th Cir. 1987), cert,
denied, 486 U.S. 1054 (1988), petitioner argues that for § 2 03 6 to
apply, a transfer must have both (i) a "significant" testamentary
purpose, and (ii) the transferor must retain "significant" control
over the transferred property. Mahoney does not support petitioner's argument.
The notion that the transferor must retain significant
control over the transferred property is not the holding of Mahoney. The
taxpayer in Mahoney argued that because the decedent had no control over the
trust to which the property was transferred, the transfer did not fall within
the scope of *14 § 2036(a)(1). The court rejected that argument,
noting that, although the retention of control is sufficient to include a
transfer under § 2036(a), it is not a necessary condition to
includability. The court stated: "Indeed, imposition of a 'control'
requirement would seemingly transgress this court's admonitions that 'transfer'
is to be given its usual meaning, and is not to be restrictively
interpreted." Id. at 648, n.8 (citations omitted). Thus, Mahoney does not
support petitioner's contention that "control" or "significant
control" is a prerequisite to inclusion under § 2036(a)(1). [FN2]
FN2. Although petitioner states that "significant
control" is the standard to be applied, it does not discuss this issue in
this portion of its brief. Later in the brief, petitioner does discuss the
reasons why it believes that the decedent did not retain a sufficient interest
in or control of the stock contributed to the business trusts for §
2036 to come into play. Respondent disagrees with petitioner for the reasons
discussed on pp. 62-79 of his opening brief and pp. 52-69 of this brief.
Similarly, Mahoney does not support petitioner's argument
that a significant testamentary purpose is required for § 2036(a) to
apply. The Mahoney court confined its analysis of testamentary intent to two
factors: the trust document and the family relationship. The court concluded
its brief analysis of testamentary intent, stating: "Since the named
remaindermen were the decedent's wife and lineal descendants, the natural
objects of his bounty, we have no difficulty in concluding that the decedent's
contribution to the Trust was 'essentially *15 testamentary,' and therefore
includable under section 2036 (a)." Id. at 649. The court did not discuss
the degree of testamentary intent needed before § 2036 becomes
applicable.
Although Mahoney does not support the propositions for which
it is cited, it is instructive, however, in determining the type of evidence
that should be considered when attempting to ascertain the purpose the
transaction served. The Mahoney court rejected an attempt to characterize the
transaction based on subjective evidence, concluding that statements by
relatives and business associates as to the subjective intent of an intrafamily
transfer "create 'substantial obstacles to the proper application of the
federal estate tax laws.' " Id. at 647, quoting United States v. Estate of
Grace, 395 U.S. 316, 323 (1969). Instead, the Mahoney court relied on
objectively verifiable evidence, such as (i) the trust documents, (ii) the
timing of the transfers, (iii) the value of the property transferred, (iv)
verifiable contemporary characterizations of the transaction, (v) objective
economic effects, and (vi) the manner in which the parties deal with the property.
Id. at 647.
Petitioner contends that the business trusts were
"formed primarily to put into place an entity to perpetuate [the
decedent's] buy and hold investment philosophy with respect to the DuPont and
Exxon stock belonging both to [the decedent] and *16 to the Wilmington Trust
Company Trusts'." [FN3] Petitioner concludes that this was a
non-testamentary, business purpose and contends that respondent's counsel
conceded as much during his opening statement. (Tr. 17) Respondent disagrees.
FN3. As support for its position, petitioner contends that
beginning in the 1970's, the decedent and his wife formed several trusts
"[i]n furtherance of the buy and hold investment philosophy." There
is no evidence in the record to support the contention that those trusts were
formed for that purpose. Rather, the evidence supports the inference that they
were formed as part of the decedent's and his wife's estate plans.
The objective evidence in this case does not support
petitioner's position that the business trusts were formed primarily to
perpetuate the decedent's investment philosophy. As discussed in respondent's
opening brief (pp. 95-107), the preponderance of the evidence establishes that
they were formed primarily to accomplish the decedent's estate planning
objectives; namely, to create valuation discounts and to serve as a vehicle to
be used to make annual exclusion gifts at discounted values.
Assuming for the sake of argument that the business trusts
were formed primarily to perpetuate the decedent's investment philosophy,
petitioner incorrectly concludes that this constitutes a non-testamentary,
business purpose. As discussed on pp. 97 through 99 of respondent's opening
brief, even if the decedent formed the business trusts to prevent his heirs
from *17 dissipating the family's wealth, this is itself a testamentary motive.
See Estate of Harper v. Commissioner, T.C. Memo. 2 002-121, 83 T.C.M. (CCH)
1641, 1652 (finding that even if the decedent had formed the family limited
partnership to protect the assets transferred from his daughter's creditors,
that in itself was a testamentary purpose).
The decedent's testamentary motives are particularly evident
in this case as it is clear that he was concerned about the dissipation of the
family's wealth after his death as opposed to during his lifetime. While he was
alive, he controlled the sale of stock held by his revocable trust. Similarly,
as the direction or consent advisor to the bank trusts, none of the stock held
by those entities could be sold without his consent. The only risk that assets
held by the bank trusts could be sold without his consent was if one of his
children predeceased him, thereby causing a distribution of a portion of the
trust assets to that child's issue. Since his surviving children were all in
good health when the business trusts were formed and the decedent was not,
there is little doubt that the decedent was concerned about what would happen
to the family's wealth after his death.
Even if the stock was transferred from the bank trusts to
the business trusts to perpetuate the decedent's investment philosophy,
petitioner fails to explain why the decedent believed it was necessary to
transfer stock from his revocable trust to *18 the business trusts to
accomplish that objective. The decedent's revocable trust agreement provided
that upon his death, the bulk of the trust assets would be used to fund several
trusts to be administered by his son and son-in-law as trustees. Since the
decedent also selected them to serve as the successor trustees for the business
trusts, presumably they subscribed to the decedent's investment philosophy.
Consequently, control over the investment decisions relating to the stock the
decedent contributed to the business trusts did not change after the transfer.
The decedent continued to make those decisions during his lifetime, and his son
and son-in-law would, as before, make those decisions after his death. Since
the transfer of the stock from the decedent's revocable trust to the business
trusts did not result in a change in investment philosophy, one must conclude
that the real purpose for those transfers was to create valuation discounts for
gift and estate tax purposes. [FN4]
FN4. Petitioner requested that the Court find that the bank
required the decedent to transfer some of his assets to the business trusts.
See Pet. Req. Finding of Fact Number 61. As discussed in respondent's
objection, that requested finding of fact is not supported by the record.
Petitioner's argument is further undermined by the fact that
initially the decedent only contemplated transferring stock from his revocable
trust to a business trust. (Tr. 51-52) As discussed above, it was not necessary
for the decedent to *19 transfer assets from his revocable trust to perpetuate
his investment philosophy. Although involving the bank trusts in the plan did
accomplish that objective at least for the term of the business trusts, it is
clear that the decedent was not motivated by his concern about the dissipation
of the family's wealth when he instructed Mr. Dinneen to contact Mr. Sweeney to
discuss the formation of a new entity. [FN5] Rather, as Mr. Sweeney testified,
the decedent was simply following through on Mr. Dinneen's and Mr. Sweeney's
recommendation that he form a new entity that could be used to continue his
practice of making annual exclusion gifts. (Tr. 51)
FN5. It should not be forgotten that involving the bank
trusts also served a tax purpose, creating minority discounts.
Finally, petitioner mischaracterizes the concession
respondent's counsel made during his opening statement. Respondent does not
dispute that the decedent subscribed to a "buy and hold" investment
philosophy and wished to perpetuate that philosophy after his death vis-a-vis
the assets comprising the family's wealth. Nor does respondent dispute that the
decedent was concerned that his grandchildren might dispose of the DuPont and
Exxon stock that they, as beneficiaries of the bank trusts, would receive upon
the death of the decedent's children. Transferring the DuPont and Exxon stock
from the bank trusts to the business trusts served to perpetuate the decedent's
*20 investment philosophy for the duration of the business trust agreements.
[FN6] However, as respondent's counsel stated during his opening statement, and
as argued in respondent's opening brief and in this brief, respondent does not
agree that the decedent's dominant motivation for forming the business trusts
was to perpetuate his investment philosophy. Nor has respondent conceded, as
petitioner suggests, that the decedent's desire to perpetuate his investment
philosophy was a non-testamentary, business purpose.
FN6. The business trust agreements terminate in 2048 unless
the trustee and the unit holders agree to their extension. Presumably, the
successor trustees will have died before that time and the trust units will
have been
distributed to the decedent's grandchildren and their issue.
Once the named successor trustees are unable to serve, then the unit holders
can select a successor trustee by a two-third's vote. Also, if all the unit
holders consent, the business trusts may be terminated before 2048. Therefore,
the business trusts only serve to perpetuate the decedent's investment
philosophy in the short run. Petitioner does not explain, nor does the record
disclose, why the business trusts were not given perpetual existence as
permitted under state law.
Petitioner does not dispute that the decedent transferred
the DuPont and Exxon stock from his revocable trust to the business trusts.
However, petitioner argues that because the estate and gift tax provisions are
construed in pari materia, the *21 meaning of "transfer" for gift tax
purposes applies to § 2036 as well. Petitioner reasons that only
"donative" or "gratuitous transfers" are gift tax transfers
and concludes that absent the "donative" or "gratuitous"
element, there is no gift and, it follows, no § 2036 transfer.
Petitioner contends that since the decedent's revocable trust received pro rata
interests in the business trusts in return for the stock contributed and since
the contributions of stock were properly credited to the capital account, no donative
transfer was made upon the creation of the business trusts. [FN7]
FN7. It appears that petitioner is arguing that a gift must
take place
upon the creation of the entity for § 2036 to
apply. See Pet. Opening Br. pp. 45-46. Clearly, there is no support for that
position. Even if donative intent is a factor, that determination would be made
based on the overall purpose of the transfer rather than on whether the
transfer resulted in gifts to the other parties to the transaction.
The notion that a gift requires a "donative" or
"gratuitous" act is unsupported. As stated in Treas. Reg. §
25.2512-1(g), "[d]onative intent on the part of the transferor is not an
essential element in the application of the gift tax to the transfer.' '[A]ny
transaction in which an interest in property is gratuitously passed or
conferred upon another, regardless of the means or device employed, constitutes
a gift subject to tax." Treas. Reg. § 25.2511-1(c) (1).
*22 In 1945, the Supreme Court considered whether a
transferor's lack of donative intent exempted a transfer from the gift tax.
Commissioner v. Wemyss, 324 U.S. 303 (1945), rev'g 144 F.2d 78 (6th Cir. 1944),
rev'g 2 T.C. 876 (1943). In holding that it did not, the Supreme Court
explained:
Congress chose not to require an ascertainment of what too
often is an elusive state of mind. For purposes of the gift tax it not only
dispensed with the test of 'donative intent'. It formulated a much more
workable external test, that where 'property is transferred for less than an
adequate and full consideration in money or money's worth,' the excess in such
money value 'shall for the purpose of the tax imposed by this title, be deemed
a gift....'
Nor does the exclusion of ordinary business transactions
from the gift tax make donative intent a prerequisite to a gift. "[A]
sale, exchange or other transfer of property made in the ordinary course of
business (a transaction which is bona fide, at arm's length, and free from any
donative intent), will be considered as made for an adequate and full
consideration in money or money's worth." Treas. Reg. §
25.2512-8. In construing this regulation, the court in Heyen v. United States,
945 F.2d 359 (10th Cir. 1991), aff'g 731 F. Supp. 1488 (D. Kan. 1990),
explained: "Although, an absence of proof of donative intent will *23 not
necessarily prevent a transfer from being subject to gift tax, when donative
intent is present it suggests there has been a gift." Id. at 362
(citations omitted).
Petitioner contends that this Court's opinions in Estate of
Stone v. Commissioner, T.C. Memo. 2003-309, 86 T.C.M. (CCH) 551; Estate of
Harrison v. Commissioner, T.C. Memo. 1987-8, 52 T.C.M. (CCH) 1306; and Estate
of Michelson v. Commissioner, T.C. Memo. 1978-371, 37 T.C.M. (CCH) 1534,
support its contention that § 2036 only applies to "donative
transfers." However, in Stone, the Court did not determine that §
2036 only applies to donative transfers, but rather its holding that §
2036 did not apply to the transactions at issue was based on its findings that
(i) there were arm's- length negotiations between the decedent/transferors and
their children leading up to the formation of the partnerships, (ii) the
partnerships were formed primarily to serve business purposes, and (iii) the
decedent/transferors' relationship to the assets changed significantly after
the transfers to the partnerships. Similarly, the holding in Harrison is based
on a finding that there was no evidence in the record indicating that the
partnership was created for other than business purposes. Finally, as
petitioner notes, the Court did state in Michelson that "[t]here being no
gratuitous transfer involved in the creation of the Michelson Realty Trust,
there is no basis for the *24 application of either section 2036(a) or section
2038 (a) (1)." 37 T.C.M. (CCH) at 1538. However, the issue there was
whether the decedent's son had provided adequate consideration for his interest
in the realty trust. The Court found that he had, so clearly the value of the
son's interest in the trust would not be included in the decedent's gross
estate under § 2036 or § 2038. Given the factual scenario, it
does not follow that the Court meant that only donative transfers are covered
by those sections.
Petitioner also cites Estate of Schafer v. Commissioner, 749
F.2d 1216 (6th Cir. 1984), as support for this proposition. In that case, the
decedent purchased real property and had the seller grant a life estate to him
and his wife and the remainder interest to his children. The estate argued that
the value of the property should not be included in the gross estate under §
2036 because the seller, rather than the decedent, had transferred the
remainder interest to the decedent's children. The court refused to elevate
form over substance and held that § 2036 applied. While donative
intent was an aspect of the transfer at issue in Schafer, there is nothing in
the court's opinion suggesting that § 2036 should apply only to such
transactions.
Finally, petitioner relies on Church v. United States, 2000
U.S. Dist. LEXIS 714 (W.D. Tex. 2000), aff'd without published opinion, 268
F.3d 1063 (5th Cir. 2001), to support its argument *25 that § 2036
only applies to "gratuitous donative transfers." Respondent submits
that this Court should not follow Church for several reasons. First, neither
the district court's opinion nor the Fifth Circuit's affirming opinion is
published. As such, neither is precedent in the Fifth Circuit. Fifth Cir. Rules
47.5.4 and 47.6. Moreover, neither is precedent in this case, which is
appealable to the Third Circuit. I.R.C. § 7482(b) (1) (A).
Second, while there are statements in Church that support
petitioner's arguments, they are wrong. The court stated: "[A] taxable
gift must involve a gratuitous transfer, which by definition requires a
donee." 2000 U.S. Dist. LEXIS 714 at *20, citing Dickman v. Commissioner,
465 U.S. 330, 334 (1984). The court then concludes that a gratuitous donative
transfer must be present to apply § 2036. 2000 U.S. Dist. LEXIS 714 at
*20-21.
Contrary to the district court's finding, Dickman does not
state that taxable gifts only consist of gratuitous transfers. [FN8] At issue
in Dickman were the gift tax consequences of interest-free loans made by the
parents to their son and a closely-held family corporation. Significantly,
there was no dispute that, if a transfer was made, it was a gratuitous
transfer. The issue in dispute was whether "a gratuitous transfer of the
right to use *26 money [is] a 'transfer of property' within [I.R.C. §
2501(a)(1)]." 465 U.S. at 335-36. Dickman involved the parameters of
interest as property and use of property, not the makeup of a gratuitous
transfer. Thus, the Church court's reliance on Dickman for the proposition that
a taxable gift requires a gratuitous transfer is simply not correct.
FN8. Nor does Dickman state that a "transfer"
requires a donee to be a gift. As this issue is not present here, it is not
discussed.
In short, while § 2036 may apply to donative
transfers, its coverage is not limited to such transactions. As this Court
stated in Estate of Keller v. Commissioner, 44 T.C. 851, 861 (1965):
"[D]onative intent is not necessarily involved in [I.R.C. § 2036
(a)]...."
In any event, assuming for the sake of argument that
donative intent is a necessary element of § 2036, the record
establishes that such intent motivated the decedent to form the business
trusts. Before the business trusts were formed, the DuPont and Exxon stock was
held by the decedent's revocable trust. Petitioner does not contend, nor would
the record support a finding, that the decedent lacked donative intent when he
initially transferred the stock to that trust. The decedent's original intent
did not change when he decided to form the business trusts. Rather, by
exchanging the stock for units in the business trusts, he simply changed the
form of the assets held by his revocable trust. Furthermore, there was a
donative purpose for forming the business trusts as the decedent planned *27 to
use them as vehicles to continue his pattern of making annual exclusion gifts.
He also formed them to create valuation discounts for gift and estate tax
purposes, which would increase the portion of his estate available to pass on
to his heirs.
Petitioner contends that but for I.R.C. § 721, a
partner's contribution of property to the partnership would be taxed as a sale.
Petitioner then concludes that the transfers of the stock to the business
trusts should likewise be considered sales under § 2036, leaving only
the question of whether they were made for full and adequate consideration.
Initially, respondent notes that the income tax and the
estate tax are not in pari materia and, thus, the income tax treatment of a
contribution to a partnership is irrelevant. Cf. Lockard v. Commissioner, 166
F.2d 409 (1st Cir. 1948). In any event, the nonrecognition rule of §
721, first enacted into law as part of the Internal Revenue Code of 1954,
merely codified existing case law. H. Rep. No. 8300, 83rd Cong., 2d Sess.
(1954), U.S. Code Cong. & Ad. News 4019, 4367. See Helvering v. Walbridge,
70 F.2d 683 (2d Cir.), cert, denied, 293 U.S. 594 (1934) (in determining basis
of appreciated property contributed to the partnership, the court rejected the
concept that the contribution to a partnership was a realization event);
Archbald v. Commissioner, 27 B.T.A. 837 (1933), aff'd sub nom. *28Helvering v.
Walbridge, 70 F.2d 720 (2d Cir.), cert. denied, 293 U.S. 594
(1934)(contribution to a partnership is not a realization event).
Petitioner's § 721 argument overlooks the fact that
long before that section became law, contributions to partnerships were not
treated as sales. The policy reason for non-sale treatment is discussed in
Solicitor Opinion 42. To impose a sales event upon the contribution to a
partnership is analogous to "hold[ing] that the partner could make a
profit by selling to himself." Sol. Op. 42, C.B. No. 3, 61, 64, (1920). If
this analogy is followed to its logical conclusion, the decedent's contribution
of his Dupont and Exxon stock to the business trusts is akin to a transfer of
those shares to himself. Obviously, petitioner's income tax argument fails.
Essentially, petitioner argues that this Court should apply
the analysis used by the Fifth Circuit in Kimbell v. United States,
F.3d
, 2004 U.S. App. LEXIS 9911 (5th Cir. 5/20/04), rev'g and
remanding 244 F. Supp. 2d 700 (N.D. Tex. 2003), and hold that the transfers of
the stock to the business trusts constitute bona fide sales for full and
adequate consideration. In that case, Mrs. Kimbell, like the decedent in this
case, formed a revocable trust a number of years before her death to which she
transferred a significant portion of her assets. She named herself and her son
as trustees.
*29 Several months before her death at age 96, the Mrs.
Kimbell, her son, and his wife formed a limited liability company (LLC). Mrs.
Kimbell contributed $20,000 in cash for a 50% interest, and her son and his
wife each contributed $10,000 in cash for 25% interests. Soon thereafter, Mrs.
Kimbell's revocable trust and the LLC formed a family limited partnership
(FLP). The revocable trust contributed $2.5 million in cash, oil and gas
working and royalty interests, securities, notes, and other assets for a 99%
limited partnership interest. Approximately 15% of the value of the assets
contributed by the revocable trust was allocable to the oil and gas interests.
The LLC contributed $25,000 for a 1% general partner interest. The LLC, as
general partner, managed the partnership and had exclusive authority to make
distributions.
The partnership agreement indicates that the partnership was
formed for the following purposes: "(i) increase Family wealth; (ii)
establish a method by which annual gifts can be made without fractionalizing Family
Assets; (iii) continue the ownership and collective operation of Family Assets
and restrict the right of non-Family members to acquire interests in Family
Assets; (iv) provide protection to Family Assets from claims of future
creditors against family members; (v) prevent transfers of a Family member's
interest in the Partnership as a result of a failed marriage; (vi) provide
flexibility and continuity in *30 business planning for the Family not
available through trusts, corporations or other business entities; (vii)
facilitate the administration and reduce the cost associated with the
disability or probate of the estate of Family members; (viii) promote the
Family's knowledge of and communication about Family Assets; (ix) provide
resolution of any disputes which may arise among the Family in order to
preserve Family harmony and avoid the expense and problems of litigation; and
(x) consolidate fractional interests in Family Assets." These purposes
were supported by the deposition testimony of Mrs. Kimbell's son and her
business advisor. The government offered no rebuttal evidence.
Before the LLC and FLP were formed, Mrs. Kimbell's son
managed her business interests, a role he continued to perform as the sole
manager of the LLC. While Mrs. Kimbell transferred the bulk of her assets to
the FLP, she retained $450,000 to cover her personal expenses.
On its estate tax return, the estate valued Mrs. Kimbell's
interests in the LLC and the FLP applying a 49% discount for lack of
marketability and lack of control. The Service determined that §
2036(a) applied to Mrs. Kimbell's transfers to the LLC and, therefore, the full
value of the property held by those entities allocable to the decedent's
interests should have been included in her gross estate. On cross motions for
summary judgment, the district court agreed with the Service, holding *31 that
those transactions were not bona fide sales for adequate consideration. In
reaching that holding, the court relied heavily on this Court's rationale in
Estate of Harper, finding that the facts presented established that Mrs.
Kimbell had merely "recycled" the value of the assets transferred.
The Fifth Circuit reversed the district court, holding that
the transfers at issue were bona fide sales for adequate consideration and,
therefore, § 2036(a) did not apply. [FN9] Regarding the issue of
adequate consideration, the court noted that this determination involves an
"objective inquiry" as to whether the interests in the LLC and FLP
Mrs. Kimbell received in the exchange was roughly equivalent in value to the
property she transferred so that there was no depletion of her gross estate.
[FN10] Specifically, the court determined that the partnership interest
received in the exchange would be considered adequate and full consideration if
(i) the interest credited to each partner was proportionate to the fair market
value of the assets each partner contributed to the partnership, (ii) the
assets contributed by *32 each partner to the partnership were properly
credited to the respective capital accounts, and (iii) on termination or
dissolution of the partnership the partners were entitled to distributions from
the partnership in amounts equal to their respective capital accounts. Based on
the facts presented, the court concluded that this test was met. [FN11]
FN9. The circuit court remanded the case to the district
court to consider whether the decedent's interest in the partnership was an
"assignee interest" as opposed to a "partnership interest"
for purposes of valuing that interest.
FN10. The court concluded that the decedent's reasons (i.e.,
testamentary motives versus non-testamentary motives) for making the transfer
were not relevant to the determination of whether the consideration is
adequate.
FN11. The government argued that since the estate discounted
the LLC and FLP interests by 49%, it had conceded that those interests were not
roughly equivalent in value to the property transferred. The court, as did this
Court in the Estate of Stone, rejected that argument.
The court then went on to consider whether the transfers to
the LLC and FLP were bona fide sales. [FN12] The court stated that, as a
general proposition, a bona fide sale occurs if the decedent/transferor parts
with his/her interest in the property transferred, and the entity to which the
property is transferred parts with an interest in the exchange roughly
equivalent in value. But the court noted that intrafamily transfers are not
bona fide sales for purposes of § 2036 if they are shams or disguised
gifts.
FN12. The court noted that the "recycling
argument" is more germane to the bona fide sale analysis than to the issue
of whether there was adequate consideration.
Applying the facts established through the summary judgment
motions, the court held that the transfers to the LLC and FLP were not sham
transactions or disguised gifts for the following *33 reasons: (i) Mrs. Kimbell
retained sufficient assets for her support, and there was no commingling of the
partnership assets with her personal assets; (ii) partnership formalities were
observed, and the assets were actually transferred to the partnership; (iii) a
significant portion of the assets transferred was comprised of working oil and
gas interests that had to be managed; and (iv) the estate advanced several credible
and unchallenged non-tax, business reasons for forming the FLP.
Regarding this last point, the court found persuasive the
following facts established through Mrs. Kimbell's business manager's
deposition: (i) Mrs. Kimbell's revocable trust did not afford the protection
from creditors the partnership offered, particularly protection from claims
that might be asserted against her personally for environmental issues related
to the oil and gas properties; (ii) pooling capital in one entity would enhance
the operation of the business over time and reduce administrative costs,
including the cost of recording the transfers of the oil and gas interests when
they were passed from one generation to the next; (iii) putting the assets in
the partnership would prevent unwanted transfers of the partnership assets to
third parties (e.g., transfers incident to a divorce); (iv) the partnership
provided a structure for continuity of management should something happen to
Mrs. Kimbell's son (he had health problems at that time); and (v) the
partnership agreement, *34 which mandated the use of mediation and arbitration
to resolve disputes, provided a mechanism to resolve conflicts and avoid
intrafamily litigation.
Respondent contends that the facts in Kimbell are
distinguishable from those in this case. First, the economic benefits and
control retained by the decedent in this case were much more extensive than
those retained by Mrs. Kimbell. In Kimbell, the LLC was the general partner and
controlled the partnership property, including the decision to make
distributions of the partnership's income to Mrs. Kimbell. As only a 50%
shareholder, Mrs. Kimbell did not control the LLC. Moreover, Mrs. Kimbell's
son, as the manager, made all decisions for the LLC. Conversely, the decedent in
this case retained total control of the stock he transferred to the business
trusts. He also had the right to receive all of the business trust income
allocable to that stock. Thus, the interest he retained in the transferred
property was much more significant than the interest the decedent retained in
Kimbell.
Second, unlike the record in Kimbell, there is a
considerable amount of evidence in this case supporting respondent's contention
that testamentary concerns were the dominant factor in the decedent's decision
to form the business trusts. As discussed in respondent's opening brief (pp.
101-02), the decedent and his advisors invested a great deal of time and *35
effort focusing on the tax benefits that could be achieved by-transferring
assets to the business trusts. In Kimbell, there was no evidence rebutting the
statements of business purpose set forth in the partnership agreement and in
the deposition testimony of Mrs. Kimbell's son and her business advisor.
Third, the court in Kimbell considered significant the fact
that working oil and gas interests were involved in the transfer. The court
noted that, unlike royalty interests, working interests in oil and gas
properties had to be actively managed, and even nonoperating working interest
owners were obligated to pay their share of the operating expenses and had the
right to participate in the decision making process for the activity. In
contrast, the business trusts did not hold any assets that had to be actively
managed. Unlike the holders of working interests in oil and gas properties, the
business trust unit holders simply held passive interests in the trust; they
were not personally responsible for the trusts' expenses, nor did they have any
say in how the trusts were administered.
Finally, none of the "business purposes" cited by
the court in Kimbell are present in this case. [FN13] For instance, there is no
*36 ??the business trusts were formed to protect the ??assets from the
beneficiaries' creditors or to shield them from liability for third-party
claims relating to the management of those assets. These concerns do not apply
here since the trusts, unlike the partnership in Kimbell, did not hold any
assets that had to be actively managed.
FN13. Respondent submits that some of the "business
purposes" cited by the court address post mortem concerns and, therefore,
reflect Mrs. Kimbell's testamentary motives. For example, her -desire to
preserve the property for her descendants and reduce the cost of transferring
the oil and gas interests as they pass from generation to generation are
testamentary motives.
Furthermore, there is no evidence that the business trusts
were formed to improve the management of the decedent's assets, to reduce
administrative costs, to provide for continuity of management, or to reduce
intrafamily litigation, all factors cited by the court in Kimbell as
"business purposes" for the FLP. For instance, there is no evidence
that the business trusts provided a better vehicle than the decedent's
revocable trust for managing his assets during his lifetime. In fact, the
record establishes that the business trusts were not formed to actively manage
the trusts' assets, but rather were designed to simply hold the stock
contributed upon their formation. For all practical purposes, the decedent, as
trustee of teh business trusts, retained all of the management powers to held
before the transfers. Similarly, the business trusts did not achieve any
apparent reduction in the administrative costs involved as?? bank continued to
collect fees equal to those charged?? transfers. There is no evidence that any
other?? costs were reduced by transferring the?? *37 trusts. Finally, there is
no evidence that the decedent was concerned about intrafamily litigation or
that the business trusts would provide a better vehicle than the decedent's
revocable trust or the bank trusts for avoiding litigation. Unlike the
partnership agreement in Kimbell, the business trust agreements do no contain a
provision requiring that all disputes be resolved through mediation or
arbitration.
Petitioner relies on the following factors cited by the
court in Kimbell as support for its argument- that the transfers of stock to
the business trusts were bona fide sales: (i) the decedent retained sufficient
assets to maintain his lifestyle; (ii) the decedent did not commingle the
business trust assets with his personal assets; (iii) all of the trust
formalities were observed; and (iv) the DuPont and Exxon stock was actually
transferred to the trusts. Respondent agrees that these factors are present in
this case as well. However, while they support the contention that the business
trusts were not shams, they do not establish that those transfers should be
considered bona fide sales for purposes of § 2036. Rather, the Fifth
Circuit considered those factors in conjunction with a number of other factors
to reach its conclusion that the bona fide sale requirement had been met in
Kimbell. As discussed above, those other factors are not present in this case.
*38 Petitioner claims that Kimbell supports its contention
that the decedent's desire to perpetuate his investment philosophy after his
death is a sufficient non-tax, business purpose to avoid the application of §
2036. It is true that the Fifth Circuit mentioned as part of its business
purpose analysis several factors that related to Mrs. Kimbell's post mortem
planning. For instance, the court noted that the partnership was formed, in
part, because "Mrs. Kimbell wanted the oil and gas operations to continue
beyond her lifetime and they [Mrs. Kimbell and her business advisor] felt that
by putting the assets in a limited partnership, they could keep the pool of
capital together in one entity that would be enhanced over time rather than
subdivided by distributions to subsequent generations." 2004 U.S. App.
LEXIS 9911 at *28- 29. The court also noted that Mrs. Kimbell believed that by
placing the oil and gas properties in the partnership, she could avoid the
recording fees that would be charged "as the property was passed from generation
to generation." 2004 U.S. App. LEXIS 9911 at *29.
It is not clear whether the Fifth Circuit believes that
non-tax, post mortem planning alone constitutes a sufficient business purpose
to render § 2036 inapplicable as it also cited a number of other
factors to support its conclusion. If that is the Fifth Circuit's position,
then respondent submits that it is incomplete. This Court considered a similar
argument in Estate *39 of Harper, where the petitioner argued that the decedent
had transferred assets from his revocable trust to a family limited partnership
to protect those assets from his daughter's creditors after his death. This
Court responded: "The emphasis of this discussion is patently post mortem
as opposed to inter vivos. Hence, not only the objective evidence concerning
[the partnership's] history but also the subjective motivation underlying the
entity's creation support an inference that the arrangement was primarily
testamentary in nature." 83 T.C.M. (CCH) at 1652.
Petitioner also cites Estate of Bischoff v. Commissioner, 69
T.C. 32 (1977); Estate of Reynolds v. Commissioner, 55 T.C. 172 (1970); and
Church, supra, as support for its position that non-tax, post mortem planning
qualifies as a business purpose under § 2036. Estate of Bischoff
involved the question of whether the value of the decedent's interests in two
partnerships should be limited to the amounts provided for in the buy-sell
provisions contained in the partnership agreements. Respondent argued that those
provisions should be disregarded because they did not serve a business purpose
but rather were merely substitutes for testamentary dispositions to the objects
of the decedent's bounty. While conceding that, in general, buy-sell provisions
serve the business purpose of maintaining the continuity of management,
respondent argued that such rationale did not apply *40 because limited
partnership interests were involved. The Court rejected that argument, finding
that the buy-sell provisions were placed in the partnership agreements to
ensure that the businesses would be continued without outside interference. The
Court concluded "that the buy-sell provisions were grounded on legitimate
business considerations." 6 9 T.C. at 40.
Estate of Reynolds involved a similar issue; namely, whether
the preemption price provisions in a voting trust agreement should be
considered in valuing the decedent's voting trust certificates. Respondent
argued that the preemption price provisions should be disregarded "because
they represent a tax device and are testamentary in nature." 5 5 T.C. at
194. The Court disagreed, finding that the principal purpose of the voting
trust agreement was to ensure continuity of the company's management and
policies.
Since neither Estate of Bischoff nor Estate of Reynolds
involves § 2036, their relevance is tenuous at best. There is a big
difference between shareholders restricting the sale of stock to retain control
of the corporation amongst themselves, clearly a business purpose, and the
decedent's desire to prevent the objects of his bounty from selling the DuPont
and Exxon stock after his death, clearly a testamentary motive. For instance,
the buy-sell provisions involved in Estate of Bischoff and Estate of Reynolds
controlled the sale of the partnership interests or *41 voting trust
certificates both during the holder's life as well as upon his/her death. In
contrast, the decedent wanted to prevent the objects of his bounty from selling
the DuPont and Exxon stock after his death.
As petitioner noted in its opening brief (p. 56), the
district court in Church did "find that the primary purpose of the
partners in forming the partnership was a desire to preserve the family
ranching enterprise for themselves and their descendants." 2000 U.S. Dist.
LEXIS 714 at *9-10. To the extent that the court considered post mortem
planning as a valid business purpose under § 2 036, respondent submits
that the court was incorrect. In any event, it is clear that the court found
that the partnership in Church served a business purpose during the decedent's
life as well as after her death. The court noted that: (i) the partnership was
formed, in part, to consolidate the undivided interests in the property held by
the decedent, her daughter, and her son and to provide centralized management
of their ranching activity both during the decedent's lifetime and after her
death; (ii) the decedent was concerned that she might be subjected to
substantial tort claims and wanted to protect her personal assets from judgment
creditors; and (iii) "[t]he partnership was formed with an eye towards the
possibility of actively engaging in raising cattle." These facts, if
accepted *42 as true, indicate that the decedent was not motivated solely by
testamentary concerns.
Petitioner contends that the Fifth Circuit in Kimbell
rejected respondent's argument that the attention the decedent and his advisors
gave to the tax ramifications of the proposed plan to form the business trusts
indicates that the decedent was motivated primarily by testamentary concerns.
Petitioner apparently does not understand the point made by the court in
Kimbell The court simply stated that there is nothing wrong with tax planning
if the decedent was motivated primarily by business concerns. The court further
noted that "[a] transaction motivated solely by tax planning with no
business or corporate purpose is nothing more than a contrivance without
substance that is rightly ignored for purposes of the tax computation."
[FN14] 2004 U.S. App. LEXIS 9911 at *16. It is respondent's position in this
case that the decedent's primary or dominant motivation for forming the
business trusts was to reduce his estate taxes by making either inter vivos or
testamentary gifts of the business trust units at discounted values. *43
Respondent further contends that the "business purpose" advanced by
petitioner (i.e., the decedent's desire to perpetuate his investment
philosophy) is itself a testamentary, as opposed to a business, motive.
FN14. Although the court used the word "solely,"
respondent submits that a transaction does not qualify as a "bona fide
sale" if the dominant or primary motivation was tax planning or some other
testamentary purpose. See,e.g., Estate of Stone, 86 T.C.M. (CCH) at 580
("[T]he record shows that those transfers were motivated primarily by
investment and business concerns") (emphasis added).
Petitioner also relies on Estate of Stone as support for the
proposition that receipt of a pro rata interest in return for a contribution to
a family partnership constitutes adequate consideration. Estate of Stone is a
factually unusual case, which held that the parents' transfers to five
partnerships were bona fide, arm's-length transfers. The parties in Estate of
Stone agreed that the partners received a percentage interest in each
partnership that was proportionate to the fair market value of the assets that
the partners transferred to each partnership. 86 T.C.M. (CCH) at 560, n.18.
Unlike the decedents involved in Estate of Reichardt v.
Commissioner, 114 T.C. 144 (2000), Estate of Thompson v. Commissioner, T.C.
Memo. 2002-246, 84 T.C.M. (CCH) 374, appeal docketed, 03-3173 (3d Cir.
7/22/03), and Estate of Harper, the Court in Estate of Stone found that the
Stones did substantially more than change the form in which they held their
beneficial interests in the contributed property. More particularly, the Court
opined that "each of the Five Partnerships was created, funded, and
operated as a joint enterprise for profit for the management of its assets in
which there was a genuine pooling of *44 property and services." 86 T.C.M.
(CCH) at 581. Furthermore, when the Stone partnerships were formed and funded
to resolve the children's lawsuits, substantial negotiations over the terms of
the agreements took place, with each member represented by separate counsel, and
all of the partners contemplated and intended a joint enterprise for profit
with the children managing the partnership assets. As Mr. and Ms. Stone
intended, they ceded control and the children began to actively manage the
assets of their respective partnerships, with assistance from independent
professionals.
Thus, it is clear that the outcome in Estate of Stone is
based on the entire record, not simply on the receipt of a proportionate
partnership interest with the contributions properly credited to each capital
account. This Court rejected such a simplistic approach in Estate of Harper,
stating: "The estate apparently argues that the just-cited cases establish
that a proportionate partnership interest constitutes per se adequate and full
consideration for contributed assets. We believe, however, that any such global
formulation would overreach what can be drawn from the decisions." 83
T.C.M. (CCH) at 1654.
Petitioner contends that the transfer of stock to the
business trusts resulted in a "pooling of assets" similar to what
occurred in Estate of Stone. However, the facts in Estate of Stone stand in
sharp contrast to those in this case. In Estate *45 of Stone, the partnerships
engaged in rental activities, undertook renovations of a house to make it ready
for rental, the partners made investment decisions, and developed property. 86
T.C.M. (CCH) at 569-70. In short, the partnerships became joint enterprises
actively managed by the partners. Furthermore, each partnership hired different
advisors and accountants. 86 T.C.M. (CCH) at 569.
Here, the business trusts simply served as passive entities
established solely to hold the DuPont and Exxon stock contributed to the trusts
upon their formation. Moreover, control of the stock did not change after the
transfers. As before, the decedent had exclusive authority to exercise all of
the rights of ownership attributable to those shares. Unlike a typical joint
venture, the bank had no right to participate in any decision relating to the
operation of the business trusts.
Where there is a genuine pooling of assets for business
purposes, there is a potential for the creation of intangibles. Estate of
Harper, 83 T.C.M. (CCH) at 1654. Here, there was no such potential. Since each
business trust was funded with the same stock, no diversification of assets
occurred that would change the nature of each unit holder's ownership interest.
Rather, the trust units simply represented the unit holders' retained interest
in the stock they contributed to the business trusts upon their formation.
Moreover, the business trusts were *46 not formed to engage in any investment
activities other than to hold the DuPont and Exxon stock. Thus, the transfers
to the business trusts did not change the potential for profits or capital
appreciation that existed before the transfers. See Estate of Harper, 83 T.C.M.
(CCH) at 1653.
Petitioner contends that this case is factually similar to
Estate of Stone in that (i) the trusts were formed for a business purpose, (ii)
the decedent received full and adequate consideration for the stock he
contributed, (iii) the business trust agreements were the product of protracted
negotiations, (iv) the stock the decedent contributed to the business trusts
was actually credited to his capital accounts, and (v) the decedent retained
sufficient assets after the transfers to maintain his lifestyle. Respondent
submits, for the reasons discussed in his opening brief (pp. 103-05), that
there are significant differences between the facts in this case and those in
Estate of Stone.
Regarding the first three factors listed above, the record
establishes that those factors do not exist in this case. As discussed in
respondent's opening brief (pp. 83-107) and previously in this brief (pp.
13-20), the record does not support petitioner's contention that the business
trusts were formed for a legitimate business purpose, but rather the record
establishes that they simply served as testamentary vehicles which the *47
decedent planned to use to make gifts to his children and grandchildren at discounted
values. Similarly, since the decedent's relationship to the stock he
contributed to the business trusts did not change after the transfers, the
trust units he received in the exchange did not constitute full and adequate
consideration. See pp. 90-94 of respondent's opening brief. Nor were there any
meaningful negotiations concerning the essential terms of the business trust
agreements. See pp. 86-90 of respondent's opening brief. The decedent dictated
the terms of those agreements; the bank was only concerned about protecting
itself as a fiduciary and maintaining its fees.
Respondent agrees that the assets the decedent contributed
to the business trusts were properly credited to his capital account and that
he retained sufficient assets to maintain his lifestyle. However, the presence
of these two factors does not mean that a bona fide sale for full and adequate
consideration took place. Had proper credits to the capital account not been
made, or if the other formalities relating to the formation of the trusts had
not been observed, then that would have undercut petitioner's argument that a
bona fide sale occurred. Similarly, had the decedent transferred substantially
all of his assets to the business trusts, then this would have further
supported respondent's contention that the transfers were made for testamentary
purposes. Although these factors were among those *48 cited in Estate of Stone
as evidence that a bona fide sale had occurred, they do not support the same
conclusion here given the absence of the other factors relied upon by the Court
in that case.
Finally, petitioner contends that the facts in this case are
distinguishable from those in Estate of Strangi v. Commissioner, T.C. Memo.
2003-145, 85 T.C.M. (CCH) 1331, appeal docketed, No. 03-60992 (5th Cir.
11/21/03); Estate of Thompson, supra; and Estate of Harper, supra. Again,
petitioner argues that unlike the factual scenarios in those cases, the
business trusts were formed for substantial business purposes after extensive
arm's-length negotiations with the bank. As previously discussed in this brief
and in respondent's opening brief, the record does not support these
assertions. The trusts were not formed for any business reasons, but rather the
preponderance of the evidence establishes that they were created primarily to
serve as a vehicle the decedent could use to make inter vivos and testamentary
gifts at discounted values. To the extent that the decedent was motivated by
his desire to perpetuate his investment philosophy, that also was a testamentary,
as opposed to a business, purpose.
Regarding the petitioner's claim that the bank was actively
involved in determining how the business trusts would be structured and
operated, again the record does not support *49 petitioner's assertion. [FN15] The
decedent unilaterally determined how the trusts would be structured and
operated and what property would be contributed. Discussions with the bank
centered on tax issues and on matters relating to their fiduciary
responsibilities and fees.
FN15. Petitioner implies that this case is different from
Estate of Strangi, Estate of Thompson, and Estate of Harper because it does not
involve intrafamily transactions. Petitioner ignores the fact that the bank, as
trustee of the bank trusts, simply represented the interests of the decedent's
children and grandchildren, who were the bank trust beneficiaries. Since they
all supported the plan as proposed by the decedent, this case does not involve
the type of adverse interests present in Estate of Stone. Moreover, the bank
was not a truly independent party since the decedent could have directed it to
transfer stock from several of the bank trusts to the business trusts and could
have removed it as trustee of all of the bank trusts had it not agreed to the
plan he proposed.
Petitioner asserts that this case does not involve
"unilateral value recycling," as determined by this Court in Estate
of Strangi, Estate of Thompson, and Estate of Harper because the decedent
retained substantial assets and did not commingle trust assets with his
personal assets. Nothing in those opinions indicates that either of these
factors must be present before the Court will find that a mere "recycling
of value" has occurred. Rather, the issue is whether the transfer caused
any meaningful change in the decedent/transferor's relationship to the
property. Since the decedent retained all of the incidents of ownership he
possessed before the transfers, and *50 since the transfers served no business
purpose, the trust units he received in the exchange do not qualify as full and
adequate consideration. See Estate of Strangi, supra; Estate of Thompson,
supra; Estate of Harper, supra.
Petitioner contends that the decedent did not retain the
possession or enjoyment of the stock he transferred to the business trusts
because there was no implied agreement that the decedent could use trust assets
for his personal benefit. While the record supports petitioner's contention
that there was no such "implied agreement," petitioner's argument
misses the point.
It is well settled that for purposes of § 2036, the
right to possess or enjoy the property transferred may be established by
express or implied agreement. See,e.g., Estate of Strangi, 85 T.C.M. (CCH) at
1337; Estate of Thompson, 84 T.C.M. (CCH) at 386; Estate of Harper, 83 T.C.M.
(CCH) at 1648. Cf. Estate of McNichol v. Commissioner, 265 F.2d 667 (3d Cir.
1959), aff'g 29 T.C. 1179 (1958) (holding that an express agreement is not
required under the predecessor to § 2036). As discussed in
respondent's opening brief (pp. 62-66), respondent relies upon the express
terms of the business trust agreements to support his argument that the
decedent retained possession or enjoyment of the property he contributed to the
business trusts. The fact *51 that there was no implied agreement between the
decedent and the bank is irrelevant. See Estate of Strangi, 85 T.C.M. (CCH) at
1337 ("[W]e observe that our analysis above of the express documents
suggests inclusion of the contributed property under section 2036(a)(1) based
on the 'right to the income' criterion, without need further to probe for an
implied agreement regarding other benefits such as possession or
enjoyment.").
Petitioner also contends that § 2036 (a)(1) does
not apply because the decedent did not retain the right to receive the actual
dividends paid on the stock he contributed to the business trusts. Petitioner
concludes that the decedent's right to share in the trusts' income is based on
his interest in each trust as opposed to a retained interest in the stock.
It is well settled that the substance of a transaction
rather than its form will determine whether it falls under the scope of §
2036. See Estate of McNichol, 265 F.2d at 673 ("Substance not form is made
the touchstone of taxability."), citing Commissioner v. Estate of Church,
335 U.S. 632 (1949). See also Estate of Strangi, 85 T.C.M. (CCH) at 1336 (§
2036 "describes a broad scheme of inclusion in the gross estate, not
limited in form of the transaction, but concerned with all inter vivos
transfers where outright disposition of the property is delayed until the
transferor's death."), quoting Guynn v. United States, 437 F.2d 1148, 1150
(4th Cir. 1971); *52Estate of Harper, 83 T.C.M. (CCH) at 1647. Here, there is
no doubt that the decedent, in substance, retained the right to receive the
trust income allocable to the stock he contributed to the business trusts. Upon
the formation of each business trust, the decedent received business trust
units proportional in number to the value of the stock he contributed to the
total value of all stock contributed the trust. Since the trust agreements
require trust income to be distributed to the unit holders pro rata, the
decedent in reality had the right to receive the portion of the trust income
(less trust expenses) allocable to the stock he contributed. [FN16]
Petitioner's argument that § 2036 should not apply because the
decedent did not retain the right to receive directly the actual dividends and
other income attributable to the stock he contributed to the business trusts
ignores the substance of the transactions. Cf. United States v. Estate of
Grace, 395 U.S. 316 (1969) (holding in a case involving the predecessor to *53 §
2036(a)(1) that where the donors created reciprocal trusts which did not change
the economic position of each donor vis-Ì -vis the property contributed, the
trust corpus was included in the donor's gross estate even though under the
statute's literal terms it did not apply); Lehman v. Commissioner, 109 F.2d 99,
100 (2d Cir.), cert, denied, 310 U.S. 637 (1940) ( "The fact that the
trusts were reciprocated or 'crossed' is a trifle, quite lacking in practical
or legal significance.... The law searches out the reality and is not concerned
with the form.").
FN16. Petitioner's income interest in the stock under the
business trust
agreements is really no different than the income interest
he held before the transfers. Before the transfers, the decedent received the
net income derived from the stock (i.e., the dividends paid less the portion of
the trust expenses allocable to the stock). After the transfers, he continued
to receive the net income from the stock. Moreover, the fact that the decedent
did not receive the full amount of the dividends paid on the stock he
contributed to the business trusts does not make § 2036 (a)(1)
inapplicable. That section applies to partial retentions of the right to income
as well.
Petitioner claims that Lewis G. Hutchens Non-Marital Trust
v. Commissioner, T.C. Memo. 1993-600, 66 T.C.M. (CCH) 345 and Estate of Boykin
v. Commissioner, T.C. Memo. 1987-134, 53 T.C.M. (CCH) 345, support its argument
that the decedent did not retain an income interest in the stock he contributed
to the business trusts. Both cases are distinguishable on the facts and do not
stand for the proposition for which they are cited. Furthermore, neither case
suggests that the form, as opposed to the substance, of a transaction controls
the application of § 2036 (a)(1).
In Lewis G. Hutchens Non-Marital Trust, the decedent, as
part of the recapitalization of his corporation, exchanged his common stock for
preferred stock. The common stock was then cancelled. Respondent argued that
the decedent had, in essence, retained the same ownership interest and the same
voting rights he held when he possessed the common stock and, thus, the value
*54 of those rights and not the value of the preferred shares should be
included in the gross estate under § 2036 (a). The Court held that §
2036(a) did not apply because the decedent received full and adequate
consideration for his common stock. The Court further held that the preferred
stock did not represent a retained interest in the common stock. The Court
determined that the preferred stock was distinct and separate property with its
own dividend and liquidation preferences and voting privileges.
In Estate of Boykin, the decedent transferred his voting
shares to a trust for the benefit of his children and retained his nonvoting
shares. Respondent argued that the value of the voting shares should be
included in the decedent's gross estate under § 2036 because, as the
holder of the nonvoting shares, the decedent would receive the bulk of any
dividends issued by the corporation. The Court rejected respondent's argument,
holding that the decedent had transferred his interest in the voting stock
before his death. The Court noted that the only rights retained by the decedent
were those accorded to the nonvoting stock, which were separate and distinct
from the rights possessed by shareholders holding the voting stock.
Not only are these two cases factually distinguishable, but
it is clear that the stock retained by the decedents was not used as a vehicle
to retain an interest in the stock transferred. Rather, this Court found that
the stock held by each decedent at *55 the time of his death was separate and
distinct from the stock transferred during his lifetime. In contrast, the trust
units held by the decedent simply represented his retained interest in the
stock he contributed to the business trusts. Unlike the decedent in Lewis G.
Hutchens Non-Marital Trust and Estate of Boykin, the decedent in this case
retained the same bundle of rights he possessed before the stock was
transferred to the business trusts.
If the Court were to adopt petitioner's position, then §
2036(a)(1) would never apply to a transfer of property to an entity where the
decedent/transferor received an interest in the entity in the exchange.
According to petitioner, the decedent/transferor's right to income in those
cases would be based on his/her ownership interest in the entity and not on a
retained interest in the property transferred. Clearly, that position is
contrary to this Court's holdings in Estate of Strangi, Estate of Thompson, and
Estate of Harper.
Petitioner, citing United States v. Byrum, 408 U.S. 125, 136
(1972), argues that the decedent's power, as trustee, to manage the trust
assets did not constitute the power to designate the person or persons who
would possess or enjoy the trust property *56 or the income therefrom.
Respondent submits that petitioner oversimplifies the holding in Byrum. The
test under Byrum is whether the decedent's powers as trustee were sufficiently
limited by his fiduciary obligations to the trust beneficiaries to effectively
eliminate his ability to designate the person or persons who would possess or
enjoy the trust property. For the reasons discussed in respondent's opening
brief (pp. 76-79), respondent submits that the decedent's powers as trustee
were not sufficiently constrained to eliminate his power to designate.
Petitioner states that the decedent "did not retain the
discretion to direct distributions from Schutt I and Schutt II." Pet.
Opening Br. p. 64. While it is true that he was required to distribute each
trust's "net cash flow" on a quarterly basis, he had the absolute
discretion to withhold so much of the net cash flow as he determined was needed
for working capital and to cover contingencies. He could also affect the amount
of income that would be distributed to the trust beneficiaries by deciding not
to reinvest the proceeds from the sale of trust assets. Under the business
trust agreements, the proceeds from the sale of trust assets must be
distributed as part of the trust's "net cash flow" if not reinvested
in new assets. Respondent submits that these provisions, in effect, gave the
decedent the ability to designate the person or persons who would possess or
enjoy the property.
*57 Two cases cited by petitioner -- Estate of Cohen v.
Commissioner, 79 T.C. 1015 (1982), and Jennings v. Smith, 161 F.2d 74 (2d Cir.
1947) -- do not support petitioner's position. In Estate of Cohen, this Court
held that the trust agreement provided sufficient limits on the exercise of the
trustees' discretion that could be enforced by the state courts. Similarly, the
court held in Jennings that the trust agreements contained ascertainable
standards limiting the trustee's discretion to decide whether or not trust
income would be distributed to the trust beneficiaries. As discussed in
respondent's opening brief (pp. 76-79), there are no ascertainable standards in
the business trust agreements limiting the decedent's authority to withhold
trust income for working capital needs and to cover contingencies. Likewise, no
restrictions are placed on his authority to sell trust assets and either
reinvest the proceeds or distribute them as part of the net cash flow.
Petitioner contends that the power the decedent shared with
the bank to dissolve the business trusts "does not equate to the right to
'designate the person or persons who shall possess or enjoy the property or the
income therefrom' under § 2036(a)(2)." Petitioner states that the
"in conjunction with" language in § 2036(a) does not apply
to mere powers to persuade others holding a similar power to act jointly.
*58 Petitioner misreads the case law it cites. In Helvering
v. Helmholz, 296 U.S. 93 (1935), aff'g 75 F.2d 245 (D.C. Cir. 1934), aff'g 28
B.T.A. 165 (1933), the decedent retained a limited power of appointment in a
trust created prior to the enactment of Section 302 of the Revenue Act of 1926.
The decedent had no power to alter, amend, or revoke under the trust
instrument, although under local law she, in conjunction with all of the other
interested persons, had the power to revoke the trust. The Court ruled that to
subject the trust to estate tax on the basis of a power derived from local law
would, in effect, impose a retroactive tax since the decedent had parted with
all real control. Id. at 97-98. In this case, the powers possessed by the
decedent involved neither powers of appointment nor powers based solely on
local law.
In Estate of Tully v. United States, 528 F.2d 1401 (Ct. Cl.
1976), the decedent contracted with his corporate employer, of which the
decedent was also a director and shareholder, to pay his widow certain death
benefits. The court concluded that the decedent did not retain a power to
alter, amend, revoke, or terminate the enjoyment of the death benefits because
his power was not demonstrable, real, apparent, and evident, but was
speculative. Id. at 1404. As the Court of Claims explained another opinion
issued during the following year, the decedent in Estate of Tully could have
altered the terms of the death *59 benefits agreement only with the cooperation
of the other 50% owner of the corporation which was to pay the benefits. Estate
of Farrel v. United States, 553 F.2d 637 (1977). The power of the decedent in
Estate of Tully was actually the power of persuasion, not a "real"
power under the standard for § 2038. Each owner in Estate of Tully had
an equal stake in the corporation. "Each, realizing that he might be the
survivor, had an interest in keeping a reasonable ceiling on the size of the
payments and in preventing frequent changes in the agreement. Each, therefore,
acted as a brake on the other." Id. at 643, citing Estate of Tully, 528
F.2d at 1404-05. The focus of Estate of Tully is the illusive nature of the
power because, like Byrum, it arose from the decedent's ownership of a
corporation. The fact that the decedent's power could be exercised in conjunction
with another did not cure the basic problem of the speculative nature of the
power.
Estate of Tully does not invalidate an otherwise valid power
because the decedent had to exercise it in conjunction with another person or
persons. Petitioner would blur the concepts of (i) differentiating between
powers within and outside the statutory bounds, and (ii) exercising a power in
conjunction with another.
It appears that petitioner is arguing that §
2036(a)(2) should not apply in this case because the bank would not have *60
consented to the termination of the trust agreements. [FN17] See Pet. Opening
Br. p. 67. However, this position is contrary to the regulations and case law.
The regulations do not imply that the "in conjunction with" language
requires that the other person (or persons) be susceptible to persuasion in
order to conclude that a § 2036(a)(2) power is exercisable in
conjunction with another. In fact, just the opposite can be concluded from the
regulations. "With respect to such a [right to designate] power, it is
immaterial (i) whether the power was exercisable alone or only in conjunction
with another person or persons, whether or not having an adverse interest; (ii)
in what capacity the power was exercisable by decedent or by another person or
persons in conjunction with the decedent;..." Treas. Reg. §
20.2036-Kb)(3).
FN17. Petitioner's contention is based on Mr. Howard's
testimony. As discussed in respondent's opening brief (pp. 94) and in this
brief (p. 10), his testimony on this point is not credible.
Likewise, this Court has not made susceptibility to
persuasion a prerequisite to finding that a § 2036(a)(2) power is
exercisable in conjunction with another. In Estate of Yawkey v. Commissioner,
12 T.C. 1164, 1172 (1949), acq. 1949-2 C.B. 2 and 3, the taxpayer argued that
the decedent's two co-trustees could together frustrate any decision by the
decedent under the majority rule in the trust instrument. In response to this
*61 argument, the Court stated: "But if decedent joined with either of the
other trustees, his action became effective. In our view, that is what is meant
by the statutory phrase 'the right either alone or in conjunction with any
person.' " See also Estate of Moir v. Commissioner, 47 B.T.A. 765, 772
(1942), acq. 1942-2 C.B. 13 (decedent's contribution to a pension trust was
included in his gross estate because he, in conjunction unanimously with the
other trustees, had a power to revoke the trust and take back his contribution,
even if such revocation would affect the contributions of others as well as his
own). The power to persuade is irrelevant to a power to designate that is
exercised in conjunction with others.
Petitioner relies on precedent under § 203 8 to
support its position. Petitioner argues that the words "in conjunction
with" found in § 2 03 8 are limited to determining whether a
decedent held a joint power to terminate an entity and that state law powers
requiring unanimous consent do not trigger § 2038. It appears that
petitioner may be arguing that § 2 03 6 designation rights, like §
2038 powers, do not include a right to dissolve an entity where that power
arises under state law.
The holding in Helmholz, supra, has been incorporated into
the regulations under § 2 038, but not the regulations under §
2 036. Treas. Reg. § 20.2038- 1(a)(2) makes an exception to §
2038 if the decedent's power could be exercised only with the *62 consent of
all parties having an interest (vested or contingent) in the transferred
property, and if the power adds nothing to the rights of the parties under
local law. This § 2038 regulatory exception was at issue in Estate of
Cohen v. Commissioner, 79 T.C. 1015, 1028-29 (1982), cited by petitioner on p.
65. As discussed in respondent's opening brief (pp. 79-83), the powers to
terminate or amend retained in the business trust agreements exceed those
provided under Delaware law. [FN18]
FN18. Petitioner does not discuss which provisions of
Delaware law provide for dissolution of business trusts by the unanimous
consent of the unit holders. Later in its brief, as part of its discussion of §
2038, petitioner contends that 12 DEL. CODE ANN. § 3808 contains such
a provision because it allows members of a business trust to provide for
dissolution in the trust agreement. Pet. Opening Br. pp. 69-70.
In any event, the regulations under § 2038 do not
govern the application of § 2036(a). In Estate of Farrel, supra, the
taxpayer argued that an accepted interpretation of § 2038 dealing with
contingent rights should apply to § 2036. The court analyzed the
differences between the two sections and declined to apply § 2038
precedent to § 2036 for two reasons: (i) "the critical
points-of-view of the two provisions differ," and (ii) "the
regulations governing the two sections take diametrically opposed positions [on
the contingent rights exception to I.R.C. § 2038]." 553 F.2d at
640. The Estate of Farrel analysis is pertinent here.
*63 On the question of rights arising under state law, the
regulations governing the two sections take differing positions. The §
2 03 6 regulations contain nothing comparable to Treas. Reg. §
20.2038-1(a) (2). State law rights are not excepted from § 2 036, nor
are they relevant to the "in conjunction with" language found in that
section.
The need to convince or persuade is irrelevant under §
2036, as discussed earlier in this section. Petitioner's argument founded on
the decedent's need to convince others to vote to dissolve the business trusts
lacks any foundation in § 2036 for the reasons already discussed.
Petitioner argues at pp. 67-68 of its brief that, in effect,
the decedent's designation rights amount to naught because he could not control
who benefits. Petitioner correctly observes that "[t]he determination of
who would enjoy the property upon dissolution was made at the time of the
formation of Schutt I and Schutt II in the governing agreements;..." (Pet.
Opening Br. p. 68) Petitioner's argument is flawed because it ignores the
statute: Under § 2036(a) (2), "the right, either alone or in
conjunction with any person, to designate the persons who shall possess or
enjoy the property or the income therefrom" includes the right to control
the timing when the beneficiary might enjoy the property. The word
"enjoy" means substantial present economic benefit of the transferred
property, rather than *64 technical vesting of title or estates. Commissioner
v. Holmes, 32S U.S. 480, 48S (194S). This definition was recently applied by
this Court in Estate of Strangi, which notes: "The Supreme Court indicated
in United States v. Byrum, 408 U.S. at 143 n.23 (citing Commissioner v. Estate
of Holmes, 326 U.S. 480, 90 L. Ed. 228, 66 S. Ct. 257 (1946), that a 'power to
terminate the trust and thereby designate the beneficiaries at a time selected
by the settlor' would implicate section 2036(a)(2)." 85 T.C.M. (CCH) at
1341.
Based on partnership provisions and the corporate
dissolution and termination provisions, the Court in Estate of Strangi
concluded that the decedent had the power to act together with the shareholders
and essentially revoke the partnership and accelerate present enjoyment of the
partnership assets. 85 T.C.M. (CCH) at 1341. In other words, the right to
decide when a recipient will enjoy the transferred property triggers the
application of § 2036(a)(2). In Struthers v. Kelm, 218 F.2d 810 (8th
Cir. 1955), it did not matter that the beneficiaries' rights were vested at the
time the trusts were established because the trust granted the donor, who was
also a trustee, the right to decide when the beneficiaries would enjoy the
income or principal.
Here, the decedent's termination rights, exercised in
conjunction with only one other person, the bank, allowed the *65 decedent to
control the timing of the enjoyment of the DuPont and Exxon shares he
transferred to the business trusts. See the discussion at p. 71 of respondent's
opening brief.
In Estate of Strangi, this Court held that §
2036(a)(2) applied because the decedent retained the right to designate who
would possess or enjoy the partnership property. In its attempt to distinguish
that case, petitioner oversimplifies and thereby misrepresents its holding as
to the right to designate, in conjunction with another, as it applies to both
distributions and dividends. [FN19]
FN19. Nor is the § 2036(a)(2) discussion in Estate
of Strangi dicta, as petitioner states. It is an alternative holding.
According to petitioner, this case is distinguishable from
Estate of Strangi because the "mandated distribution of net cash flow is
far different from the 'sole discretion' distribution provisions in the Strangi
partnership agreement." (Pet. Opening Br. p. 64-65). Petitioner's argument
is incorrect for two reasons. First, as discussed previously, it is factually
incorrect because the decedent did have rights under the business trust
agreements that enabled him to affect the amount of trust income that would be
distributed to the unit holders.
Second, petitioner's interpretation of the Court's §
2036(a)(2) analysis is flawed. According to petitioner, the Court
"determined that § 2036(a)(2) was applicable because *66 Mr.
Strangi's attorney-in-fact had sole discretion to make distribution
decisions...." (Pet. Opening Br. p. 64). While it is true that the Court
held that § 2036(a)(2) applied to the Strangi FLP distributions because
Mr. Strangi's attorney-in-fact had sole discretion to make distributions, it
does not follow, as petitioner assumes, that § 2036(a)(2) is triggered
only when the retained right to designate income is held solely by the
transferor. The Court did not need to expressly address the question of whether
Mr. Strangi retained the right to designate income in conjunction with another
person because it had already found that he had retained it alone. Similarly,
it is respondent's position in this case that the decedent had the sole
discretion to exercise the rights that allowed him, in effect, to determine how
much of the trusts' net cash flow would be distributed to the unit holders.
In Estate of Strangi, the Court's analysis of the dividend
distributions from Stranco makes it clear that it had not established a
"sole discretion" standard. Since a vote of the majority of the board
of directors of Stranco was required to declare dividends, Mr. Strangi did not
possess the unilateral right to declare a dividend; he could have joined with
another director to declare a dividend. As explained by the Court,
"[u]nder the bylaws, a majority of the directors then serving constitutes
a quorum. Because Stranco had five directors, a *67 quorum would consist of
three, so two directors (e.g. decedent through Mr. Gulig and one other) could
potentially act together to declare a dividend." 85 T.C.M. (CCH) at
1341-42.
Petitioner's position that the decedent's right along with
the bank to dissolve the business trusts does not implicate §
2036(a)(2) is diametrically opposed to the holding in Estate of Strangi. The
Court determined that the Srangi FLP "would be dissolved and terminated
upon a unanimous vote of the limited partners and the unanimous consent of the
general partner.' 85 T.C.M. (CCH) at 1341. Because Mr. Strangi 'retained the
right, acting in conjunction with the other Stranco shareholders," to
cause a liquidation of the Strangi FLP, he retained the right to designate who
shall enjoy the transferred property. 85 T.C.M. (CCH) at 1341. Like Mr.
Strangi, the decedent also retained liquidation rights as he along with the
other unit holders could have dissolved the business trusts before their
December 31, 2048 termination date.
Petitioner contends that § 203 8 does not apply
because the transfers of stock to the business trusts were bona fide sales for
full and adequate consideration. For the reasons discussed earlier in this
brief and in respondent's opening brief, the record does not support this contention.
*68 Petitioner, citing to Treas. Reg. §
20.2038-l(a)(2), further argues that the right retained by unit holders to
dissolve the business trusts by unanimous consent adds nothing to the rights
granted to the parties under state law. Respondent has addressed this issue in
his opening brief (pp. 79-83). To summarize, state law contains no provision
allowing the members of a Delaware business trust to dissolve the entity by
unanimous consent, but rather it provides that business trusts will have
perpetual existence unless otherwise provided in the trust agreement. The
question that must be asked is whether absent the termination rights set forth
in the trust agreements, would the unit holders have had the right by unanimous
consent to dissolve the business trusts? The answer is no.
Petitioner ignores the fact that the unit holders could
amend the trust agreements by less than unanimous consent. [FN20] Again, as
discussed in respondent's opening brief (pp. 79-83), *69 there is no provision
under state law allowing for the amendment of a business trust agreement if the
agreement does not so provide.
FN20. The trust agreements provide that they may be amended
by a two-thirds vote of the unit holders. Petitioner may argue that since the
bank, as trustee of the bank trusts, controls the business trust units held by
those trusts, in reality unanimous consent would be needed to amend the
business trust agreements. However, it is conceivable that the bank might take
an inconsistent position on whether the business trusts should be dissolved if,
for example, the beneficiaries of some of the bank trusts supported termination
while the beneficiaries of the others did not. Furthermore, upon the death of
any of the decedent's children, the business trust units would be distributed
to the decedent's grandchildren and their issue. This could also create a
situation where the business trust agreements could be amended without
unanimous consent.
It follows that the determination of the Commissioner of
Internal Revenue should be sustained.