Estate of Edna Korby v. Commissioner IR , 471 F.3d 848 ( 2006 )

United States Court of Appeals
FOR THE EIGHTH CIRCUIT
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No. 06-1201
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Estate of Edna Korby, deceased; *
Austin Korby, Jr., Trustee of the *
Austin and Edna Korby Living Trust; *
Estate of Edna Korby, deceased, *
Transferor; Austin Korby, Jr., Trustee *
of the Austin and Edna Korby Living *
Trust, Transferee, *
*
Appellants, *
*
v. *
*
Commissioner of Internal Revenue, *
*
Appellee. *
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Appeals from the
No. 06-1203 United States Tax Court.
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Estate of Austin Korby, deceased; *
Austin Korby, Jr., Trustee of the *
Austin and Edna Korby Living Trust; *
Estate of Austin Korby, deceased, *
Transferor; Austin Korby, Jr., Trustee *
of the Austin and Edna Korby Living *
Trust, Transferee, *
*
Appellants, *
*
v. *
Commissioner of Internal Revenue, *
*
Appellee. *
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Submitted: September 29, 2006
Filed: December 8, 2006
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Before ARNOLD, BYE, and MELLOY, Circuit Judges.
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BYE, Circuit Judge.
The estates of Edna and Austin Korby, along with the trustee of the Edna and
Austin Korby Living Trust (collectively the Korbys), appeal the tax court's1 decisions
finding estate tax due from both estates under 26 U.S.C. § 2036 on the grounds the
Korbys retained the right to income from property they transferred to a family limited
partnership prior to their deaths, and the transfer was not a bona fide sale for
consideration. We affirm.
I
Austin and Edna Korby married in 1948. During the course of their marriage,
Austin operated a bridge-building construction company. The couple accumulated a
modest estate which they desired to pass on to their four sons, Austin, Jr., Gary,
Donald, and Steven. In 1993, when Edna was sixty-eight and Austin seventy-nine
years old, they attended a free estate planning seminar and later met with the attorney
who conducted the seminar. The attorney helped the Korbys form a revocable living
trust and a family limited partnership as part of their estate planning. In June 1993,
1
The Honorable Joseph Robert Goeke, United States Tax Court.
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the Korbys placed in the living trust their family home, household furnishings, a
vacant lot, a money market account, bank accounts, and their monthly Social Security
income. In March 1994, the Korbys created the Korby Properties Limited Partnership
(KPLP). A year later, the Korbys transferred to KPLP stocks valued at $1,330,442,
state and municipal bonds valued at $449,378, and savings bonds valued at $71,043,
for a total transfer of $1,850,863. In return, the Korbys obtained a 98% limited
partnership interest from KPLP. In addition, the Korbys' living trust transferred to
KPLP a savings account worth $37,841, to bring the full funding of KPLP to
$1,888,704. In return, the living trust obtained a 2% general partnership interest from
KPLP.
In 1995, the Korbys gifted their 98% limited partnership interest in KPLP to
four irrevocable trusts created for their sons, with each son's trust receiving a 24.5%
KPLP limited partnership interest. The Korbys filed gift tax returns in 1995 claiming
a discount of 43.61% on the book value of each gift because the limited partnership
interests were minority interests, their transfer was restricted, and they lacked
management control. Thus, while each gift had a book value of $462,732.48, the gift
tax returns reported each gift as being worth $260,935.
Between 1995 and 1998 – the year both Korbys died – KPLP made several
distributions to the living trust as general partner, as well as a limited number of
distributions to the four sons' trusts as limited partners. KPLP made payments to the
Korbys' living trust totaling $120,795 ($30,387 in 1995, $19,334 in 1996, $32,324 in
1997, and $38,750 in 1998). The Korbys used these payments to help defray Edna's
nursing home costs of over $30,000 per year2 and pay the couple's taxes, medical bills,
and other expenses. The payments to the limited partners during the same period
2
Edna Korby began living in a nursing home in Pelican Lake, Minnesota, in
February 1993 when she was diagnosed with severe Alzheimer's dementia. She lived
there until she died on July 3, 1998.
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totaled $34,562 ($18,101 in 1996, $4,400 in 1997, and $12,061 in 1998), and were
intended to pay for the limited partners' income taxes.3
Edna Korby died on July 3, 1998; Austin Korby died on December 2, 1998.
Both estates filed tax returns on September 7, 1999. Edna's estate return listed a total
gross estate value of $73,398, listing as jointly owned property the couple's home, the
vacant lot, and a checking account. The return also listed half of the general
partnership interest in KPLP, or 1%. Austin's estate return reported the couple's home,
the vacant lot, the checking account, some personal property, and the full general
partnership interest in KPLP, or 2%, as owned by Austin at the time of his death.
Neither return included the value of the assets transferred to KPLP in 1995.
The Internal Revenue Service (IRS) issued notices of deficiency as to both their
estates on August 29, 2002, determining the full value of the KPLP assets includable
in the gross estates on the ground the Korbys retained for their lives "the possession
or enjoyment of, or the right to the income from, the property." 26 U.S.C. § 2036.
The notices of deficiency totaled $2,175,117 ($1,104,635 for Edna's estate, and
$1,070,482 for Austin's estate). The estates filed timely petitions for redetermination
of the deficiencies in the tax court.
As relevant to this appeal, the tax court decided three issues against the Korbys.
First, the tax court found the Korbys retained a right to the assets transferred to KPLP,
rejecting the claim that payments from KPLP to the living trust were "management
fees" for work performed as the partnership's general partner. The tax court found "an
implied agreement existed between Austin, on his own behalf and on behalf of Edna,
3
In June 1998, KPLP redeemed the savings bonds the Korbys had contributed
to it and received from the United States Treasury two checks for $43,638 each. One
of those two checks was deposited directly into the living trust, which in turn issued
a $10,000 check to each of the Korby sons. The living trust retained the remaining
$3,638, bringing the total amount KPLP distributed to the living trust to $124,433.
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and the four Korby sons that after the assets were transferred to KPLP, income from
the assets would continue to be available to Austin and Edna for as long as they
needed income." The tax court noted the lack of a written management contract
between the living trust and KPLP, as well as the fact KPLP made payments to the
living trust whenever Austin Korby requested them rather than by a set schedule. In
addition, Austin did not keep track of the hours he worked managing the partnership's
assets, nor did the payments to the living trust reflect a certain percentage of KPLP's
income or assets, which is commonly how management fees are calculated. The tax
court also noted Austin did not report the income the living trust received for his
services as self-employment income on his tax returns (although the 1998 income tax
return filed on behalf of Austin after his death did so).
Second, the tax court determined the transfer to KPLP did not satisfy the
§ 2036(a) exception for bona fide sales for adequate consideration. The Korbys
claimed KPLP was created to protect the family from commercial and personal
liability or from liability arising from divorce. The tax court examined the facts and
circumstances surrounding the formation of KPLP, such as Austin's involvement with
the help of an estate lawyer and without the assistance of the limited partners, and
found Austin "essentially stood on all sides of the partnership's formation." The tax
court further determined the Korbys had not shown the terms of the KPLP agreement
kept its assets beyond the reach of a limited partner's creditors. The tax court
concluded credit protection was not a significant reason for forming KPLP, and the
real reason for forming KPLP was tax avoidance.
Finally, the tax court rejected the estates' contention the Commissioner of
Internal Revenue admitted the Korbys lacked control over the KPLP assets. Edna's
estate sought a marital deduction under 26 U.S.C. § 2056, arguing Edna's rights to and
power over the KPLP assets passed to her husband at the time of her death under the
terms of the living trust. In opposing that contention, the Commissioner argued the
assets used to fund KPLP never passed through the living trust:
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The 98 percent [KPLP] limited interest was transferred to the decedent's
sons on January 1, 1995. Thus, it appears that the 98 percent [KPLP]
limited interest would not have passed from decedent to the surviving
spouse as required by section 2056 because petitioner has not established
that the limited partnership interest was part of the Trust corpus at
decedent's death. Moreover, under the terms of the Korby trust, the
surviving spouse has no right to the income or the corpus of 98 percent
of the property that decedent transferred to the [KPLP], nor does the
surviving spouse have a power of appointment over that property.
(Emphasis added).
The Korbys contended the statement in emphasis constituted a judicial
admission the Korbys lacked control over the assets transferred to KPLP, i.e., "[t]he
Government cannot prevail on the marital deduction issue due to the Decedents' lack
of control and prevail on the 2036 issue due to their simultaneous right to exercise
control."
The tax court concluded the Commissioner – simply by referring to the terms
of the living trust in the context of arguing the KPLP assets never passed through the
trust – did not admit the Korbys lacked control over the KPLP assets under § 2036.
Ultimately, in resolving the marital deduction claim, Edna's estate conceded the
deduction did not apply if only 38.26% of the KPLP assets were included in Edna's
gross estate. Based upon that concession, the tax court included just 38.26% of
KPLP's assets when calculating the deficiency against Edna's estate.
The tax court assessed deficiencies against both estates totaling $503,285
($124,135 for Edna's estate and $379,150 for Austin's estate). The Korbys filed timely
appeals of the tax court's decisions pursuant to 26 U.S.C. § 7482.
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II
We review tax court decisions in the same manner as we review civil bench
trials held by district courts, that is, conclusions of law are reviewed de novo and
findings of fact are upheld unless clearly erroneous. Black Hills Corp. v. Comm'r, 73
F.3d 799, 804 (8th Cir. 1996). In this case, the question whether the Korbys retained
a right to income from KPLP assets for purposes of § 2036 turns on the tax court's
determination that "an implied agreement existed between Austin, on his own behalf
and on behalf of Edna, and the four Korby sons that after the assets were transferred
to KPLP, income from the assets would continue to be available to Austin and Edna
for as long as they needed income." That finding is one of fact reviewed for clear
error. See, e.g., Strangi v. Comm'r, 417 F.3d 468, 476-77 (5th Cir. 2005). Similarly,
the question whether there was a bona fide sale for an adequate and full consideration
is one of fact reviewed for clear error. Id. at 479-80. Finally, determining whether a
particular statement constitutes a judicial admission is a question of law we review de
novo. See Rowe Int'l, Inc. v. J-B Enters., Inc., 647 F.2d 830, 836 (8th Cir. 1981)
(analyzing a statement to determine "whether it had sufficient formality or
conclusiveness to be considered a judicial admission.").
Section 2036 of the Internal Revenue Code provides in relevant part:
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 . . . by trust or otherwise, under which he has retained for his
life or for any period not ascertainable without reference to his death . .
. the possession or enjoyment of, or the right to the income from, the
property.
26 U.S.C. § 2036.
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We find no clear error in the tax court's determination that an implied agreement
existed between the Korbys and their four sons which allowed Austin and Edna to
retain the right to income from KPLP after its initial funding. As outlined above,
KPLP made significant payments to the Korbys' living trust over the remainder of
their lifetimes. The lack of a written management contract between the living trust
and KPLP, Austin's failure to keep track of the hours he spent managing KPLP, the
manner in which the payments were made, and Austin's failure to report the payments
as self-employment income, all support the tax court's rejection of the Korbys'
management-fee claim. In addition, the evidence considered by the tax court included
the fact the Korbys retained less than $10,000 in assets in the living trust (their only
source of income) following the funding of KPLP – despite the fact both of the
Korbys were in poor health and could expect to incur living expenses beyond amounts
their Social Security benefits would cover.
Several circuits have reviewed decisions from the tax court with similar facts
and concluded the tax court did not clearly err in finding a retained right of control.
See Strangi, 417 F.3d at 477-78 (upholding tax court's finding of an implied
agreement to retain possession and control where decedent transferred 98% of his
wealth to a family limited partnership (FLP) two months before his death, leaving
himself just $762 in liquid assets, and thereafter lived rent free in transferred house
and received nearly $34,000 from FLP to cover living expenses and over $100,000 to
cover funeral payments, estate administration expenses, specific bequests and various
personal debts); Abraham v. Comm'r, 408 F.3d 26, 39-40 (1st Cir. 2005) (upholding
tax court's finding of an implied agreement to retain control in similar FLP situation
where decedent's children and attorney managing the FLPs testified it was their
understanding the income from their FLPs would be available to pay their mother's
expenses first regardless of the children's ownership interests); Thompson v. Comm'r,
382 F.3d 367, 376 (3d Cir. 2004) (upholding tax court's finding of an implied
agreement to retain control where decedent transferred 95% of his assets to FLPs and
did not retain sufficient assets to support himself for the remainder of his life, and
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FLPs made significant cash distributions to the decedent in the three years prior to his
death). We agree with those decisions, and affirm the tax court's finding that the
Korbys retained for their lives the right to the income from the assets transferred to
KPLP.
We also find no clear error in the tax court's finding that the KPLP transfer did
not satisfy the § 2036(a) exception for bona fide sales for adequate consideration.
Section 2036 of the Internal Revenue Code contains an exception for excluding from
the gross estate transfers a decedent makes prior to his or her death if the transfer is
"a bona fide sale for an adequate and full consideration in money or money's worth."
26 U.S.C. § 2036(a). A transfer is typically not considered a bona fide sale when the
taxpayer stands on both sides of the transaction. See Estate of Bongard, 124 T.C. 95,
118 (2005). The transaction must "be made in good faith" which requires an
examination as to whether there was "some potential for benefit other than the
potential estate tax advantages that might result from holding assets in the partnership
form." Thompson, 382 F.3d at 383. "[I]f there is no discernable purpose or benefit
for the transfer other than estate tax savings, the sale is not 'bona fide' within the
meaning of § 2036." Id.; see also Strangi, 417 F.3d at 479 ("[A] sale is 'bona fide' if,
as an objective matter, it serves a 'substantial business [or] other non-tax' purpose."
(quoting Kimbell v. United States, 371 F.3d 257, 267 (5th Cir. 2004))).
Austin formed KPLP with the help of his estate lawyer and without the
involvement of his sons, who testified they were unfamiliar with the terms of the
KPLP agreement. Austin alone decided which assets would be included in funding
the partnership. As a consequence, the tax court found Austin "essentially stood on
all sides of the partnership's formation and approved the provisions of the KPLP
agreement without negotiation or input from the limited partners." The tax court also
rejected the Korbys' claim KPLP was created to protect the family from commercial
and personal injury liability arising from their bridge-building business, as well as
liability from divorce, stating "the estate has not shown that the terms of the KPLP
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agreement would prevent a creditor of a partner from obtaining that partner's KPLP
interest in an involuntary transfer." The tax court found "Austin and Edna formed
KPLP in order to make a testamentary transfer of their assets to their sons at a
discounted value while still having access to the income from those assets for their
lifetime." Based on the facts present in this case, we find no basis for concluding that
the tax court's factual determinations are clearly erroneous.
Finally, the Korbys contend the Commissioner, based upon statements made in
countering the claim for a marital deduction, judicially admitted the Korbys did not
retain an interest in the assets transferred to KPLP. We disagree. The Korbys do not
dispute the KPLP assets would have to transfer from Edna to Austin via the terms of
the living trust for Edna's estate to qualify for the marital deduction. The
Commissioner's statements made exactly that point, i.e., that the claim for a marital
deduction was based on the terms of the living trust. We do not read the
Commissioner's statements, outlining the terms of the living trust in that context, as
a judicial admission the Korbys retained no control over KPLP for purposes of §
2036. Throughout these proceedings, the Commissioner has always maintained that
both Edna and Austin retained an interest in the assets transferred to KPLP; such a
claim is not inconsistent with contending the interest did not pass from Edna to Austin
at the time of her death via the terms of the living trust.
III
For the reasons discussed, we affirm the tax court's decisions.
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