Estate of Robert E. Cartwright, Deceased, Dorothy G. Cartwright v. Commissioner of Internal Revenue , 183 F.3d 1034 ( 1999 )

Opinion by Judge SILVERMAN; Partial Concurrence and Partial Dissent by Judge THOMAS.

SILVERMAN, Circuit Judge:

At the time of his death in 1988, Robert E. Cartwright was the majority shareholder of the law firm of Cartwright, Slobodin, Bokelman, Borowsky, Wartnick, Moore & Harris, Inc. (“CSB”). When he died, the firm received life insurance proceeds of over five million dollars, which it paid to his estate under the terms of a shareholders’ agreement. In light of the language of the agreement, the tax court held that the proceeds constituted payment not only for Cartwright’s share of CSB stock, but also for any claims he might have had, in the words of the agreement, to the firm’s “cases or work in process.” As the latter portion would be “income in respect of a decedent,” the court determined that the estate owed a federal income tax deficiency of $1,105,762.

On appeal, Cartwright’s estate contends that the court erred in holding that the proceeds redeemed anything other than Cartwright’s stock in the firm. The estate also claims that the tax court failed to consider properly the effects of advanced client costs, work in process, and the life insurance proceeds in calculating the value of the stock. We remand to the tax court for a redetermination of the effects of advanced client costs and work in process on the stock value, but affirm the decision of the tax court in all other respects.

FACTUAL AND PROCEDURAL BACKGROUND

In 1969 Cartwright arid others incorporated CSB. Only CSB attorneys were shareholders. The firm distributed no dividends, but paid to each associate and shareholder a salary and distributed its profits as bonuses. CSB’s shareholders determined the amounts of the yearly bonuses based on each attorney’s contribution to the firm.

In a 1973 shareholders’ agreement, CSB addressed what would happen to the interest of a shareholder upon his death. The agreement provided that CSB would purchase the deceased shareholder’s interest in the firm and, in return, pay to the shareholder’s surviving spouse or estate the following amounts: (1) the shareholder’s actual purchase price for his CSB stock; (2) any earned but unpaid profits prior to death; (3) any earned but unpaid salary prior to death; (4) incurred but unreimbursed expenses or loans; (5) 25 percent of the net amount received after death for cases that the shareholder brought to CSB; (6) ten percent of the net amount received for cases pending at the date of death that came to the firm due to the firm name or the efforts of an associate; (7) 25 percent of the net amount received during the three years following the shareholder’s death from cases for clients that the shareholder brought to the firm who provide continuing legal business; and (8) one-half of any life insurance proceeds from policies on the shareholder’s life, to be applied toward the previous obligations.

In 1988 CSB amended the shareholders’ agreement only as it related to the disposition of Cartwright’s interest in the firm upon his death. The amendment recited that CSB had purchased two life insurance policies on Cartwright’s life totaling $5,000,000. Pursuant to the amendment, CSB, the beneficiary under the polices, would use the proceeds upon Cartwright’s death exclusively to purchase his interest in the firm. The precise language of the 1988 amendment, which is crucial to our decision, is as follows:

In the event of the death of Robert E. Cartwright, the proceeds of said policies payable to the Corporation will be exclusively used to purchase and acquire from the estate and heirs of RobeH E. CaHwright all of Mr. CaHwiight’s stock in the Corporation together with any claim to any cases or work in process that may otherwise be made on behalf of RobeH E. CaHwright. In this regard, the Corporation agrees to buy all of said stock and Robert E. Cartwright agrees to sell it. The value of said stock and claim in said cases and work in process is hereby fixed as the amount of proceeds of said life insurance policies. Any amounts owed to Mr. Cartwright for unpaid salary or expenses will be additionally paid or reimbursed to his Estate .... [emphasis added]

Cartwright died on June 30, 1988, the owner of 71.43 percent of the outstanding shares of CSB. As the shareholders had agreed, CSB paid the proceeds that it received from the two policies to Cartwright’s estate. The total amount was $5,062,029, which included $62,029 in premium adjustments and interest. CSB issued a Form 1099-MISC, stating that it had paid $4,080,256 to the estate as non-employee compensation. The estate, however, did not report the proceeds it received from CSB as taxable income in its fiduciary income tax return. Instead, it took the position that the full amount of the proceeds were paid to redeem Cartwright’s stock. The IRS disagreed, finding that $4,080,256 of the $5,062,029 was compensation and that the estate owed $1,142,472 for its tax deficiency.

Cartwright’s estate appealed to the tax court. The court held that the plain language of the 1988 amendment made clear that CSB’s payment of the insurance proceeds to Cartwright’s estate was for both Cartwright’s stock and for his claim to the firm’s cases or work in process. It found that the amendment valued the total of these items at $5,000,000.

The tax court also concluded that neither CSB’s work in process nor the insurance proceeds, which CSB paid directly to the estate, should have been considered an asset of CSB for purposes of valuing Cartwright’s stock. Similarly, the court determined that the IRS’s exclusion of advanced client costs in appraising CSB’s assets was proper. Finding that the value of Cartwright’s stock was $1,105,762, the court concluded that the other $3,956,267 of the payment to the estate was taxable as income in respect of a decedent.

DISCUSSION

We review decisions of the United States Tax Court on the same basis as decisions of a district court in a civil bench trial. Delk v. Commissioner of Internal Revenue, 113 F.3d 984, 986 (9th Cir.1997). Thus, we review the tax court’s interpretation of contract provisions de novo. Confederated Tribes of Siletz Indians v. Oregon, 143 F.3d 481, 484 (9th Cir.1998). We review its determination of the value of stock for clear error. Trust Servs. of Am., Inc. v. United States, 885 F.2d 561, 568 (9th Cir.1989).

I.

The first issue for decision is whether the payment to Cartwright’s estate was made solely to redeem Cartwright’s stock or whether it was for both Cartwright’s stock and his claim to the firm’s cases or work in process. The estate contends that extrinsic evidence established an intent merely to buy out Cartwright’s shares in the firm and that the 1988 amendment set the stock redemption value at $5,000,000. It argues that because the corporation, and not any individual shareholder, owns CSB’s cases and work in process, Cartwright could have no interest in these items other than in his capacity as a shareholder. The tax court held that both the language of the amendment and the surrounding circumstances evidenced an intent to purchase more than Cartwright’s shares.

We agree with the tax court. As the plain language of the 1988 amendment explicitly provides, CSB’s distribution of the insurance proceeds to Cartwright’s estate constituted payment for both “Mr. Cartwright’s stock together with any claim to any cases or work in process.” This unambiguous language reflects what Cartwright and his colleagues understood when drafting it-that Cartwright, at the time of his death, would have or might have an interest in the firm’s “cases or work in process” that the firm agreed to buy out. The uncontradicted evidence of the firm’s practices supports this conclusion as well. The primary component of Cartwright’s compensation was not his salary. It was his bonus, paid at the end of each year based on his contribution to the firm. As the firm’s majority shareholder, chairman of the board, and chief rainmaker, Cartwright, at the time of his death, had a reasonable expectation that he again would be voted a bonus for the cases that he had brought into the firm or had worked on himself.

The tax court correctly distinguished other cases in which payments made to a shareholder or his estate were held to redeem only the shareholder’s stock. In Smith v. Commissioner of Internal Revenue, 82 T.C. 705, 1984 WL 15567 (1984), the evidence demonstrated an intent to enter into a stock purchase agreement and that the $25,000 payment was equivalent to the fair market value of the stock. Similarly, in Steffen v. Commissioner of Internal Revenue, 69 T.C. 1049, 1978 WL 3394 (1978), the language of a corporate redemption agreement conclusively established that the $40,000 paid to a shareholder was solely for his stock and was not compensation. In Estate of Bette v. Commissioner of Internal Revenue, 36 T.C.M. (CCH) 1636 (1977), the tax court relied on the clear terms of a stock redemption agreement. Finally, Erickson v. Commissioner of Internal Revenue, 56 T.C. 1112, 1971 WL 2470 (1971), also involved an unambiguous agreement providing only for the purchase of stock. In the instant case, both the clear language of the 1988 amendment and the underlying facts compel the conclusion that the parties intended that CSB buy out more than just Cartwright’s shares of CSB stock. Any claims to work in process were included in the purchase price.¹

II.

Having determined that the insurance proceeds constituted payment for both Cartwright’s stock and his claim to cases or work in process, we must now decide whether the tax court correctly apportioned the payment between these two components. After hearing conflicting expert testimony from witnesses called by both parties, the court adopted the findings of the IRS’s expert, who relied, upon the 1973 agreement and its 1988 amendment in ascertaining the intent of the parties.

The estate argues that, even if the proceeds redeemed Cartwright’s stock plus his claim to cases or work in process, the court made three errors in its valuation of his stock: (1) it failed to consider the effect of CSB’s advanced client costs, (2) it ignored CSB’s work in process on its contingent fee cases, and (3) it should have included the insurance proceeds as a nonop-erating asset of CSB.

The estate is correct that the tax court should have included advanced client costs, which CSB maintained as a negative asset account, among the firm’s assets, because they properly are treated as loans. See Canelo v. Commissioner of Internal Revenue, 447 F.2d 484, 485 (9th Cir.1971). The tax court also should have included the firm’s work in process on contingent fee cases as an asset, since it would have influenced what a willing buyer would have paid for CSB stock. See Estate of James E. Curry v. Commissioner of Internal Revenue, 74 T.C. 540, 546-47, 1980 WL 4454 (1980).

The tax court did not err, however, by not including the life insurance proceeds as an asset of the firm for stock valuation purposes. It is true that in valuing stock, “consideration shall also be given to nonoperating assets, including proceeds of life insurance policies payable to or for the benefit of the company, to the extent such nonoperating assets have not been taken into account in the determination of net worth, prospective earning power and dividend-earning capacity.” 26 C.F.R. § 20.2031 — 2(f)(2). The court, however, properly determined that CSB’s insurance policy would not necessarily affect what a willing buyer would pay for the firm’s stock because it was offset dollar-for-dollar by CSB’s obligation to pay out the entirety of the policy benefits to Cartwright’s estate. See Estate of John L. Huntsman v. Commissioner of Internal Revenue, 66 T.C. 861, 875, 1976 WL 3635 (1976).

CONCLUSION

The tax court correctly determined that CSB’s payment of life insurance proceeds to Cartwright’s estate redeemed both Cartwright’s stock and his claim to the firm’s eases or work in process. The unambiguous language of the 1988 amendment and an understanding of CSB’s practices compel this conclusion. The court erred, however, in calculating what portion of the proceeds was for Cartwright’s stock and what portion was for his claim to cases or work in process. We remand to the tax court for a redetermination of the value of the stock to, take into account advanced client costs and work in process. We affirm in all other respects.

AFFIRMED IN PART AND REMANDED.

1 . Judge Thomas makes an argument — not contained in the briefs — that the law firm’s 1988 tax return somehow proves that Cartwright was compensated for his “cases or work in process’’ before he died and that therefore, by process of elimination, all of the insurance money paid to the estate is attributable to the purchase of the stock. We respectfully suggest that the tax return proves nothing of the sort. The return shows that in 1988, the firm deducted a total of $4,356,256 as compensation to Cartwright. As specifically reported in the return at an addendum to Schedule E, the firm attributed $4,080,256 of this amount to cases or work in process. This is the amount in controversy — the amount paid to the estate from the insurance proceeds and about which it issued a Form 1099-MISC to the estate. The remaining $276,000, reflected separately in a W-2 form, was nothing more than the salary that had been paid to Cartwright in 1988 before he died.