Court Opinion

ID: 4474601
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:11:02.375924+00
Date Added: 2024-06-11T07:55:54.893498
License: Public Domain

Halpern, J., concurring in part and dissenting in part.1  I. Introduction I write separately to express my disagreement with the majority’s interpretation of the bona fide sale exception found in section 2036(a).2  The majority states: In the context of family limited partnerships, the bona fide sale for adequate and full consideration exception is met where the record establishes [1] the existence of a legitimate and significant nontax reason for creating the family limited partnership, and [2] the transferors received partnership interests proportionate to the value of the property transferred. * * * [Majority op. p. 118.] I believe that the majority has strayed from the traditional interpretation of the bona fide sale exception by incorporating into the exception an inappropriate motive test (“a legitimate and significant nontax reason”), and by concluding that a partnership interest “proportionate” to the value of the property transferred constitutes adequate and full consideration in money or money’s worth. II. Bona Fide Sale Exception A. Introduction Section 2036 is entitled “Transfers With Retained Life Estate”, and subsection (a) thereof provides the following general rule: SEC. 2036(a). General Rule. — The value of the gross estate shall include the value of all property to the extent of any interest therein of which the decedent has at any time made a transfer (except in case of a bona fide sale for an adequate and full consideration in money or money’s worth), by trust or otherwise, under which he has retained for his life or for any period not ascertainable without reference to his death or for any period which does not in fact end before his death— (1) the possession or enjoyment of, or the right to the income from, the property, or (2) the right, either alone or in conjunction with any person, to designate the persons who shall possess or enjoy the property or the income therefrom. [Emphasis added.] Thus, even if a transferor of property retains lifetime possession, enjoyment, income, or control of the property, the value of the property will not show up in her gross estate if the transfer was a bona fide sale within the meaning of the underscored language (the bona fide sale exception). With respect to at least that portion of the bona fide sale exception that requires “adequate and full consideration in money or money’s worth” (for short, sometimes, full consideration), the identical language appears in section 2512(b), which provides that a gift occurs when property is transferred for insufficient consideration.3 That language has the same meaning in the respective contexts of the gift tax and the estate tax. Estate of Friedman v. Commissioner, 40 T.C. 714, 718-719 (1963) (“[I]f the transfer under scrutiny is considered as made for an adequate and full consideration for gift tax purposes, it likewise is to be considered for estate tax purposes.”); see also Merrill v. Fahs, 324 U.S. 308, 311 (1945) (the gift and estate taxes are in pari materia and must be construed together). The gift-on-account-of-insufficient-consideration rule of section 2512(b) is construed in section 25.2512-8, Gift Tax Regs., which, in pertinent part, provides: SEC. 25.2512-8 Transfers for insufficient consideration. Transfers reached by the gift tax are not confined to those only which, being without a valuable consideration, accord with the common law concept of gifts, but embrace as well sales, exchanges, and other dispositions of property for a consideration to the extent that the value of the property transferred by the donor exceeds the value in money or money’s worth of the consideration given therefor. However, a sale, exchange, or other transfer of property made in the ordinary course of business (a transaction which is bona fide, at arm’s length, and free from any donative intent), will be considered as made for an adequate and full consideration in money or money’s worth. * * * Under that regulation, transfers of property reached by the gift tax include transfers where (and to the extent) the value of the property transferred by the donor exceeds the value in money or money’s worth (cash value) of the consideration given in exchange therefor.4 A presumption of full consideration arises, however, in the case of a transfer of property made in the ordinary course of business; i.e., a transfer that is “bona fide, at arm’s length, and free from any donative intent”. Id. One consequence of satisfying the ordinary-course-of-business test is that the inquiry as to full consideration is avoided (and the actual fair market value of the consideration given for the transferred property is irrelevant). B. Approach of the Majority On pages 106-107 of its report, the majority makes the following finding: On December 28, 1996, decedent signed a letter that was written by Mr. Fullmer and addressed to decedent’s children. The letter expressed some reasons for forming WCB Holdings and BFLP. The letter explained that the entities provided, among other things, a method for giving assets to decedent’s family members without deterring them from working hard and becoming educated, protection of his estate from frivolous lawsuits and creditors, greater flexibility than trusts, a means to limit expenses if any lawsuits should arise, tutelage with respect to managing the family’s assets, and tax benefits with respect to transfer taxes. * * * Mr. Fullmer was decedent’s estate planning attorney, see majority op. pp. 101-102, and among the reasons set forth by decedent for forming WCB Holdings, LLC (WCB Holdings) and the Bongard Family Limited Partnership (BFLP) are family gifts and the achievement of transfer tax benefits (read, “savings”). The transfer tax savings result from the loss in value (giving rise to a valuation discount) that petitioner claims accompanied decedent’s sequential packaging of (1) his Empak, Inc. (Empak), stock in WCB Holdings and (2) his WCH Holdings Class B units in BFLP. The lost value, of course, was not beyond reclamation: It would be restored if BFLP and WCB Holdings were unpacked, which seems likely once decedent’s interests in the two entities passed through decedent’s estate and the Empak shares became more liquid. The transfer tax savings that decedent admitted were his objective thus serve only to increase by the amount of those savings (less, of course, transaction costs, such as lawyer’s fees) the size of decedent’s estate passing into the hands of his heirs. The achievement of transfer tax savings evidences donative intent because such savings translate almost dollar for dollar into the enhancement of the net value that decedent could gratuitously transfer to family members. Consequently, the transfers to WCB Holdings and bflp (together, the transfers) were not free of donative intent. That being the case, the transfers were not, in the terms of section 25.2512-8, Gift Tax Regs., made in the ordinary course of business, and there is no presumption that either the WCB Holdings membership units received by decedent for his Empak shares or the 99-percent limited partnership interest in BFLP received by decedent for his WCB class B membership units constituted full consideration for those transfers. Id. Therefore, to establish that the transfers were for full consideration, petitioner must, for each transfer, establish that the value of the property transferred by decedent did not exceed the cash value of the property received by him. Id. By the explicit terms of section 25.2512-8, Gift Tax Regs., the resulting inquiry is limited to an economic calculus, and there is no room for any inquiry as to the transferor’s (decedent’s) state of mind. Yet the majority makes his state of mind critical: Decedent * * * received [an interest] in WCB Holdings proportionate to the number of Empak shares * * * [he] contributed. Although by itself this may not be sufficient evidence to meet the adequate and full consideration requirement, two additional facts do support such a finding. We have determined that the respective assets contributed by the members were properly credited to the respective capital accounts of each contributing member, and distributions from WCB Holdings required a negative adjustment in the distributee member’s capital account. Most importantly, we have found the presence of a legitimate and significant nontax business reason for engaging in this transaction. [Majority op. p. 124; emphasis added.] Certainly, decedent’s state of mind (i.e., his intent) is important in determining whether the ordinary-course-of-business exception applies (was the transfer “free of any donative intent”), but once it is determined that the transfer in question was not made in the ordinary course of business, intent is no longer relevant to the determination of whether the transfer was for full consideration. I also disagree with the implication of the majority opinion that, in the context of a transfer to an entity (here, transfers to both a limited liability company and a family limited partnership), the full consideration requirement can be met by a showing that the transferor received an entity interest (e.g., a limited partnership interest) proportionate to the value of the property contributed to the entity. While an inquiry as to proportionality may have some bearing on whether the transfer was in the ordinary course of business, within the meaning of section 25.2512-8, Gift Tax Regs, (e.g., was at arm’s length5), I fail to see how proportionality aids the inquiry as to whether the value of the property transferred exceeded the cash value of the consideration received in exchange. See id. Here, because of the presence of donative intent, the transfers cannot be considered in the ordinary course of business, as that term is used in section 25.2512-8, Gift Tax Regs., and proportionality is irrelevant. Finally, as I read the majority’s approach to the bona fide sale exception, the majority has added to the exception the requirement that the taxpayer show that the decedent’s transfer to the entity was motivated “by a legitimate and significant nontax purpose.” Majority op. p. 118.6 If, indeed, that is the majority’s approach, then even if an objective analysis indicates that the transferor received full consideration, the bona fide sale exception presumably would not be satisfied if a subjective analysis reveals that the transaction did not have a legitimate and significant nontax purpose. According to the majority, indicators of the lack of such purpose include (1) that the transferor stood on both sides of the transaction, (2) commingling of the transferor’s and the transferee’s funds, and (3) the failure of the transferor actually to make a transfer. Majority op. pp. 118-119. Certainly, the “bona fide sale” portion of the bona fide sale exception would exclude transfers that were shams or based on illusory consideration. See, e.g., Wheeler v. United States, 116 F.3d 749, 764 (5th Cir. 1997). Beyond that, however, so long as an objective analysis demonstrates that, in exchange for the transferred property, the transferor received consideration with at least an equal cash value, no depletion of the transferor’s wealth has occurred, and it is difficult to see any policy reason to bring back into the gross estate the value of the property transferred. As we reasoned in Estate of Frothingham v. Commissioner, 60 T.C. 211, 215-216 (1973) (emphasis added): [W]here the transferred property is replaced by other property of equal value received in exchange, there is no reason to impose an estate tax in respect of the transferred property, for it is reasonable to assume that the property acquired in exchange will find its way into the decedent’s gross estate at his death unless consumed or otherwise disposed of in a nontesta-mentary transaction in much the same manner as would the transferred property itself had the transfer not taken place. * * * In short, unless replaced by property of equal value that could be exposed to inclusion in the decedent’s gross estate, the property transferred in a testamentary transaction of the type described in the statute must be included in his gross estate. * * * See also Kimbell v. United States, 371 F.3d 257, 262 (5th Cir. 2004) (citing Wheeler v. United States, supra); Magnin v. Commissioner, 184 F.3d 1074, 1079 (9th Cir. 1999), revg. T.C. Memo. 1996-25; Estate of D’Ambrosio v. Commissioner, 101 F.3d 309, 312 (3d Cir. 1996), revg. and remanding 105 T.C. 252 (1995).7  C. Conclusion I would approach the question of whether the value of property transferred by a decedent is included in the gross estate on account of section 2036 by, first, determining whether the decedent retained lifetime possession, enjoyment, income, or control of transferred property. Only after answering that question in the affirmative would I proceed to determine whether the bona fide sale exception applies to the transfer. In determining whether the bona fide sale exception applies, I would first determine whether the transfer was made in the ordinary course of business, as that term is used in section 25.2512-8, Gift Tax Regs. If not, I would determine whether the transfer was made for full value (i.e., whether the value of the transferred property at most equaled the cash value of the consideration received therefor). If not, then I would find that the value of the transferred property was included in the value of the gross estate pursuant to section 2036. Motive would only play the limited role I have outlined above (i.e., determining donative intent for purposes of the ordinary-course-of-business test). III. Gift on Formation The foregoing analysis suggests that, in forming a family-owned entity (e.g., a family limited partnership), one or more of the transfers to the entity might be deemed gifts, within the meaning of section 2512, because the transfers were for insufficient consideration, within the meaning of section 25.2512-8, Gift Tax Regs. I believe that a transfer to a family-owned entity may constitute a taxable gift, even if the size of the entity interest received by each transferor is deemed proportional to the value of the property contributed by that transferor.8  Consider the following hypothetical situation:9  Father, son, and daughter (F, S, and D) join in the formation of a family limited partnership (FLP), father making the bulk of the total contribution and receiving a limited partnership interest, S and D making smaller contributions and receiving general and limited interests. Each transferor receives a percentage interest in profits, losses, and capital that is strictly proportionate to the value that each contributes (in relation to the total value contributed). Based on claims of lack of marketability, loss of control, and other value diminishing factors, each interest is accorded some loss of value (in comparison to the value of the property exchanged therefore). F’s will and other testamentary-type documents are executed contemporaneously with the partnership agreement. They disclose that F’s interest in FLP ultimately will pass to S, D, and their children. Does any of the transferors make a gift on account of his or her contribution to the partnership for an interest of lesser value? Most likely, S and D do not. The reason is that, in pertinent part, section 25.2512-8, Gift Tax Regs., provides: “[A] sale, exchange, or other transfer of property made in the ordinary course of business (a transaction which is bona fide, at arm’s length, and free from any donative intent), will be considered as made for an adequate and full consideration in money or money’s worth.” From S’s and D’s viewpoints, the transfers to FLP are made in the ordinary course of business, at least as that term is used in section 25.2512-8, Gift Tax Regs. See Rosenthal v. Commissioner, 205 F.2d 505, 509 (2d Cir. 1953) (“even a family transaction may for gift tax purposes be treated as one ‘in the ordinary course of business’ as defined in * * * [the predecessor to section 25.2512-8, Gift Tax Regs.] if each of the parenthetical criteria is fully met”), revg. and remanding 17 T.C. 1047 (1951). For S and D, the transfers are motivated strictly by self-interest and are free from donative intent. They have agreed to form a partnership that they believe will serve as a vehicle for the delivery of F’s property to them and their children through a process whereby the transfer tax cost of the delivery will be substantially reduced through various valuation discounts. They agree to suffer a temporary loss of independence and control (and perhaps some loss of fair market value) in order to facilitate the reduction of transfer tax, the burden of which ultimately would fall on them. For them, the transfers are motivated by an acquisitive motive, not a donative motive. They make no gifts because they are deemed to have received full value under the ordinary-course-of-business test found in section 25.2512-8, Gift Tax Regs. So long as it can be shown that F’s contribution was not free of donative intent, the result is different for F. F’s purpose (not necessarily his sole purpose, but an important one) is to pass his property to his family with a reduction in transfer tax cost that translates dollar for dollar into an enhancement of the net value that the family will receive. F cannot, therefore, pass the ordinary-course-of-business test in section 25.2512-8, Gift Tax Regs., and, because of the valuation discounts claimed, cannot show full consideration. F, therefore, has made gifts within the meaning of section 2512 and section 25.2512-8, Gift Tax Regs. The measure of the gifts is not the transfer tax reduction but is the inadequacy of the cash value of the limited partnership interest that F received in consideration for his contribution to FLP. See sec. 25.2512-8, Gift Tax Regs. It is precisely that debasement in value that F sought to achieve as his means of generating the transfer tax saving, and it is appropriate that that be the measure of his gift. The fact that S, D, and their children may not realize the measure of F’s gift (the difference between the inside and outside value of F’s interest in flp) until, by bequests, they receive his interest is not an impediment to concluding that F made a gift. Section 25.2511-2(a), Gift Tax Regs., provides: Sec. 25.2511-2 Cessation of donor’s dominion and control. (a) The gift tax is not imposed upon the receipt of the property by the donee, nor is it necessarily determined by the measure of enrichment resulting to the donee from the transfer, nor is it conditioned upon ability to identify the donee at the time of the transfer. On the contrary, the tax is a primary and personal liability of the donor, is an excise upon his act of making the transfer, is measured by the value of the property passing from the donor, and attaches regardless of the fact that the identity of the donee may not then be known or ascertainable. In Commissioner v. Wemyss, 324 U.S. 303, 307 (1945), the Supreme Court said: “The section taxing as gifts transfers that are not made for ‘adequate and full (money) consideration’ aims to reach those transfers which are withdrawn from the donor’s estate.” The value discounts obtained by F on the transfer to FLP withdrew from his estate amounts that will (and are intended to) reappear in the hands of his heirs. Taxation of those amounts under section 2512 is appropriate.   I concur with the majority insofar as it decides that the value of the shares of Empak, Inc., transferred by decedent to WCB Holdings, LLC (WCB Holdings), is not included in the value of the gross estate (although I do not agree with the reasoning the majority uses to reach that result). I disagree with the majority that the value of the WCB Holdings membership units transferred to the Bongard Family Limited Partnership is included in that value.    I have not joined Judge Laro’s separate opinion because, in important particulars, I disagree with his stated views.    Sec. 2512(b) provides: SEC. 2512(b). Where property is transferred for less than an adequate and full consideration in money or money’s worth, then the amount by which the value of the property exceeded the value of the consideration shall be deemed a gift, and shall be included in computing the amount of gifts made during the calendar year.    As we have recently said: “The meaning of the phrase ‘in money or money’s worth’, when it follows ‘adequate and full consideration’, has been interpreted to confine the scope of ‘consideration’ to money or its equivalent; i.e., to exclude a mere promise or agreement as consideration.” Abeid v. Commissioner, 122 T.C. 404, 409 n.7 (2004); see also sec. 25.2512-8, Gift Tax Regs. (“A consideration not reducible to a value in money or money’s worth, as love and affection, promise of marriage, etc., is to be wholly disregarded [in determining adequate and full consideration], and the entire value of the property transferred constitutes the amount of the gift.”).    1 do not wish to suggest that proportionality (as discussed in the text) is determinative that a transaction is at arm’s length. Unless a gift motive is conceded or some secret knowledge is presumed, I am not persuaded that a rational person dealing at arm’s length would ever knowingly exchange assets worth $300 for an interest in an entity worth $200, with no right to control the entity or compel a distribution of her share of the entity’s assets.    As I see it, the addition of that separate test is not necessary here, since petitioner has not otherwise shown that the transfers satisfy the bona fide sale exception.    Two commentators on the family limited partnership scene add the following with respect to meaning of the “bona fide sale” portion of the bona fide sale exception: Treas. reg. section 20.2036-1 indicates that the exception applies where there is “adequate and full consideration.” It does not mention any requirement that the sale also be a bona fide one. It does, however, cross-reference Treas. reg. section 20.2043-l(a), which does appear to contemplate the need to satisfy two conditions for the exception to apply: that the sale be a bona fide one and that the consideration be adequate. Nonetheless, the latter regulation is not inconsistent with the traditional (Wheeler’s [Wheeler v. United States, 116 F.3d 749, 764 (5th Cir. 1997)]) understanding of the exception. Its use of the phrase “bona fide” is obviously designed to do nothing more than make certain that the consideration was actually supplied and not an illusory one. Indeed, the last sentence of the provision confirms this reading. It provides that, if the value at the time of death of the transferred asset to be included under section 2036 (or similar section) exceeds the consideration received by the decedent, only the excess is included in the gross estate. The failure to require that the sale be a bona fide one to qualify for treatment under this last sentence makes it clear that it was intended to embrace the traditional understanding of the exception. Gans & Blattmachr, “Strangi: A Critical Analysis and Planning Suggestions”, 100 Tax Notes 1153, 1162, n.78 (Sept. 1, 2003).    Judge Ruwe suggests a gift-on-formation analysis in his dissenting opinion in Estate of Strangi v. Commissioner, 115 T.C. 478, 496 (Ruwe, J., dissenting), affd. in part and revd. in part 293 F.3d 279 (5th Cir. 2002). The Estate of Strangi majority opinion, which I joined, rejects that possibility, at least on the facts presented, on the grounds that Mr. Strangi (the decedent) did not give up control of the assets he contributed to the family limited partnership (for a 99-percent limited partnership interest) and his contribution was allocated to his capital account: “Realistically, in this case, the disparity between the value of the assets in the hands of decedent and the alleged value of his partnership interest reflects on the credibility of the claimed discount applicable to the partnership interest. It does not reflect a taxable gift.” Id. at 490. Similarly, in Estate of Jones v. Commissioner, 116 T.C. 121, 128 (2001), we said: “All of the contributions of property were properly reflected in the capital accounts of decedent, and the value of the other partners’ interests was not enhanced by the contributions of decedent. Therefore, the contributions do not reflect taxable gifts.”    The hypothetical and some of the following analysis are suggested by Professor Leo L. Schmolka. Schmolka, “FLPs and GRATs: What to do?”, 86 Tax Notes 1473 (Special Supplement, Mar. 13, 2000).