TAX COURT OPINION

Case: Estate of Marvin M. Schwan, Deceased; Lawrence A. Burgdorf, Special Administrator, Petitioner, Schwa
Docket Number: 21554-97
Judge: Nims
Opinion Type: memo
Filed: 07/13/2001
Pages: 14

T.C. Memo. 2001-174 T. TJDGE UNITED STATES TAX COURT ESTATE OF MARVIN M. SCHWAN, DECEASED, LAWRENCE A. BURGDORF, SPECIAL ADMINISTRATOR, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent THE MARVIN M. SCHWAN FOUNDATION, f.k.a. THE KING'S FOUNDATION, TRANSFEREE OF A TRANSFEREE OF THE ESTATE OF MARVIN M. SCHWAN, DECEASED, ALFRED PAUL G. SCHWAN AND LAWRENCE A. BURGDORF, TRUSTEES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent • Docket Nos. 21554-97, 21555-97. Filed July 13, 2001. At the time of his death, D owned two-thirds of a closely held the voting and nonvoting shares in SSE, corporation. D's estate plan provided for the distribution of such shares to a charitable foundation and for the subsequent redemption by SSE of certain of the "securities" as defined in a redemption agreement. The dispute between the parties in these cases centers on the valuation of D's SSE stock for purposes of computing the gross estate and the allowable charitable deduction under Federal motion for summary judgment and respondent's crossmotion for partial summary judgment, held: On peti.tioners' tax laws. (1) Because of potential impediments under State law relating to stockholder rights, an alleged power on REßVED JUL 1 3 2001í . - 3 - MEMORANDUM OPINION NIMS, Judge: Respondent determined a Federal estate tax deficiency for the estate of decedent Marvin M. Schwan (the Estate) in the primary amount of $415,480,079 and in an alternative amount of $181,921,766. In computing the primary deficiency, respondent determined that no deduction was allowable for a gharitable bequest to the Marvin M. Schwan Foundation (the Foundation) because, due to "an unresolved controversy", the amount to be received by the Foundation had not been established to exceed the estate taxes payable from such bequest. The parties now agree that the referenced controversy has been settled, and respondent has conceded this primary position. Hence, only respondent's alternative position, which was based on the terms of decedent's estate plan without regard to the pending controversy, presently remains at issue. . By a separate notice of deficiency, respondent further determined that the Foundation was similarly liable for the foregoing deficiencies as a result of its transferee status. Procedural Posture These consolidated cases are before the Court on petitioners' motion for summary judgment and respondent's cross- motion for partial summary judgment. Unless otherwise indicated, all section references are to sections of the Internal Revenue Code in effect as of the date of decedent's death, and all Rule - 5 - Factual Background Petitioners Decedent died testate on May 9, 1993, in Poway, California. He was at that time a domiciliary of Sioux Falls, South Dakota, and his will was subsequently admitted to probate in the Circuit Court of Minnehaha County, South Dakota. Lawrence A. Burgdorf, a friend of decedent, was appointed by the circuit court as special administrator for purposes of the Estate's tax controversy with the Internal Revenue Service. The petitions filed in these cases provide a mailing address for Lawrence in St. Louis, Missouri. . The Foundation is a section 501(c)(3) charitable entity established under the laws of South Dakota. Lawrence and Alfred Paul G. Schwan, decedent's brother, serve as the Foundation's trustees. Alfred used a mailing address -in Salina, Kansas, at the time the petitions in these cases were filed. Events Prior to May 9, 1993 Until his death on May 9, 1993, decedent was the president and majority shareholder of Schwan's Sales Enterprises, Inc. (SSE). SSE is primarily engaged in the production and distribution of frozen food products throughout the United States and Canada. SSE has at all relevant times been a closely held corporation organized under the laws of the Minnesota. Capitalization of SSE has also at all pertinent times been divided between voting common shares and nonvoting common shares. In general, pursuant to these instruments and as pertinent to the pending motions, decedent's estate plan was structured in the following manner. Decedent's will devised all stock in SSE owned by him at the time of his death to the trustees of the 1992 Trust. (We note, however, that while the parties do not discuss any specific date of transfer, the record seems to indicate that decedent's complete SSE holdings were in fact placed in the.1992 Trust prior to his death.) The trust agreement, in turn, directed that all SSE stock be distributed by the trustees outright to the Foundation. The Redemption Agreement then specified that, on the 10th business day after the due date for decedent's Federal estate tax return, SSE was to redeem the "Securities", as.defined therein, from the Foundation for a purchase price equal to the value of the Securities as determined for Federal estate tax purposes. The Securities subject to the • Redemption Agreement were defined to include: 1) Common or other Voting Capital Stock of 2) voting capital stock of any affiliate of and 3) voting capital stock that reorganization of the Company * * * the Company; the Company is the product of any In this connection the Foundation charter also provided that the Foundation trustees: may vote stock or shares of any corporation or trust directly or by proxy in such manner as they deem advisable * If the Foundation is a party to a redemption agreement with Schwan's Sales Enterprises, Inc., the Trustees shall perform said agreement, and shall not exercise their voting power hereunder so as to rescind it. * * . _ 9 Lorrie Irrevocable Trust Mark Mark Irrevocable Trust David David Irrevocable Trust Paul Irrevocable Trust Trusts created by the Schwan children 79 79 79 79 79 158 0 790,000 765,000 790,000 740,000 790,000 1,530,000 175,000 TOTAL 7,610 38,550,000 The relevant directors and officers of SSE as of that date were Alfred, Adrian J. Anderson, and Donald M. Miller. The record additionally reflects that, as of decedent' s date of death, Alfred and Lawrence were the trustees of the 1992 Trust, the 3G Trust, and the Foundation. The trustees for the Children' s Trusts and the Grandchildren' s Trust appear to have been Alfred, Lawrence, and Elton Huebner. The named executors of the Estate were Lawrence, Mark, and Paul. In December of 1993, the 5,076 voting and 25,910,000 nonvoting shares of SSE he,ld by the 1992 Trust were transferred to the Foundation. Thereafter, on August 4, 1994, a document entitled "Amendment to Agreement" (the 1994 Amendment) was executed by Alfred and Lawrence in their capacities as trustees of the Foundation, by Alfred and Lawrence in their capacities as trustees of the 1992 Trust, by Lawrence in his capacity as executor of the Estate, and by Donald on behalf of SSE. The 1994 amendment recited: - 11 - redeem only the outstanding voting stock owned by the Foundation upon Marvin's death and not the non-votino stock." The plaintiffs alleged injury to their position as minority shareholders and trust beneficiaries on grounds including violation of statutory corporate law, fraud, breach of fiduciary duty, and conspiracy. This litigation eventually settled in November of 1997. Pursuant to the settlement reached, the redemption transaction remained in place, and SSE agreed to redeem as well the stock held by the plaintiffs for a price of nearly $160 million. In the notice of deficiency sent by respondent to the Estate in August of 1997, respondent determined that the value of the SSE stock in decedent's gross estate was $1,064,591,322, an increase of $195,140,522 over the reported value. As relevant to . the instant motions, respondent further determined that the fair market value of the SSE shares passing to the Foundation for purposes of the charitable deduction was $857,572,432, a decrease of $11,878,368 from the reported value. Discussion I. Petitioners' Motion for Summary Judgment A. Power To Recapitalize Petitioners move for summary judgment on the primarý grounds that "the Foundation's power to convert the non-voting stock to voting stock gave it the same rights as were included in the - 13 - petitioners maintain that, as a matter of law, the Foundation received rights having the same value as those included in the gross estate. (In this connection, we note that while petitioners summarize their position in terms of the Foundation possessing the "same rights" as were included in the gross estate, their principal argument rests more particularly on the Foundation's receiving potentially nonidentical rights having the same value as those in the gross estate.) Petitioners also raise the alternative point that even if a postrecapitalization redemption of shares not originally designated voting could be prevented or enjoined, the Foundation's power to recapitalize would in that event have enabled it to continue indefinitely in possession of a two-thirds interest in b.oth the equity and the voting power of SSE, mirroring the interest held by decedent. . The parties are seemingly in agreement, and we concur, that . Minnesota corporate law governs activities related to SSE. We conclude, however, that we cannot at this juncture appropriatel·y grant petitioners' motion for summary judgment on the basis of such law. While Minnesota statutes may provide a mechanism for recapitalization of a corporation by majority shareholder vote, they also contain certain protections for minority shareholders. See Minn. Stat. Ann. secs. 302A.135, 302A.751 (West 1985 & Supp. . - 15 - judgment on the alternative ground that "if the Redemption Agreement diminished the value of the stock, it equally diminished the value of the gross estate." Petitioners maintain that the Redemption Agreement took effect no later than the moment of decedent's death and thus imposed any value-lessening constraints on the stock as it existed in the gross estate, prior to any distribution to beneficiaries. This argument is essentially the converse of the first point on which respondent moves for partial summary judgment. Because we grant respondent's motion on such point for the reasons discussed immediately below, we hold that petitioners are not entitled to summary judgment on their postulated alternative basis. We therefore will deny petitioners' motion in its entirety. II. Respondent's Cross-Motion for Partial Summary Judgment A. Unitary, Unrestricted Gross Estate Valuation Respondent asks this Court to find as a matter of law that, for gross estate purposes, "decedent's voting and non-voting stock interest in the Schwan Corporation which was held in a revocable trust ("1992 Trust") at the time of his death should be valued as a unitary holding, unrestricted by the terms of the 1992 Trust, the terms of the redemption agreement he executed prior to his Death ("Pre-Death Redemption Agreement") or the terms of the Schwan Corporation by-laws". As indicated above, petitioners advance the contrary view that the Redemption - 17 - The timing issue involved in placing a value on the gross estate was addressed by the Court of Appeals for the Fifth Circuit in the following oft-quoted pronouncement: the decedent ends and the the interest that ceases or of the Instead, the valuation is the successors begins. Brief as is the instant of death, the court must its valuation at this instant--the moment of It is a fallacy, to argue value before--or--after death on pinpoint truth, when the ownership of ownership of therefore, the notion that valuation must be determined by the value either of interest that begins. determined by the interest that passes, and the value of as it serves to indicate the value at death. usual case death brings no change in the value of property. alters value, as well as ownership, necessary to determine whether the value at death reflects the change caused by death, loss of services of a valuable partner to a small business. (5th Cir. 1962).) [United States v. Land, 303 F.2d 170, 172 It is only in the few cases where death that it is the time of for example, the interest before or after death is pertinent only In the Thus, it is now generally held, including in this Court, that the estate tax is laid on the interest that passes or is • transferred at death. Estate of Chenoweth v. Commissioner, 88 T.C. 1577, 1582 (1987). Furthermore, while in the typical scenario this interest will be identical to that held by the decedent, it must be recognized that situations can exist where death itself will change the value of a property interest. Likewise, case law also establishes that valuation should "take into account transformations brought about by those aspects of the estate plan which go into effect logically prior to the distribution of property in the gross estate to the - 19 - of the Redemption Agreement took effect only upon and because of the distribution to the Foundation. On the facts before us, we agree with respondent. Since the Redemption Agreement placed no restrictions on decedent's freedom to use or dispose of his interest in SSE, the instrument clearly had no impact on the stock's value prior to his death. More importantly and notwithstanding the existence of the Redemption Agreement, neither did decedent's death cause his 25,915,076 shares in SSE to represent anything less than two- thirds of the equity and two-thirds of the vote in SSE. If, prior to the distribution to the Foundation, a hypothe.tical buyer could have purchased all of the stock from the Estate, such buyer would have succeeded to decedent's full interest, unrestricted by the terms of the Redemption Agreement. This follows from the fact that the Foundation is the only person or entity upon whom . • the Redemption Agreement would operate to require the surrender of shares. Hence, any changes in value accruing as a result of the Redemption Agreement would be a function of the stock's coming to rest in the hands of a particular beneficiary. Such changes do not involve a predistribution transformation required to be considered for purposes of the gross estate. See Ahmanson Found. v. United States, supra at 768. Furthermore, if and when the Redemption Agreement became. operative upon distribution of the stock to the Foundation, the . - 21 - unpublished Order of this Court. With respect to the bylaws, the pertinent provisions merely afforded SSE an option to acquire its stock at fair market value in the event that a shareholder elected during life or at death to transfer the shares to a party other than a family member or a charity. Since such terms do not limit transferability or prevent receipt of fair market value, they would not result in a lesser value for gross estate purposes. Accordingly, we grant respondent's motion for partial summary judgment on this point and hold that decedent's shareholdings in SSE are to be valued in his gross estate as a unitary, unrestricted two-thirds interest in the company. B. Redemption of Only Voting Stock Respondent secondly requests this Court to find as a matter of law that "The Pre-Death Redemption Agreement executed by Marvin M. Schwan, the Foundation, Marvin M. Schwan's revocable trust and the Schwan Corporation required the Foundation to deliver, and the Schwan Corporation to redeem, only voting stock, not both voting and non-voting stock". Respondent contends that the language of the document as a whole, augmented by the legends stamped on various stock certificates, clearly provides that only the voting shares were to be redeemed. Petitioners in opposition assert that the express terms of the Redemption Agreement plainly require redemption of both classes. - 23 - Suffice it to say that, on the record before us, we find the Redemption Agreement to be ambiguous. We note that both sides raise colorable textual arguments, that even the. 1994 Amendment to the Redemption Agreement characterizes the original instrument as susceptible to differing interpretations, and that this issue formed the basis for protracted and contested litigation extending over a period of several years before eventually settling. Such circumstances belie the parties' representations that the document is clear on its face. Accordingly, we conclude that the issue of decedent's intent in drafting the Redemption Agreement remains a question of material fact as to which extrinsic evidence will aid in reaching an appropriate result. At present the record is lacking in information which could shed light on decedent's intentions, and we therefore leave this matter for development at trial. We will deny respondent's motion for partial summary judgment on this second point. C. Treatment of Taxes and Administrative Expenses The third point upon which respondent asks for judgment as a matter of law is as follows: "Under the operative documents, and state law properly applied, the burden of taxes and administrative expenses shall be borne by the Foundation." More specifically, it is respondent's position that: (1) Any charitable deduction allowable to the Estate for the bequest to - 25 - therefore is whether the bonus may be applied to payment of taxes and expenses in lieu of gross estate assets which would support a deduction if transferred to charity. The property from which a decedent's debts and taxes are payable and the order of payment of those items are governed by applicable State law. See Riggs v. Del Drago, 317 U.S. 95, 97-98 (1942). T.he pertinent law in this case regarding the administration of the Estate is that of South Dakota. Under South Dakota law as in effect in 1993, where a decedent's will, construed together with other testamentary instruments, directs the source from which obligations are to be paid, such directions are given effect. See S.D. Codified Laws secs. 29-5-1, 2.9-5-2, 29-5-4, 29-6-7, 29-7-1 (1993). The statutory codification then provides additional default rules to ensure a complete and orderly disposition of the decedent's property. Accordingly, we • must first consider the portions of decedent's will and the 1992 Trust agreement which speak to this issue. Decedent's will states the following regarding taxes and expenses: Payment of debts, expenses and death taxes. . I direct my Executors to pay out of my residuary estate my legally enforceable debts and the expenses of my last illness, I direct that all inheritance, estate, succession and transfer taxes * * which may be imposed by any domestic or foreign law by reason of my death or because of funeral and burial. the transfer, * - 27 - 3.3 Source of Payments. All payments made the Trust Estate * to the provisions of paragraph 3.1 or 3.2 * pursuant * shall be made from the assets of remaining after complying with the provisions of Articles 4, 5, and 6 of this Trust Agreement and from assets of the provisions of paragraph 8.2 of Article 8 of this Trust Agreement. Enterprises, voting stock shall be used before voting stock. Inc., must be used for any payment, noñ- the Trust Estate otherwise disposed of under If stock of Schwan's Sales * * * Given these directives, the principal difficulty with petitioners' argument is that it conflicts with the explicit language of paragraph 2.3 above. That·paragraph states that "Upon the death of the Settlor, whatever then constitutes the Trust Estate" (emphasis added) shall be subject to distribution in accordance with the enumerated provisions. One such provision is Article 3, which governs payment of taxes and expenses. Hence, assets received after decedent's date of death are not covered by Article 3 and consequently are not among those which decedent specified are to be used to pay tax and expense obligations. Although pet.itioners reference an ability on the part of the fiduciaries to allocate the bonus to principal under the Revised Uniform Principal and Income Act, no amount of such allocating can retroactively render the bonus then-existino principal. The controlling testamentary instruments simply do