T.C. Memo. 2002-246

UNITED STATES TAX COURT

ESTATE OF THEODORE R. THOMPSON, DECEASED, BETSY T. TURNER,

EXECUTRIX, Petitioner v

. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 7578-99. Filed September 26, 2002.

Victor F. Keen and Thomas W. Ostrander , for petitioner.

Joseph M. Abele

, Joellyn R. Cattell

, James C. Fee, Jr.

,

and David A. Breen , for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

JACOBS, Judge : Respondent determined a $707,054 deficiency in

the Federal estate tax of the Estate of Theodore R. Thompson.

Hereinafter, The odore R. Thompson is referred to as decedent and

his estate as decedent’s estate.- 2 -

After concessions by decedent’s es tate, the issue remaining

for decision is whether decedent’s gross estate includes (1) the

value of interests in two family limited partnerships (namely, the

Thompson Turner Family Limited Partnership (the Turner Partnership)

and the Thompson Family Li mited Partnership (the Thompson

Partnership)), and in the respective corporate general partners of

those partnerships that decedent possessed at death or transferred

prior to dea th (and if so, the value of those interests), or (2)

pursuant to section 2036(a), t he value of the property which

decedent transferred to the family limited partnerships and to the

respective corporate general partners of those partnerships (and if

so, the value of such property).

All section references are to the Internal Revenue Code as

amended and in effect as of the date of decedent’s death, and all

Rule references are to the Tax Court Rules of Practice and

Procedure.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found. The

stipulations of facts and exhibits submitted therewith are

incorporated herein by this reference.

I. Background

Decedent was a resident of the State of Delaware at the time

of his death on May 15, 1995. Decedent’s estate was administered

in Delaware. Betsy Thompson Turner, decedent’s daughter and- 3 -

executrix of his estate, resided in Kennett Square, Pennsylvania,

when the petition in this case was filed.

A. Decedent and His Family

Decedent was born on January 7, 1898, in Kennett Squ are,

Pennsylvania. In the 1920s, he attended college at Swarthmore

College for 2 years. He left college to help his father start a

family rose-growing business, Thom pson Roses, in Kennett Square,

Pennsylvania. After his father’s death in 1924, decedent operated

Thompson Roses with his brother, Howard.

Decedent and h is wife, Marian, had two children, Betsy and

Robert. Robert attended Penn State University and subsequently

enlisted in the military for 3 years. Upon discharge from the

military, he entered Cornell University, majoring in horticulture.

Upon graduat ion from college, Robert began working at Thompson

Roses.

In 1956, decedent gave his one-half interest in Thompson Roses

to Robert and to Betsy’s husband, Geor ge Turner. Decedent’s

brother continued to own the remaining half of the business.

Decedent retired from Thompson Roses in 1980. After decedent

retired, he and Marian divided their time between a condominium at

Cokesbury Village (a retirement community in Hockessin, Delaware)

and a winter home in Naples, Florida. Decedent’s retirement

activities included golf, fishing, bridge, and woodworking.- 4 -

1 George died in 1999.

2 Robert divorced in 1969 and remarried in 1995. His

children are from his first marriage.

3 The trustee was originally the National Bank a nd Trust

Co. of Kennett Square, which merged with, and became part of, the

American Bank and Trust Co. of Reading, which in turn merged with

and became Meridian Trust Co. Marian died in 1985, after which decedent moved into an

assisted living facility at Cokesbury Village. Decedent resided in

this facility until his death in 1995.

Robert retired from Thompson Roses in 1988 and moved to

Colorado. George retired in 1991.

Betsy and George 1 had four children--Geo rge Clayton, Jr.

(“Clay”), William Joel (“Bill”), Pho e be, and Robert--and five

grandchildren. Robert had four children 2 -–Amy, Margaret, Theodore

Robert, and John–-and four grandchildren.

B. Decedent’s Finances

By a deed of trust dated January 16, 1969, decedent

established a revocable trust with the Meridian Trust Co. 3 (the

1969 trust).

Decedent executed his will in 1979. The will, as subsequently

amended by four codicils, provided for, amo ng other things,

specific bequests of $100,000 to Betsy and Robert, gifts in varying

amounts to his grandchildren, and gifts of $10,000 to each of his

great-grandchildren. The residue of decedent’s estate went into

the 1969 trust. In 1991, decedent executed a durable power of- 5 -

attorney appointing Betsy and Robert as his attorneys in fact and

granting them power to handle all of his financial affairs.

On March 17, 1993, decedent executed an amendment to the 1969

trust. As a consequence of this amendment, a new revocable trust

(the 1993 trust) was created. The 1993 trust was funded with the

assets of the 1969 trust. Betsy and Robert were the trustees of

the 1993 trust. The assets (worth approximately $1.5 million)

transferred to the 1993 trust consisted of securities and cash held

in an account at Dean Witter Reynolds, Inc. (Dean Witter).

From 1989 to 1993, Virginia Newnam was the account executive

of decedent’s trust’s holdings at Dean Witter. In 1993, Ms. Newnam

changed her employment to Alex Brown, Inc., and the trust portfolio

was then transferred to that brokerage firm.

Decedent received the income from the securities held in the

1993 t rust. In addition, decedent received annual income of

approximately $8,000 from Social Security and approximately $6,000

from annuities with Cigna Insurance Co. and Provident Mutual Life

Insurance Co. Decedent had other assets, including shares in a

mutual fund, funds in a checking account, and loans receivable owed

to him by family members. Decedent’s lifestyle was simple, and his

expenses were fairly consistent from 1993 to his death in 1995.

Decedent often made substantial gifts of cash, bonds, or

insurance policies to his children and grandchildren. From time to

time he made loans to his grandchildren, in exchange for promissory- 6 -

4 In Strangi v. Commission er , 115 T.C. 478, 480 (2000),

affd. in part and revd. in part 293 F.3d 279 (5th Cir. 2002), we

described the Fortress Plan promoted by Fortress Financial Group,

Inc. (Fortress) as follows:

(continued...) notes. Decedent made the following loans to Robert’s children:

(1) On December 21, 1978, decedent made a $35,000 mortgage loan to

Theodore Robert, at 6-percent interest, payable over 20 years; (2)

on September 30, 1987, decedent made a $156,000 mortgage loan to

Amy, payable over 20 years; and (3) on June 30, 1989, decedent lent

$140,000 to Margaret. Decedent made the following loans to Betsy’s

children: (1) Decedent lent $15,000 to Phoebe on January 3, 1990;

(2) decedent lent $100,000 to William on September 11, 1992; and

(3) decedent lent $10,000 to Clay on October 9, 1992, and $15,000

on February 23, 1993.

II. Formation of the Family Limited Partnerships and Corporations

A. Introduction to the Fortress Plan

Sometime in 1992 or 1993, Betsy, Robert, and their spouses met

with Christian DeVol and William W. Warder. Mr. DeVol was a selfemployed financial adviser. Mr. Warder was an insurance salesman

and financial adviser with APS Financial Services, Inc. (APS). APS

was the licensee for the Fortress Financial Group, Inc., and as a

licensee APS was authorized to assist in the implementation of the

“Fortress Plan”. 4- 7 -

4 (...continued)

Fortress trains and educates professionals on the use of

family limited partnerships as a tool to (1) reduce

income tax, (2) reduce the reported value of property in

an estate, (3) preserve assets, an d (4) facilitate

charitable giving. The Fortress Plan recommends

contributing assets to a family limited partnership with

a corporate general pa rtner being created for control

purposes. The Fortress Plan also suggests that shares of

stock of the corporate general partner or an interest in

the family limited partnership be donated to a charity.

To facilitate the plan, Fortres s licenses the use of

copyrighted limited partnership agreements and

shareholders’ agreements. Messrs. Warder and DeVol in troduced Betsy and Robert to

Charles G. Cheleden, an attorney licensed in the S tate of

Pennsylvania. Mr. Cheleden reviewed decedent’s existing trust

documents and will.

In February or March 1993, Messr s. Cheleden and Warder

described to Betsy and Robert an estate plan that used family

limited partnerships. In a letter dated March 9, 1993, Mr. Warder

recommended using two family limited partnerships, each headed by

a corporate general partner, one for Betsy and her family and one

for Robert and his family. In promoting this arrangement, Mr.

Warder indicated the primary advantages of the program were (1)

lowering the taxable value of the estate, (2) ma ximizing the

preservation of assets, (3) reducing income taxes by having the

corporate general partner provide medical, retirement, and “income

splitting” benefits for family members, and (4) facilitating family

a nd charitable giving. In addition, he stated that “All of the- 8 -

benefits above can be achieved while total control of all assets is

retained by the directors of the Corporate General Partner.” The

decision to form the family limited partnerships was made

approximately a week later at a meeting at Betsy and George’s home

attended by decedent, Betsy, George, Robert, and Messrs. Cheleden

and Warder.

On March 26, 1993, George P. Brown, president of APS, wrote to

decedent, Betsy, and Robert. Mr. Brown outlined the services APS

agreed to provide in implementing the Fortress Plan. He further

explained that the fee for those services would be $32,000, which

fee would be shared with Mr. Cheleden.

A letter of the same date from Mr. Cheleden to decedent,

Betsy, and Robert accompanied the March 26, 1993, letter from APS.

In his letter, Mr. Cheleden stated that the Fortress Plan was

designed to protect assets from third party claims , maximize the

amount that passes to heirs, and “allow the Family to maintain

control, to the extent possible, consistent with the above.” He

advised decedent, Betsy, and Robert that the lim ited partnership

interests were “expected to enjoy the benefit of ‘discounting’ for

gifts and estate tax valuation purposes.” Mr. Cheleden indicated

that a 40-percent discount was a realistic expectation.

Decedent, Robert, Betsy, and George agreed to form two family

limited partnerships and two corporations to serve as the corporate

general partners-–the Turner Partnership and Turner Corp. for- 9 -

Betsy’s family, and the Thompson Partnership and R. P. Thompson

Corp. (Thompson Corp.) for Robert’s family. The Turner Partnership

and Turner Corp. were to be established under the laws of

Pennsylvania, where Betsy resided, and the Thompson Partnership and

Thompson Corp. were to be established under the laws of Colorado,

where Robert lived.

In implementing the Fortress Plan, Mr. Cheleden prepared the

partnership and shareholder agreements for the Turner Partnership

and Turner Corp., the Pennsylvania entities. Because Mr. Cheleden

was not licensed outside of Pennsylvania, he arra nged for the

partnership and shareholder agreements for the Thompson Partnership

and Thompson Corp. to be prepared by Frederick Meyer, an attorney

licensed to practice in Colorado.

B. Formation of the Turner Partnership and Turner Corp.

On April 21, 1993, Tur ner Corp. and the Turner Partnership

were formed under the laws of Pennsylvania. Articles of

incorporation for T urner Corp. and a certificate of limited

partnership for the Turner Partnership were filed with the

Department of State of the Commonwealth of Pennsylvania. The

registered office and place of business of both Turner entities was

Woodside Farm, Kennett Square, Pennsylvania. Woodside Farm was the

residence of Betsy and George.

Stock certificates were issued to decedent (490 shares), Betsy

(245 shares), George (245 shares), and Natio nal Foundation, Inc.- 10 -

5 Turner Corp. was to pay $15,0 00 to the partnership for

it s general partnership interest. However, it did not pay the

$15,000 in cash for its interest; rather, the corporation issued a

noninterest bearing pr omissory note in favor of decedent for its

1.06-percent interest. (20 shares), an unrelated tax-exempt entity. Decedent, Betsy, and

George were the directors and officers of Turner Corp. Decedent

was the chief executive officer, Betsy was secretary, and George

was treasurer.

An agreement of limited partnership of the Turner Partnership

was executed by all of its partners. Decedent signed on behalf of

Turner Corp.

Decedent, through the 1993 T rust, contributed to the

partnership approximately $1,286,000 of his listed securities, plus

notes receivable due from Betsy’s children. George contributed to

the partnership $1,000 in cash and real property in Vermont valued

at $49,000. At the time of the formation of the Turner

Partnership, decedent held a 95.4-percent limited partnership

interest, George held a 3.54-percent limited partnership interest,

and Turner Corp., as the sole general partner of the Turner

Partnership, held the remaining 1.06 percent. 5

The assets of the Turner Partnership (and the values of those

assets) as of July 1993 were as follows:

Shares Value

Decedent’s contribution

Municipal bonds- 11 -

Chester Co. --- $50,180

Madison Co. --- 10,327

PA Higher Ed --- 50,472

Puerto Rico --- 5,246

Dela. State --- 52,131

Shares Value

Stocks

Atlantic Richfield 100 11,575

Coca Cola 2,400 103,800

GTE 11,200 404,600

General Electric 1,600 157,600

Intercap Qual Muni Inv. 2,000 32,000

Intercap Qual Muni Inc. 1,200 18,150

IBM 426 18,957

Johnson & Johnson 600 21,900

Merck 900 27,563

Meridian Bankcorp 1,000 32,125

3M 200 21,000

Phila. Elec./PECO Energy 500 15,750

Petrolite 3,000 105,000

Xerox 1,800 131,400

Mutual funds

John Hancock 900 15,894

Loans receivable

Phoebe Turner --- 15,000

William Turner --- 100,000

George Turner, Jr. --- 10,000

Decedent’s total 1,410,670

Betsy/Georges’s contribution

Cash (checking account) --- 1,000

Real Property

Vermont property --- 49,000

Betsy/George’s total 50,000

Total assets 1,460,670

In 1994, after George contributed the Vermont property to the

Turner Partnership, Mr. Cheleden advised him that the initial

capitalization of the partnership might present certain investment

company issue s pursuant to section 721(b) which could affect the

intended nonrecognition treatment of capital contributions to the

partnership. Accordingly, Mr. Cheleden recommended that the Turner- 12 -

Partnership limited partnership agreem ent be amended to allocate

the gains, losses, and distributions from the Vermont property to

George.

By an undated amendment to the limited partnership agreement,

retroactive to April 23, 1993, the partners allocated all gains and

losses from, and distribution of real estate contributed to, the

partnership to the co ntributing partner. The amendment was

intended to apply only to certain real property held in Vermont by

George. In accordance with the amendment, George was entitled to

keep all net proceeds from the timber sales generated from the

Vermont property owned by the partnership.

C. The Thompson Partnership and Thompson Corp.

Thompson Corp. was duly formed and organiz ed as a Colorado

corporation on April 21, 1993. The Thompson Partnership was duly

formed and organized as a Colorado limited partnership on April 30,

1993. Robert was the registered agent. His ranch in Norwood,

Colorado, was the registered office and place of business for both

the Thompson Partnership and Thompson Corp. Thompson Corp. was the

corporate general partner of the Thompson Partnership. Decedent

and Robert each held 49 percent (490 shares) of the stock of

Thompson Corp. Robert H. Thompson (an unrelated third party) held

the remaining 2 percent (20 shares). Robert was the president,

Robert H. Thompson was the vice-president, and dec edent was the

secretary/treasurer. Upon formation of the Thompson Partnership,- 13 -

decedent contributed approximately $1,118,500 of his listed

securiti es, along with notes receivable from Robert’s family

members, to the partnership. Robert contributed to the partnership

his interest in 10 T. Rowe Price mutual funds worth approximately

$372,000, and his Norwood ranch in Colorado (appraised at

$460,000).

The assets of the Thompson Partnership (and the values of

those assets) as of July 1993 were as follows:

Shares Value

Decedent’s contributions

Municipal bonds

Dist. Columbia --- $53,685

Dover Dela. Wtr & Swr --- 27,498

Dover Dela. Wtr & Swr --- 22,019

Orlando Waste --- 5,208

Dela. Hlth --- 33,548

Tampa Wtr & Swr -–- 43,713

Stocks

Atlantic Richfield 100 11,575

Coca Cola 2,400 103,800

GTE 9,200 332,350

General Electric 1,600 157,600

Intercapital invest 2,000 32,000

Intercapital income 800 12,100

IBM 400 17,800

Johnson & Johnson 600 21,900

Merck 900 27,563

Meridian Bankcorp 1,000 32,125

3M 200 21,000

Phila. Elec./PECO Energy 500 15,750

Xerox 1,800 131,400

Mutual Funds

John Hancock Freedom 900 15,894

Loans receivable

Amy Thompson -–- 139,739

Ted Thompson --- 14,064

Margaret Thompson --- 140,000

Decedent’s total 1,412,331- 14 -

Robert’s contributions

Shares Value

Mutual Funds

Equity income -–- $64,811

European stock -–- 10,673

Intl stock -–- 32,710

Japan fund -–- 35,268

New American growth -–- 37,660

New Asia -–- 22,449

Science & Technology -–- 58,236

High yield -–- 5,597

Intl bond -–- 103,905

Prime Reserve-cash -–- 1,499

Ranch in Norwood, CO --- 460,000

Robert’s total 832,808

Total assets 2,245,138

At the time of the formation of the partnership, decedent held

a 62 .27-percent limited partnership interest and Robert held a

36.72-percent limited partnership interest. The Thompson Corp., as

the general partner of the Thompson Partnership, held the remaining

1.01-percent interest.

III. Operation of the Partnerships

A. Decedent’s Financial Affairs Through the Turner

Partnership and the Thompson Partnership

Before forming the partnerships and corporations, Betsy,

Robert, and decedent had agreed that decedent would be taken care

of financially. They also wanted to make sure that decedent could

access money in the partnerships in order to continue making gifts

t o his children, grandchildren, and great-grandchildren. In a

letter dated April 4, 1993, to Mr. Warder, Betsy asked how

decedent’s access to his checking account with his broker would be

affected by the family partnerships. She specifically asked- 15 -

whether her father would be able to draw money from the Dean Witter

account in order to give $10,000 gifts to children, grandchildren,

and great-grandchildren each year.

In a letter dated November 28, 1993, George wrote to Mr. DeVol

asking: “How does Betsy’s father get $40,000 to give away as

Christmas presents (with checks dated January 1994)? (Bob Thompson

has a similar question.).”

In 1993 both the Turner Partnership and Thompson Partnership

made distributions of $40,000 to decedent in order that he could

continue his practice of giving gifts at Christmastime to family

memb ers. The $40,000 distributions from the partnerships were

shown on decedent’s Schedule K-1, Beneficiary’s Shar e of Income,

Deductions, Credits, etc., as a distribution/withdrawal for that

year and as a reduction in his capital account.

On January 11, 1995, the Thompson Partnership made a

distribution of $45,500 to d ecedent’s checking account, in order

that decedent’s Christmas checks to Robert, his children, and his

grandchildren would not bounce. On the same date, the Turner

Partnership made a distribution of $45,220 to decedent’s checking

acco unt, in order that decedent’s Christmas checks to Betsy, her

children, and her grandchildren would not bounce.

In 1994 and/or 1995, in addition to some cash gifts, decedent

made gifts of interests in the Turner Partnership and the Thompson

Partnership. Gift tax returns filed by decedent (or on his behalf)- 16 -

reported adjusted taxable gifts of $9,324 for gifts of the Turner

Partnership interests and $10,000 for gifts of the Thompson

Partnership interests.

The partnerships distributed funds to decedent to pay for his

personal expenses. In a January 19, 1995, handwritten letter to

Robert, Betsy wrote:

Here is a list of Dad’s 1994 expen ses (The Keely

Mgt. fee will not be repeated.) The miscellaneous will

not be quite as high as he no longer buys lumber. But as

you can see he will need an infusion.

He still has, in his Alex Brown Acct. as of today

$31,806, $5,000 of this in cash.

C.G. Cheleden suggested we transfer securities into

his per sonal Alex Brown Acct # 05312, rather than each

partnership selling something & transferring cash. I

just looked at our partnership statement. We could

transfer a Penna. Higher Ed. Fac ility (50,000 shares

worth $50,864, 1⁄2 of it worth $25,432) & Dad could sell

these off as he needed them. Do you think $25,000 from

each of us [is] the right amount?

Let me know what you think. He’s okay for now, as

there is enough cash in the account for February.

Attached to the letter was a schedule of decedent’s expenses in

1994 totaling $57,202.40. This amount included Delaware State tax

of $7,347, Federal income tax of $23,623, and Cokesbury assisted

living center expenses of $20,072.20. The $57,202.40 total did not

include $3,000 which Betsy identified as a “Keely Mgt. (fee for

discounting partnerships)”.

The Th ompson Partnership distributed $12,500 to decedent in

March 1995.- 17 -

6 The proceeds of the life ins urance policy were paid to

the Turner Partnership after George’s death in 1999. B. Operation of the Turner Partnership

1. Securities

The invest ment strategies for decedent’s trust holdings did

not change significantly after they were transferred to the Turner

Partnership. Ms. Newnam remained as adviser, and decedent’s

securities c ontinued to be held in the Alex Brown account. The

amount of activity of the Turner Par tnership account was low;

indeed, at trial, Ms. Newnam could not characterize the trading

activity of the account as even “moderately” traded.

2. Life Insurance Policies

The Turner Partnership owned insurance policies on the lives

of George and Betsy. The amount of insurance on George’s life was

$237,500 with a term rider of $196,500, for which the partnership

paid an annual premium of $15,992.88. 6 The amount on Betsy’s life

was $200,000, for which the partnership paid an annual premium of

$3,927.

3. Lewisville Properties

In September 1993, Betsy, George, and their daughter, Phoebe,

discussed investing in a real estate pro ject, known as the

Lewi sville Properties. Lewisville Properties was a modular home

construction venture. Phoebe, a real estate broker, believed that

little risk was involved in making the investment and that she- 18 -

7 In Nov. 1995, Lewisville Prope rties was sold for a net

loss to the Turner Partne rship of approximately $60,000. Phoebe

received a commission of $9,120. She applied this amount toward a

$15,000 loan borrowed from decedent. expected the investment could generate a profit of approximately

$30,000. On September 22, 1993, Phoebe brokered an agreement of

sale between the sellers and “George Turner & Betsy Turner, or

their assignee”. In October 1993, George opened a checking account

in the name of “TTLP t/a Lewisville Properties” at First National

Bank of West Chester. The account was opened with a check from the

Turner Partnership in the amount of $20,000. George advised the

bank that Phoebe, Betsy, himself, and William Robinson (a C.P.A.),

would have signatory authority for the account.

On October 15, 1993, Lewisville Properties w as purchased by

the Turner Partnership for approximately $44,000. The partnership

financed the purchase and construction costs of Lewisville

Properties through a margin loan made on the brokerage account of

the Turn er Partnership. The total investment in the property was

approximately $186,000. 7

4. Woodlands Property

Woodside Farm was the private residence of Betsy and George;

it was listed as the principal place of bus iness for both the

Turner Partnership and Turner Corp. Adjacent to Woodside Farm were

22 acres known as Woodlands Property. The property contained a

swimming pool and small pool house, trails, a pond, and a dam. On- 19 -

8 In 1997, Betsy and George listed Woodside Farm for sale

and incl uded the 22-acre Woodlands Property. Woodside Farm and

Woodlands Property were sold to a single purchaser for a gross

sales price of $550,000. After reduction for settlement charges

($43,586) and the first mortgage loan ($198,274), Betsy and George

received net proceeds of $312,351. Upon the sale of the property,

Betsy and George allocated to the Turner Partnership $12,351 of the

Woodside Farm/Woodlands Property sales proceeds, which amount

equaled the partnership’s adjusted basis in the Woodlands Property. December 22, 1994, Betsy and George contributed Woodlands Property

to the Turner Partnership. Before contributing Woodlands Property

to the partnership, the Turners placed on the property a

conservation easement that prohibited the cutting or removal of

trees from the property. 8

5. Woodside Properties Partnership Interest

Betsy and George each held a 35-percent partnership interest

in a real estate partnership known as Woodside Properties. Phoebe

held the remaining 30-percent partnership interest. Woodside

Properties consisted o f six residential apartment units in two

buildings located in West Chester, Pennsylvania. Woodside

Properties’ real estate was titled in the names of Phoebe and

Betsy. Phoebe was the managing partner and listing agent for

Woodside Properties.

In December 1994, Betsy and George each assigned their

interests in Woodside Properties to the Turner Partnership. After

the assignment, Woodside Properties’ real estate remained titled in

the names of Phoebe and Betsy.- 20 -

6. Loans/Notes

The Turner Partnership was used to con tinue decedent’s

p ractice of lending money to Betsy’s children and grandchi ldren.

In April 1994, the Turner Partnership lent $35,000 to Betsy’s son

Robert and his wife. In October 1994, the principal of the loan

was increased to $45,000 and subsequently increased to $50,000. In

October 1994, the Turner Partnersh ip lent $15,000 to Betsy’s son

Bill; it lent an additional $8,000 to Bill in May 1995. The Turner

Partnership maintained records of the amounts that wer e owed and

paid on the loans.

Each partnership determined the current rate of interest to be

charged on the loans. Although monthly interest payments were

provided as a term on the loans held by the partnerships, those

interest payments were often either late or not paid at all. The

principal of such loans was payable on demand. When a principal

p ayment was made, often the loan was reamortized and subsequent

interest payments reduced. No enforcement action was taken against

any family member/borrower when payment on the loans was not made.

No loans were made to anyone outside the Turner/Thompson family.

C. Operation of the Thompson Partnership

Robert lived on the 312-acre N orwood Ranch in Colorado both

before and after it was contributed to the partnership. After he

contributed the ranch to the partnership, he entered into a lease- 21 -

9 For the years 1996 and 1997, management fees were paid by

the Thompson Partnership to Thomps on Corp. in the amounts of

$52,800 and $48,000, respectively. with the partnership. Under the terms of the lease, Robert was

required to pay rent of $12,000 per year.

Before contributing the ranch to the partnership, Robert did

not treat the ranch as a business. He maintained the ranch in the

same manner both before and after its transfer. Robert raised and

trained mules on the ranch. Any income from the sale of the mules

went to Robert individually, not to the partnership. On the

Thompson Partnership tax returns for the years 1993 through 1996,

however, the partnership claimed losses from the operation of the

ranch.

On several occasions , the partnership paid the rent it

received from Robert to Thompson Corp. as a manageme nt fee. For

the years 1993, 1994, and 1995 , management fees were paid by the

Thompson Partnership to Thompson Corp. in the amounts of $23,625,

$45,000, and $47,500, respectively. 9

Robert was paid an annual salary of $32,001 as president of

Thompson Corp. Robert’s wife, Karen, was paid a salary of $350 a

month for assisting with recordkeeping. She used the money to fund

her retirement account.

Thompson Corp. carried workman’s compensation insurance on

Robert and Karen that covered any injury or accident they suffered

in their home. In addition, the corporation paid the following- 22 -

personal expenses: Robert’s American Association of Retired

Persons (AARP) supplemental insurance of $63 month, Karen’s health

insurance of $987 per quarter, and a subscription to the Wall

Street Journal. In addition, the corporation paid Robert $200 a

month for use of his truck in maintaining the ranch.

IV. Decedent’s Estate

A. Transactions With the Partnerships

Decedent died on May 15, 1995, at the age of 97. Upon

decedent’s death, the 1993 trust was to terminate and the entire

trust balance was to be paid and distributed to decedent’s thenlivi ng lineal descendants, per stirpes. The trustees were

empowered to transfer money from the trust to decedent’s estate to

permit the funding of any monetary bequests made in decedent’s will

and the payment of any expenses.

At the time of his death, decedent held a majority interest in

the Turner and Thompson Partnerships, as well as stock in their

corporate general partners. He also held an interest in a

brokerage account of approximately $56,000, an interest in a mutual

fund of approximately $25,000, a checking account of approximately

$8,000, and a promissory note in the amount of $9,300.

The assets of the Turner Partnership (and the values of those

assets) as of decedent’s date of death were as follows:

Assets Value

First National Bank

General $3,404

Lewisville 1,479- 23 -

Assets Value

Total $4,883

Marketable securities

Municipal bonds

Chester Co 15,118

Madison Co 12,000

PA Higher Ed 5,020

Puerto Rico 5,016

Stocks

Atlantic Richfield 11,475

Coca Cola 138,900

GTE 383,600

General Electric 184,400

Intercap Qual Muni 42,775

IBM 40,470

Johnson & Johnson 38,175

Merck 38,025

Meridian Bankcorp 33,625

3M 24,550

PECO Energy 13,375

Petrolite 93,000

Xerox 217,575

Mutual funds--John Hancock 19,710

Margin loan (208,056)

Total 1,108,753

Real Property

Vermont property 49,000

Lewisville property 154,500

Woodlands 110,000

Woodside Properties 1 102,416

Total 415,916

Loans receivable

Phoebe Turner 14,961

William Turner 98,519

George Turner, Jr. 9,843

William Turner, IV 13,171

Robert & Lorraine Turner 48,275

Bill’s Bloom, Inc. 8,000

Total 192,769

Accrued Int. & Div. 3,032

Cash value life insurance

George 8,907

Betsy 1,821

Unearned premium 15,905

Total 2 1,751,986

1 Decedent’s estate valued Woodside Properties at $15,786.- 24 -

2 The estate’s total value ascribed to the assets was

$1,655,356.

The assets of the Thompson Partnership (and the value of those

assets) as of decedent’s date of death were as follows:

Assets Value

Cash $57,096

Marketable securities

Municipal bonds

Dist. Columbia 50,141

Dover Dela. Wtr. & Swr 20,813

Dela. Hlth 26,880

Intercapital invest 36,975

Intercapital income 13,375

Stocks

Atlantic Richfield 11,475

Barrick Gold 16,363

Coca Cola 138,900

Fluor Corp. 15,188

GTE 315,100

General Electric 184,400

Glaxo Wellcome PLC 20,813

IBM 38,000

Johnson & Johnson 38,175

Merck 38,025

Meridian Bankcorp 33,625

3M 24,550

PECO Energy 13,375

Xerox 217,575

Mutual Funds

John Hancock Freedom 19,710

Equity income 61,486

Intl Stock 40,348

Latin America 18,444

Mid-cap growth 45,953

New Asia 12,495

Science & Technology 68,912

Intl bond 128,903

U.S. Treasury 43,926

Total 1 1,693,925

Loans receivable

Amy Thompson 103,451

Ted Thompson 9,348

Margaret Thompson 116,852

Total 229,651- 25 -

Assets Value

Accrued interest & dividends $4,066

Ranch in Norwood, CO 595,000

Total 2 2,579,738

1 Decedent’s estate valued marketable securities at

$1,693,922.

2 Decedent’s estate’s total value ascribed to the assets

was $2,579,734.

On May 27, 1995, the Turner Partnership sold over $347,000 of

securities it held through the Alex Brown account. Around the same

time, the Thompson Partnership sold more than $350,000 in

securities. On October 8, 1995, distributions were made from the

1993 trust, in partial satisfaction of specific bequests in

decedent’s will, as follows:

Betsy’s children:

George Turner Jr. $15,000

Phoebe Turner 4,000

Robert J. Turner 20,000

Robert’s children:

Amy Thompson $20,000

Margaret Thompson 14,000

John W. Thompson 20,000

Theodore R. Thompson 20,000

In January 1996, the Turner Partnership and the Thompson

Partnership each paid $246,500, or a total of $493,000, to a

checking account to fund the specific bequests set forth in

decedent’s will; these distributions reduced the estate’s interests

in the partnerships’ assets. Likewise, the partnerships provided

funds to pay decedent’s estate taxes.- 26 -

On August 7, 1996, because the estate contained insufficient

assets to fund all bequests in decedent’s will, an assignment of

partnership interest in the Turner Partnership was executed between

decedent’s estate and Betsy’s five grandchildren, transferring

partial interests in the Turner Partnership to them.

B. Estate Tax Return

A Form 706 , United States Estate (and Generation-Skipping

Transfer) Tax Return, was filed on February 21, 1996. A

supplemental estate tax return was filed on December 10, 1996.

On the return, decedent’s estate reported that decedent held

an 87.65-percent interest in the Turner Partnership (with a value

of $875,811) and a 54.12-percent interest in the Thompson

Partnership (with a value of $837,691). The return reported that

decedent held 490 shares of Turner Corp. stock valued at $5,190 and

490 shares of Thompson Corp. stock valued at $7,88 8. The values

r eported on the return were determined by applying a 40-percent

combined discount for minority interest and lack of marketability

to the net asset value of the assets of the partnerships.

The estate tax return reported $19,324 as prior adjusted

taxable gifts pursuant to section 2001(b) relat ed to decedent’s

gifts of the partnership interests in the Turn er Partnership and

the Thompson Partnership . The value of the prior gifts had also

been determined by applying a 40-per cent combined discount for

minority interest and lack of marketability.- 27 -

C. Notice of Deficiency

Respondent issued a notice of deficien cy determining a

$707,054 deficiency in Federal estate tax. In the notice of

deficiency, respondent increased the values of decedent’s interests

in the limited partnerships and increased the amount of taxable

gifts related to decedent’s lifetime gifts of partnership interests

in those partnerships.

Respondent determined that the value of decedent’s interest in

the Thompson Partnership was $1,396,152, rather than $837,691, and

the value of his interest in the Turner Partnership was $1,717,977,

rather than $875,811. As a result of those determinations,

respondent increased decedent’s taxable estate by $1,400,627.

Responde nt also determined that the value of decedent’s 490

shares of Thompson Corp. was $13,977, rather than $7,888, and the

value of his 490 shar es of Turner Corp. was $4,094, rather than

$5,190. As a result of those determinations, respondent increased

decedent’s taxable estate by $4,993.

Respond ent’s notice of deficiency also proposed to increase

the prior taxable gifts from $19,324 to $166,167.

OPINION

As a general rule, s ection 2001(a) of the Internal Revenue

Code imposes a Federal tax “on the transfer of the taxable estate

of every deced ent who is a citizen or resident of the United

States.” Section 2001(b) provides that the estate tax is based- 28 -

upon the value of the taxable estate, plus taxable gifts made after

1976 and not includable in the gross estate, less gift taxes

payable on post-1976 taxable gifts. A decedent’s taxable estate is

determined by determining the value of the decedent’s gross estate

and by deducting therefrom those deductions p rovided for in

sections 2053 through 2056. Sec. 2051.

The parties in this case disagree as to whet her decedent’s

gross estate includes (1) the value of interests in family limited

partnerships and in the corporate general partner of those

partnerships that decedent possessed at death or transferred prior

to death (and if so, the value of such interests), or (2) pursuant

to section 2036(a), the value of the property wh ich decedent

transferred to the family limited partnerships and related

corporate general partners.

Decedent’s estate maintains that decedent’s gross estate

includes the value of his interests in the family limited

partnerships (not the value of the property transferred by him to

the partnerships) and that the value of each of his partnership

interests at the date of transfer (that is, the date of the gift or

the date of decedent’s death) is decedent’s proportionate share of

the fair market value of the assets of the partnership at the date

of transfer, discounted by 40 percent to reflect lack of control as

well as a lack of marketability.

On the other hand, asserting two alternative the ories,- 29 -

respondent contends that the full fair market value of the assets

decedent contributed to the partnerships is includ able in

decedent’s gross estate.

Respondent argues first that the partnerships lacked economic

substance and thus should be disregarded for transfer tax purposes.

Alternatively, respondent argues because decedent retained the

economic benefit and control of the transferred assets, section

2036(a) applies so t hat the date-of-death value of the assets

decedent transferred to the partnerships is includa ble in

decedent’s gross estate. Finally, respondent asserts that if the

partnerships are recognized for estate tax purposes and if section

2036(a) does not apply, then the amount of the combined minority

and lack of marketability discounts to apply in valuing decedent’s

interests in the partnerships is less than 40 percent, as claimed

by decedent’s estate.

I. Burden of Proof

As a preliminary matter, decedent’s estate maintains that the

issues of (1) whether the partnerships are to be recognized for

estate tax purposes, and (2) the applicability of section 2036 are

new matters which were not raised in the notice of deficiency. The

estate thus concludes that the burden of proof as to those issues

is placed upon respondent. We agree.

Generally, except as otherwise provided by statute or- 30 -

10 In certain circumstances, if the taxpayer introduces

credible evidence with respect to any factua l issue relevant to

ascertaining the proper tax liability, sec. 7491 places the burden

of proof on the Commissioner. Sec. 7491(a); Rule 142(a)(2).

Decedent’s estate does not contend that sec. 7491 applies in this

case. determined by the Court, the burden of proof is on the taxpayer.

Rul e 142(a); W elch v. Helvering

, 290 U.S. 111, 115 (1933). 10 The

burden of proof is on the Commissioner, however, in respect of any

new matter not raised in the notice of deficiency, increases in

deficiency, and affirmative defenses raised by the Commissioner in

an answer. Rule 142(a).

A notice of deficiency must “describe the basis” for the tax

deficiency. Sec. 7522. In some situations, failure to describe

the basis for the tax deficiency in the notice of deficiency

results in a new matter being ra ised under Rule 142(a). S hea v.

Commissioner

, 112 T.C. 183, 197 (1999) ; Wayne Bolt & Nut Co. v.

Commissioner

, 93 T.C. 500, 507 (1989); Estate of Ballantyne v.

Commissioner

, T.C. Memo. 2002-160. A new matter is raised when the

basis or theory on which the Commissioner relies is not stated or

described in the notice of deficiency and the new theory or basis

requires the presentation of different evidence. W ayne Bolt & Nut

Co. v. Commissioner

, supra at 507. In such situation, the burden

of proof is placed on the Commissioner with respect to that issue.

Id.- 31 -

In the case herein, respondent’s notice of deficiency

in creased the value of decedent’s interest in the Turner

Partnership from $875,811, as reported on the return, to

$1,717,977, and increased the value of decedent’s interest in the

Thompson Partnership from $837,691, as reported on the return, to

$1,396,152. Respondent explained the changes to the value of his

partnership interests as follows: “The 20% minority discount and

20% lack of marketability discount has been disallowed on each of

the above limited partnerships.” In addition, respondent decreased

the value of decedent’s Turner Corp. stock from $5,190, as reported

on the return, to $4,094, and increased the value of his Thompson

Corp. stock from $7,888, as reported on the return, to $13,977.

In an amendment to the answer, respondent asserted that the

limited partnerships and the two family corporations sho uld be

disregarded for Federal estate tax purposes and that the property

includable in decedent’s gross estate is his share of the

underlying assets owned by the partnerships as of the date of his

death. In the alternative, respondent asserted in the amendment to

the answer that with respect to the assets transferred by decedent

to the partnerships, decedent retained con trol and enjoyment

sufficient to include th e date-of-death value of those assets in

the gross estate pursuant to section 2036(a).

The adjustments made by respondent in the notice of deficiency

resulted from respondent’s disallowance of any discounts for- 32 -

minority interest or lack of marketabi lity. The disallowance of

those discounts did not call into question the economic substance

of the pa rtnerships or raise the applicability of section 2036.

Moreover, the amount of discount for lack of control and

marketability requires different evidence than that required for

the matters first raised in the amendment to the answer.

Entitlement to the discounts requi res proof that a willing buyer

would pay less for decedent’s interest in the partnerships than net

asset value because the interests did not have control over the

partnership and because there was no ready market for the sale of

the partnership interests. Evidence required to establish that the

entities should b e respected for estate and gift tax purposes

includes evidence that the entities were properly established under

State law and that other formalities have been followed. Evidence

required to prove that section 2036(a) does not apply includes

evidence that decedent did not retain the enjoyment of the property

or control over who has the enjoyment of the property or that

decedent transferred the property for adequate consideration. See

infra pp. 33-49. These are new matters raised in the amendment to

the answer.

II. Whether the Turner Partnership and the Thompson Partnership

Will Be Recognized for Federal Estate Tax Purposes

Respondent contends that the Thompson Partnership and the

Turner Partnership should be disregarded for Federal tax purposes

because they lack economic substance and business purpose. “Mere- 33 -

suspicion and speculation about a dece dent’s estate planning and

testamentary objectives are not sufficient to disregard an

agreement in the absence of persuasive evidence that the agreement

is not susceptible of enforcement or would not be enforced by

parties to the agreement.” E state of Strangi v. Commissioner

, 115

T.C. 478, 485 (2000), affd. on this issue, revd., and remanded 293

F.3d 279, 282 (5th Cir. 2002); Hall v. Commissioner , 92 T.C. 312,

335 (1989).

The Thompson Partnersh i p and Thompson Corp. were validly

formed pursuant to Colorado law, and the Turner Partnership and

Turn er Corp. were validly formed pursuant to Pennsylvania law.

Potential purchasers of decedent’s assets would not disregard the

partnership. Thus, the partnerships had sufficient substance to be

recognized for Federal estate and gift tax purposes. K night v.

Commissioner

, 115 T.C. 506, 513-515 (2000); Estate of Strangi v.

Commissioner

, supra ; Dailey v. Commissioner , T.C. Memo. 2001-263.

III. Whether the Assets Decedent Transferred to the Partnerships

Should Be Included in Decedent’s Gross Estate Under Section

2036(a)

Section 2051 defines the “taxable estate” as “the value of the

gross estate, less applicable deductions.” Section 2031(a)

specifies that the gross estate comprises “all property, real or

personal, tangible or intangible, wherever situated”. Section 2033

broadly states that “The value of the gross estate shall include

the value of all property to the extent of the interest therein of- 34 -

the decedent at the time of his death.” Sections 2034 through 2045

include in the gross estate s everal 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 h as at any

time made a transfer (except in case of a bona fide sale

for an adequate and full considera tion 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 ref erence 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.

Section 2036(a) effectively includes in the gross estate the

full fair mark et value, at the date of death, of all property

transferred in which the decedent had retained an interest, rather

than the value of only the retained interest. F idelityPhiladelphia Trust Co. v. Rothensies

, 324 U.S. 108 (1945). This

furthers the legislative policy to “include in a decedent’s gross

estate transfers that are essentially testamentary--i.e., transfers

which l eave the transferor a significant interest in or control

over the property transferred during his lifetime.” U nited States

v. Estate of Grace

, 395 U.S. 316, 320 (1969). Thus, an asset- 35 -

transferred by a decedent while he was alive cannot be excluded

from his gross estate unless he “absolutely, unequivocally,

irrevocably, and without possible reservations, parts with all of

his title and all of his possession and all of his enjoyment of the

transferred property.” C ommissioner v. Estate of Church

, 335 U.S.

632, 645 (1949). Application of section 2036(a) depends upon

practical considerations; its effects are not dependent upon

“‘various niceties of the art of conveyancing’”. I d. at 642

(quoting Klein v. United States , 283 U.S. 231, 234 (1931)).

A. Whether Decedent Retained Possession, Enjoyment, or the

Right to the Income From the Transferred Property During

His Lifetime; Section 2036(a)(1)

For purposes of section 2036(a)(1), a transferor retains the

enjoyment of property if there is an express or implied agreement

at the time of the transfer that the tran sferor will retain the

present economic bene fits of the property, even if the retained

right is not legally enforceable. See G uynn v. United States

, 437

F.2d 114 8, 1150 (4th Cir. 1971); Estate of McNichol v.

Commissioner

, 265 F.2d 667, 671 (3d Cir. 1959), affg. 29 T.C. 1179

(1958); Estate of Reichardt v. Commissioner

, 114 T.C. 144, 151

(2000); see also sec. 20.2036-1(a) Estate Tax Regs. The existence

of such an implied agreement or understanding can be inferred from

the facts and circumstan ces surrounding both the transfer itself

and the subsequent use of the property. E state of Reichardt v.

Commissioner

, supra ; Estate of Spruill v. Commissioner , 88 T.C.- 36 -

1197, 1225 (1987); Estate of Rapelje v. Commissioner , 73 T.C. 82,

86 (1979).

In this case, the circumstances surrounding establishment of

the partnerships show that, at the time of the transfer, there was

an implied agr eement or understanding that decedent would retain

the enjoyment and economic benefit of the property he had

transferred. Before the partnerships were formed, Betsy sought

assurances from the financial advisers that decedent would be able

to withdraw assets from the partnerships in order to make cash

gifts each year to his children, grandchildren, and great

grandchildren. In late November 1993 after the partnerships were

formed, George asked the advisers how decedent could get $40,000

out of the partnerships to give as Christmas presents. The implied

agreement among decedent, Robert, Betsy, and George that decedent

would retain the enjoyment and economic benefit of the transferred

property is reflected also by the distributions made by the

partnerships to decedent. Late in 1993 and again in 1994, both the

Turner Partnership and the Thompson Partnership made distributions

to decedent of $40,000 so that he could continue his practice of

giving substantial gifts at Christmastime to his family members.

The circumstances also demonstrate an understanding that

decedent’s interest in t he transferred property would last until

his death. When the partnerships were established, decedent parted

with almost all of his wealth, retaining enough to support himself- 37 -

11 Further, sec. 2036(a) applies when the decedent has “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.” Sec. 2036(a)(2). (Emphasis added.) The parties have

limited their arguments to the application of s ec. 2036(a)(1).

Since we find that decedent retained enjoyment of the property

within the meaning of sec. 2036(a)(1), we leave to another day the

application of sec. 2036(a)(2) to family limited partnerships such

as those existing in this case. for less than 2 years. Betsy’s correspondence in early 1995 to

Robert shows that the amount decedent retained was insufficient–-

his original holdings had diminished to $31,806, while his expenses

for the prior year totaled $57,202. Betsy informed Robert that

decedent would need “an infusion” of funds to cover the balance of

decedent’s anticipated 1995 expenses. She proposed that the Turner

Partnership and the Thompson Partnership transfer assets of equal

value to their father. In March 1995 the Thompson Partnership

distributed $12,500 to decedent.

We are not persuaded otherwise by the insistence of decedent’s

es tate that decedent always asked Betsy and Robert, in their

respective capacity as officers of the corporate general partners

of their partnerships, for the cash decedent needed to provide

Christmas gifts. 11 The fact that decedent requested those sums does

not vitiate the existence of an understanding that he would receive

them.

He re, decedent’s outright transfer of the vast bulk of his

assets to the partnerships would have deprived him of the assets- 38 -

needed for his own support. Thus, the transfers from the

partnerships to decedent can only be explained if decedent had at

least an implied understanding that his children would agree to his

requests for money from the assets he contributed to the

partnerships, and that they would do so for as long as he lived.

While we acknowledge that, as a result of the creation of the

partnerships, prior to decedent’s death some change ensued in the

formal relationship of decedent to the assets he contributed to the

partnerships, we are satisfied that the practical effect of these

changes during decedent’s life was minimal. Decedent continued to

be the principal economic beneficiary of the contributed property

after the partnerships were created. Based on these facts, we

conclude that nothing but legal title changed in the decedent’s

relationship to his assets after he transferred them to the

partne rships. E state of Reichardt v. Commissioner

, supra at

152-153.

An y control over management and distributions by Betsy and

Robert is likewise of little import. Documents in the record show

that the composition of the portfolio changed little prior to

decedent’s death. We place little weight on averments concerning

change, during decedent’s life, in the partners’ relationships to

the contributed property.

In Mahoney v. United States , 831 F.2d 641, 646-647 (6th Cir.

1987) the court explained:- 39 -

“The general purpose of the statute was to include in a

decedent’s gross estate transfers that are essentially

testamentary--i.e., transfers which leave the transferor

a significant interest in or control over the property

transferred during his lif etime.” * * * By taxing

essentially testamentar y transactions, section 2036(a)

prevents “circumvention of federal estate tax by use of

schemes which do not significantly alter lifetime

beneficial enjoyment of property supposedly transferred

by a decedent.” * * * The applicability of section

2036(a), therefore, is not controlled by the “various

niceties of the art of conveyancing,” * * * but is

instead dependent upon “the nature and operative effect

of the transfer,” * * *. As such, the statute operates

to tax transfers of property “that are too much akin to

testamentary dispositions not to be subjected to the same

excise.” * * *

We have applied the aforementioned principles to the creation

of family partnerships. We have often held that section 2036(a)

applies to return to the estate the assets of an elderly and

wealthy individual who had placed the bulk of his or her assets

into a partnership that is controlled by that individual and his

family, while the individual possessed continued use of the assets

so transferred. See E state of Reichardt v. Commissioner

, 114 T.C.

144 (2000); Estate of Harper v. Commissioner

, T.C. Memo. 2002-121;

Estate of Schauerhamer v. Commissioner , T.C. Memo. 1997-242

.

In light of decedent’s personal situation, the fact that the

contributed property constituted the majority of decedent’s assets,

including nearly all of his investments, the establishment of the

partnerships is far more consistent with an estate plan than with

any sort of arm’s-length joint enterprise between partners. In

summary, we are satisfied that the partnerships were created- 40 -

principally as an alternate vehicle th rough which decedent would

provide for his children at his death. Estate of Schauerhamer v.

Commissioner

, supra

. We conclude that decedent retained enjoyment

of the contributed property within the meaning of section

2036(a)(1).

B. Whether Decedent Transferred Property to the Partnership

in a Bona Fide Sale for Full and Adequate Consideration

Section 2036(a) does not apply to a transfer that is “a bona

fide sale for an adequate and full consideration in money or

money’s worth”. Decedent’s estate contends that decedent’s

transfer of his assets to the partnerships falls within that

exception. We disagree. We believe that decedent’s transfer of

his property to the partnerships does not constitute “a bona fide

sale for an adequate and full consideration”, within the meaning of

section 2036(a).

The exemption under sect ion 2036(a) is limited to those

transfers where the transferor has received full consideration in

a genuine arm ’s-length transaction. E state of Goetchius v.

Commissioner

, 17 T.C. 495, 503 (1951). The exemption is not

allowed where there is only contractual consideration but not

“adequate and full consideration in money or money’s worth.” Id.

When a family partnership is only a vehicle for changing the

form in which the decedent held his property--a mere “recycling of

value”--the decedent’s receipt of a partnership interest in- 41 -

exchange f or his testamentary assets is not full and adequate

consideration within the meaning of section 2036. In Estate of

Harper v. Commissioner

, supra

, we rejected the taxpayer’s argument

that the decedent’s receipt of a partnership interest, in exchange

for his trust assets, was a “bona fide sale for an adequate and

full consideration in money or money’s worth”. We observe therein

that in reality, the assets were not invested in a business

enterprise, they were only “recycle d”. And where a transaction

involves only the genre of value “recycling” and does not appear to

be motivated primarily by legitimate business concerns, no transfer

for consideration within the meaning of section 2036(a) has taken

place. Id.

In Estate of Har per v. Commissioner

, s upra

, we further

observed that our interpretation of “adequate consideration” for

transfers to family partnerships was consistent with and supported

by our holdings in other cases, including Estate of Reichardt v.

Commis sioner

, s upra

, and Estate of Schauerhamer v. Commissioner

,

supra

.

In contrast to those situations involving “alternative

testamentary vehicles”, we h ave also addressed cases wherein a

decedent has transferred his or her assets into a valid functioning

business enterprise. In those cases, we generally have found that

the transfer was made for full and adequate consideration. As

such, the decedent’s receipt of income from the enterprise will not- 42 -

cause the value of the property he contributed to the enterprise to

be retur ned to his estate. See, e.g., E state of Harrison v.

Commissioner

, T.C. Memo. 1987-8; E state of Michelson v.

Commissioner

, T.C. Memo. 1978-371. In those cases, there was no

expres sed or implied agreement between the partners in the

partnerships that the decedents could continue to use, possess, or

enjoy partnership property, within the meaning of section 2036(a).

In the case before us, however, the transactions were not

motivated by the type of legitimate business concerns that

furnished “adequ ate consideration” as described in E state of

Harrison v. Commissioner

, supra

, and E state of Michelson v.

Commissioner

, supra

. Further, we have found that in the case

before us, the partners did, in fact, have an expressed or implied

understanding that decedent could continu e to use the assets he

transferred to the partnerships.

A number of factors influence our finding. Initially, we note

that none of the individual partners in either of the partnerships

was involved in the conduct of an active business. Additionally,

it is clear that Robert, B etsy, and George did not actually pool

their assets with those of decedent. To the extent the

partnerships could have generated income resulting fromtheir

separate activities, they arranged matters so that any such income

went to them directly, and not to the partnerships. For example,

in Robert’s case, any income from the sale of the mules went to him- 43 -

12 The practice continued after decedent’s death. When

Betsy and George sold their private residence, Woodside Farm, they

included the 22 acres of Woodlands Property adjacent to their home

in the same sale. After the sale, they allocated to the Turner

Partnership an amount of the Woodside Farm/Woodlands Property sales

proceeds that exactly equa led the partnership’s basis in the

Woodlands Property. In so doing, they effectively eliminated any

partnership gain or loss from the sale for Federal tax purposes. individually, not to the partnership. In the case of Betsy and

George, their partnership agr eement was amended in 1994 so that

George, and not the partnership, received all income from the sale

of timber on the Vermont property that prior to the amendment

George had contributed to the partnership. Thus, although each of

decedent’s children (and/or their spouses) invested in the

partnerships, they kept their own assets, as well as any income

those assets may have generated, effectively separate from those of

decedent. They, like decedent, merely “recycled” their property

through the partnership form. 12

Moreover, although decedent’s stock s and bonds formed the

principal assets o f both partnerships, no substantial change in

investment strategy or activity took place from the date decedent

transferred the assets to the partnerships to the date of his

death.

In the fin al analysis, neither decedent nor his family

conducted the partnerships in a businesslike manner. None of the

parties involved in the partnerships joined together with the

intent to either form business enterprises or otherwise to conduct- 44 -

13 After decedent’s death, the Turner Partnership and

Thompson Partn ership continued making loans to family members.

Some of these loans included underwriting Phoebe’s $40,000 loss in

the construction of Lewisville Properties, an auto loan of $15,000

to Phoebe (since partially repaid), and a loan to Betsy’s 17-year

old grandson to purchase a lobster boat. In addition, the Turner

Partnership made loans to Betsy’s son, William, to start a rosegrowing business, and made additional loans for his business,

despite the ultimate failure of the business venture. There is

nothing to support that either Robert or Betsy made partnership

investment decisions in their children’s and grandchildren’s

ventures with the same careful consideration one would expect to be

exercised by a managing partner of a partnership having a valid

business purpose. any trade or business. The partnerships did not engage in

transactions with anyone outside the family; loans and gifts were

made to family members only. The lending activities of the

partnerships lacked any semblance of legitimate business

transactions. This exclusivity might be consistent with decedent’s

generosity towards his family members, but it was inconsistent with

any valid business operation. 13 In reality, these loans continued

to be testamentary in nature, using decedent’s money as a source of

fina ncing for the needs of individual family members, not for

business purposes.

In conclusion, we find that ther e was no bona fide sale for

adequate and full consideration. Consequently, we hold that the

full date-of-death value of th e assets that decedent transferred

from his trusts to the Thompson and Turner Partnerships is

includable in his gross estate pursuant to section 2036(a).- 45 -

C. Amount Included in Decedent’s Estate Under Section

2036(a)

We now turn to the issue of which assets are to be included in

decedent’s gross estate, bearing in mind that the burden of proof

is on respondent.

The assets of the Turner Partnership (and the values of those

assets) as of July 1993 (upon contribution to the partnership) and

May 15, 1995 (decedent’s date of death), were as follows:

7/93 5/15/95

Shares Value Shares Value

Decedent’s contribution

Municipal bonds

Chester Co

--- $50,180

--- 15,118

Madison Co

--- 10,327

--- 12,000

PA Higher Ed

--- 50,472

--- 5,020

Puerto Rico

--- 5,246

--- 5,016

Dela. State

--- 52,131

--- ---

Stocks

Atlantic Richfield 100 11,575 100 11,475

Coca Cola 2,400 103,800 2,400 138,900

GTE 11,200 404,600 11,200 383,600

General Electric 1,600 157,600 3,200 184,400

Intercap Qual Muni Inv. 2,000 32,000 2,950 42,775

Intercap Qual Muni Inc. 1,200 18,150

-–- ---

IBM 426 18,957 426 40,470

Johnson & Johnson 600 21,900 600 38,175

Merck 900 27,563 900 38,025

Meridian Bankcorp 1,000 32,125 1,000 33,625

3M 200 21,000 400 24,550

Phila. Elec./PECO Energy 500 15,750 500 13,375

Petrolite 3,000 105,000 3,000 93,000

Xerox 1,800 131,400 1,800 217,575

Mutual funds

John Hancock 900 15,894 900 19,710

Margin loan

--- --- --- (208,056)

Loans receivable

Phoebe Turner

--- 15,000

--- 14,961

William Turner

--- 100,000

--- 98,519

George Turner, Jr.

--- 10,000

--- 9,843

Decedent’s total 1,410,670 1,232,076

Betsy/George’s Contribution

Cash (checking account)

--- 1,000

--- --- Real Property

Vermont property --- 49,000

--- 49,000

Woodlands

--- --- --- 110,000

Woodside Properties

--- --- --- 102,416

Betsy’s total 50,000 261,416- 46 -

7/93 5/15/95

Shares Value Shares Value

New assets

First National Bank account

General

--- --- --- 3,404

Lewisville

--- --- --- 1,479

Real Property

Lewisville property

--- --- --- 154,500

Cash value life insurance

George

--- --- --- 8,907

Betsy --- --- --- 1,821

Total 10,728

Unearned premium--

life insurance

--- --- --- 15,905

Loans receivable

William Turner, IV

--- --- --- 13,171

Robert & Lorraine Turner

--- --- --- $48,275

Bill’s Bloom, Inc.

--- --- --- 8,000

Accrued int. & div.

--- --- --- 3,032

Unattributed total 258,494

Total assets 1,460,670 1,751,986

The securities totaling $1,232,076 were assets transferred to

the Turner Partnership by decedent. In addition to those

securities, n ew assets that derived from assets transferred by

decedent are included in decedent’s taxable estate unde r section

2036(a). The Lewisville Property was funded with the margin loan

attributabl e to the securities contributed by decedent. None of

the real estate contributed by George to the partnership produced

any income. At most, the $1,479 in the Lewisville Properties

account could be attributed to the $1,000 contributed by George on

the formation of the partnership. The remaining $257,015 ($258,494

- $1,479) of the new assets held by the partnership at decedent’s

death m ust have derived from the assets contributed by decedent.

We find, therefore, that assets totaling $1,489,091 ($1,232,076 +

$257,015) held by the Turner Partnership at the date of decedent’s

death are included in the taxable estate under section 2036(a).- 47 -

The assets of the Thompson Partnership (and the values of

those assets) as of Jul y 1993 (upon contribution to the

partnership) and May 15, 1995 (decedent’s date of death), were as

follows:

7/93 5/15/95

Shares Value Shares Value

Decedent’s contributions

Municipal bonds

Dist. Columbia

--- $53,685

--- $50,141

Dover Dela. Wtr & Swr

--- 27,498

--- ---

Dover Dela. Wtr & Swr

--- 22,019

--- 20,813

Orlando Waste

--- 5,208

--- ---

Dela. Hlth

--- 33,548

--- 26,880

Tampa Wtr & Swr

-–- 43,713

-–- -–-

Total 185,671 97,834

Stocks

Atlantic Richfield 100 11,575 100 11,475

Coca Cola 2,400 103,800 2,400 138,900

GTE 9,200 332,350 9,200 315,100

General Electric 1,600 157,600 3,200 184,400

Intercapital invest 2,000 32,000 2,550 36,975

Intercapital income 800 12,100 1,000 13,375

IBM 400 17,800 400 38,000

Johnson & Johnson 600 21,900 600 38,175

Merck 900 27,563 900 38,025

Meridian Bankcorp 1,000 32,125 1,000 33,625

3M 200 21,000 400 24,550

Phila. Elec./PECO Energy 500 15,750 500 13,375

Xerox 1,800 131,400 1,800 217,575

Total 916,963 1,103,550

Mutual Funds

John Hancock Freedom 900 15,894 900 19,710

Loans receivable

Amy Thompson

-–- 139,739

--- 103,451

Ted Thompson

--- 14,064

--- 9,348

Margaret Thompson

--- 140,000

--- 116,852

Total 293,803 229,651

Decedent’s total 1,412,331 1,450,745

Robert’s contributions

Mutual Funds

Equity income

-–- 64,811

--- 61,486

European stock

-–- 10,673

-–- ---

Intl stock

-–- 32,710

-–- 40,348

Japan fund

-–- 35,268

-–- --- New American growth

-–- 37,660

-–- ---

New Asia

-–- 22,449

-–- 12,495

Science & Technology

-–- 58,236

--- 68,912

High yield

-–- 5,597

--- ---

Intl bond

-–- 103,905

--- 128,903

Prime Reserve-cash

-–- 1,499

-–- ---

Total 372,808 312,144- 48 -

7/93 5/15/95

Shares Value Shares Value

Ranch in Norwood, CO --- 460,000

--- 595,000

Robert’s total 832,808 907,144

New Assets

Cash

--- --- --- 57,097

Stock

Barrick Gold

-–- --- 700 16,363

Fluor Corp.

--- --- 300 15,188

Glaxo Wellcome PLC

--- --- --- 20,813

Mutual Funds

Latin America

-–- -–- --- 18,444

Mid-cap growth

-–- -–- -–- 45,953

U.S. Treasury

-–- -–- -–- 43,926

Accrued int & div

--- --- --- 4,066

Total Unattributed assets 221,850

Total Assets 2,245,138 2,579,739

The new assets held by the Thompson Partnership on the date of

decedent’s death could have derived from mutual funds contributed

to the partnership by Robert. We are not persuaded that any of the

new assets derived from the assets contributed by decedent. We

find, there fore, that assets totaling $1,450,745 held by the

Thompson Partnership at the date of decedent’s death are included

in the taxable estate under section 2036(a).

The record establishes that George and Robert retained

enjoyment and c ontrol over the property they contributed to the

partnership. Decedent’s interests in the partnerships had no value

attributable to the property contributed by George and Robe rt to

the partnerships. We find, therefore, that no additional value

attributable to the partnerships over the value of the property

included in decedent’s estate under section 2036(a) is included in

decedent’s taxable estate.- 49 -

Further, decedent’s stock in Turner Corp. and Thompson Corp.

had no value apart from the corporat ions’ interests in the

partnerships. The value of decedent’s stock in the corporations is

included in the value of the assets included in his estate under

section 2036(a). We find, therefore, that no additional value

attributable to such stock is in cluded in computing decedent’s

taxable estate.

D. Adjusted Taxable Gifts

Decedent’s estate’s estate tax return included, as part of the

gross estate, $19,324 as “adjusted taxable gifts” pursuant to

section 20 01(b) for lifetime transfers of decedent’s interest in

the partnerships. Respondent’s notice of deficiency proposed to

increase this amount to $166,167.

Neither party addresses the impact of the application of

section 2036(a) on the value of the prior gifts of partnership

interests. We have found that pursuant to section 2036(a)

decedent’s taxable estate includes the full value as of decedent’s

death of assets transferred by him to the partnerships and held by

the partnerships at decedent’s death. We have also found that

dece dent’s interests in the partnerships had no value apart from

the assets he contributed t o the partnerships because Betsy and

Robert maintained control over the property they transferred to

their respective partnerships. Therefore, we hold that in

computing the proper estate tax due, it is not appropriate to- 50 -

include a separate val ue attributable to decedent’s lifetime

transfers of partnersh ip interests. See E state of Harper v.

Commissioner , T.C. Memo. 2002-121.

E. Conclusion

The value of decedent’s interests in the partnerships as

reported on decedent’s estate tax return and as dete rmined by

respondent in the notice of deficiency and the value of the assets

that we have found are to be included in the estate under section

2036(a) are as follows:

Estate Tax Notice of Sec.

Return Deficiency 2036

Thompson Partnership $837,691 $1,396,152 $1,450,745

Turner Partnership 875,811 1,717,977 1,489,091

Thompson Corp. 7,888 13,977 0

Turner Corp. 5,190 4,094 0

Prior taxable gifts 19,324 166,167 0

Total 1,745,904 3,335,177 2,939,836

To reflect the foregoing,

Decision will be entered

under Rule 155

.