Source: http://www.pgdc.com/pgdc/court-rules-stock-transferred-flp-not-includible-estate
Timestamp: 2017-10-17 09:50:59
Document Index: 504130614

Matched Legal Cases: ['§ 7491', '§ 7491', '§ 2036', '§ 2036', '§ 2036', '§ 2044']

Court Rules Stock Transferred to FLP Not Includible in Estate | Planned Giving Design Center
Court Rules Stock Transferred to FLP Not Includible in Estate
News story posted in U.S. Tax Court by Marc Hoffman on 16 December 2009| comments
In a case of first impression, the Tax Court has ruled that an individual's transfer of stock to a family limited partnership followed by the individual's transfer of partnership units to a marital trust for the benefit of his spouse, who predeceased him, and to a college constituted a bona fide sale under IRC section 2036(a); therefore, the individual's gross estate does not include the value of the transferred stock apportionable to his date-of-death interest in the partnership. The court further ruled on the funding date of the marital trust and certain administrative expenses.
Published in Dec 2009
Citation: Estate of Samuel P. Black Jr. et al. v. Commissioner; 133 T.C. No. 15; Nos. 23188-05, 23191-05, 23516-06
ESTATE OF SAMUEL P. BLACK, JR., DECEASED,
SAMUEL P. BLACK, III, EXECUTOR, ET AL.,
SAMUEL P. BLACK, III, EXECUTOR, ET AL.,1
U.S. Treasury -- Federal
estate tax payment $54,000,000
estate tax refund (22,263,473) $31,736,527
of Revenue -- inheritance
& estate taxes 15,700,000
reimburse costs 982,070
U.S. Treasury -- fiduciary
income taxes 515,973
Revenue -- fiduciary
income taxes 65,376
If a taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the taxpayer's tax liability and the taxpayer complies with all substantiation requirements, maintains all required records, and cooperates with the Commissioner's reasonable requests for witnesses, section 7491 places the burden of proof on the Commissioner with respect to that issue. Sec. 7491(a)(1) and (2); Rule 142(a)(2). Petitioner alleges that he has satisfied all the prerequisites to the application of section 7491 and that, therefore, "Respondent bears the burden of proof under § 7491(a) with regard to each of the factual issues in this case". Respondent alleges that petitioner has "not introduced credible evidence with respect to the material factual issues in this case as required by § 7491(a)."
Where, as here, the transferee partnership does not operate a legitimate business, and the record demonstrates the valuation discount provides the sole benefit for converting liquid, marketable assets into illiquid partnership interests, there is no transfer for consideration within the meaning of § 2036(a).
The Court of Appeals for the Third Circuit has likewise opined that while the dissipated value resulting from a transfer to a closely held entity does not automatically constitute inadequate consideration for section 2036(a) purposes, heightened scrutiny is triggered. Estate of Thompson v. Commissioner, 382 F.3d at 381. To wit, and consistent with the focus of the Court of Appeals in the bona fide sale context, where "the transferee partnership does not operate a legitimate business, and the record demonstrates the valuation discount provides the sole benefit for converting liquid, marketable assets into illiquid partnership interests, there is no transfer for consideration within the meaning of § 2036(a)." Id.
After a thorough review of the record, we agree with the Tax Court that decedent's inter vivos transfers do not qualify for the § 2036(a) exception because neither the Thompson Partnership nor Turner Partnership conducted any legitimate business operations, nor provided decedent with any potential non-tax benefit from the transfers. [Estate of Thompson v. Commissioner, 382 F.3d at 383; emphasis supplied.]
We also find that whatever portion of petitioner's fee that may be said to have compensated him for his services related to the marital trust (services that, allegedly, consumed 90 percent of his time) must be divided equally between the estates. Petitioner's argument for full deductibility of the fee is that "the marital trust has a direct nexus to Mrs. Black's Estate because the estate tax liability for the inclusion of the Marital Trust's assets in the gross estate is borne by Mrs. Black's Estate. See I.R.C. § 2044." But the fee has an equally direct nexus to Mr. Black's estate because his estate may deduct under section 2056 the value on the date of his death of the marital trust's assets. That deduction exactly mirrors the inclusion, by Mrs. Black's estate, of the value of those assets on the date of her death and is of equal significance.
1The following cases are consolidated herewith for trial, briefing, and opinion: Estate of Irene M. Black, Deceased, Samuel P. Black, III, Executor, docket Nos. 23191-05 and 23516-06.
2Unless otherwise stated, all section references are to the Internal Revenue Code as amended and in effect for the dates of decedents' deaths, and all Rule references are to the Tax Court Rules of Practice and Procedure. We round all dollar amounts to the nearest dollar.
3Karen Black did, in fact, receive the 125,000 pledged Erie shares in the divorce, by which time that stock had been released from its pledge to PNC Bank.
4Because of his concerns regarding the management of Erie, petitioner ultimately caused Black LP to sell the remaining two-thirds of its Erie stock in 2005 and 2006, at which time Erie stock was publicly traded. The partnership had sold the first roughly one-third of the stock in a secondary offering after Mrs. Black's death in 2002. See infra.
5Both at the creation of the $20 million bequest to Penn State Erie in 1998 and when it was time to fund that bequest after Mr. Black's death in 2001, Penn State Erie expressed a preference for cash, to which Mr. Black acquiesced. As a result of petitioner's disclaimer of the $20 million bequest to him, pursuant to the terms of the amended trust, Penn State Erie received a $20 million cash bequest.
6During that same period, the Blacks received cumulative income of approximately $22,544,000 from Black LP, which represented approximately 80 percent of their total income for the period.
7Sec. 2056(a) permits a deduction from the decedent's gross estate for "an amount equal to the value of any interest in property which passes * * * from the decedent to his surviving spouse". Pursuant to sec. 2056(b)(1), however, a marital deduction is not ordinarily available for property passing to a surviving spouse where the interest of the surviving spouse may terminate or fail, e.g., as in this case, upon the surviving spouse's death. Sec. 2056(b)(7), however, allows a marital deduction for qualified terminable interest property (QTIP),which is defined, in sec. 2056(b)(7)(B)(i), as property passing from a decedent in which the spouse has a qualified income interest for life, and to which a QTIP election applies. Respondent does not dispute that petitioner made a timely QTIP election.
8At the time, Black LP owned 8,726,250 shares of Erie class A common stock so that the 3 million shares sold in the secondary offering represented slightly more than one-third of Black LP's Erie stock.
9At trial, the parties stipulated that the accumulated interest would, in fact, be paid on Nov. 30, 2007 (which was the next day), but Mr. Cullen testified that the $71 million principal amount would be refinanced, perhaps by means of installment payments, because Mrs. Black's estate did not have sufficient liquidity to repay it.
10Mr. Black's estate did not claim any deduction for administration expenses.
11During the audit years, the identical language was contained in sec. 20.2036-1(a), Estate Tax Regs. The language was moved to sec. 20.2036-1(c)(1)(i), Estate Tax Regs., by T.D.9414, 2008-35 I.R.B. 454, 458, and that provision is applicable to estates of decedents dying after Aug. 16, 1954. See sec. 20.2036-1(c)(3), Estate Tax Regs.
12With respect to the bona fide sale issue, the parties take opposing views on the similarity of these cases to Estate of Schutt v. Commissioner, T.C. Memo. 2005-126. Whether we reach the same result here that we reached in Estate of Schutt will depend on our answers to two questions: (1) Whether Mr. Black's buy-and-hold philosophy with respect to the family's Erie stock was a legitimate and significant nontax purpose for the formation of, and contribution of Erie stock to, Black LP, and (2) if so, whether, to ensure the implementation of that philosophy and the anticipated nontax benefits attendant thereupon, Mr. Black and petitioner (individually and as trustee of the grandson trusts) needed to transfer their Erie stock to Black LP.
13Assuming Mr. Black's desire to perpetuate the holding of Erie stock by the Black family constituted a legitimate and significant nontax purpose for the formation of Black LP, respondent does not argue, in the alternative, that Mr. Black's transfer of less than all of his Erie stock in exchange for a controlling general partnership interest in Black LP would have sufficed to accomplish that purpose. Therefore, we do not address that alternative argument.
14That respondent does not require the legitimate and significant nontax purpose to be the partnership's operation of a business is also made clear both by his failure to make that argument on brief and by the following colloquy between respondent's counsel and the Court at the end of trial:
15Judge Greenberg, concurring in Estate of Thompson v. Commissioner, 382 F.3d 367, 383 (3d Cir. 2004), joins the majority opinion "without reservation" but appears to read that opinion as suggesting that, for a discounted, proportionate interest in a family limited partnership to constitute full and adequate consideration, the partnership hold a "legitimate" business. Judge Greenberg's point is that the Court's refusal to apply the sec. 2036(a) parenthetical exception in the case "should not discourage transfers in ordinary commercial transactions, even within families". In that context, Judge Greenberg states:
16See supra note 7.
17Neither party suggests that Pennsylvania law bars the executor of an estate from claiming an interest expense as an administration expense with respect to the estate. Therefore, for purposes of these cases, we find that the interest expense for which petitioner claims a deduction was properly incurred under Pennsylvania law, despite the absence of evidence that it was specifically approved by a Pennsylvania court. See sec. 20.2053-1(b)(2), Estate Tax Regs. (A "deduction * * * of a reasonable expense of administration will not be denied because no court decree has been entered if the amount would be allowable under local law.").
18See supra note 9.
19Our conclusion that repayment of the note necessarily would require a sale of the Erie stock attributable to the borrowers' partnership interests in Black LP is premised on the assumption that, on the date they executed the promissory note, the borrowers intended to repay the loan in full on Nov. 30,2007. Petitioner does not argue to the contrary. He argues only that the eventual decision to refinance the loan does not alter its status as a bona fide loan.
20Alternatively, the partial redemption scenario could have been structured as a sale of Erie stock by Black LP pursuant to the secondary offering that actually occurred followed by a distribution of $71 million in cash to the estate and the revocable trust in redemption of their partnership interests in Black LP.
21Because we deny the entire deduction for interest on the ground that the $71 million loan (or, indeed, any loan) from Black LP was unnecessary to enable Mrs. Black's estate to discharge its debts, we have not addressed respondent's alternative argument that the loan was larger than what was needed to discharge the debts of Mrs. Black's estate, and that interest attributable to the loan proceeds used to fund the $20million bequest to Penn State Erie (an obligation of Mr. Black's estate) should be treated as nondeductible.
22Although Mrs. Black's estate and the revocable trust, as coborrowers under the loan agreement, both agreed to reimburse Black LP for its expenses related to the secondary offering, and although petitioner signed that agreement in his dual capacity as executor for the estate and trustee of the trust, respondent does not dispute that the estate made the payment at issue; he disputes only its deductibility by the estate.
23Because such expenses relate to no probate property, they are not subject to the requirement, in sec. 2053(a), that they be "allowable by the laws of the jurisdiction * * * under which the estate is being administered."
24The evidence indicates that some portion of each of the fees in question relates to activities that necessarily involve the administration of both probate and no probate property. Because the principles governing deductibility are identical for both types of expenditures, the distinction is without consequence herein. Moreover, as in the case of the interest expense incurred by Mrs. Black's estate, to the extent the fees in question relate to probate property, respondent does not argue that Pennsylvania law bars petitioner from claiming the fees as proper administration expenses. See supra note 16.
25Petitioner argues, in connection with the interest deductibility issue, that the entire $71 million loan was needed to pay the tax liabilities and administrative expenses estimated to be payable by Mrs. Black's estate as of the February 2003 loan date. Petitioner includes in that computation the $54 million Federal estate tax payment that accompanied the February 2003Form 4768, Application For Extension of Time to File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes. There is no explanation in the record for the more than $22million overpayment (which was refunded to the estate) of Federal estate taxes, but Mr. Cullen's July 29, 2002, letter to Erie soliciting Erie's assistance in raising cash for the estate makes clear that, among the items for which a cash infusion was said to be necessary, was "$50 million to fulfill Mr. and Mrs. Black's charitable bequests", the only such bequest being Mr. Black's $20million bequest to Penn State Erie via the revocable trust. Therefore, we reject petitioner's attempt to allocate $54 million of the loan proceeds to Federal estate taxes and nothing to the $20 million bequest to Penn State Erie.
26The record does not contain a copy of the MacDonald Illig bill for services rendered to Mrs. Black's estate. Therefore, we do not know how that firm apportioned its fee to the various services rendered.
27No petition filed in these consolidated cases alleges that all or any portion of the executor's fee and/or legal fees disallowed as deductions to Mrs. Black's estate should be allowed as deductions to Mr. Black's estate. Moreover, petitioner has neither amended the pleadings under either Rule 41(a) or (b) nor filed supplemental pleadings under Rule 41(c) to so allege. Therefore, we do not consider the deductibility by Mr. Black's estate of all or any portion of the disallowed amounts.