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T.C. Memo.
2005-126, 2005 WL 1244686 (U.S.Tax Ct.), 89 T.C.M. (CCH) 1353, T.C.M.
(RIA) 2005-126, 2005 RIA TC Memo 2005-126 United States Tax
Court. ESTATE OF Charles
Porter SCHUTT, Deceased, Charles P. Schutt, Jr., and Henry I. Brown III,
Co-Executors, Petitioner v. COMMISSIONER OF
INTERNAL REVENUE, Respondent No. 19208-02. May 26, 2005. COUNSEL: John W. Porter, W. Donald Sparks II, and
Michael R. Stein, for petitioner. Gerald A. Thorpe, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION OPINION BY: WHERRY, J. S1 and S2, Delaware business trusts, were formed in 1998 and were
capitalized by the contribution thereto of stock by D through a revocable trust
and by WTC as trustee of various trusts created for the benefit of D’s
children and grandchildren. At his death in 1999, D held through the revocable
trust a 45.236-percent interest in S1 and a 47.336-percent interest in S2. Held: D’s transfers of stock to S1 and S2 were bona fide
sales for adequate and full consideration within the meaning of secs.2036(a)
and 2038, I.R.C., such that the value of the transferred assets is not included
in his gross estate under these statutes. By a statutory notice dated October 11, 2002, respondent
determined a Federal estate tax deficiency in the amount of $6,113,583.03 with
respect to the estate of Charles Porter Schutt (the estate). By answer,
respondent asserted an increase in the deficiency of $1,409,884.65. Thereafter,
by amendment to answer, respondent asserted a further increase in the deficiency
of $3,595,513.32 (for a total deficiency of $11,118,981). After concessions,
the principal issue for decision is whether the fair market value of stock
contributed by Charles Porter Schutt (decedent) through a revocable trust to
Schutt, I, Business Trust (Schutt I) and Schutt, II, Business Trust (Schutt II)
is includable in his gross estate pursuant to section 2036(a) or 2038. [FN1] FINDINGS OF FACT Some of the facts have been stipulated and are so found. The
stipulations of the parties, with accompanying exhibits, are incorporated
herein by this reference. Decedent was a resident of the State of Delaware when
he died testate on April 21, 1999, and his will was probated in that State. The
co-executors of decedent’s estate both resided in the Commonwealth of
Pennsylvania at the time the petition in this case was filed. General Background Decedent was born on February 11, 1911. Decedent later married
Phyllis duPont (Mrs. Schutt), the daughter of Eugene E. duPont (Mr. duPont).
Decedent and Mrs. Schutt had four children, each of whom subsequently married:
Sarah Schutt Harrison, Caroline Schutt Brown, Katherine D. Schutt Streitweiser,
and Charles P. Schutt, Jr. Decedent’s son Charles P. Schutt, Jr., and
his son-in-law Henry I. Brown III are the co-executors of his estate. Each of
decedent’s four children had children of his or her own, such that
decedent and Mrs. Schutt were survived by 14 grandchildren. Historically, a significant portion of the Schutt family wealth
has been invested in, and a concomitant significant and steady portion of the
family income has been generated by, an interest in E.I. du Pont de Nemours and
Company (DuPont) stock and Phillips Petroleum Company stock initially obtained
from Mr. duPont. Throughout the decades, Mr. duPont, decedent, and Mrs. Schutt
have, in the administration of these and other holdings, established a number
of trusts for the benefit of themselves and/or their issue. [FN2] In the
mid-1980s, the Schutt family’s holdings in Phillips Petroleum stock
were sold, due to dissatisfaction with the management of Phillips Petroleum,
and were replaced with stock in Exxon Corporation. Trust 3044 During 1940, Mr. duPont as trustor and Wilmington Trust Company
(WTC) as trustee entered into a trust agreement dated December 30, 1940 (Trust
3044). In accordance with this agreement, shares of DuPont and Christiana
Securities Company [FN3] stock were placed in trust for the benefit of Mrs.
Schutt and her issue. As pertinent here, [FN4] Trust 3044 provided that, until
Mrs. Schutt’s death, income was to be distributed quarterly to her
issue per stirpes, or if none to Mrs. Schutt. Upon Mrs. Schutt’s death, the trust corpus was to be
divided into shares, per stirpes, for the benefit of her issue. If such share
was set aside for a living child of Mrs. Schutt, the corpus so allocated was to
be held in trust for the child and income therefrom was to continue to be
distributed in quarterly installments to the child. Upon the child’s
death, the trustee was to distribute the corpus free of trust to the
child’s descendants, per stirpes, subject to specified age
restrictions. As regards administration, Trust 3044 granted to the trustee,
subject to specified limitations, “in general, the power to do and
perform any and all acts and things in relation to the trust fund in the same
manner and to the same extent as an individual might or could do with respect
to his own property.” Concerning limitations, the trust agreement
provided for the appointment of an “adviser of the trust”
(also referred to herein as a “consent adviser”) by Mrs.
Schutt and stated that enumerated powers granted to the trustee shall be
exercised only with the written consent of the adviser of the trust; provided,
however, that if at any time during the continuance of this trust there shall
be no adviser of the trust, or if the adviser of the trust shall fail to
communicate in writing to Trustee his or her consent or disapproval as to the
exercise of any of the aforesaid powers for which exercise the consent of such
adviser shall be necessary, within twenty days after Trustee shall have sent to
the adviser of the trust, by registered mail, at his or her last known address,
a written request for such consent, then Trustee is hereby authorized and
empowered to take such action in the premises as it, in its sole discretion,
shall deem to be for the best interest of any beneficiary of this trust. The specified powers subject to the above consent provision were
the trustee’s authority: (1) To sell or otherwise dispose of trust
property; (2) to hold cash uninvested or to invest in income-producing
property; (3) to vote shares of stock held by the trust; and (4) to participate
in any plan or proceeding with respect to rights or obligations arising from
ownership of any security held by the trust. The trust agreement recited that any trust established thereunder
would terminate no later than 21 years after the death of the last survivor of
Mr. duPont, his then-living issue, and his sons-in-law. At that juncture, any
remaining principal was to be distributed free of trust to the income
beneficiaries thereof at the time of the termination. By a letter to WTC dated March 11, 1941, Mrs. Schutt appointed Mr.
duPont and decedent as advisers of Trust 3044. The letter further stated that
upon the death of either appointee, the survivor would act as sole adviser
until such time as Mrs. Schutt appointed another adviser. Mr. duPont died on
December 17, 1966, and decedent remained as sole adviser with respect to Trust
3044 and trusts created thereunder, a position he continued to hold at the time
of his own death on April 21, 1999. Mrs. Schutt died on August 5, 1989. Upon her death, Trust 3044 was
divided into separate trusts for the benefit of her four children. These trusts
are referred to as Trusts 3044-1, 3044-2, 3044-3, 3044-4, 3044-5, 3044-6,
3044-7, and 3044-8. Decedent’s and Mrs. Schutt’s daughter Katherine
D. Schutt Streitweiser died of leukemia on March 27, 1993. At that time, she
was the current beneficiary of Trusts 3044-3 and 3044-7. In accordance with the
provisions of those trusts, the assets held therein were distributed outright
to her children. Trust 2064 Mrs. Schutt’s death was also significant with respect to
the structure of two additional trusts directly pertinent to this litigation.
By means of a trust agreement dated October 6, 1934, between Mr. duPont and
WTC, Mr. duPont conferred upon Mrs. Schutt a limited power of appointment over
what is referred to as Trust 2064. Under her will dated December 1, 1988, as
amended by a first codicil dated January 25, 1989, Mrs. Schutt exercised this
power of appointment. These documents provided that the property subject to the
power was to be held in trust by WTC. At Mrs. Schutt’s death and after
the distribution of $1,000 to each of her surviving children, the balance of
the trust was to be divided into shares, with one share set aside for each
surviving grandchild and one share set aside for the then-living issue (as a
group) of any grandchild who predeceased her but left surviving issue. Any share set aside for a predeceased grandchild was to be
distributed free of trust to that grandchild’s issue, per stirpes,
subject to the minor’s trust provision set forth in the will. The
shares set aside for grandchildren who survived Mrs. Schutt were to be held as
a single trust, from which net income was to be distributed quarterly in equal
shares to each grandchild until the youngest such grandchild achieved the age
of 40. Trust 2064 was to terminate on the earlier of (1) the date the youngest
grandchild living at Mrs. Schutt’s death reached 40, (2) the death of
all grandchildren living at Mrs. Schutt’s death, or (3) the date 21
years after the death of the last survivor of the issue of Mrs.
Schutt’s grandfather, Alexis Irenee duPont, living on October 6, 1934.
Trust property remaining at termination was to be distributed, if any such
persons survived, in equal shares to the income beneficiaries thereof. As pertains to the administration of Trust 2064, Mrs.
Schutt’s will provided a representative listing of powers granted to
the trustee, subject to specified limitations. More specifically, the will
provided for an adviser of the trust (also referred to herein as a
“direction adviser”), and appointed decedent as the initial
direction adviser, a position he continued to hold until his death. A committee
made up of Mrs. Schutt’s daughter-in-law Katherine Draper Schutt and
son-in-law Henry I. Brown III was designated to succeed decedent in this role.
Regarding the direction adviser, the will stated, in relevant part: I direct the trustee of each trust created in this Will to
exercise the powers granted to it * * *, relating to buying, selling, leasing,
exchanging, mortgaging, or pledging property held in such trust, and
participation in incorporations, reorganizations, consolidations, liquidations,
or mergers, only upon the written direction of the advisor of such trust or of
the Committee, as the case may be. * * * Notwithstanding the previous provisions of this Article, if at any
time during the administration of any trust hereunder, the advisor or Committee
fail to communicate in writing to Trustee any direction or disapproval with
respect to Trustee’s exercise of any power requiring the direction of
the advisor or Committee within fifteen (15) days after trustee has sent a
written request for such direction to the advisor’s or Committee
members’ last known address by registered or certified mail (but
Trustee shall not be required to take the initiative to seek any such
direction), then Trustee is authorized to take such action in the matter as it,
in its sole discretion, deems appropriate. The will further directed that the direction adviser and Committee
members exercise their functions in a fiduciary capacity. Trust 11258-3 As previously indicated, Mrs. Schutt’s death was also
significant with respect to the structure of a second trust directly relevant
to the factual background of this proceeding. On January 16, 1976, Mrs. Schutt
had established a revocable trust, which was subsequently amended by
supplemental trust agreements dated April 9, 1976, June 6, 1979, December 30,
1982, and December 1, 1988. [FN5] At Mrs. Schutt’s death, following
payment of certain cash bequests, the corpus of the revocable trust was divided
into three trusts: (1) A marital trust; (2) a generation-skipping transfer tax
exemption trust (GST trust); and (3) a residuary trust. WTC became trustee of
these trusts, the GST portion of which is also referred to as Trust 11258-3. The marital trust was to be funded with the “marital
deduction amount”, an amount which, taking into account applicable
provisions of the Code, resulted in a taxable estate of $2.5 million, less the
amount of any adjusted taxable gifts. During decedent’s life, he was
to receive net income therefrom and so much of principal as he requested. At
his death, remaining corpus was to be distributed according to the exercise of
a power of appointment granted to decedent. In absence of an exercise of this
power, and after taking into account specified provisions relating to payment
of taxes and expenses, remaining marital trust assets were to be added to the
residuary trust. The GST trust was to be funded with property equal in value to the
maximum amount then available to Mrs. Schutt under the generation-skipping
transfer tax exemption set forth in the Code. The trustee was authorized, in
its sole discretion, to distribute net income and principal to Mrs.
Schutt’s issue more remote than children for their support,
maintenance, education, care, and welfare. The GST trust was to terminate 110
years after becoming irrevocable, at which time the property was to be distributed
free of trust to Mrs. Schutt’s then-living issue, per stirpes. The remaining assets of the revocable trust were to be placed into
the residuary trust. A share of the residuary trust was set aside for each of
Mrs. Schutt’s four children. Subject to certain differences not
material here, each child was given a lifetime income interest in, and a
limited testamentary power of appointment over, his or her share. In default of
any such appointment by the child, the trustee was directed upon the
child’s death to distribute the assets free of trust to the
child’s then-living issue, per stirpes. Mrs. Schutt’s son,
Charles P. Schutt, Jr., was also authorized to withdraw up to one-third of the
value of his share upon request. With respect to administration, the trust indenture provided for
powers to the trustee and a direction adviser or committee in terms
substantially identical to those contained in Trust 2064. Mrs. Schutt was named
as the initial direction adviser. She was succeeded at her death in that role
by decedent, a position he held until his own death. Katherine Draper Schutt
and Henry I. Brown III were again named as the members of the committee to
succeed decedent. Revocable Trust Like Mrs. Schutt, decedent on January 16, 1976, had established a
revocable trust, subsequently amended by supplemental trust agreements dated
April 9, 1976, June 6, 1979, December 30, 1982, December 1, 1988, January 24,
1989, July 18, 1989, April 6, 1990, May 4, 1994, May 20, 1994, December 10,
1996, and May 21, 1997 (Revocable Trust). The Revocable Trust was initially
funded with life insurance policies on decedent’s life and with
various holdings in common stock. Decedent, Henry I. Brown III, and Charles P.
Schutt, Jr., were named as co-trustees, positions they held until
decedent’s death, at which time Henry I. Brown III and Charles P.
Schutt, Jr., continued as successor co-trustees. As amended, the trust agreement made the following provisions with
respect to distributions. During decedent’s life, he was to receive
all net income of the trust and so much of the principal as he requested in
writing at any time. At decedent’s death, specified cash bequests were
to be made to named beneficiaries. Remaining corpus was to be divided into
three trusts: (1) A charitable lead trust; (2) a so-called special trust; and
(3) a residuary trust. The charitable lead trust provided for a charitable lead unitrust
term beginning on the date of decedent’s death and terminating 25 years
thereafter, and for a unitrust amount to charity annually of 5 percent of the
value of the trust assets. The total value of the trust fund was to be an
amount which would produce a charitable deduction for the charitable lead trust
sufficiently large to leave a taxable estate equal to decedent’s
unused generation-skipping transfer tax exemption. At the termination of the
charitable interest, specified amounts were to be distributed to grandchildren
born after Mrs. Schutt’s death and to then-living issue of any
predeceased grandchild. Assets not distributed under the just-described provisions were to
be held in trust and to be paid at the sole discretion of the trustee for the
support, maintenance, education, care, and welfare of then-living grandchildren
of decedent and then-living issue of any grandchild dying prior to the
termination of the charitable lead. This trust was to terminate upon the
earlier of the death of decedent’s last-surviving grandchild or 110
years after decedent’s death. At that time, the corpus was to be
distributed outright, per stirpes, to decedent’s then-living
great-grandchildren and to issue of any predeceased great-grandchild. The special trust was to be created by setting aside $2 million.
Until the death of the last to die of decedent’s children, income
could be paid to any then-living child in the discretion of the trustee, so
long as the trustee was not a child of decedent. Following the death of the
last to die of decedent’s children, the trustee was to pay annually to
the University of Virginia an annuity equal to 4 percent of the value of the
special trust on the date of the last child’s death. Throughout the
trust’s term, principal could be used for the full-time undergraduate
college tuition of the issue of any of decedent’s children. Unless
earlier exhausted, the special trust was to terminate 90 years after the death
of the last grandchild living at decedent’s death, at which time the
corpus was to be distributed free of trust to the University of Virginia. The remaining assets of the revocable trust were to be placed into
the residuary trust. A share of the residuary trust was to be set aside for
each of decedent’s three living children and the issue per stirpes of
his predeceased daughter. Each primary beneficiary was given a lifetime income
interest in, and a limited testamentary power of appointment over, his or her
share. In default of any such appointment, the trustee was directed upon the
beneficiary’s death to distribute the assets free of trust to the
beneficiary’s then-living issue, per stirpes. Decedent’s son
was also authorized to withdraw principal not in excess of one-third of the
value of his share upon request. Schutt Family Limited Partnership In addition to the foregoing trusts, decedent and two of his
children, Charles P. Schutt, Jr., and Caroline Schutt Brown, on December 23,
1994, created the Schutt Family Limited Partnership. On behalf of himself and
the two children, decedent contributed to the partnership Alabama timberlands,
[FN6] securities, and cash. In return for these contributions (or deemed
contributions), the partners received units in the entity representing the
following interests: Charles Porter Schutt:
5-percent general partnership interest
82.112-percent limited partnership interest
Charles P. Schutt, Jr.:
1-percent general partnership interest 5.444-percent
limited partnership interest
Caroline Schutt Brown:
1-percent general partnership interest
5.444-percent limited partnership interest Thereafter, decedent began making annual gifts of limited
partnership interests, apparently intended to qualify for the exclusion under
section 2503(b), to certain of his children, their spouses, and their children. Decedent’s Lifestyle and Health At some time after his first wife’s death and prior to
May of 1994, decedent remarried, and he remained married to Greta Brown
Layton-Schutt at the time of his death. During the 1995 through 1998 period,
decedent led an active lifestyle. This lifestyle included extensive traveling,
boating, hunting, and socializing, and decedent remained at his residence in
Wilmington, Delaware, only about 50 percent of the time. For instance, during
the 1995 through 1998 period, decedent made regular visits to Vredenburgh,
Alabama, to oversee both a working farm he owned there and Schutt family
timberlands in the vicinity. He also traveled to, inter alia, England, Turkey,
China, Russia, and Africa, and he spent a substantial amount of time cruising
the Chesapeake Bay area on his yacht. When at his home in Wilmington, decedent typically spent mornings
during the work week at the Carpenter/Schutt family office [FN7] reviewing
investment literature, followed by lunch at the Wilmington Club (a social
club), followed by a return to the family office for additional investment
research. Decedent subscribed to a buy and hold investment philosophy, as had
his father-in-law, Mr. duPont. This philosophy emphasized the acquisition of stock in quality
companies that would provide both income and value appreciation, which would
then be held for the long term. In particular, decedent, like Mr. duPont before
him, stressed maintaining the family’s large holdings in DuPont and,
depending on the time frame and absent drastic circumstances, Phillips or
Exxon. Over the years, decedent also on numerous occasions expressed concern
about family members selling DuPont or Exxon shares, and he was displeased with
such sales made by grandchildren during the 1990s. During the 1996 through 1998 period, decedent was under the
regular care of his family physician and a cardiologist in Wilmington,
Delaware, and of another family physician in Camden, Alabama.
Decedent’s health history during the period included coronary artery
disease, congestive heart failure, hyperlipidemia, hypertension, renal
insufficiency, and gout. On November 29, 1996, decedent was admitted to the
hospital complaining of shortness of breath. He was released on December 5,
1996, after receipt of fluids, monitoring, and adjustment of his medication. He
was also admitted briefly to a hospital in Camden, Alabama, on January 6, 1998,
because of similar medical problems. Schutt I and II During late 1996 or early 1997, decedent and two of his principal
advisers, Stephen J. Dinneen and Thomas P. Sweeney, began discussions
concerning the transfer of assets out of the Revocable Trust to another
investment vehicle. Mr. Dinneen was a certified public accountant who was in
charge of accounting and tax work and served as the office manager for the
Carpenter/Schutt family office. Among other things, he advised Schutt family
members on investment and business matters and had been employed by the family
since 1973. Mr. Sweeney, a member of the law firm Richards, Layton & Finger,
P.A ., during this period served as decedent’s attorney on tax and
estate planning matters. Decedent had been a client of Mr. Sweeney since 1967. Among the considerations providing an impetus for this potential
restructuring of decedent’s assets, Mr. Sweeney and/or Mr. Dinneen
recall discussing: (1) Decedent’s concerns regarding sales by family
members of core stockholdings and his desire to extend and perpetuate his buy
and hold investment philosophy over family assets; (2) the need to develop
another vehicle through which decedent could continue to make annual exclusion
gifts due to exhaustion of available units in the family limited partnership
for this purpose; and (3) the possibility of valuation discounts. Following the
initial discussions with decedent, Mr. Sweeney and Mr. Dinneen undertook to
investigate possible alternative entity structures for decedent’s
assets. Over the course of the next 15 months, a process of meetings,
discussions, and research, extensively documented in letters, memoranda, and
notes, took place and culminated in the formation of Schutt I and II on March
17, 1998. On January 27, 1997, Mr. Sweeney sent to Mr. Dinneen a letter
enclosing a memorandum entitled “CONSIDERATIONS RELEVANT IN CHOOSING
BETWEEN A FAMILY LIMITED PARTNERSHIP, A LIMITED LIABILITY COMPANY, AND A
DELAWARE BUSINESS TRUST”. [FN8] The memorandum first summarized
characteristics, benefits, and problems associated with each entity, including
potential transfer tax savings and the problem of being classified as an
“investment company” within the meaning of section 721(b).
The second half of the memorandum was then devoted to a more extended
discussion of valuation discounts for estate planning purposes. In the cover
letter, Mr. Sweeney recommended use of “a Delaware business trust
because this would avoid the implications of an investment company since what
is to be transferred is a diversified portfolio of marketable securities being
transferred by one person.” He also expressed general observations
regarding the types of discounts that could be available “If Porter
died owning a substantial portion of the interest” in the entity and
noted the need for a qualified appraiser to determine the precise amount of the
discount. On February 3, 1997, Mr. Sweeney met with decedent and Mr. Dinneen
to further discuss entity formation issues raised in the January 27 letter.
Upon reviewing the memorandum, Mr. Dinneen had come up with the idea of
creating a Delaware business trust in which decedent held a minority interest
and served as trustee, while the remaining interests would be held for the
benefit of his children and grandchildren by WTC trusts of which decedent was
the direction or consent adviser. The participants agreed to pursue this idea,
and decedent authorized Mr. Sweeney to contact representatives of WTC to
discuss the joint creation of a business trust. They also reviewed at the
meeting a computation prepared by Mr. Dinneen reflecting the estimated
difference in Federal estate tax and net inherited amount under
decedent’s current estate plan and under a plan where a portion of his
assets would be placed into an entity subject to minority and marketability
discounts. In early February 1997, on decedent’s behalf, Mr. Sweeney
met with representatives of WTC to determine whether the company would consider
being involved with decedent in forming a Delaware business trust and, if so,
under what conditions. Specifically, on February 5, 1997, Mr. Sweeney met with
George W. Helme IV, senior vice president and head of the trust department of
WTC. Mr. Helme indicated that, in concept, the company was willing to
participate, and he directed Mr. Sweeney to speak with the legal staff of the
trust department regarding details. Mr. Sweeney reported these developments to
decedent in a letter dated February 6, 1997. On February 10, 1997, Mr. Sweeney sent a memorandum to Kathleen E.
Lee, another attorney at his firm, asking her to research certain issues with
respect to the potential business trust transaction. He also summarized therein
as follows: The present concept that is being considered is that Porter would
put up $40 million of his portfolio, and between trusts 2064 and 3044-5, 3044-6
and 3044- 8, the Wilmington Trust Company would put up approximately $42
million. The net effect would be that Porter’s funded revocable trust
would then have a minority interest in the business trust, and possibly at
Porter’s death, we could obtain both lack of marketability and minority
interest discounts with respect to Porter’s interest in the Delaware
business trust. He further noted: “it is anticipated that Porter Schutt
will at some time in the not too distant future after the transaction is
implemented commence to give away to his children in the form of taxable gifts
interests in the Delaware business trust.” Ms. Lee responded to the following four questions by memorandum
dated March 5, 1997: 1. If our client and the Wilmington Trust Company contribute
investment portfolios consisting of marketable securities into a Delaware
Business Trust, would such contributions give rise to investment company status
under § 721(b) of the Internal Revenue Code of 1986, as amended (the
“Code”) such that a realization of gain must be recognized
upon the creation of the Delaware Business Trust? 2. Can the Delaware Business Trust make an election under
§ 754 of the Code to increase basis in the underlying assets of the
Delaware Business Trust? 3. How should the Delaware Business Trust be structured so that
the entity will continue after the death of our client? 4. What valuation discounts should be given for a minority
interest and a lack of marketability in a Delaware Business Trust which
consists solely of a portfolio of marketable securities? During the period March through August 1997, Mr. Sweeney continued
discussions with WTC concerning the formation of a Delaware business trust to
hold certain of the assets of the WTC trusts and the Revocable Trust. These
discussions began with a meeting that took place on March 4, 1997, between
Cynthia L. Corliss, Mary B. Hickok, and Neal J. Howard, who attended the
meeting on behalf of the trust department legal staff of WTC, and Mr. Sweeney.
Subsequent to this meeting, Mr. Sweeney received a memorandum from Ms. Corliss,
Ms. Hickok, and Mr. Howard, dated March 6, 1997, stating initial concerns of
WTC regarding use of a business trust. Specifically, the memorandum expressed
desire on the part of WTC: (1) To ensure that none of the WTC trusts would be
subjected to tax on built-in capital gains attributable to sales of assets
contributed by the Revocable Trust or any other WTC trust; (2) to structure the
business trust so that WTC and decedent remained in the same relative positions
as then enjoyed with respect to control over investment decisions; (3) to
obtain consents from existing beneficiaries of the WTC trusts agreeing to
formation of the business trust; and (4) to have all assets of the business
trust held in a WTC custody account. Thereafter, Mr. Sweeney and attorneys at his firm undertook to
research and address the concerns raised by WTC. For instance, at Mr.
Sweeney’s direction, Cynthia D. Kaiser analyzed potential securities
law issues attendant to the proposed transaction and Julian H. Baumann, Jr.,
researched partnership income tax matters broached in WTC’s March 6,
1997, memorandum. In addition, discussions and negotiations between Mr. Sweeney
and WTC representatives, in which Mr. Howard took the lead role on behalf of
WTC, continued in the form of letters, telephone conversations, and other
meetings. Mr. Sweeney and Mr. Dinneen also communicated regularly about issues
that arose, as phrased in one letter, “in connection with our pursuing
the Delaware business trust for Porter and his family in order to make certain
that those entities with respect to which Porter has investment responsibility
are being managed in a consistent manner.” Decedent was likewise kept
informed regarding the status of the discussions and negotiations. For example,
a letter to decedent from Mr. Sweeney, dated July 14, 1997, explained as
follows: I apologize for the delay in getting to you this letter which
outlines the structure for a Delaware business trust. There are still a number
of issues which need to be addressed and worked through with the Wilmington
Trust Company, and we will proceed to have further discussions with them in
this regard. The purpose of the Delaware business trust would be to have under
one document all of the trust assets of which you are either the direction or
consent investment advisor, including a substantial portion of your own
portfolio presently held in your funded revocable trust. In this manner, there
could be a consistent investment policy with respect to the assets in which the
Schutt family has an equitable interest and thus provide a vehicle through
which a more coordinated investment policy can be administered. The first major issue which needs to be addressed and with respect
to which hopefully Steve Dinneen can provide the detailed information from the
Wilmington Trust Company reports from the various trusts is to make certain
that going into a Delaware business trust does not create a taxable
transaction. The critical thing is to make certain that the creation of the
business trust does not constitute “an investment company” in
the context of the pertinent provisions of the Internal Revenue Code. * * * * * * Structurally, it would be proposed that you be named as the
initial trustee of the Delaware business trust with perhaps the Wilmington
Trust Company being the successor trustee, and that the business trust have
perpetual existence which would not be terminated or revoked by a beneficial
owner or other person except in accordance with the terms of its governing
instrument. In addition, it should provide that death, incapacity, dissolution,
termination or bankruptcy of a beneficial owner will not result in the
termination or dissolution of the business trust except to the extent as
otherwise provided in the governing instrument of the business trust. We would propose that investment decisions would be those
recommended by you, subject to review by the Wilmington Trust Company, and that
your view would control based on the terms of the various trusts which would
become participants. In the event of termination of one of the trusts investing in the
Delaware business trust occurs, then the assets which would be distributed to
the persons entitled to the beneficial [sic] would be interests in the Delaware
business trust which would continue in existence as noted above. The issue raised in the March 6 Wilmington Trust Company memo
pertaining to separate sections of the Delaware business trust so that certain
trusts are not subject to a share of the capital gains generated by other sales
is of concern because it appears that that would be inconsistent with the
normal treatment of investment partnerships for tax purposes. * * * In addition to the foregoing, we have examined certain federal and
Delaware security law aspects of creating such a business trust. There may be
both state and federal filing requirements to consider. However, these
requirements will be somewhat limited if it can be illustrated that each
investor is a “credited investor,” * * * * * * Once we are certain that you are in agreement with structuring the
business trust as generally indicated above, then we will go back to the
Wilmington Trust Company and try to work out with them in more detail the
issues they have raised and the proposed solutions in connection therewith. On August 27, 1997, Mr. Sweeney met with Mr. Dinneen and decedent
to review whether, given the preliminary work completed to date, decedent was
willing to proceed with the transaction. Decedent indicated a willingness to do
so, but during the meeting, several points were emphasized: (1) The trust
should be structured so as to avoid the “investment company problem”;
(2) decedent wished to be the trustee, with his son, son-in-law, and perhaps
even their wives as successor trustees; (3) decedent wanted to ensure that fees
to be received by WTC for serving as both trustee of the WTC trusts and
custodian of the business trust assets would not result in “double
dipping” and thereby exceed fees currently being charged; (4) the
trust arrangement should be such that only precontribution gain, and not
postcontribution gain, was allocated solely to the contributing trust; and (5)
decedent desired to retain final say on investment decisions, although WTC
could be permitted some involvement. Shortly thereafter, on September 4, 1997, Mr. Sweeney met with Mr.
Howard and Ms. Hickok of WTC. The following issues were among those addressed
at this conference. (1) With respect to the burden of capital gains tax on
future asset sales, Mr. Howard and Ms. Hickok clarified that the concern
previously raised focused on precontribution gain, and they agreed that
operative partnership tax rules under section 704 resolved their concerns. (2)
In connection with fulfilling fiduciary duties, Mr. Howard and Ms. Hickok
indicated a desire to obtain consents from beneficiaries of various WTC trusts
participating in the business trust transaction. (3) As to the investment
company issue, the participants discussed the stock concentrations within the
relevant portfolios and broached as a topic for further research whether
contributing only DuPont stock to the business trust could avoid the problem.
(4) Regarding the length of the trust’s existence, the WTC
representatives expressed interest in a 30-to 40-year term, while Mr. Sweeney
suggested at least a 40- to 50-year term. (5) On the matter of investment
decisions, Mr. Sweeney stressed that decedent wanted the trust structured so
that he would have the final vote and control, to which Mr. Howard and Ms.
Hickok ultimately agreed so long as WTC had some input. (6) Lastly, as to
WTC’s fees, Mr. Howard and Ms. Hickok agreed that with respect to
assets contributed by the WTC trusts, the combined custodian and trustee fees
would not exceed current charges. However, they indicated that “new”
fees would be charged for custody of stock contributed by decedent’s
Revocable Trust. Mr. Sweeney indicated that this issue would have to be
analyzed further and negotiated. Mr. Sweeney reported the foregoing to decedent in a letter dated
September 5, 1997, and also on that date requested that Ms. Lee research
certain of the issues raised. On September 22, 1997, Mr. Sweeney sent a further
letter to decedent indicating that contribution of only DuPont stock to the
business trust appeared, based on the research performed, to avoid the
investment company problem. Mr. Sweeney asked decedent to consider whether
proceeding on that basis would accomplish his objectives. During late 1997, discussions continued between Mr. Sweeney and
WTC representatives, with Mr. Sweeney making several proposals to address WTC
concerns. In particular, following analysis by Mr. Dinneen of holdings of the
various trusts, Mr. Sweeney proposed that, in order to avoid characterization
as an investment company for income tax purposes under section 721(b), two
separate business trusts be created. One would hold exclusively DuPont stock,
and the other would hold only Exxon shares. WTC, in a November 26, 1997, letter to Mr. Sweeney, ultimately
agreed to structure the transactions as Mr. Sweeney proposed, subject to
enumerated conditions: (1) WTC would have the opportunity to review the
business trusts to ensure they were in a form satisfactory for WTC to proceed;
(2) all adult beneficiaries of the WTC trusts would execute a consent form, to
which a copy of the business trusts would be attached, “whereby they
acknowledge and consent to the trusts’ investing in the business
trusts and that they recognize that the business trusts may last beyond the
termination date of the trusts of which they are a beneficiary”; and
(3) business trust assets would be placed in custody with WTC, with fees
charged as set forth in an attached November 25, 1997, proposal. Mr. Sweeney communicated these conditions to decedent, and
negotiations continued with respect to the fee arrangement. For instance,
decedent requested that the proposed fee agreement be amended: (1) To provide
clearly that WTC’s commissions as custodian of the business trust
assets would not exceed the fees lost on trustee fees from the participating
trusts, and (2) to address the ability of the trustee of the business trusts to
change the custodian if WTC were to be acquired by another bank. WTC agreed to
make changes addressing these concerns. Also during December of 1997, drafts of the business trusts were
prepared and circulated for comment amongst decedent, his advisers, and WTC.
Mr. Sweeney had initially asked Ms. Lee to begin drafting the documents in a
November 14, 1997, memorandum that set forth details regarding certain
provisions to be included. Regarding purpose, the memorandum stated: You will recall that the purpose of the two Delaware business
trusts is to preserve and coordinate Porter Schutt’s investment
philosophy with respect to those trusts over which he has either direction or
consent investment advice of which the Wilmington Trust Company is trustee, as
well as his own funded revocable trust. Over the years, Porter Schutt has
developed a buy and hold philosophy which has been quite successful, and he is
anxious to have that philosophy preserved for his family for the future. In a January 6, 1998, telephone conversation, Mr. Howard pointed
out, along with several minor drafting errors, what he considered to be a
significant substantive problem with the provision then included in the trust
documents regarding distributions. The initial drafts of the trust stated that
net cashflow would be distributed at such times and in such amounts as
determined by the trustee in his discretion. WTC wanted the trusts to provide
for distribution of net cashflow at least annually. Mr. Sweeney thought that
quarterly distributions could accord with decedent’s original intent,
and the documents were revised to so provide, for further review by the
participants. By a letter dated January 9, 1998, WTC confirmed its agreement
with the form and content of the Schutt I and Schutt II indentures, and work
proceeded to prepare and finalize the beneficiary consent documents. Like the
trusts, the consents were circulated for comment and revision. Mr. Sweeney sent
a draft consent to decedent on January 23, 1998, under a cover letter
summarizing the rationale for certain provisions, e.g., we have included a
recital to the effect that you will be contributing DuPont and Exxon stock out
of your trust to the respective Business Trusts which clarifies that this is
really a family matter and a method of preserving the investment philosophy you
have developed which has been so successful for the family. Mr. Howard subsequently suggested on behalf of WTC that the
consents indicate the percentage of the participating trust’s assets
being contributed to the business trusts so that the beneficiaries would have a
clearer understanding of the impact of the investments on their beneficial
interests. Decedent agreed to this modification. The finalized consent forms, accompanied by copies of the business
trust agreements, were circulated to the beneficiaries for signature on
February 12, 1998. The forms provided that the beneficiaries consented to the
contribution of certain securities to the business trusts and released WTC and
decedent “from any and all action, suits, claims, accounts, and
demands * * * for or on account of any matter or thing made, done, or permitted
by the Advisor or the Trustees in connection with the contribution of
securities to the Business Trusts.” All living beneficiaries of Trusts
2064, 3044-1, 3044-2, 3044-5, 3044- 6, 3044-8, and 11253-3 executed the consent
and release forms in February and early March of 1998. The trust agreements for Schutt I and Schutt II were signed on
March 11, 1998, by WTC as trustee for Trusts 2064, 3044-1, 3044-2, 3044-5,
3044-6, 3044-8, and 11258-3 and were signed on March 17, 1998, by decedent,
Charles P. Schutt, Jr., and Henry I. Brown III as trustees of the Revocable
Trust. On or about March 30, 1998, a Form SS-4, Application for Employer
Identification Number, was signed and thereafter filed with the Internal
Revenue Service for each business trust. Similarly, on April 1, 1998, a
Certificate of Business Trust Registration for each Schutt I and Schutt II was
filed with the Office of the Secretary of State for the State of Delaware. Funding of the business trusts began in March of 1998 and
establishment of a WTC account for each business trust, with the account for
Schutt I holding the DuPont securities and the account for Schutt II holding
the Exxon securities, was completed at least by mid-April. The custody
agreements for the business trusts were executed by decedent and a
representative of WTC on April 1, 1998. As a result of the funding, the
following capital contributions were made, and proportionate percentage
interests received, in Schutt I and Schutt II:
SCHUTT
I
------------------------------------------------------------------- Unit Holder DuPont Shares Monetary Value Percentage Interest --------------- ------------- -------------- -------------------
Revocable Trust 472,200 $30,752,025.00
45.236 Trust 2064
108,000
7,033,500.00
10.346 Trust 3044-1
19,098
1,243,757.25
1.830 Trust 3044-2
23,670
1,541,508.75
2.268 Trust 3044-5
132,962
8,659,150.25
12.738 Trust 3044-6
132,962
8,659,150.25
12.738 Trust 3044-8
132,960
8,659,020.00
12.737 Trust 11258-3
22,000
1,432,750.00
2.108
------------- -------------- -------------------
Totals
1,043,852
67,980,861.50
100
(rounded)
SCHUTT II
-------------------------------------------------------------------
Unit Holder Exxon Shares Monetary Value Percentage Interest --------------- ------------- -------------- -------------------
Revocable Trust 178,200 $11,237,737.50
47.336 Trust 2064
156,000
9,837,750.00
41.439 Trust 3044-5
11,418
720,047.63
3.033 Trust 3044-6
11,418
720,047.63
3.033 Trust 3044-8 11,418 720,047.63
3.033 Trust 11258-3
8,000
504,500.00
2.125
------------- -------------- -------------------
Totals
376,454 23,740,130.39
100
(rounded) The values of the shares and resultant percentage interests were
calculated based on the average of the high and low prices for the stock on
March 17, 1998, the effective date of the business trust agreements. At the time Schutt I and Schutt II were formed, decedent owned
assets not contributed to the business trusts with a fair market value of
approximately $30,000,000. These assets included, without limitation,
marketable securities, Alabama timberland, cattle, investments in partnerships,
a one-third undivided interest in South Carolina real estate, residential real
estate located in Delaware and Alabama, and tangible personal property. The trust agreements for Schutt I and Schutt II entered into as of
March 17, 1998, were substantially identical and set forth the governing
provisions for the entities. The agreements recited an intent to create a
Delaware business trust, to be classified as a partnership for Federal income
tax purposes. The stated purpose of the trusts was to engage in any lawful act or activity for which business trusts
may be formed under the Act [Delaware Business Trust Act, Del.Code Ann. tit.
12, secs. 3801-3822], including the ownership and operation of every type of
property and business, and the Trust may perform all acts necessary or
incidental to the furtherance of such purpose. The trust agreements were to be governed by and interpreted in
accordance with the laws of the State of Delaware. Decedent was named as the initial trustee, with his term to
continue until his death, resignation, or adjudged incompetence. Charles P.
Schutt, Jr., Henry I. Brown III, and Caroline S. Brown, in that order, were
designated successor trustees. If none of the named successor trustees was able
or willing to serve, an individual resident in the State of Delaware was to be
selected by the vote of unit holders holding at least 66 percent of the
interests in the trust. As regards powers of the trustee, the agreements provided
generally: Subject to the express limitations herein, the business and
affairs of the Trust shall be managed by or under the direction of the Trustee,
who shall have full, exclusive and absolute power, control and authority over
the Property and over the business of the Trust. The Trustee may take any
actions as in his or her sole judgment and discretion are necessary or
desirable to conduct the business of the Trust. This Agreement shall be
construed with a presumption in favor of the grant of power and authority to
the Trustee. * * * The agreements then enumerated specific powers, such as the
ability to invest, transfer, dispose of, lend, and exercise voting and other
ownership rights of trust property. The trustee was also expressly authorized
to establish or change policies to govern the investment of trust assets. Concerning capital contributions and accounts, the agreements
stated that a capital account was to be maintained for each unit holder by
crediting thereto the unit holder’s capital contributions,
distributive share of profits, and amount of any trust liabilities assumed, and
by debiting the value of cash or other property distributed to the unit holder,
the unit holder’s distributive share of losses, and the amount of unit
holder liabilities assumed by the trust. Profits and losses were generally to
be allocated in proportion to the unit holders’ interests in the
entity, and allocations for tax purposes with respect to contributed property
were to be made in accordance with section 704(c). Any return of a capital
contribution, in whole or in part, could be made only upon the consent of a
majority in interest of the unit holders. With respect to distributions, the trust agreements specified that
“Net Cash Flow shall be distributed by the Trustee on or before the
last day of each calendar quarter”. “Net Cash Flow”
was defined as gross cash receipts, less amounts paid by or for the account of
the trust, less “any amounts determined by the Trustee, in his
discretion, to be necessary to provide a reasonable reserve for working-capital
needs or to provide funds for any other contingencies of the Trust.”
The distributions were to be made in accordance with the proportionate
interests of the unit holders in the entity. The agreements prohibited the sale, transfer, assignment, pledge,
encumbrance, mortgage, or other hypothecation of any unit holder’s
interest, as well as withdrawal by a unit holder from the trust, without the
consent of all unit holders. The stated term of the trusts was to extend until
December 31, 2048, but the agreements provided that the term could be extended
beyond that date with the written approval before December 31, 2048, of both
the trustee and a majority in interest of the unit holders, or the trusts could
be dissolved prior to that date upon the written consent of all unit holders.
Upon dissolution and termination, the trusts were to be liquidated. Proceeds of
the liquidation were to be disposed of first in payment to creditors of the
trusts, then for the establishment of any additional reserves deemed by the
trustee to be reasonably necessary for any contingent liabilities, and then to
unit holders in accordance with their capital account balances. Regarding amendments, the trust agreements provided as a general
rule that any amendment must be in writing and approved by holders of at least
an aggregate 66-percent interest in the entity. Two modifications of this rule
were likewise set forth. First, the trustee was authorized to amend the
agreements without any unit holder’s consent to (1) correct any patent
error, omission, or ambiguity, and (2) add or delete any provision as necessary
to attain and maintain qualification as a partnership for Federal income tax
purposes or to comply with any Federal or State securities law, regulation, or
other requirement. The second modification required the written consent of all
unit holders to convert the trust to a general partnership or to change the
liability of or reduce the interests in capital, profits, or losses of the unit
holders. On a related point, the trust agreements specifically mandated 66 percent
approval for transfer of any part of the trust corpus to another business
trust, partnership, or corporation in exchange for an ownership interest in the
entity and for merger or consolidation of the trust with another business
entity. Since the formation and funding of Schutt I and II, the net
cashflow of each trust has been distributed pro rata on a quarterly basis, as
required by the trust documents. The trusts have also filed annual Federal
income tax returns reporting, inter alia, the pro rata distributive shares of
income, credits, deductions, etc., allocated to each unit holder. Through at
least the time of decedent’s death, the trusts had never sold any of
the DuPont or Exxon shares used to fund the entities, nor had they acquired any
other assets. [FN9] Decedent’s personal assets were not commingled
with those of Schutt I or Schutt II. Estate Tax Proceedings As previously stated, decedent died on April 21, 1999,
approximately 1 year after Schutt I and II were formed. A Form 706, United
States Estate (and Generation-Skipping Transfer) Tax Return, was filed on
behalf of decedent on or about January 21, 2000. An election was made therein
to use the alternate valuation date of October 21, 1999. The value reported for
the gross estate on the Form 706 was $61,590,355.08, which included
$15,837,295.45 and $7,237,104.56 for the Revocable Trust’s interests
in Schutt I and Schutt II, respectively. As of October 21, 1999, the underlying
asset value of Schutt I was $65,273,495, of which the Revocable
Trust’s proportionate share was $29,527,314. The underlying asset
value of Schutt II was $28,504,626, of which the Revocable Trust’s
proportionate share was $13,493,064. In the notice of deficiency issued on October 11, 2002, respondent
determined that the discounts applied in valuing the interests in Schutt I and
Schutt II were excessive. The estate timely filed the instant proceeding
challenging the statutory notice. By amendment to answer filed in this case,
respondent then asserted an increased deficiency on the grounds that the full
fair market value of the underlying assets contributed by the Revocable Trust
to Schutt I and Schutt II should be included in decedent’s gross
estate under sections 2036(a) and 2038. The parties have since stipulated that
if the Court rejects respondent’s position under sections 2036 and
2038, they agree that the Schutt I and II units held by the Revocable Trust
should be included in decedent’s gross estate at the respective values
of $19,930,937 and $9,107,818. OPINION I. Inclusion in the Gross Estate—Sections 2036 and 2038 A. General Rules As a general rule, the Code imposes a Federal excise tax
“on the transfer of the taxable estate of every decedent who is a
citizen or resident of the United States.” Sec.2001(a). The taxable
estate, in turn, is defined as “the value of the gross estate”,
less applicable deductions. Sec.2051. Section 2031(a) specifies that the gross
estate comprises “all property, real or personal, tangible or
intangible, wherever situated”, to the extent provided in sections
2033 through 2045 (i.e., subtitle B, chapter 11, subchapter A, part III of the
Code). Section 2033 states broadly that “The value of the gross
estate shall include the value of all property to the extent of the interest
therein of the decedent at the time of his death.” Sections 2034
through 2045 then explicitly mandate inclusion of several more narrowly defined
classes of assets. Among these specific sections is section 2036, which reads
in pertinent part as follows: SEC.2036. TRANSFERS WITH RETAINED LIFE ESTATE. (a) General Rule.—The value of the gross estate shall
include the value of all property to the extent of any interest therein of
which the decedent has at any time made a transfer (except in case of a bona
fide sale for an adequate and full consideration in money or money’s
worth), by trust or otherwise, under which he has retained for his life or for
any period not ascertainable without reference to his death or for any period
which does not in fact end before his death— (1) the possession or enjoyment of, or the right to the income
from, the property, or (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. Regulations further explain that “An interest or right is
treated as having been retained or reserved if at the time of the transfer
there was an understanding, express or implied, that the interest or right
would later be conferred.” Sec. 20.2036-1(a), Estate Tax Regs. Given the language used in the above-quoted provisions, it has
long been recognized that “The general purpose of this section is
‘to include in a decedent’s gross estate transfers that are
essentially testamentary’ in nature.” Ray v. United States, 762 F.2d 1361, 1362
(9th Cir.1985) (quoting United States v. Estate of Grace, 395 U.S. 316, 320, 89 S.Ct.
1730, 23 L.Ed.2d 332 (1969)). The Supreme Court has defined as
“essentially testamentary” those “transfers which
leave the transferor a significant interest in or control over the property
transferred during his lifetime.” United States v. Estate of Grace,
supra at 320. Accordingly, courts have emphasized that the statute
“describes a broad scheme of inclusion in the gross estate, not
limited by the form of the transaction, but concerned with all inter vivos
transfers where outright disposition of the property is delayed until the
transferor’s death.” Guynn v. United States, 437 F.2d 1148, 1150
(4th Cir.1971). As used in section 2036(a)(1), the term “enjoyment”
has been described as “synonymous with substantial present economic
benefit.” Estate of McNichol v. Commissioner, 265 F.2d 667, 671
(3d Cir.1959), affg. 29 T.C. 1179, 1958 WL 1158 (1958); see also Estate of
Reichardt v. Commissioner, 114 T.C. 144, 151, 2000 WL 230358 (2000). Regulations
additionally provide that use, possession, right to income, or other enjoyment
of transferred property is considered as having been retained or reserved
“to the extent that the use, possession, right to the income, or other
enjoyment is to be applied toward the discharge of a legal obligation of the
decedent, or otherwise for his pecuniary benefit.” Sec.
20.2036-1(b)(2), Estate Tax Regs. Moreover, possession or enjoyment of
transferred property is retained for purposes of section 2036(a)(1) where there
is an express or implied understanding to that effect among the parties at the
time of the transfer, even if the retained interest is not legally enforceable.
Estate of Maxwell v. Commissioner, 3 F.3d 591, 593 (2d Cir.1993), affg. 98 T.C.
594, 1992 WL 98972 (1992); Guynn v. United States, supra at 1150; Estate of
Reichardt v. Commissioner, supra at 151; Estate of Rapelje v. Commissioner, 73 T.C. 82, 86, 1979
WL 3799 (1979). The existence or nonexistence of such an understanding is
determined from all of the facts and circumstances surrounding both the
transfer itself and the subsequent use of the property. Estate of Reichardt
v. Commissioner, supra at 151; Estate of Rapelje v. Commissioner, supra at 86. As used in section 2036(a)(2), the term “right” has
been construed to “connote[ ] an ascertainable and legally enforceable
power”. United States v. Byrum, 408 U.S. 125, 136, 92
S.Ct. 2382, 33 L.Ed.2d 238 (1972). Nonetheless, regulations clarify: With respect to such a 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 the decedent or by another person or persons in
conjunction with the decedent; and (iii) whether the exercise of the power was
subject to a contingency beyond the decedent’s control which did not
occur before his death (e.g., the death of another person during the
decedent’s lifetime). The phrase, however, does not include a power
over the transferred property itself which does not affect the enjoyment of the
income received or earned during the decedent’s life. * * * Nor does
the phrase apply to a power held solely by a person other than the decedent.
But, for example, if the decedent reserved the unrestricted power to remove or
discharge a trustee at any time and appoint himself as trustee, the decedent is
considered as having the powers of the trustee. [Sec. 20.2036-1(b)(3), Estate
Tax Regs.] Additionally, retention of a right to exercise managerial power
over transferred assets or investments does not in and of itself result in
inclusion under section 2036(a)(2). United States v. Byrum, supra at 132-134. An exception to the treatment mandated by section 2036(a) exists
where the facts establish “a bona fide sale for an adequate and full
consideration in money or money’s worth”. Like section 2036, section 2038 provides for inclusion in the
gross estate of the value of transferred property. Specifically, as pertinent
here, section 2038(a)(1) addresses revocable transfers and requires inclusion
of the value of property: To the extent of any interest therein of which the decedent has at
any time made a transfer (except in case of a bona fide sale for an adequate
and full consideration in money or money’s worth), by trust or
otherwise, where the enjoyment thereof was subject at the date of his death to
any change through the exercise of a power (in whatever capacity exercisable)
by the decedent alone or by the decedent in conjunction with any other person
(without regard to when or from what source the decedent acquired such power),
to alter, amend, revoke, or terminate, or where any such power is relinquished
during the 3-year period ending on the date of the decedent’s death. Regulations promulgated under the statute clarify that section
2038 does not apply: (1) To the extent that the transfer was for an adequate and full
consideration in money or money’s worth (see § 20.2043-1); (2) If the decedent’s power could be exercised only with
the 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; or (3) To a power held solely by a person other than the decedent. *
* * [Sec. 20-2038-1(a), Estate Tax Regs.] B. Burden of Proof Typically, the burden of disproving the existence of an agreement
regarding a retained interest has rested on the estate, and this burden has
often been characterized as particularly onerous in intrafamily situations. Estate
of Maxwell v. Commissioner, supra at 594; Estate of Reichardt v.
Commissioner, supra at 151-152; Estate of Rapelje v. Commissioner, supra at 86. In this case,
however, the section 2036 and 2038 issues were not raised in the statutory
notice of deficiency and are therefore new matters within the meaning of Rule
142(a). Thus, as respondent has conceded, the burden of proof is on respondent. C. The Parenthetical Exception Sections 2036 and 2038 each contain an identical parenthetical
exception for “a bona fide sale for an adequate and full consideration
in money or money’s worth”. Regulations promulgated under
both sections reference the definition for this phrase contained in section
20.2043-1, Estate Tax Regs. Secs. 20.2036-1(a), 20.2038-1(a)(1), Estate Tax
Regs. Section 20.20431(a), Estate Tax Regs., provides: “To constitute
a bona fide sale for an adequate and full consideration in money or
money’s worth, the transfer must have been made in good faith, and the
price must have been an adequate and full equivalent reducible to a money
value.” Availability of the exception thus rests on two requirements: (1)
A bona fide sale and (2) adequate and full consideration. This Court has
recently summarized when these requirements will be satisfied, as follows: In the context of family limited partnerships, the bona fide sale
for adequate and full consideration exception is met where the record
establishes the existence of a legitimate and significant nontax reason for
creating the family limited partnership, and the transferors received
partnership interests proportionate to the value of the property transferred. *
* * The objective evidence must indicate that the nontax reason was a
significant factor that motivated the partnership’s creation. * * * [Estate
of Bongard v. Commissioner, 124 T.C. ——, ——,
(2005) (slip op. at 39).] Bona Fide Sale The Court of Appeals for the Third Circuit, to which appeal in
this case would normally lie, has emphasized that the bona fide sale prong will
only be met where the transfer was made in good faith. Estate of Thompson v.
Commissioner, 382 F.3d 367, 383 (3d Cir.2004) (citing sec. 20.2043-1(a),
Estate Tax Regs.), affg. T.C. Memo.2002-246. In the context of family entities,
the Court of Appeals set forth the following test: “A ‘good
faith’ transfer to a family limited partnership must provide the transferor
some potential for benefit other than the potential estate tax advantages that
might result from holding assets in the partnership form.” Id. Stated
otherwise, “if there is no discernable purpose or benefit for the
transfer other than estate tax savings, the sale is not ‘bona
fide’ within the meaning of § 2036.” Id. The Court of Appeals
further indicated that while this test does not necessarily demand a
transaction between a transferor and an unrelated third party, intrafamily
transfers should be subjected to heightened scrutiny. Id. at 382. The approach of the Court of Appeals for the Third Circuit
correlates with this Court’s requirement of a legitimate and
significant nontax purpose for the entity. This Court has expressed this
requirement using the alternate phraseology of an arm’s-length
transaction, in the sense of “the standard for testing whether the
resulting terms and conditions of a transaction were the same as if unrelated
parties had engaged in the same transaction.” Estate of Bongard v.
Commissioner, supra at —— (slip op. at 46). Intrafamily or
related-party transactions are not barred under this standard, but they are
subjected to a higher level of scrutiny. Id . at
—— (slip op. at 46-47). In probing the presence or absence of a bona fide sale and
corollary legitimate and significant nontax purpose, courts have identified
various factual circumstances weighing in this analysis. These factors include
whether the entity engaged in legitimate business operations, whether property
was actually transferred to the entity, whether personal and entity assets were
commingled, whether the taxpayer was financially dependent on distributions
from the entity, and whether the transferor stood on both sides of the
transaction. See, e.g., Estate of Thompson v. Commissioner, supra; Kimbell
v. United States, 371 F.3d 257 (5th Cir.2004); Estate of Bongard v.
Commissioner, supra; Estate of Hillgren v. Commissioner, T.C. Memo.2004- 46; Estate
of Stone v. Commissioner, T.C. Memo.2003-309; Estate of Strangi v. Commissioner, T.C. Memo.2003-145; Estate
of Harper v. Commissioner, T.C. Memo.2002-121. Hence, in evaluating whether decedent’s transfers to
Schutt I and II are properly characterized as bona fide sales, the essential
task is to “separate the true nontax reasons for the
[entities’] formation from those that merely clothe transfer tax
savings motives.” Estate of Bongard v. Commissioner, supra at
—— (slip op. at 44). It must be recognized, however, that
“Legitimate nontax purposes are often inextricably interwoven with
testamentary objectives.” Id. Furthermore, with respect to the
particular case at bar, the Court must be cognizant of any potential divergence
between decedent’s actual motives and the concerns of his advisers. The estate’s position is that Schutt I and II were
“formed primarily to put into place an entity to perpetuate Mr.
Schutt’s buy and hold investment philosophy with respect to the DuPont
and Exxon stock belonging both to Mr. Schutt and to the Wilmington Trust
Company Trusts.” In service of this objective, Schutt I and II were
aimed at “the furtherance and protection of * * *
[decedent’s] family’s wealth by providing for the centralized
management of his family’s holdings in duPont [sic] stock and Exxon
stock during his lifetime and to prevent the improvident disposition of this
stock during his lifetime and to the extent possible after his death.”
The estate contends that the desired preservation of decedent’s
investment policy “could not be accomplished without the creation of
Schutt I and Schutt II, as the WTC Trusts were scheduled to terminate at
various intervals and the assets of those trusts would be distributed, free of
trust, to their respective beneficiaries.” Respondent’s argument to the contrary is summarized as
follows: (1) it was not necessary to transfer stock from Mr.
Schutt’s revocable trust to the business trusts to perpetuate his
investment philosophy; (2) the record establishes that obtaining valuation
discounts for gift and estate tax purposes was the dominant, if not the sole,
reason for forming the business trusts; and (3) in any event, Mr.
Schutt’s desire to perpetuate his investment philosophy was itself a
testamentary motive. * * * The totality of the record in this case, when viewed as a whole,
supports the estate’s position that a significant motive for
decedent’s creation of Schutt I and II was to perpetuate his buy and
hold investment philosophy. That decedent was in fact a committed adherent to
the buy and hold approach is undisputed. His longstanding concern with
disposition of core stockholdings by his descendants is also well attested. Mr.
Sweeney testified that decedent “would raise, at least annually and,
quite often, more than annually, his concern about the ability of children or
grandchildren or whoever it might be to sell principal rather than using the
income from the principal”. Mr. Dinneen likewise testified that
decedent expressed concern about Schutt family members’ selling of
stock from “Back in the early seventies and on a regular basis from
there on out.” The documentary record also furnishes at least a measure of
objective support for the decedent’s willingness to act based on these
worries. In 1994, decedent declined to make annual exclusion gifts of limited
partnership interests in the Schutt Family Limited Partnership to his daughter
Sarah S. Harrison and her children. The estate attributes this decision to
concern about the investment philosophy of these individuals, and the limited
evidence does reflect 13 occasions on which DuPont or Exxon stock was sold by
Harrison grandchildren from 1989 through 1997. Further corroborating the bona fides of the professed intent
underlying creation of Schutt I and II is the fact that formation of the
business trusts did serve to advance this goal. Respondent’s
contention that the business trusts were unnecessary to perpetuate decedent’s
investment philosophy unduly emphasizes management of the assets held by the
Revocable Trust and minimizes any focus on the considerable assets held in the
WTC trusts. Respondent points out that, under the Revocable Trust indenture,
decedent could control investment decisions pertaining to the assets until his
death, at which time various successor trusts to be administered by his son and
son-in-law would be funded. Respondent argues that the situation under the
business trusts was functionally equivalent, with decedent as trustee setting
investment philosophy during his lifetime, followed by his son and son-in-law
as successor trustees. However, by only considering the Revocable Trust assets in
isolation, this analysis disregards more than half of the property involved in
the business trusts. Decedent in effect used the assets of the Revocable Trust
[FN10] to enhance his ability to perpetuate a philosophy vis-a-vis the stock of
the WTC trusts, such that none of the contributions should be disregarded in
evaluating the practical implications of Schutt I and II. Mr. Howard testified
that he did not believe he would have considered a proposal involving
contribution only of the WTC trusts’ assets to entities structured as
were Schutt I and II, without decedent’s willingness to place his own
property alongside. As Mr. Howard explained: “it made real to me,
certainly, when someone is willing to contribute that sum of money and tie it
up the same way we were tying it up with respect to distributions, if not with
respect to management, that this was something that he and the family, if they
were willing to agree to it, felt strongly about.” This importance of
decedent’s contributions to those negotiating on behalf of WTC, at
least on a psychological level, reflects a critical interconnectedness between
decedent’s contributions and those of the WTC trusts. The effect of Schutt I and II on the assets of the WTC trusts
shows that the business trusts advanced decedent’s objectives in a
meaningful way. Respondent’s argument, however, to the extent that it
takes into account the WTC assets, seeks to counter this conclusion by once
again placing unwarranted emphasis on certain features or results of the
structure to the exclusion of others. In discussing the alleged motive for
involving the WTC trusts in the transaction, respondent states that
“even if the decedent formed the business trusts to prevent his heirs
from dissipating the family’s wealth, this is itself a testamentary
motive.” More specifically, respondent dismisses the estate’s
contentions as follows: 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. The Court disagrees that decedent’s motives may properly
be dismissed, in the unique circumstances of this case, as merely testamentary.
The record on the whole supports that decedent’s greatest worry with
respect to wealth dissipation centered on outright distribution of assets to
the beneficiaries of the various WTC trusts. It is clear from the structures of
the WTC trusts involved that outright distribution created the single largest
risk to the perpetuation of a buy and hold philosophy, and testimony confirmed
decedent’s concern over a termination situation. Because none of the
events that would trigger such a distribution turned on decedent’s own
death, to call the underlying motive testamentary is inappropriate. Trust 2064, which contributed 10.346 percent of the DuPont stock
to Schutt I and 41.439 percent of the Exxon stock to Schutt II, was to
terminate, and the corpus was to be distributed free of trust to
decedent’s grandchildren, no later than when the youngest grandchild
turned 40. Notably, the health of both decedent and his issue was irrelevant to
this precipitating event. According to the parties’ stipulations,
decedent’s youngest grandchild, Katherine D. Schutt, was 24 years of
age at the time of decedent’s 1999 death. The provisions of Trust 2064
would therefore dictate termination no later than the spring of 2015. Schutt I
and II were structured to continue to 2048, absent agreement to the contrary in
accordance with limited procedures set forth in the business trust indentures. The Trust 3044 subtrusts, which in the aggregate contributed
42.310 percent of the DuPont stock to Schutt I and 9.099 percent of the Exxon
stock to Schutt II, specified that at the death of a primary beneficiary, one
of decedent’s children, the assets were to be distributed free of
trust to the corresponding grandchildren. Respondent apparently seeks to
belittle any concern decedent may have felt over these provisions by citing the
good health of decedent’s three surviving children, who were 61, 60,
and 56 at the time of decedent’s death. Yet respondent has offered no
evidence contradicting the bona fides of decedent’s fears in this
regard. Nor is the Court prepared to say that decedent, who had already lost
one child to cancer and observed firsthand the operation of the outright
distribution mechanism, would be unjustified in taking steps to guard against
this risk. Still another aspect of the evidence in this case that
corroborates decedent’s desire to perpetuate his investment philosophy
through establishment of Schutt I and II stems from WTC’s concerns
with and reactions to the proposed arrangement. The record indicates that WTC
perceived the business trust transactions as having a meaningful economic
impact on the rights of the beneficiaries of the WTC trusts. From early in the
planning process, representatives of WTC consistently voiced concerns regarding
the effect of the business trusts on liquidity. Mr. Howard testified regarding the tone of the conversation when
Mr. Helme first asked him to look into the possibility of participating in a
business trust transaction: “It was a matter where we were going to
take substantial portions of a series of trusts and put them into a business
trust where we would not have the immediacy of control and liquidity that we
had at the moment to meet the needs of the beneficiary. That’s not an
insignificant matter to review”. Similarly, the initial March 6, 1997,
memorandum from WTC to Mr. Sweeney memorializing issues of concern to WTC
explained the impetus for obtaining consents from involved beneficiaries as
follows: Each trust’s interest in the DBT will be non-marketable
for a period of time, perhaps beyond the termination of a trust. WTC would not
normally invest marketable assets so as to cause them to become illiquid. The
beneficiaries of the trust who are “sui juris” should,
therefore, consent to this investment. To the extent these illiquidity concerns
can be minimized by structuring the DBT so as to allow pro rata distributions
on the occurrence of certain events, e.g., the death of one of Mr.
Schutt’s children, this should be done . [FN11] Notes made by Mr. Sweeney of a September 4, 1997, meeting with
decedent, Mr. Howard, and Ms. Hickok likewise reflect continued emphasis by WTC
representatives on the need for beneficiary consent in conjunction with issues
related to the duration of the business trusts. As a final example, in Mr.
Howard’s November 26, 1997, letter agreeing to investment in Schutt I
and II subject to three conditions, the condition pertaining to consent read: All of the beneficiaries of the various trusts who are of age will
execute a form of consent whereby they acknowledge and consent to the
trusts’ investing in the business trusts and that they recognize that
the business trusts may last beyond the termination date of the trusts of which
they are a beneficiary. The form of the Delaware business trusts will be
attached to the consents. Mr. Howard testified that the latter requirement of the
just-quoted condition was suggested and insisted upon by him to ensure that the
consent given by the beneficiaries was meaningful. Despite the evidence discussed above, it is nonetheless
respondent’s position that tax savings through valuation discounts
constituted the dominant reason for formation of Schutt I and II. Respondent
characterizes the issue of valuation discounts as having “dominated”
the early discussions concerning the formation of a new entity. Respondent also
notes that decedent and his advisers initially contemplated only transferring
stock from the Revocable Trust to a business trust and emphasizes that the
subsequent decision to involve the WTC trusts served a tax purpose of making
available minority as well as marketability discounts. However, while it is
clear that estate tax implications were recognized and considered in the
initial stages of the planning process, the record fails to reflect that such
issues predominated in decedent’s thinking and desires. What may have
originally been approached as a relatively routine estate planning transaction
rapidly developed into an opportunity and vehicle for addressing more
fundamental concerns of decedent. As Mr. Sweeney and Mr. Dinneen acknowledged at trial, both had a
background in tax and so would naturally have taken tax and valuation matters
into account in any recommendations they made for decedent. Yet the documentary
evidence and testimony fall short of enabling the Court to infer that decedent
himself was principally focused on tax savings. To the contrary, the record
compiled over the course of the ensuing year suggests otherwise. The valuation questions evaluated by decedent’s advisers
in February and early March of 1997 were left virtually untouched throughout
the remaining approximately 12 months of the planning and formation process.
Furthermore, to the extent that the notes taken by Mr. Sweeney of meetings
involving decedent enable us to identify the particular concerns or comments
emphasized by decedent himself, these concerns never touch on valuation
discounts. Rather, there is a notable focus on matters such as
decedent’s desire for investment control. Additionally, in the letters
sent by Mr. Sweeney to decedent for purposes of updating him on the progress of
negotiations and presumably focusing on issues about which decedent would be
most interested, transfer tax issues are nearly absent. Thus, the proffered
evidence is insufficient to establish that estate tax savings were
decedent’s predominant reason for forming Schutt I and II and to
contradict the estate’s contention that a true and significant motive
for decedent’s creation of the entities was to perpetuate his buy and
hold investment philosophy. Given this conclusion regarding decedent’s motive, the
question then becomes whether perpetuation of a buy and hold investment
strategy qualifies as a “legitimate and significant nontax reason”
within the meaning of Estate of Bongard v. Commissioner, 124 T.C. at
—— (slip op. at 39). As respondent points out, the buy and
hold investment philosophy by definition resulted in passive entities designed
principally to hold the DuPont and Exxon stock. Active management, trading, or
“churning” of the portfolios as a means of generating profits
was not intended. Furthermore, because each trust was funded with the stock of
a single issuer, asset diversification did not ensue. The Court of Appeals for the Third Circuit has in a similar vein
suggested that the mere holding of an untraded portfolio of marketable
securities weighs negatively in the assessment of potential nontax benefits
available as a result of a transfer to a family entity. Estate of Thompson
v. Commissioner, 382 F.3d at 380. As a general premise, this Court has agreed
with the Court of Appeals, particularly in cases where the securities are
contributed almost exclusively by one person. See Estate of Strangi v.
Commissioner, T.C. Memo.2003-145; Estate of Harper v. Commissioner, T.C. Memo.2002-121.
In the unique circumstances of this case, however, a key difference exists in
that decedent’s primary concern was in perpetuating his philosophy
vis-a-vis the stock of the WTC trusts in the event of a termination of one of
those trusts. Here, by contributing stock in the Revocable Trust, decedent was
able to achieve that aim with respect to securities of the WTC trusts even
exceeding the value of his own contributions. In this unusual scenario, we
cannot blindly apply the same analysis appropriate in cases implicating nothing
more than traditional investment management considerations. To summarize, the record reflects that decedent’s desire
to prevent sale of core holdings in the WTC trusts in the event of a
distribution to beneficiaries was real, was a significant factor in motivating
the creation of Schutt I and II, was appreciably advanced by formation of the
business trusts, and was unrelated to tax ramifications. The Court is thus able
to conclude in this case that Schutt I and II were formed for a legitimate and
significant nontax purpose without further probing the parties’
disagreement as to whether, in theory, an investment strategy premised on buy
and hold should offer just as much justification for an entity premised thereon
as a philosophy that focuses on active trading. As regards other factors considered indicative of a bona fide
sale, these too tend to support the estate’s position. The contributed
property was actually transferred to Schutt I and II in a timely manner. Entity
and personal assets were not commingled. Decedent was not financially dependent
on distributions from Schutt I and II, retaining sufficient assets outside of
the business trusts amply to support his needs and lifestyle. Nor was decedent
effectively standing on both sides of the transactions. Concerning this latter point, it is respondent’s position
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.” Respondent maintains that WTC, while ostensibly an
independent third party, simply represented the interests of
decedent’s children and grandchildren and that decedent dictated all
material terms. The Court, however, is unpersuaded by respondent’s
attempts to downplay the give-and-take reflected in the record. As detailed in
the facts recounted above and the stipulated exhibits, WTC representatives
thoroughly evaluated the business trust proposals, raised questions, offered
suggestions, and made requests. Some of those suggestions or requests were
accepted or acquiesced in; others were not. Such a scenario bears the earmarks
of considered negotiations, not blind accommodation. There is no prerequisite that
arm’s-length bargaining be strictly adversarial or acrimonious. Regardless of whether the Schutt I and II transactions should be
subjected to the heightened scrutiny appropriate in intrafamily situations, the
record here is sufficient to show that the negotiations and discussions were
more than a mere facade. [FN12] The Court concludes that the transfers to
Schutt I and II satisfy the bona fide sale requirement for purposes of sections
2036 and 2038. Adequate and Full Consideration In this Court’s recent discussion of the adequate and
full consideration prong in Estate of Bongard v. Commissioner, 124 T.C. at
—— (slip op. at 48-49), four factors were noted in support of
a finding that the consideration requirement had been met: (1) The interests
received by the participants in the entity at issue were proportionate to the
value of the property each contributed to the entity; (2) the respective assets
contributed were properly credited to the capital accounts of the transferors;
(3) distributions from the entity required a negative adjustment in the
distributee’s capital account; and (4) there existed a legitimate and
significant nontax reason for engaging in the transaction. Given these
circumstances, we concluded that the resultant discounted value attributable to
entity interest valuation principles was not per se to be equated with
inadequate consideration. Id. at —— (slip op. at 49-50). The Court of Appeals for the Third Circuit has likewise opined
that while the dissipated value resulting from a transfer to a closely held
entity does not automatically constitute inadequate consideration for section
2036(a) purposes, heightened scrutiny is triggered. Estate of Thompson v.
Commissioner, 382 F.3d at 381. To wit, and consistent with the focus of the
Court of Appeals in the bona fide sale context, where “the transferee
partnership does not operate a legitimate business, and the record demonstrates
the valuation discount provides the sole benefit for converting liquid,
marketable assets into illiquid partnership interests, there is no transfer for
consideration within the meaning of § 2036(a).” Id. In reaching this conclusion, the Court of Appeals referenced the
“recycling” of value concept first articulated by this Court
in Estate of Harper v. Commissioner, T.C. Memo.2002-121. Estate of Thompson v.
Commissioner, supra at 378-381. As we explained with respect to the situation
before us in Estate of Harper v. Commissioner, supra: to call what occurred here a transfer for consideration within the
meaning of section 2036(a), much less a transfer for an adequate and full
consideration, would stretch the exception far beyond its intended scope. In
actuality, all decedent did was to change the form in which he held his
beneficial interest in the contributed property. We see little practical
difference in whether the Trust held the property directly or as a 99-percent
partner (and entitled to a commensurate 99-percent share of profits) in a
partnership holding the property. Essentially, the value of the partnership
interest the Trust received derived solely from the assets the Trust had just
contributed. Without any change whatsoever in the underlying pool of assets or
prospect for profit, as, for example, where others make contributions of
property or services in the interest of true joint ownership or enterprise,
there exists nothing but a circuitous “recycling” of value.
We are satisfied that such instances of pure recycling do not rise to the level
of a payment of consideration. To hold otherwise would open section 2036 to a
myriad of abuses engendered by unilateral paper transformations. Respondent contends that the instant case features the genre of
value recycling described in Estate of Harper v. Commissioner, supra, and
subsequent cases such as Estate of Strangi v. Commissioner, T.C. Memo.2003-
145. Respondent, stressing that decedent enjoyed all incidents of ownership
related to the contributed stock both before and after the transfers (e.g., the
right to the income generated, the right to sell the stock and reinvest the
proceeds, the right to vote the shares), maintains that contribution to Schutt
I and II engendered no meaningful change in decedent’s relationship to
the assets. Again, however, this reasoning disregards unique factual
circumstances present in this case that were not involved in Estate of Harper
v. Commissioner, supra, and its progeny. Undoubtedly, looking in isolation at
the relationship of a decedent to his or her assets may be sufficient where the
decedent’s contributions make up the bulk of the property held by the
relevant entity and no suggestion of any benefit beyond change in form is
evident. Yet here, where others contributed more than half of the property
funding the entities and the record reflects that decedent used his own assets
primarily to alter his relationship vis-a-vis those other assets, the analysis
must look more broadly at the transactions. In that decedent employed his
capital to achieve a legitimate nontax purpose, the Court cannot conclude that
he merely recycled his shareholdings. Furthermore, with respect to the additional criteria cited in
Estate of Bongard v. Commissioner, supra at —— (slip op. at
48-49), each participant in Schutt I and II received an interest proportionate
in value to its respective contribution, the capital contributions made were
properly credited to each transferor’s capital account, and
distributions required a negative adjustment in the distributee’s
capital account. Liquidating distributions would also be made in accordance
with capital account balances. Hence, existing precedent shows that decedent is
considered to have received adequate and full consideration as used in sections
2036(a) and 2038 for his transfers to Schutt I and II. II. Conclusion The Court has concluded in the unique circumstances of this case
that decedent’s transfers to Schutt I and II constitute bona fide
sales for adequate and full consideration for purposes of sections 2036(a) and
2038. Because the record supports finding that both prongs of this test have
been met, respondent has failed to carry the burden of proving otherwise.
Accordingly, the transfers to Schutt I and II are excepted from inclusion in
decedent’s gross estate under either section 2036(a) or 2038. The
Court therefore need not probe other arguments by the parties with regard to
the application of these statutes. To reflect the foregoing and to give effect to the
parties’ stipulations, Decision will be entered under Rule 155. FN1. Unless otherwise indicated, section
references are to the Internal Revenue Code (Code) in effect as of the date of
decedent’s death, and Rule references are to the Tax Court Rules of
Practice and Procedure. FN2. Various trusts directly pertinent to the
instant litigation are described in detail infra in text. Decedent and/or Mrs.
Schutt also established at least three additional trusts during the 1970s for
the benefit of their grandchildren and the issue of their grandchildren. FN3. Christiana Securities Company was a
holding company established by certain branches of the duPont family to hold
DuPont stock. The company was later merged into DuPont, and at times relevant
to this proceeding, the corpus of Trust 3044 (or subtrusts thereunder) included
DuPont and Exxon stock. FN4. The following explanations in text of the
various trusts pertinent to this litigation are intended to serve as summaries
of the most salient provisions. The recitations do not attempt to set forth
every feature and/or contingency. FN5. One of the parties’ stipulations
contains a mistaken reference to the date of the final supplemental trust
agreement as Sept. 1, 1998. Elsewhere in the same stipulation, as well as in
the accompanying exhibit, the correct date of Dec. 1, 1988, is reflected. FN6. Decedent had acquired interests in
Alabama timberlands with two of his brothers-in-law during the 1960s. Portions
of decedent’s interests in the timberlands and related operations were
placed in trust in 1971, see supra note 2, portions were used in funding the
Schutt Family Limited Partnership, and still other portions continued to be
owned outright by decedent at his death. FN7. Mrs. Carpenter and Mrs. Schutt were both
daughters of Mr. duPont. Since at least the early 1970s, the two families had
maintained a joint family office with staff overseeing and assisting in
business and personal matters for family members. FN8. During the 1997 to early 1998 period, a
Delaware business trust was formed pursuant to the Delaware Business Trust Act,
Del.Code Ann. tit. 12, secs. 3801-3822 (Supp.2004). Effective September 1,
2002, the Delaware Business Trust Act was replaced by the Delaware Statutory
Trust Act, Del.Code Ann. tit. 12, secs. 3801-3826 (Supp.2004). FN9. At trial, on direct examination, Mr.
Dineen was asked: “And have either Schutt I or Schutt II sold DuPont
stock?” He responded: “No.” Although not free from
ambiguity given that Schutt II held only Exxon stock, a reasonable inference
from this testimony would appear to be that neither business trust had sold
assets through the time of trial. FN10. To employ an oft-used metaphor, the
assets of the Revocable Trust served essentially as leverage in the form of a
carrot. FN11. The Court notes that this suggestion
pertaining to distributions would manifestly have conflicted with
decedent’s objectives and was not incorporated. FN12. The Court also notes that Wilmington
Trust Company (WTC) was founded in 1903 by the duPont family and has among its
Clients numerous duPont descendants. According to public filings with the
Securities and Exchange Commission, WTC subsequently became the principal
operating and banking entity of Wilmington Trust Corporation, a financial
holding company which as of Dec. 31, 1997, was publicly traded with 33,478,113
shares outstanding and 10,164 shareholders of record, had total assets of $6.12
billion, and possessed stockholders’ equity of $503 million. Given
this size and scope, WTC’s historical connection to the duPont family
is not germane to our analysis. Likewise, although Mr. Sweeney has served as a
director of WTC and/or Wilmington Trust Corporation since 1983 and his firm has
served as outside counsel to WTC, he during 1997 was one of 21 directors, and
both Mr. Sweeney and Mr. Howard testified credibly that the relationship made
the participants more circumspect, rather than less, in their dealings. Motions, Pleadings
and Filings • Reply Brief for Respondent (Jul. 14, 2004) • Petitioner’s Amended Brief (Jun. 02, 2004) • Opening Brief for Respondent (May. 27, 2004) • Petitioner’s Brief (May. 26, 2004) |