Estate of Samuel P. Black, Jr., Samuel P. Black, III v. Commissioner , 133 T.C. 340 ( 2009 )

133 T.C. No. 15UNITED STATES TAX COURT
ESTATE OF SAMUEL P. BLACK, JR., DECEASED, SAMUEL P. BLACK, III,
EXECUTOR, ET AL.,1 Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 23188-05, 23191-05, Filed December 14, 2009.
23516-06.
From 1927 until 1993, Mr. B was an employee,
officer, or director of E (an insurance company) and
was a major contributor to E’s success. In 1993, he,
his son, P, and trusts for P’s two sons contributed
their unencumbered E stock to BLP, a family limited
partnership, in exchange for partnership interests
proportionate to the fair market value of the E stock
each contributed. Mr. B’s advisers had explained the
estate tax advantages of placing his E stock in BLP,
but the transaction was initiated to implement Mr. B’s
buy-and-hold philosophy with respect to the family’s E
stock. Specifically, that transaction was a solution
to his concerns that (1) P’s wife and her parents (she
in connection with a possible divorce from P, they
because of their continual financial problems) would
require P to sell or pledge some of his E stock to
1
The 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.
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satisfy their monetary needs (P previously had pledged
125,000 E shares as collateral for a loan), and (2) his
grandsons would sell all or some of the E stock that
they would receive upon the termination of their
trusts. In 1993, P and the two trusts owned
approximately $12 million (of the B family’s
approximately $80 million) worth of E stock.
Mr. B’s estate plan established a pecuniary
marital trust for Mrs. B and a $20 million bequest to a
university endowment. Mr. B died in December 2001, and
Mrs. B, 5 months later, before there was time to fund
the marital trust, which P, as executor of both
estates, had intended to fund with a portion of Mr. B’s
estate’s interest in BLP. On Mrs. B’s estate’s Federal
estate tax return, P deemed the marital trust to be
funded as of the date of her death.
Because Mrs. B’s estate lacked sufficient liquid
assets to discharge its tax and other liabilities, P,
BLP’s managing partner, and E agreed to have BLP sell
some of its E stock in a secondary offering. That sale
raised $98 million, of which E lent to Mrs. B’s estate
$71 million. The interest on the loan was payable in a
lump sum on the purported due date, more than 4 years
from the date of the loan, and was deducted in full on
Mrs. B’s estate’s tax return under sec. 20.2053-
1(b)(3), Estate Tax Regs. Mrs. B’s estate used the
funds to discharge its Federal and State tax
liabilities, pay the $20 million bequest to the
university endowment, reimburse E’s costs, totaling
$980,625, in connection with the secondary offering,
and pay $1,155,000 each to P, as executor fees, and to
a law firm, as legal fees.
R determined that (1) the value of the E stock
apportionable to Mr. B’s partnership interest in BLP at his
death is includable in his gross estate under either sec.
2035(a) or 2036(a)(1) or (2), I.R.C., (2) the marital
deduction to which Mr. B’s estate is entitled under sec.
2056, I.R.C., is limited to the value of the partnership
interest in BLP that actually passed to the marital trust,
(3) the deemed funding date of the marital trust and, hence,
the size of the BLP interest includable in Mrs. B’s estate
under sec. 2044, I.R.C., is determined by reference to the
value of BLP on the date of Mr. B’s death, not on the date
of Mrs. B’s death when the value of BLP was higher and it
would require a smaller interest in BLP to fund the trust,
(4) the interest payable on the BLP loan to Mrs. B’s estate
is not a deductible administration expense under sec.
2053(a)(2), I.R.C., and (5) Mrs. B’s estate is not entitled
to deduct the $980,625 reimbursement of E’s secondary
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offering costs and is entitled to deduct only $500,000 of
P’s executor fee and $500,000 of the legal fees.
1. Held: Because Mr. B’s transfer of E stock to BLP
in exchange for a partnership interest therein constituted
“a bona fide sale for an adequate and full consideration in
money or money’s worth” within the meaning of sec. 2036(a),
I.R.C., the value of Mr. B’s gross estate does not include
the value of the transferred E stock apportionable to his
date-of-death interest in BLP.
2. Held, further, holding No. 1 renders R’s
second determination moot.
3. Held, further, the deemed funding date of the
marital trust is the date of Mrs. B’s death.
4. Held, further, the loan from BLP to Mrs. B’s
estate was not “necessarily incurred” within the
meaning of sec. 20.2053-3(a), Estate Tax Regs., and,
therefore, the interest thereon is not a deductible
administration expense under sec. 2053(a)(2), I.R.C.
5. Held, further, Mrs. B’s estate is entitled to
deduct $481,000 of its reimbursement of E’s secondary
offering costs, $577,500 for P’s executor fee, and
$577,500 for legal fees because only those amounts
correspond to expenditures or effort on behalf of Mrs.
B’s estate.
John W. Porter, J. Graham Kenney, Stephanie Loomis-Price,
and Jason S. Zarin, for petitioner.
Gerald A. Thorpe and Andrew M. Stroot, for respondent.
HALPERN, Judge: Respondent has issued four notices of
deficiency (the notices) to Samuel P. Black III (petitioner).
Two were issued to him in his capacity as executor of the estate
of Samuel P. Black, Jr. (Mr. Black’s estate and Mr. Black,
respectively), and two were issued to him in his capacity as
executor of the estate of Irene M. Black (Mrs. Black’s estate and
Mrs. Black, respectively). Two notices were with respect to
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Federal gift tax (one with respect to Mr. Black and one with
respect to Mrs. Black), each determining a deficiency in tax of
$147,623 for 2001 for gifts by Mr. Black that were treated for
Federal gift tax purposes as made one-half by each spouse. The
other two notices were with respect to Federal estate tax, one
determining a deficiency in tax of $129,166,964 for Mr. Black’s
estate, and the other determining a deficiency in tax of
$82,224,024 for Mrs. Black’s estate. Petitioner is the son of
Mr. and Mrs. Black.
After concessions (all of which relate to valuation issues
and issues resolved by the settlement of the valuation issues)
the issues for decision are (1) whether the fair market value of
stock that Mr. Black contributed to the Black Interests Limited
Partnership (Black LP) is includable in his gross estate pursuant
to section 20362 (the section 2036 issue); (2) if we decide that
the fair market value of the stock Mr. Black contributed to Black
LP, rather than the fair market value of Mr. Black’s interest in
Black LP, is includable in his gross estate under section 2036,
whether the marital deduction to which Mr. Black’s estate is
entitled under section 2056 should be computed according to the
value of the partnership interest that actually passed to Mrs.
Black or according to the value of the underlying stock
apportionable to that interest (the marital deduction issue); (3)
2
Unless 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.
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for purposes of determining the value of the marital trust
property includable in Mrs. Black’s gross estate under section
2044, whether the marital trust that Mr. Black established for
Mrs. Black’s benefit should be deemed funded on the date of his
death or on the date of her death (the date of funding issue);
(4) whether Mrs. Black’s estate may deduct, as an administrative
expense under section 2053(a)(2), $20,296,274 in interest on an
alleged loan from Black LP (the interest deductibility issue);
(5) whether Mrs. Black’s estate may deduct, as administrative
expenses under section 2053, the following fees or expense
reimbursements: (a) a $1,150,000 fee paid to petitioner for
services as the executor of Mrs. Black’s estate and trustee of
the marital trust, (b) a $1,150,000 fee paid to the law firm of
MacDonald, Illig, Jones & Britton LLP (MacDonald Illig), and (c)
$980,625 paid to Black LP as reimbursement for expenses incurred
in connection with a secondary offering of stock Black LP held
(together, the fee deductibility issues); (6) whether under
section 7491(a) respondent bears the burden of proof with respect
to all factual issues (the burden of proof issue). The notices
also contain certain other adjustments that are purely
computational. Their resolution depends on our resolution of the
issues in dispute.
FINDINGS OF FACT
Some facts are stipulated and are so found. The stipulation
of facts, with accompanying exhibits, is incorporated herein by
this reference.
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At the time the petitions were filed, petitioner resided in
Pennsylvania.
The Black Family
Mr. Black was born on April 2, 1902, and died, at the age of
99, on December 12, 2001. Mrs. Black was born on December 18,
1906, and died shortly after Mr. Black, on May 25, 2002. Mr. and
Mrs. Black were married in 1932 and remained married until Mr.
Black’s death. The Blacks were survived by their son
(petitioner) and grandsons (petitioner’s children), Samuel P.
Black IV (Samuel), and Christopher Black (Christopher), who were
33 and 31 years old, respectively, when Mrs. Black died.
Mr. Black’s History With Erie Indemnity Company
Mr. Black was born into poverty in Mercer County,
Pennsylvania. At age 11, he was selling bread on the street
corner and peddling newspapers door-to-door. At age 19, he began
work as an insurance adjuster at the Philadelphia Indemnity
Exchange, where he worked with H.O. Hirt and O.G. Crawford.
In 1925, H.O. Hirt and O.G. Crawford founded Erie Indemnity
Co. (Erie) and, in 1927, hired Mr. Black as Erie’s first full-
time claims manager. In 1925, Erie was a Pennsylvania automobile
insurance company; by the early 1990s, Erie had become a
multiline insurance company offering auto, home, commercial, and
life insurance in 11 States and the District of Columbia through
a network of independent insurance agents. Erie also managed the
Erie Insurance Exchange, a reciprocal insurer.
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Mr. Black was a large part of Erie’s success. Upon joining
Erie, Mr. Black installed an extension of the “home office”
telephone in his room at the YMCA across the street from Erie’s
office, making Erie one of the first insurance companies to offer
around-the-clock claims service. Mr. Black established Erie’s
underwriting department, where he drafted policies and
endorsements and filed documents to conform to State and Federal
laws. Mr. Black also recruited agents and managed sales
territories for Erie.
In 1930, Mr. Black became a member of the board of directors
of Erie. In 1962, when he was 60 years old, Mr. Black retired
from his position as senior vice president. After his retirement
from Erie, Mr. Black continued to serve on Erie’s board of
directors. In 1997, when he retired from the board of directors
(at the age of 95), Mr. Black had not missed a single board
meeting in 67 years. According to William F. Hirt, son of
founder H.O. Hirt, Mr. Black was “a major, major contributor to
the success of Erie.” In 1997, petitioner was elected to succeed
Mr. Black as a member of Erie’s board of directors.
Through the years, Mr. Black acquired in Erie both class B
voting stock and class A nonvoting stock. Mr. Black was very
bullish about the growth prospects for Erie stock, and he bought
it at every opportunity. By the 1960s, Mr. Black had become the
second largest Erie shareholder. Mr. Black was a conservative
investor who subscribed to the “buy and hold” investment
philosophy, particularly with regard to Erie stock.
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Upon his retirement from Erie, Mr. Black received permission
from Erie to form his own insurance agency, Samuel P. Black &
Associates, Inc., which became one of Erie’s independent
insurance agents. Although by 1992 petitioner had taken over
management of Samuel P. Black & Associates, Inc., Mr. Black was
actively involved in its operation until shortly before his death
in 2001.
Mr. Black’s Gifts of Erie Stock
On October 6, 1988, Mr. Black, as settlor, and petitioner,
as trustee, created two trusts, one for each of Mr. Black’s
grandsons, Samuel and Christopher (together, the grandson
trusts). Each grandson trust was funded with 10 shares of Erie
class A nonvoting stock.
In October 1988, December 1989, and December 1990, Mr. Black
gave 600 shares, 1,120 shares, and 804 shares, respectively, of
Erie class A nonvoting stock to petitioner. Also, in December
1989, December 1990, December 1992, and January 1993, Mr. Black
gave a total of 2,829 shares of Erie class A nonvoting stock,
through petitioner, to each of the grandson trusts.
Before 1988, Mr. Black had made other gifts of both Erie
class A nonvoting stock and Erie class B voting stock to
petitioner. Before 1993, petitioner had acquired Erie stock only
by gift from Mr. Black or through stock splits.
As of October 11, 1993, Mr. Black owned 2,425,752 shares of
Erie class A nonvoting stock and 400 shares of Erie class B
voting stock.
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Formation of Black Interests Limited Partnership
Between 1988 and 1993, when Mr. Black transferred Erie stock
to petitioner and created trusts that held Erie stock for his
grandsons, the stock split several times and substantially
increased in value. Mr. Black became concerned that his
grandsons (each of whom would be able to withdraw the trust
principal, one-half at age 25 and the balance at age 30, at which
point the grandson trusts would terminate) and petitioner would
either need to or want to sell some or all of their Erie stock.
His concern increased as the value of that stock increased.
Mr. Black’s fear that petitioner might dispose of some or
all of his Erie stock arose out of his concern (1) that
petitioner might default on a personal loan from PNC Bank for
which he had previously pledged 125,000 Erie shares as
collateral, and that he might need to satisfy his obligation with
that pledged stock, (2) over the status of petitioner’s marriage
to Karen Black, to whom he had been married since 1965, which Mr.
Black thought would not last much longer and which, if it ended
in divorce (as it did in 2004), might result in the transfer of
some of petitioner’s Erie stock to her,3 and (3) about Karen
Black’s father’s business and personal bankruptcies, which
resulted in her parents’ continuing need to obtain money from her
and petitioner, a need that could conceivably require the sale of
some of petitioner’s Erie stock.
3
Karen 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.
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Mr. Black’s fear that his grandsons might dispose of some or
all of the Erie stock that they would receive upon termination of
their trusts arose out of his concern (1) that, as of 1993,
although both Samuel and Christopher were over 20 years old,
neither held a job or was even looking for one, (2) that, in Mr.
Black’s view, both grandsons were too close to their mother, whom
Mr. Black considered to be lazy, and (3) that they were both
inexperienced financially and, therefore, might fall prey to
people anxious to have them invest their money.
Mr. Black was also concerned about a brewing split between
the two children of H.O. Hirt, William F. Hirt (Mr. Hirt) and
Susan Hirt Hagen (Ms. Hagen), each of whom was a trustee of one
of two trusts (created by H.O. Hirt) that, as of October 12,
1993, controlled 76.2 percent of Erie’s voting stock. The two
trusts shared a common institutional cotrustee. Under the terms
of the trusts, the voting stock both trusts held was to be voted
as a unit as directed by a majority of the three trustees.
In 1990, Ms. Hagen’s husband, Thomas B. Hagen (Mr. Hagen),
became Erie’s chief executive officer. By 1993, however, an
inappropriate relationship between Mr. Hagen and another senior
officer was disrupting business decisions and causing valuable
employees to resign. Ultimately, at a board meeting in September
1993, a majority of Erie’s directors voted to terminate Mr.
Hagen’s employment. Mr. Black disapproved of Mr. Hagen’s conduct
and of his management of Erie, and he approved of Mr. Hagen’s
dismissal. He foresaw the possibility that the growing
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antagonism between Mr. Hirt and Ms. Hagen might result in a split
of the H.O. Hirt trusts and that the Black family stock, which,
by 1993, represented 13 to 14 percent of the total voting and
nonvoting Erie stock, might represent the swing vote in favor of
the Hirt camp against the Hagen camp. That was another reason he
wanted to consolidate and retain the family’s Erie stock.
Mr. Black’s gifts of Erie stock to petitioner and to the
trusts for his grandsons were in some measure influenced by two
of his regular advisers: James D. Cullen (Mr. Cullen) of
MacDonald Illig, Mr. Black’s business and estate planning lawyer;
and Robert L. Wagner (Mr. Wagner), a certified public accountant
with Ernst & Young (E&Y), Mr. Black’s tax and financial adviser.
Beginning in 1988, Messrs. Cullen and Wagner regularly met with
Mr. Black and advised him to take advantage of his lifetime gift
tax exclusion by making gifts of Erie stock to family members
which, as described supra, he did. By the early 1990s, however,
Mr. Black was expressing to those two advisers his concerns over
the potential disposal of Erie stock by his grandsons and
petitioner. During a meeting with Messrs. Cullen and Wagner, the
latter offered to consult with one of his partners, Andy Painter
(Mr. Painter). In August 1992, Mr. Painter gave Mr. Wagner a
memorandum suggesting--and later himself met with Mr. Black to
suggest--a number of alternative, essentially tax planning,
vehicles for Mr. Black to consider, including a family limited
partnership, grantor retained interest trusts, and, to satisfy
Mr. Black’s desires with respect to charitable giving, an income
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or remainder charitable trust, or private foundation. Mr.
Painter’s memorandum refers to an article written by Stacy
Eastland (Mr. Eastland), at that time an attorney with the law
firm of Baker & Botts LLP, who specialized in estate planning.
Mr. Cullen spoke with Mr. Black about the article, which outlines
a number of nontax reasons for forming a family limited
partnership, including keeping family assets in the family,
reducing costs by consolidating family assets, protecting family
assets from future creditors, and protecting family assets from
divorce proceedings.
Ultimately, Mr. Black’s advisers recommended the formation
of a family limited partnership to satisfy his goals of (1)
consolidating and protecting the family’s Erie stock and (2)
minimizing the estate taxes that would be payable upon his death
and Mrs. Black’s death. Mr. Black followed their recommendation.
To that end, in October 1992 he retained Mr. Eastland to draft a
family limited partnership agreement.
On March 2, 1993, Mr. Eastland sent to Mr. Black a draft
partnership agreement for the creation of Black LP, and, on
October 12, 1993, Black LP was created as a Texas limited
partnership pursuant to the “Agreement and Articles of
Partnership of Black Interests Limited Partnership” (the
partnership agreement) executed on that date by the partners, Mr.
Black and petitioner, the latter both in his individual capacity
and as trustee of the grandson trusts. On October 12, 1993, a
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certificate of limited partnership for Black LP was filed with
the Texas secretary of state.
At the time of the formation of Black LP, Mr. Black, at age
91, was in good health. He was not suffering from any life-
threatening illness, and he maintained an active lifestyle. He
participated in the daily operations of Samuel P. Black &
Associates, Inc., was an active member of the Erie board of
directors, maintained a lively social schedule, remained an avid
golfer, and traveled to Florida several times a year.
Upon the formation of Black LP, Mr. Black contributed to it
all his Erie class A nonvoting stock (2,425,752 shares) and 390
of his 400 shares of Erie class B voting stock in exchange for
all the class A limited partnership interests, an 83.985-percent
class B limited partnership interest, and a 1-percent class B
general partnership interest; petitioner contributed to Black LP
444,446 shares of Erie class A nonvoting stock in exchange for a
0.5-percent class B general partnership interest and a 13.317-
percent class B limited partnership interest. In his capacity as
trustee of the grandson trusts, petitioner contributed 19,276
shares of Erie class A nonvoting stock on behalf of each trust in
exchange for two 0.599-percent class B limited partnership
interests. The only Black family Erie stock held out of Black LP
were the 125,000 shares that petitioner had pledged to PNC Bank
and 20 class B voting shares, of which Mr. Black and petitioner
each held 10 shares.
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Upon the formation of Black LP, each partner therein (Mr.
Black, petitioner, and the two trusts) received an interest in
the partnership proportionate to the fair market value of the
assets contributed.
Section 2.06 of the partnership agreement sets forth the
purposes of Black LP as follows:
Section 2.06. Purposes. The purposes of the
Partnership are the following:
(a) To consolidate the management of certain
properties owned directly and indirectly by the family
of Samuel P. Black, Jr.; to promote efficient and
economical management of the properties by holding them
in a single entity; to avoid the division of certain of
the properties of the family of Samuel P. Black, Jr. in
order to promote the greater sales potential of the
properties; to avoid potential expensive litigation and
disputes over certain of the properties of the family
of Samuel P. Black, Jr. by providing mechanisms which
will provide for management and procedures in Article
VIII and Section 11.01 to resolve disputes; to provide
mechanisms which will eliminate the potential in the
future of any member of the family transferring his or
her interest in the Partnership without first offering
that interest to the other family members;
(b) To engage generally in the insurance business,
to acquire, own, hold, develop and operate insurance
enterprises, either as operator, managing agent,
principal, agent, partner, stockholder, syndicate
member, associate, joint venturer, participant or
otherwise; to invest funds in, and to raise funds to be
invested in such business; to purchase, construct or
otherwise acquire and own, develop, operate, lease,
mortgage, pledge and to sell or otherwise dispose of
insurance enterprises, and other properties and any
interest therein; or to do any and all things necessary
or incident thereto;
(c) To acquire, invest, hold, own, develop,
operate mortgage, pledge, sell or otherwise dispose of
the stock of Erie Indemnity Company; to do any and all
things necessary or incident thereto;
(d) To manage and control investments in other
partnerships, businesses and entities, whether debt,
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equity, or otherwise; to hold, buy, sell, lease,
pledge, mortgage, and otherwise deal in or dispose of
those investments or similar interests;
(e) To invest in stocks, bonds, securities, and
other similar interests, including, without limitation,
purchasing, selling, and dealing in stocks, bonds,
notes, and evidences of indebtedness of any person,
firm, enterprise, corporation or association, domestic
or foreign and bonds and any other obligations of any
government, state or municipality, school district or
any political subdivision thereof, domestic or foreign,
and bills of exchange and commercial paper, and any and
all other securities of any kind, nature, or
description whatsoever, to invest in gold, silver,
grain, cotton and other commodities and provisions
usually dealt in or on exchanges, or upon the over-the-
counter-market; to form, organize, capitalize and
invest in, alone or jointly with others, and to sell or
otherwise dispose of the same to others, and to form
corporations, partnerships, joint ventures, limited
liability companies and other business entities, and in
general, without limitation of the foregoing, to
conduct such activities as are usual and customary in
connection with, stocks, bonds and securities and other
investments in corporations, partnerships, joint
ventures, limited liability companies and other
business entities;
(f) To transact or engage in any other business
that may be conducted in partnership form * * *
Management of Black LP was vested in the managing partner.
Mr. Black was the managing partner from formation until October
16, 1998, when he ceded to petitioner his 1-percent general
partnership interest and his responsibilities as a managing
partner.
The partnership agreement generally prohibits a general or
limited partner or the partner’s spouse (including a divorced
spouse) from transferring an interest in the partnership to
persons or entities unrelated to any of the partners without “the
written consent of the Partnership and all other Partners”. The
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partnership agreement grants to the partnership or the partners a
right of first refusal to purchase any partnership interest with
respect to any lifetime disposition, including involuntary
dispositions and dispositions incident to the divorce of a
partner, and any testamentary disposition upon the death of a
partner or the spouse of a partner.
The partnership agreement requires that the net cashflow of
the partnership (defined as the yearend excess of cash over
reasonable reserves for working capital and other cash
requirements) be distributed, at least annually, to each class B
and general partner, pro rata. It provides that, in any event,
there be distributed to the partners sufficient amounts to enable
the partners to discharge their income tax liabilities
attributable to their interests in the partnership. Except for
those distributions and distributions in liquidation, the
partnership agreement permits no distributions to partners until
termination and liquidation of the partnership. The partnership
agreement also generally provides for the pro rata allocation of
profits and losses to the class B general and limited partners.
The partnership agreement provides that, when Mr. Black is
not serving as managing partner, the managing partner is
prohibited, unless he obtains the prior written consent of a
majority of the limited partnership interests, from (1) making
any single investment or series of related investments during a
calendar year requiring a total capital commitment greater than
the lesser of 5 percent of the book value of the partnership
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assets or $2,500,000, (2) acquiring debt of any kind that would
result in the partnership’s having outstanding aggregate debt
equal to or greater than 10 percent of the book value of the
partnership assets, (3) agreeing or consenting to the sale,
lease, transfer, or other disposition (whether in one transaction
or a series of related transactions) of any partnership asset or
assets the value of which is equal to or greater than 5 percent
of the book value of the partnership assets, (4) disposing of all
or any portion of any partnership asset to a permitted assignee
(as the partnership agreement defines that term) where the value
of the asset, or the portion proposed to be disposed of, has a
book value in excess of $100,000.
The partnership agreement provides that no general or
limited partner shall have the right to withdraw from the
partnership before it dissolves and liquidates.
Lastly, the partnership agreement provides that it “may be
modified, terminated or waived only by a writing signed by the
party to be charged with such modification, termination or
waiver.”
Activities of the Partnership
According to Mr. Black’s wishes, Black LP retained all its
Erie stock from formation (in 1993) until after Mr. Black died
(in 2001). Indeed, upon becoming Black LP’s sole managing
partner in 1998, petitioner followed Mr. Black’s wishes despite
misgivings over Black LP’s continued retention of Erie stock.
Those misgivings arose out of his concern regarding the ongoing
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feud between the Hirts and the Hagens and the adverse effect that
feud might have on the company and the price of its stock.4
Nonetheless, between 1993 and 2001, the net asset value of Black
LP, consisting mostly of Erie stock, rose from approximately $80
million to more than $318 million.
During 1995 and 1996, Black LP purchased for $830,000
commercial condominium units in Erie, Pennsylvania, which it
leased in part to Samuel P. Black & Associates, Inc., and in part
to an independent insurance agency of which petitioner owned 65
percent and was president and treasurer. One or more of those
condominium units was later leased to Erie after Samuel P. Black
& Associates, Inc., moved out. In 1996, Black LP spent more than
$37,000 making leasehold improvements to those units. In 2001,
before Mr. Black’s death, Black LP paid $89,900 for another
commercial property in Erie, Pennsylvania, which, in 2002, it
leased to Samuel P. Black & Associates, Inc.
In February, April, and October 2000, Black LP paid $924,000
to purchase 4,400 shares (approximately 80 percent of the
outstanding stock) of Samuel P. Black & Associates, Inc.
Black LP’s cumulative income, from 1994 through 2001,
consisted of $27,835,476 attributable to Erie dividends and
$100,561 attributable to other income, consisting almost entirely
4
Because 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.
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of property rentals, and it made total distributions to partners
of $25,659,526, over $20 million (or approximately 80 percent) of
which was distributed to Mr. Black. That is, during that time,
Black LP distributed an amount equal to approximately 92 percent
of the Erie dividends it received.
Mr. Black’s Assignments of Partnership Interests
On October 16, 1998, Mr. Black assigned his 1-percent
general partnership interest in Black LP to petitioner.
Between 1993 and 2001, Mr. Black also made numerous gifts of
his class A and class B limited partnership interests in Black LP
to the Erie Community Foundation (which received his entire class
A limited partnership interest), petitioner, the grandson trusts,
his grandchildren individually (after their trusts terminated),
and five separate charitable trusts Mr. Black created.
Cumulatively, Mr. Black’s gifts of class B limited partnership
interests to family members (including the grandson trusts) and
private charities constituted 6.8974 percent of the total class B
limited partnership interest and reduced his initial 83.985-
percent class B limited partnership interest to a 77.0876-percent
interest.
On October 4, 1995, Mr. Black, as both settlor and trustee,
established the Samuel P. Black, Jr. Revocable Trust (the
original trust), whose terms he amended on March 20, 1998 (the
amended trust) (together, the revocable trust), and to which, on
August 27, 2001, he transferred his 77.0876-percent class B
limited partnership interest in Black LP. The transfer was made
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specifically subject to the partnership agreement “with respect
to the class B Limited Partnership Interest assigned hereby, and
the restrictions on transferability therein contained.”
The Revocable Trust
The original trust document provided for the payment of the
net income from the trust principal to Mr. Black (or for his
benefit) for his life, and for the distribution of the trust
estate, upon Mr. Black’s death, as he “shall appoint and direct *
* * in his last will and testament”, or, failing to so “appoint
and direct” (which, in fact, was the case), in the manner set
forth in the original trust. The original trust document also
provided for the creation of a marital trust for Mrs. Black as
follows:
If the Settlor’s wife, IRENE M. BLACK, survives
the Settlor, the Trustee shall hold IN TRUST, as the
Marital Trust under Section C below, a legacy equal to
the smallest amount, if any, needed to reduce the
federal estate tax liability of the Settlor’s estate to
zero or to the lowest possible figure. In calculating
this amount, the Trustee shall first take into account
the amount of all other property, which, for federal
estate tax purposes, is includable in the Settlor’s
gross estate and which passes or has passed in any
manner (other than by the terms of this paragraph) to
the Settlor’s wife in a form which qualifies for the
marital deduction. The Trustee shall also take into
account all other deductions and all credits against
the federal estate tax finally allowed to the Settlor’s
estate for federal estate tax purposes.
In making the computation necessary to determine
such amount the final determination in the federal
estate tax proceeding of the Settlor’s estate shall
control. This amount shall be satisfied only out of
assets that qualify for the marital deduction under the
provisions of the Internal Revenue Code applicable at
the time of the Settlor’s death or out of the proceeds
of such assets. Assets distributed in kind in
satisfaction of this amount shall be distributed at
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their market value on the date or dates of
distribution.
The residual trust property, not held in the marital trust or
otherwise distributed, was to go to petitioner, as was the after-
tax principal of the marital trust upon Mrs. Black’s death.
The amended trust document did not include the language in
the original trust providing for the disposition of marital trust
property to petitioner and instead substituted the following two
provisions:
If the Settlor’s wife, IRENE M. BLACK, survives
the Settlor, then the Trustee shall distribute to the
Settlor’s son, SAMUEL P. BLACK III, the sum of Twenty
Million Dollars ($20,000,000). Any part or portion of
this gift which the Settlor’s son, SAMUEL P. BLACK III,
disclaims shall be added to the “Samuel and Irene Black
Endowment” established by the Settlor with The
Pennsylvania State University for the purpose of
enhancing Penn State Erie, The Behrend College.
During his lifetime, the Settlor established an
endowment known as the “Samuel and Irene Black
Endowment” with the Pennsylvania State University for
the purpose of enhancing Penn State Erie, The Behrend
College. Following the death of the Settlor’s wife,
Irene M. Black, the Trustee shall distribute from the
principal of the Marital Trust that amount, if any,
which is needed to bring the funding level of the
Endowment to Twenty Million dollars ($20,000,000). In
determining the amount to be paid to the Endowment from
the Marital Trust, the Trustee shall subtract all
contributions made after 1995 by or on behalf of the
Settlor during his lifetime, the Settlor’s son, Samuel
P. Black III, and from the Settlor’s estate following
his death, including contributions from The Black
Family Foundation and contributions from The Samuel P.
Black Fund at the Erie Community Foundation. The
remaining principal of the Marital Trust shall be
distributed to the Settlor’s son, SAMUEL P. BLACK III,
if living, otherwise in accordance with Section D of
this Article I.
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The effect of those two provisions was to provide a maximum
bequest of $20 million to Penn State Erie, The Behrend College
(Penn State Erie).5
Mr. and Mrs. Black’s Nonpartnership Assets and Income
In 1993, at the time of the formation of Black LP, Mr. and
Mrs. Black owned assets, other than Mr. Black’s Erie stock, worth
more than $4 million. Beginning in 1994 (the first full taxable
year for Black LP) and for all years through 2001 (the year of
Mr. Black’s death), the Blacks received cumulative income from
sources other than Black LP of approximately $5,610,000, ranging
from a low of approximately $303,000 (in 1994) to a high of
approximately $2,228,000 (in 2001).6 Thus, both before and after
the formation of Black LP, the Blacks received annual income from
sources other than the Erie stock Mr. Black transferred to Black
LP that was more than sufficient to cover their personal living
expenses.
5
Both 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.
6
During 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.
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Administration of the Estates
Implementation of the Wills and the Revocable Trust
Both Mr. and Mrs. Black appointed petitioner executor of
their respective estates. In that capacity, he filed a Form 706,
United States Estate (and Generation-Skipping Transfer) Tax
Return, on behalf of each estate (Mr. Black’s Federal estate tax
return and Mrs. Black’s Federal estate tax return, respectively).
Mr. Black’s Federal estate tax return was filed on September 12,
2002, and Mrs. Black’s, on August 25, 2003.
Pursuant to Mr. Black’s will, his residuary estate
(everything other than his tangible personal property) was to be
distributed according to the terms of the revocable trust. Mrs.
Black bequeathed her residuary estate to petitioner. The
foregoing provisions resulted in petitioner’s receipt of (1) all
Mr. Black’s residuary estate not held in the marital trust and
(2) the principal of the marital trust that remained after
payment of the amount Mrs. Black’s estate owed because of “any
increase in taxes payable by her estate because of the inclusion
in her gross estate of all or any portion of * * * [the] Marital
Trust.” Petitioner did, however, disclaim the $20 million
specific bequest to him in the revocable trust. As a result,
that bequest, by its terms, went to Penn State Erie and rendered
inoperative the alternative method of providing $20 million to
Penn State Erie through the marital trust.
The short period between Mr. Black’s death, on December 12,
2001, and Mrs. Black’s death, on May 25, 2002, did not provide
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sufficient time to compute Mr. Black’s pecuniary bequest to the
marital trust provided for under the terms of the revocable
trust, and the marital trust was not funded as of the date of
Mrs. Black’s death. Moreover, because, pursuant to the terms of
the revocable trust, the marital trust terminated upon Mrs.
Black’s death, it was never funded. In his capacity as the
executor of Mrs. Black’s estate, petitioner deemed the marital
trust to be funded on the date of her death. In that same
capacity, petitioner also made an election on Mr. Black’s estate
tax return, under section 2056(b)(7), to treat the property
funding the marital trust as qualified terminable interest
property.7 He filed a statement with Mr. Black’s estate tax
return explaining that he, as (successor) trustee of the
revocable trust, intended to fund the marital trust with a
portion of the 77.0876-percent class B limited partnership
interest in Black LP that Mr. Black had assigned to the revocable
trust during his lifetime.
7
Sec. 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.
- 25 -
The parties have stipulated (and we so find) that (1) the
fair market value of a 77.0876-percent class B limited
partnership interest in Black LP was $165,476,495 on December 12,
2001 (the date of Mr. Black’s death), and (2) the fair market
value of a 1-percent class B limited partnership interest in
Black LP was $2,469,728 on May 25, 2002 (the date of Mrs. Black’s
death), and $2,281,124 on November 25, 2002 (the alternate
valuation date elected by Mrs. Black’s estate).
The Secondary Offering
Mr. Black’s estate reported a Federal estate tax liability
of approximately $1.7 million, which, on or about September 12,
2002, it paid with its cash assets. Mrs. Black’s estate lacked
sufficient liquid assets to pay what were anticipated to be
substantial Federal and State tax liabilities attributable to the
Black LP class B limited partnership interest that was to
constitute the principal of the marital trust.
In an attempt to borrow money to pay both tax liabilities
and administration expenses on behalf of Mrs. Black’s estate,
petitioner, as executor of the estate, first approached
commercial lending institutions, including PNC Bank, National
City Bank, Wachovia Bank, Credit Suisse, First Boston, Goldman
Sachs, and several local banks. None of those institutions would
accept the pledge of a partnership interest in Black LP as
security for a loan. Instead, each wanted Black LP to pledge its
Erie stock as security. In addition, they required “collaring”,
an agreement that the Erie shares would be sold if their value
- 26 -
fell below a certain price. Petitioner found those terms
unacceptable. He was particularly concerned that the Erie shares
would drop in price because of the discord among Erie’s board of
directors and that the “collaring” requirement might result in
the forced sale of the thinly traded Erie shares, which would
further depress their price.
Petitioner next turned to Erie for a loan, but Erie was not
interested in lending money to either the trust or the estate.
On July 29, 2002, Mr. Cullen sent a letter to Erie’s president
and chief executive officer describing Mrs. Black’s estate’s need
for cash and suggesting as one “liquidity solution” Erie’s
participation in a secondary offering of some of Black LP’s Erie
stock. Erie felt that a secondary offering would enhance Erie
shareholder value, and it agreed with Messrs. Cullen and Black to
participate in a secondary offering of about one-third of Black
LP’s Erie stock.
On January 29, 2003, Black LP sold 3 million shares of Erie
class A nonvoting stock in a secondary offering at $34.50 per
share.8 As a condition of Erie’s participation in the secondary
offering, Black LP agreed to pay Erie’s expenses incurred in
connection therewith, which included an underwriting discount of
$1.81 per share resulting in net proceeds to Black LP, before
8
At 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.
- 27 -
other expenses, of $32.69 per share, for a total of approximately
$98 million.
The Transfer of Funds From Black LP to Mrs. Black’s Estate
and The Revocable Trust
On October 11, 2002, in preparation for the secondary
offering and on behalf of Mrs. Black’s estate and the revocable
trust, petitioner entered into a “Loan Commitment Agreement” with
Black LP (the loan agreement) whereby Black LP (as “Lender”),
upon receipt of the proceeds from the secondary offering, agreed
to lend $71 million to Mrs. Black’s estate and the revocable
trust (as “Borrowers”) “with all interest and principal due in
full not earlier than November 30, 2007.” The borrowers agreed
to “reimburse the Lender” for all expenses it incurred in
connection with the secondary offering.
On February 25, 2003, Black LP transferred $71 million to
Mrs. Black’s estate and the revocable trust in exchange for a
promissory note for that amount executed by petitioner on behalf
of both. The note provided for 6 percent simple interest with
all principal and interest “due and payable not earlier than
November 30, 2007.”9 The note provided that the borrowers “shall
have no right to prepay principal or interest at any time.” The
note further provided for a “late charge” equal to 5 percent of
9
At 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.
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any payment “not received by the Lender within TEN (10) days
after the due date” (referred to as an “overdue payment”).
Also, on February 25, 2003, the parties to the loan
agreement executed a “Pledge Agreement” and an “Assignment of
Partnership Interest” whereby, as security for the $71 million
loan, Mrs. Black’s estate and the revocable trust pledged and
assigned their class B limited partnership interest in Black LP
to the lender, Black LP.
The interest due on November 30, 2007, was computed to be
$20,296,274 and was deducted, in full, on Schedule J, Funeral
Expenses and Expenses Incurred in Administering Property Subject
to Claims, of Mrs. Black’s estate tax return.
Mrs. Black’s Estate’s Use of the Funds Received From Black LP
Mrs. Black’s estate dispersed the $71 million it received
from Black LP (and an additional $309,946) as follows:
U.S. Treasury--Federal
estate tax payment $54,000,000
U.S. Treasury--Federal
estate tax refund (22,263,473) $31,736,527
Pennsylvania Department
of Revenue--inheritance
& estate taxes 15,700,000
Erie Insurance Co.
reimburse costs 982,070
Petitioner--executor fees 1,155,000
MacDonald Illig--legal fees 1,155,000
Gift to Penn State Erie 20,000,000
U.S. Treasury--fiduciary
income taxes 515,973
- 29 -
Pennsylvania Department of
Revenue--fiduciary
income taxes 65,376
Total 71,309,946
The $982,070 payment was to reimburse Black LP for its
reimbursement of Erie for Erie’s expenses in conjunction with the
secondary offering, including legal fees, the cost of filings
with the Securities and Exchange Commission, and some of the
costs incurred for meetings with investment firms. Mrs. Black’s
estate deducted that expenditure, in addition to the $1,155,000
payment to MacDonald Illig for legal services and the $1,155,000
paid to petitioner as executor and/or trustee fees, as
administration expenses.10
OPINION
I. The Burden of Proof Issue
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
10
Mr. Black’s estate did not claim any deduction for
administration expenses.
- 30 -
petitioner has “not introduced credible evidence with respect to
the material factual issues in this case as required by §
7491(a).”
We need not decide whether section 7491(a) applies to the
material factual issues in these consolidated cases because we
find that a preponderance of the evidence supports our resolution
of each of those issues. Therefore, resolution of those issues
does not depend on which party bears the burden of proof. See,
e.g., Estate of Bongard v. Commissioner, 124 T.C. 95, 111 (2005).
II. The Section 2036 Issue
A. General Principles
Section 2001(a) imposes a tax “on the transfer of the
taxable estate of every decedent who is a citizen or resident of
the United States.” Section 2051 defines the taxable estate as
“the value of the gross estate” less applicable deductions.
Section 2031(a) specifies that the gross estate comprises “all
property, real or personal, tangible or intangible, wherever
situated”, to the extent provided in sections 2033 through 2046.
Section 2033 broadly provides: “The value of the gross
estate shall include the value of all property to the extent of
the interest therein of the decedent at the time of his death.”
Sections 2034 through 2046 then explicitly mandate the inclusion
of several more narrowly defined classes of assets. Among those
specific sections is section 2036, which provides, in pertinent
part, as follows:
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SEC. 2036. TRANSFERS WITH RETAINED LIFE ESTATE.
(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.
Section 20.2036-1(c)(1)(i), Estate Tax Regs., further
explains: “An interest or right is treated as having been
retained or reserved if at the time of the transfer there was an
understanding, express or implied, that the interest or right
would later be conferred.”11
“The general purpose of * * * [section 2036] is ‘to include
in a decedent’s gross estate transfers that are essentially
testamentary’ in nature.” Ray v. United States, 762 F.2d 1361,
1362 (9th Cir. 1985) (quoting United States v. Estate of Grace,
395 U.S. 316, 320 (1969)). Accordingly, courts have emphasized
that the statute “describes a broad scheme of inclusion in the
gross estate, not limited by the form of the transaction, but
11
During 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.
- 32 -
concerned with all inter vivos transfers where outright
disposition of the property is delayed until the transferor’s
death.” Guynn v. United States, 437 F.2d 1148, 1150 (4th Cir.
1971).
Section 20.2036-1(a), Estate Tax Regs., refers to the
section 20.2043-1, Estate Tax Regs., definition of “a bona fide
sale for an adequate and full consideration in money or money’s
worth” (the parenthetical exception). In pertinent part, section
20.2043-1(a), Estate Tax Regs., provides: “To constitute a bona
fide sale for an adequate and full consideration in money or
money’s worth, the transfer must have been made in good faith,
and the price must have been an adequate and full equivalent
reducible to a money value.”
We must decide whether the Erie stock that Mr. Black
contributed to Black LP, rather than his partnership interest
therein, is includable in his gross estate under section 2036(a)
because (1) his transfer of that stock to Black LP did not
constitute a bona fide sale for an adequate and full
consideration and (2) he retained an interest in the transferred
stock within the meaning of section 2036(a)(1) or (2). We begin
by considering whether Mr. Black’s transfer of Erie stock to
Black LP was a bona fide sale for adequate and full
consideration. We find that it was.
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B. Mr. Black’s Transfer of Erie Stock to Black LP as a Bona
Fide Sale for Adequate and Full Consideration
1. Introduction
To avail himself of the parenthetical exception, petitioner
must show that the transfer was both (1) a bona fide sale and
(2) for adequate and full consideration. We consider each
requirement in turn.
2. Mr. Black’s Transfer of Erie Stock to Black LP as a
Bona Fide Sale of That Stock
a. General Principles
The Court of Appeals for the Third Circuit, to which an
appeal of these cases would lie, barring stipulation to the
contrary, see sec. 7482(b), has stated that, whereas a “bona fide
sale” does not necessarily require an “arm’s length transaction”,
the sale (which we understand to include an exchange) still must
be “made in good faith”, Estate of Thompson v. Commissioner, 382
F.3d 367, 383 (3d Cir. 2004) (citing section 20.2043-1(a), Estate
Tax Regs.), affg. T.C. Memo. 2002-246 (2002). The Court of
Appeals further stated that “A ‘good faith’ transfer to a family
limited partnership must provide the transferor some potential
for benefit other than the potential estate tax advantages that
might result from holding assets in the partnership form.” Id.The Court of Appeals was “mindful of the mischief that may arise
in the family estate planning context” but concluded that “such
mischief can be adequately monitored by heightened scrutiny of
intra-family transfers, and does not require a uniform
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prohibition on transfers to family limited partnerships.” Id. at
382.
The requirement that the transfer be in good faith--that is,
provide the transferor some potential for benefit other than
estate tax savings--is consistent with this Court’s requirement,
“[i]n the context of family limited partnerships”, that the
transferor have “a legitimate and significant nontax reason for
creating the family limited partnership”. See Estate of Bongard
v. Commissioner, 124 T.C. at 118. We further required that “The
objective evidence must indicate that the nontax reason was a
significant factor that motivated the partnership’s creation * *
*. A significant purpose must be an actual motivation, not a
theoretical justification.” Id. A finding that the transferor
sought to save estate taxes does not preclude a finding of a bona
fide sale so long as saving estate taxes is not the predominant
motive. Accord Estate of Mirowski v. Commissioner, T.C. Memo.
2008-74; see Estate of Schutt v. Commissioner, T.C. Memo. 2005-
126 (“Thus, the proffered evidence is insufficient to establish
that estate tax savings were decedent’s predominant reason for
forming Schutt I and II and to contradict the estate’s contention
that a true and significant motive for decedent’s creation of the
entities was to perpetuate his buy and hold investment
philosophy.”).
b. Arguments of the Parties
Petitioner argues that the “undisputed facts” show that the
formation of Black LP was motivated by “‘significant and
- 35 -
legitimate’ non-tax reasons.” He notes that Mr. Black’s primary
reasons for wanting to form Black LP were to provide centralized
long-term management and protection of the Black family’s
holdings in Erie stock, to preserve Mr. Black’s buy-and-hold
investment philosophy with respect to that stock, to pool the
family’s stock so that it could be voted as a block (thereby
giving the family the swing vote in the not unlikely event of a
split between the two H.O. Hirt trust shareholders), and to
protect the Erie stock from creditors and divorce. Petitioner
further argues that Black LP accomplished those goals as follows:
! Adherence to Mr. Black’s buy-and-hold investment
philosophy resulted in the growth of Black LP’s net
asset value from $80 million when the partnership
was formed in 1993 to over $315 million when Mr.
Black died in 2001;
! the partnership prevented petitioner from selling
or encumbering the $11 million of Erie stock he
contributed to the partnership;
! the Erie stock the grandson trusts contributed to
the partnership was not available for distribution
to Mr. Black’s grandsons when their trusts
terminated in 1995 and 2000;
! the Black family’s consolidated position allowed it
to maintain a seat on the Erie board of directors
through 2004, when, because he had lost confidence
- 36 -
in Erie, petitioner resigned from the board and
decided to sell all the partnership’s Erie stock;
! the partnership protected petitioner’s Erie stock
from equitable division in his divorce and reduced
the value of the marital estate that his wife was
entitled to receive.
Petitioner relies on the similarity of the facts here to the
facts in Estate of Schutt v. Commissioner, supra, in which we
found that the use of a family partnership to perpetuate the
decedent’s buy-and-hold investment strategy with respect to
publicly traded Dupont and Exxon stock, in the “unique
circumstances” of that case, constituted “a legitimate and
significant non-tax purpose” for the formation of the
partnership. Petitioner also cites other opinions for the
proposition that consolidating family assets and providing for
long-term centralized management of those assets are valid nontax
purposes for forming a family limited partnership. E.g., Kimbell
v. United States, 371 F.3d 257 (5th Cir. 2004); Estate of
Mirowski v. Commissioner, supra; Estate of Stone v. Commissioner,
T.C. Memo. 2003-309; Estate of Harrison v. Commissioner, T.C.
Memo. 1987-8. Morever, petitioner argues that all the nontax
reasons for forming Black LP were based on Mr. Black’s actual, as
opposed to theoretical, concerns.
Respondent rejects petitioner’s arguments. Respondent
acknowledges that Mr. Black subscribed to a buy-and-hold
investment philosophy, particularly with respect to Erie stock,
- 37 -
and that Black LP was formed to hold the Erie stock that he,
petitioner, and the grandson trusts previously held so that the
family would continue to control that stock. Respondent
disagrees, however, that the transfers of Erie stock to Black LP
were necessary to achieve that goal or that Mr. Black’s alleged
concerns over the potential disposition of Erie stock by
petitioner and the grandson trusts were significant factors in
his decision to form Black LP. In reaching those conclusions,
respondent purports to distinguish the caselaw on which
petitioner relies.12
12
With 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.
Certain of respondent’s arguments in support of his position
that Mr. Black did not make a bona fide sale of Erie stock to
Black LP, e.g., that Black LP did not have a functioning business
operation, that Black LP held only passive assets, and that
petitioner was not substantially involved in the formation of
Black LP, allege the absence of factors that were also absent in
Estate of Schutt, and, for that reason, are not persuasive in
distinguishing that case. Other of respondent’s arguments, e.g.,
that Mr. Black allegedly failed to retain sufficient assets
either to pay the estate and inheritance taxes that would be
incurred by his and Mrs. Black’s estates or to fund the $20
million endowment that he had established for Penn State
University, relate to the issue of whether Mr. Black retained an
interest in the Erie stock at the time of his death for purposes
of sec. 2036(a)(1). Therefore, they are inapposite to the bona
fide sale question.
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In the recent case of Estate of Jorgensen v. Commissioner,
T.C. Memo. 2009-66, we rejected the taxpayer’s argument that the
decedent’s “investment philosophy premised on buying and holding
individual stocks with an eye toward long-term growth and capital
preservation” was “a legitimate or significant nontax reason for
transferring the bulk of one’s assets to a partnership.” In
reaching that decision, we distinguished Estate of Schutt v.
Commissioner, T.C. Memo. 2005-126, on the ground that in that
case “[t]he decedent’s wife was the daughter of Eugene E. duPont,
and the decedent hoped to maintain ownership of the stock
traditionally held by the family including stock held by certain
trusts created for the benefit of his children and grandchildren
in the event those trusts terminated.” Estate of Jorgensen v.
Commissioner, supra n.10.
In Estate of Schutt we acknowledged that the Court of
Appeals for the Third Circuit, in Estate of Thompson v.
Commissioner, 382 F.3d at 380, “suggested that the mere holding
of an untraded portfolio of marketable securities weighs
negatively in the assessment of potential nontax benefits
available as a result of a transfer to a family entity.” We
stated that we agreed with that premise, “particularly in cases
where the securities are contributed almost exclusively by one
person”, citing Estate of Strangi v. Commissioner, T.C. Memo.
2003-145, and Estate of Harper v. Commissioner, T.C. Memo. 2002-
121. Nonetheless, we determined that the entities in question
- 39 -
had been formed for a legitimate and significant nontax purpose,
reasoning as follows:
In the unique circumstances of this case, however, a
key difference exists in that decedent’s primary
concern was in perpetuating his philosophy vis-a-vis
the stock of the * * * [trusts for his children and
grandchildren] in the event of a termination of one of
those trusts. Here, by contributing stock in the
Revocable Trust, decedent was able to achieve that aim
with respect to securities of the * * * trusts even
exceeding the value of his own contributions. In this
unusual scenario, we cannot blindly apply the same
analysis appropriate in cases implicating nothing more
than traditional investment management considerations.
To summarize, the record reflects that decedent’s
desire to prevent sale of core holdings in the * * *
trusts in the event of a distribution to beneficiaries
was real, was a significant factor in motivating the
creation of * * * [the entities at issue], was
appreciably advanced by formation of * * * [those
entities], and was unrelated to tax ramifications.
* * *
Respondent attempts to distinguish these cases from Estate
of Schutt v. Commissioner, supra, by arguing that, unlike the
decedent’s concerns in that case regarding the potential
dissipation of the family’s DuPont and Exxon stock, Mr. Black’s
concerns regarding the potential dissipation of the Erie stock
held by petitioner and the grandson trusts were either ill
founded (in the case of petitioner’s stock) or insignificant (in
the case of the grandson trusts’ stock).
c. Analysis
(1) Introduction
Between 1927, when Erie hired him to be its first claims
manager, and 1997, when petitioner succeeded him as a member of
the board of directors (a period covering almost his entire adult
- 40 -
life), Mr. Black was an employee, officer, and/or director of
Erie. His ties to Erie and his belief in its financial prospects
were easily the equal of the decedent’s ties to and belief in
DuPont and Exxon in Estate of Schutt v. Commissioner, supra.Respondent does not disagree that Mr. Black desired to
perpetuate the family’s Erie stock holdings and, given Mr.
Black’s longstanding relationship with Erie and his strong belief
in its favorable earnings prospects, that that was a legitimate
and significant desire on Mr. Black’s part. Respondent does
disagree, however, that that desire was either a significant or
legitimate motivation for the formation of Black LP.
Petitioner argues that Mr. Black formed Black LP as the best
means of implementing his buy-and-hold philosophy to protect his
family’s Erie stock. Protecting his family’s Erie stock was Mr.
Black’s principal nontax motivation, and that motivation arose
out of his concerns regarding the potential dissipation of (1)
petitioner’s unpledged Erie stock and (2) the grandson trusts’
Erie stock. Together, those two blocks of Erie stock were the
only Black-owned Erie stock that Mr. Black did not himself
control. We will address the legitimacy and significance of each
of those concerns.
(2) Petitioner’s Erie Stock
Respondent argues that there was no evidence in 1993, when
Black LP was formed, that petitioner intended to sell any of his
Erie stock. He further argues that, although Mr. Black may have
been unhappy with petitioner’s decision to pledge some of his
- 41 -
Erie stock as collateral for a loan, the record does not support
a finding that Mr. Black “lacked confidence in petitioner’s
ability to manage the family’s assets.” Respondent concludes
that, had Mr. Black harbored any significant concerns about
petitioner’s commitment to perpetuate his buy-and-hold investment
philosophy regarding the continued retention of the family’s Erie
stock, he would not have transferred his managing partner
interest to petitioner in 1998 or arranged for petitioner to
succeed to his and the marital trust’s limited partnership
interests when both he and Mrs. Black had died. Respondent’s
arguments overlook petitioner’s main point, which is that,
although Mr. Black may have been satisfied that petitioner shared
his goal of retaining the family’s existing investment in Erie
stock, he feared that petitioner’s relationship with his wife and
in-laws might require him, against his better judgment or, even,
against his will, to dispose of or, alternatively, to pledge as
collateral for a new loan additional Erie stock. In particular,
Mr. Black worried that petitioner’s marriage would end in a
contentious divorce and about his father-in-law’s present and
continuing need for financial support.
Petitioner’s position is supported by the undisputed
testimony of Mr. Cullen, Mr. Black’s business and estate planning
lawyer. Respondent argues that any doubts Mr. Black may have had
concerning the status of petitioner’s marriage were speculative
or theoretical and not based on fact. As respondent states, at
the time of the formation of Black LP in 1993, petitioner had
- 42 -
been married for 28 years, and Mr. Black did not learn of
petitioner’s marriage difficulties and impending divorce until
1998. As respondent suggests, Mr. Black’s concerns were likely
based on his negative opinion of both Karen Black and her
parents. Respondent does not suggest, however, that the facts on
which that negative opinion was based were not true. And
respondent does not cast significant doubt on Mr. Cullen’s
testimony that Mr. Black did, in fact, harbor concerns that
petitioner might be pressured into selling or pledging additional
Erie stock to raise money for Karen Black or her parents.
Moreover, respondent argues that petitioner shared his father’s
buy-and-hold philosophy with respect to the family’s Erie stock.
Yet that suggests that the previous borrowing secured by 125,000
Erie shares was at the request of Karen Black and her parents,
which lends credence to Mr. Black’s concerns. We also note that
Mr. Black’s fears that petitioner’s marriage would not last
proved to be prophetic as divorce proceedings began 7 years later
and concluded with a divorce 4 years after that.
Respondent also argues that, even if Mr. Black was, in fact,
concerned about protecting petitioner’s Erie stock in the event
of divorce, putting the stock in Black LP did not enhance the
protections already available under State law, citing 23 Pa.
Cons. Stat. sec. 3501(a)(3) (1990). Pursuant to that provision,
“[p]roperty acquired by gift, except between spouses, bequest,
devise or descent” does not constitute “marital property” subject
to equitable division between divorcing spouses except to the
- 43 -
extent of the increase in the value of such property “prior to
the date of final separation”. Respondent argues that that
provision afforded the same protection against Karen Black’s
potential acquisition of the Erie stock that Mr. Black
transferred by gift to petitioner (which includes all
petitioner’s Erie stock) as did the transfer of that stock to
Black LP. Respondent makes the same argument with respect to the
Erie stock that petitioner stood to inherit upon Mrs. Black’s
death.
Respondent’s argument overlooks the fact that, even though
petitioner’s Erie stock was nonmarital property exempt (except to
the extent of some marital period appreciation) from equitable
division under Pennsylvania law, that stock might nonetheless
constitute the only significant asset available, as a practical
matter, to fund whatever award might have been made to Karen
Black under a divorce decree or marital settlement agreement.
That point was acknowledged by respondent’s counsel during his
cross-examination of Mr. Cullen:
Q (by respondent’s counsel): Okay. I guess what
I’m saying is does it matter? If the Erie stock is
inherited, it’s not marital property. The spouse can’t
reach it. If it’s partnership units that are
inherited, that’s also nonmarital property, so maybe
we’re talking about the same thing, the advantage
supposedly of the partnership interest is a valuation
question of discounted appreciation, if you will,
versus the full value of the appreciation?
A: But I’m afraid that your question might assume
that once you calculate the marital estate, and you
look at the Erie stock, that she only gets the
appreciation. One of the things that could be awarded
to her as part of her number is the Erie stock. Do you
follow me?
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Q: I don’t because if it’s nonmarital property,
how can it be awarded to her?
THE COURT: She’s due a sum of money,
and they can fund it with anything they
choose?
MR. THORPE: Yes.
THE WITNESS: Yes, sir.
MR. THORPE: That’s my point, too.
THE WITNESS: But the partnership
prevented it from being funded with Erie
stock.
The point is also illustrated by the 2005 Marital Settlement
Agreement between petitioner and Karen Black, pursuant to which
she was awarded the 125,000 Erie shares that, previously, had
been pledged as security for a loan. Conversely, Karen Black did
not receive any portion of petitioner’s interest in Black LP,
which lends credence to Mr. Black’s belief that the transfer of
petitioner’s unpledged Erie stock to a family partnership would
help to protect it from Karen Black’s property claims incident to
any divorce. Therefore, we conclude that Mr. Black reasonably
believed that the transfer of Erie stock to Black LP would
protect it from the claims of potential creditors, including
Karen Black. See Kimbell v. United States, 371 F.3d 257, 268
(5th Cir. 2004); Keller v. United States, __ F. Supp. 2d __, 104
AFTR 2d 2009-615, 2009-2 USTC par. 60,579 (S.D. Tex. 2009).
(3) The Grandson Trusts’ Erie Stock
Respondent argues that the potential dissipation of the Erie
stock that Mr. Black transferred to the grandson trusts between
October 1988 and January 1993 could not have been a significant
- 45 -
factor in Mr. Black’s decision to form Black LP because (1) those
transfers began less than 4 years before the decision to form
Black LP and continued to occur even after that decision,
suggesting Mr. Black’s lack of concern that his grandsons might
dispose of the stock upon vesting, and (2) the Erie stock in
those trusts represented an “insignificant portion”
(approximately 1.2 percent) of the family’s holdings.
The fact that Mr. Black transferred Erie stock to the
grandson trusts shortly before and even after the decision to
form Black LP is not necessarily inconsistent with the undisputed
testimony of Mr. Cullen and petitioner that Mr. Black was
concerned that his grandsons would dispose of or borrow against
the security of their Erie stock upon the termination of the
trusts. In October 1988, when Mr. Black began funding the trusts
with Erie stock, that stock was worth a fraction of its worth in
1992 and 1993, when Mr. Black made the decision to form Black LP.
Also, at that time his grandsons were both less than 20 years
old. Those facts suggest that the earlier transfers, between
October 1988 and December 1990, did not concern Mr. Black because
the value of the Erie stock transferred to the grandson trusts
was relatively low, the number of Erie shares was small, and his
grandsons had not reached an age at which their lack of ambition
was important. Two years later, when the Erie stock had
appreciated substantially and his grandsons’ lack of ambition and
financial responsibility persisted, Mr. Black transferred the
trusts’ Erie stock to a family partnership to keep it from his
- 46 -
grandsons. That decision seems reasonable. Moreover, Mr.
Black’s additional transfers to the grandson trusts in December
1992 and January 1993 were not inconsistent with his concerns
regarding his grandsons because, we presume, he and petitioner
had already decided to transfer the corpus of each of those
trusts to the soon-to-be-formed family partnership.
In Estate of Schutt v. Commissioner, T.C. Memo. 2005-126, we
found that the decedent’s desire to prevent his grandchildren
from selling DuPont and Exxon stock was a legitimate and
significant nontax purpose for the creation of the entities at
issue in that case. Respondent argues that Estate of Schutt is
distinguishable in that the children’s trusts in that case
controlled DuPont and Exxon stock worth approximately $50 million
(which exceeded the value of DuPont and Exxon stock that Mr.
Schutt himself contributed to the entities at issue), an amount
representing “a substantial portion of the Schutt family’s
wealth.” Respondent notes that, in contrast, “the stock held by
Mr. Black’s grandsons’ trusts was, at the time of the
Partnership’s formation, relatively insignificant both in terms
of its value ($963,800) and as a percentage (approximately 1%) of
the Black family wealth.” Respondent further notes that, in
Estate of Schutt, there was a history of stock sales by
grandchildren that is absent in these cases, which is to say, Mr.
Black’s concerns, unlike Mr. Schutt’s, were purely speculative.
We do not agree that Mr. Black’s concerns regarding his
grandsons were speculative or, in the language of this Court in
- 47 -
Estate of Bongard v. Commissioner, 124 T.C. at 118, a
“theoretical justification” rather than an “actual motivation”.
We find that Mr. Black’s concerns regarding his grandsons’
potential dissipation of all or some the Erie stock they would
receive upon the partial and full termination of their trusts was
reasonable given their unwillingness to seek employment and their
financial inexperience, and that those concerns motivated Mr.
Black to transfer the Erie stock in those trusts to Black LP.
We agree that the Erie class A nonvoting stock in the
grandson trusts, by itself, was, as respondent argues,
“relatively insignificant” as a percentage of the value of the
family’s Erie stock. But to focus on that stock in isolation is
improper. Mr. Black was concerned about the potential
dissipation of both that stock and petitioner’s stock, which,
together, represented more than 16.6 percent of the family’s Erie
class A nonvoting stock and, in 1993, had a value of more than
$12 million. Although the value of that Erie stock is not nearly
as great as the value of the grandchildren trust stock in Estate
of Schutt v. Commissioner, supra, it is nonetheless substantial,
and we find that Mr. Black’s concern regarding the potential
dissipation of all or some of that stock was significant as well
as legitimate.
Therefore, we agree with petitioner that these cases, like
Estate of Schutt, present a set of unique circumstances that, on
balance, require a finding that Black LP was formed for a
- 48 -
legitimate and significant nontax purpose; i.e., to perpetuate
the holding of Erie stock by the Black family.13
d. Conclusion
Mr. Black’s transfer of Erie stock to Black LP constituted a
bona fide sale of that stock.
3. Mr. Black’s Sale of Erie Stock to Black LP as a
Sale for Adequate and Full Consideration in Money
or Money’s Worth
a. Analysis
In Estate of Bongard v. Commissioner, 124 T.C. at 118, we
held that the second prong of the two-part test for finding a
bona fide sale for adequate and full consideration is met if “the
transferors received partnership interests proportionate to the
value of the property transferred.” The parties have stipulated
(and we have found) that each partner in Black LP “received an
interest in the Partnership proportionate to the fair market
value of the assets contributed.” Relying on that stipulation,
petitioner concludes: “Thus, the ‘adequate and full
consideration’ prong has been satisfied.”
After noting petitioner’s suggestion that “the test for the
‘bona fide sale exception’ adopted by this Court in * * * [Estate
of Bongard v. Commissioner, 124 T.C. 95 (2005),] is the same as
13
Assuming 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.
- 49 -
the test set forth by the Third Circuit in Estate of Thompson v.
Commissioner, 382 F.3d 367 (3d Cir. 2004)”, respondent states:
“Petitioners misapprehend the Estate of Bongard test.”
Respondent then argues that, under Estate of Bongard, “in the
absence of a tax-independent purpose, the receipt of
proportionate partnership interests does not constitute the
receipt of any consideration, but is, rather, a mere recycling of
value.” Respondent then quotes Estate of Thompson v.
Commissioner, 382 F.3d at 381:
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).
Respondent concludes as follows:
Each of these courts is saying essentially the
same thing, that the receipt of a proportionate
interest in an entity that is imbued with a tax-
independent purpose does not deplete the gross estate.
Stated another way, receipt of a proportionate interest
is necessary, but not sufficient, to constitute
adequate consideration. In the absence of a tax-
independent purpose, the interest constitutes no
consideration. Indeed, that is exactly what the
Bongard court found with regard to the partnership
interests received in exchange for the LLC interests.
124 T.C. at 129.
Here, * * * the record establishes that the
Partnership did not operate a legitimate business and
that the sole purpose for converting Mr. Black’s liquid
interest in his Erie stock into an illiquid interest in
the Partnership was to obtain valuation discounts for
gift and estate tax purposes. Consequently,
petitioners have not established that the transfer
satisfies the “adequate and full consideration” prong
of the “bona fide sale exception.”
- 50 -
Thus, respondent argues that the adequate and full
consideration prong depends on the legitimate and significant
nontax purpose prong. Of perhaps greater significance to these
cases, which, as noted supra, if appealed, are likely to be
appealed to the Court of Appeals for the Third Circuit, is
respondent’s argument that his analysis reflects the position of
both that court, as set forth in Estate of Thompson v.
Commissioner, supra, and this Court, as set forth in Estate of
Bongard v. Commissioner, supra.We have determined that Mr. Black had a legitimate and
significant nontax purpose for his transfer of Erie stock to
Black LP. Because respondent stipulated that the Black LP
partners received partnership interests proportionate to the
value of the Erie stock they transferred, he has, in effect,
conceded that Mr. Black satisfied the adequate and full
consideration prong, and we so find.
Our determination herein is consistent with our decision in
Estate of Schutt v. Commissioner, T.C. Memo. 2005-126, which was
also appealable to the Court of Appeals for the Third Circuit.
In that case, we observed that, in Estate of Bongard v.
Commissioner, 124 T.C. at 124, the presence of the following four
factors supported a finding that the adequate and full
consideration requirement had been satisfied: (1) The
participants in the entity at issue received interests
proportionate to the value of the property each contributed to
the entity; (2) the respective contributed assets were properly
- 51 -
credited to the transferors’ capital accounts; (3) distributions
required negative adjustments to distributee capital accounts;
and (4) there was a legitimate and significant nontax reason for
formation of the entity.
In these cases, respondent has conceded that the first
factor is present, and we have determined that the fourth factor
is present. The Black LP partnership returns filed for 1994 and
subsequent years demonstrate that the second and third factors
are present, too.
In Estate of Schutt v. Commissioner, supra, like respondent
in this case, we viewed the position of the Court of Appeals for
the Third Circuit in Estate of Thompson v. Commissioner, 382 F.3d
367 (3d Cir. 2004), as being consistent with our position in
Estate of Bongard v. Commissioner, 124 T.C. 95 (2005), commenting
as follows:
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.
The family limited partnership in Estate of Bongard, like
Black LP, did not conduct an active trade or business. In Estate
of Bongard, the legitimate and significant nontax purpose for the
transfer of operating company stock to the partnership was “to
- 52 -
facilitate a corporate liquidity event” for the operating
company. Therefore, we conclude that, by treating Estate of
Bongard and Estate of Thompson as consistent with respect to
their application of the parenthetical exception, respondent
concedes, and, as demonstrated by our opinion in Estate of
Schutt, this Court agrees, that a family limited partnership that
does not conduct an active trade or business may nonetheless be
formed for a legitimate and significant nontax reason.14 In
Estate of Thompson v. Commissioner, 382 F.3d at 383, the Court of
Appeals stated:15
14
That 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:
THE COURT: But this wasn’t a business that was
put into the --
MR. THORPE: Yes. Right. Well, let me rephrase
our position. I don’t think our position is so
restricted to say that under the * * * [Bongard] test,
it has to be strictly a business purpose. I mean,
certainly I think * * * [Bongard] would indicate that
it could be some significant, legitimate, nontax
purpose. That’s pretty broad.
THE COURT: Okay. So would avoiding a family
dispute suffice for the first prong of the * * *
[Bongard] test?
MR. THORPE: Yes. If it’s significant and
legitimate * * *
15
Judge 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”
(continued...)
- 53 -
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.]
b. Conclusion
Mr. Black’s transfer of Erie stock to Black LP was made for
adequate and full consideration.
C. Application of Section 2036(1) and (2)
Because we have concluded that Mr. Black’s transfer of Erie
stock to Black LP constituted a bona fide sale for adequate and
full consideration for purposes of section 2036(a), the fair
market value of that stock is not includable in Mr. Black’s gross
15
(...continued)
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:
This * * * point is important because courts
should not apply section 2036(a) in a way that will
impede the socially important goal of encouraging
accumulation of capital for commercial enterprises.
Therefore in an ordinary commercial context there
should not be a recapture under section 2036(a) and
thus the value of the estate’s interest in the entity,
though less than the value of a pro rata portion of the
entity’s assets, will be determinative for estate tax
purposes. * * * [Id. at 386; emphasis supplied.]
The third judge on the panel joined Judge Greenberg’s
concurring opinion. In the absence of respondent’s reliance on
(or even discussion of) the concurring opinion in Estate of
Thompson, we do not opine as to its impact, if any, on these
cases.
- 54 -
estate under either section 2036(a)(1) or (2), and we need not
further consider the application of either of those provisions.
D. Conclusion
The fair market value of Mr. Black’s partnership interest in
Black LP, rather than the fair market value of the Erie stock
that he contributed thereto, is includable in his gross estate.
III. The Marital Deduction Issue
Because we have decided that the fair market value of Mr.
Black’s partnership interest in Black LP, rather than the fair
market value of the Erie stock that he contributed thereto, is
includable in his gross estate, the marital deduction to which
Mr. Black’s estate is entitled under section 2056 must be
computed according to the value of the partnership interest that
actually passed to Mrs. Black, not according to the underlying
Erie stock apportionable to that interest. Therefore, the
marital deduction issue is moot.
IV. The Date of Funding Issue
A. The Arguments of the Parties
As found supra, petitioner, in his capacity as trustee of
the revocable trust, decided to fund the marital trust with a
portion of the 77.0876-percent class B limited partnership
interest in Black LP that Mr. Black had assigned to the revocable
trust. Pursuant to the terms of the revocable trust, assets
distributed in kind to fund the marital trust were required to be
distributed “at their market value on the date or dates of
distribution.” Mrs. Black died before the amount of the
- 55 -
pecuniary bequest could be determined and the marital trust
funded, and, because the trust was to terminate upon Mrs. Black’s
death, it was never actually funded. To deem the trust to have
been funded was necessary, however, to determine the amount
includable in Mrs. Black’s gross estate under section
2044(b)(1)(A). That section requires that her gross estate
include the value of all property with respect to which Mr.
Black’s estate was entitled to a marital deduction under section
2056(b)(7).16 Petitioner selected the date of her death as the
deemed date of funding.
The parties have stipulated that the fair market value of a
1-percent class B limited partnership interest in Black LP was
$2,146,603, on December 12, 2001 (the date of Mr. Black’s death),
and $2,469,728 on May 25, 2002 (the date of Mrs. Black’s death).
If the marital trust is deemed to have been funded on the date of
Mr. Black’s death, the number of class B limited partnership
units needed to fund the pecuniary bequest to that trust will be
greater than the number of such units needed to fund that bequest
on the date of Mrs. Black’s death. In that event, the fair
market value of the marital trust on the date of Mrs. Black’s
death and, therefore, the amount includable in her gross estate
under section 2044(b)(1)(A) will be greater than if the marital
trust is deemed to have been funded with the lesser number of
class B limited partnership units determined by the value of
those units on the date of her death.
16
See supra note 7.
- 56 -
Citing the requirement in the revocable trust that the
marital trust terminate at Mrs. Black’s death, petitioner argues
that “logic dictates that the Marital Trust must be deemed to be
funded as of that date.” In support of his position, petitioner
cites section 20.2044-1(e), Example (8), Estate Tax Regs.
Respondent counters that, under the terms of the revocable trust,
Mrs. Black’s “legacy passed to her upon Sam Black’s death”, and,
“[a]ccordingly, the amount comprising Irene Black’s legacy is
determined as of the date of Sam Black’s death, reflecting any
adjustments to the value of Sam Black’s gross estate as finally
determined.” Respondent argues that section 20.2044-1(e),
Example (8), Estate Tax Regs., “sheds no light on the issue of
when a QTIP trust should be deemed funded when the surviving
spouse dies before it is actually funded.”
B. Analysis
In general, the amount includable in the decedent’s gross
estate under section 2044 “is the value of the entire interest in
which the decedent had a qualifying income interest for life,
determined as of the date of the decedent’s death (or the
alternate valuation date, if applicable).” Sec. 20.2044-1(d)(1),
Estate Tax Regs. That general rule is illustrated by section
20.2044-1(e), Example (1), Estate Tax Regs., as follows:
Inclusion of trust subject to election. Under D’s
will, assets valued at $800,000 in D’s gross estate
(net of debts, expenses and other charges, including
death taxes, payable from the property) passed in trust
with income payable to S for life. Upon S’s death, the
trust principal is to be distributed to D’s children.
D’s executor elected under section 2056(b)(7) to treat
the entire trust property as qualified terminable
- 57 -
interest property and claimed a marital deduction of
$800,000. S made no disposition of the income interest
during S’s lifetime under section 2519. On the date of
S’s death, the fair market value of the trust property
was $740,000. S’s executor did not elect the alternate
valuation date. The amount included in S’s gross
estate pursuant to section 2044 is $740,000.
Section 20.2044-1(e), Example (8), Estate Tax Regs., on
which petitioner relies, provides as follows:
Inclusion of trust property when surviving spouse dies
before first decedent’s estate tax return is filed. D
dies on July 1, 1997. Under the terms of D’s will, a
trust is established for the benefit of D’s spouse, S.
The will provides that S is entitled to receive the
income from that portion of the trust that the executor
elects to treat as qualified terminable interest
property. The remaining portion of the trust passes as
of D’s date of death to a trust for the benefit of C,
D’s child. The trust terms otherwise provide S with a
qualifying income interest for life under section
2056(b)(7)(B)(ii). S dies on February 10, 1998. On
April 1, 1998, D’s executor files D’s estate tax return
on which an election is made to treat a portion of the
trust as qualified terminable interest property under
section 2056(b)(7). S’s estate tax return is filed on
November 10, 1998. The value on the date of S’s death
of the portion of the trust for which D’s executor made
a QTIP election is includible in S’s gross estate under
section 2044.
Thus, Example (8) confirms that the general rule applies to
the valuation of the property in a QTIP marital deduction trust
(i.e., that it be valued as of the date of the grantee spouse’s
death) when (as in these cases) the grantee spouse dies before
the estate tax return for the grantor spouse is filed. The
foregoing regulation and the above-quoted examples illustrating
its application necessarily presuppose that the marital trust is
funded before the beneficiary spouse dies. As respondent notes,
however, neither the regulation nor Example (8) addresses the
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actual date upon which the marital trust is considered to have
been established (funded).
Although respondent successfully rebuts petitioner’s
reliance on the above-cited regulations, he does not mount a
successful defense of his own position. To begin with,
respondent misstates the terms of the revocable trust. They do
not support respondent’s argument that Mrs. Black’s legacy passed
to her upon Mr. Black’s death. The pertinent language of the
revocable trust states: “If * * * [Mrs. Black] survives * * *
[Mr. Black], the Trustee shall hold IN TRUST, as the Marital
Trust * * * a legacy equal to * * * [the pecuniary bequest].”
The amount of the pecuniary bequest was not ascertainable until
Mr. Black’s Federal estate tax liability was known, and, because
of the need to appraise the date-of-death value of the principal
asset in Mr. Black’s estate (his 77.0876-percent class B limited
partnership interest in Black LP) to compute that liability, that
amount was not known on the date of Mr. Black’s death.
Mr. Black’s Federal estate tax return was filed on September
12, 2002, more than 3 months after Mrs. Black’s death on May 25,
2002. Moreover, the outside appraisal of the value (on the date
of his death) of Mr. Black’s 77.0876-percent class B limited
partnership interest in Black LP was dated September 11, 2002, 1
day before his Federal estate tax return was filed. Although the
result of that appraisal must have been known before September
11, 2002, Mr. Cullen testified credibly that it was not known
until after Mrs. Black’s death.
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Had Mrs. Black lived long enough to allow for the funding of
her marital trust, then, as required by the terms of the
revocable trust, that funding would have been accomplished with a
class B limited partnership interest in Black LP the size of
which would have been determined with reference to its fair
market value on the date of distribution from the revocable trust
to the marital trust. There is no reason to apply a different
rule to a deemed distribution of that interest to the marital
trust. The issue is what date, after Mr. Black’s death, to
choose. Because the marital trust was to terminate upon Mrs.
Black’s death, that is the last possible date on which it could
have been funded. We agree with petitioner that to pick that
date, which is the date closest to what would have been the
actual date of the distribution to the marital trust had Mrs.
Black survived, as the deemed date of funding is logical and
reasonable.
Lastly, under the terms of the revocable trust, petitioner
had the option of funding the marital trust with cash. Had Mrs.
Black survived long enough to enable petitioner to fund the
marital trust with cash before her death, and had he been able
(and inclined) to sell a portion of the revocable trust’s
77.0876-percent class B limited partnership interest in Black LP
to raise that cash, he would have sold that interest for its
current fair market value. He would not have sold a greater
interest determined with reference to the fair market value of
Black LP class B limited partnership units as of December 12,
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2001, the date of Mr. Black’s death. We see no reason to reach
an inconsistent result where the marital trust is funded (or
deemed to have been funded) in kind with a class B limited
partnership interest in Black LP.
C. Conclusion
For purposes of determining the value of the marital trust
property includable in Mrs. Black’s gross estate under section
2044, the marital trust that Mr. Black established for Mrs.
Black’s benefit should be deemed funded and the fair market value
of the property that was to constitute the trust corpus should be
determined as of May 25, 2002, the date of her death, not as of
December 12, 2001, the date of his death.
V. The Interest Deductibility Issue
A. General Principles
Section 2053(a)(2) provides that “the value of the taxable
estate shall be determined by deducting from the value of the
gross estate such amounts * * * for administration expenses * * *
as are allowable by the laws of the jurisdiction * * * under
which the estate is being administered.”17 Section 20.2053-3(a),
Estate Tax Regs., provides, in pertinent part: “The amounts
17
Neither 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.”).
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deductible from * * * [the] gross estate as ‘administration
expenses’ * * * are limited to such expenses as are actually and
necessarily, incurred in the administration of the decedent’s
estate”. See also Estate of Todd v. Commissioner, 57 T.C. 288,
296 (1971). Section 20.2053-1(b)(3), Estate Tax Regs., provides
that an item may be deducted on the estate tax return “though its
exact amount is not then known, provided it is ascertainable with
reasonable certainty, and will be paid. No deduction may be
taken upon the basis of a vague or uncertain estimate.”
In Estate of Graegin v. Commissioner, T.C. Memo. 1988-477,
we held that the obligation to make a balloon payment of interest
upon the maturity of a 15-year promissory note for repayment of
an amount borrowed from the decedent’s closely held corporation
to pay his estate’s Federal estate tax liability entitled the
estate to an immediate deduction for the interest as an
administration expense under section 2053(a)(2). Both principal
and interest were due in a single payment on the 15th anniversary
due date, and prepayment of both was prohibited. In sustaining
the deduction, we noted that the amount of interest was capable
of precise calculation. Although we were “disturbed” by the
single payment of principal and interest, we found it “not
unreasonable” in the light of the anticipated availability of the
assets of decedent’s spouse’s trust to repay partially both
principal and interest upon maturity of the note, the term of
which had been set according to decedent’s spouse’s life
expectancy.
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We have generally held that when, to pay the debts of an
estate, an executor borrows money instead of selling illiquid
assets, interest on the loan is deductible. See, e.g., Estate of
Bahr v. Commissioner, 68 T.C. 74 (1977); Estate of Todd v.
Commissioner, supra; Estate of Graegin v. Commissioner, supra.
Moreover, we have so held when the loan was made by a company
stock of which was included in the value of the gross estate and
which (1) was owned by the decedent’s family and (2) “was neither
able nor required to redeem enough * * * [company] shares to
provide funds to pay * * * [all debts of the estate] when due”.
McKee v. Commissioner, T.C. Memo. 1996-362. In that case, the
executors (who were also directors of the company lender)
anticipated that the company stock would increase in value, and
we concluded that “borrowing funds, rather than selling stock,
allowed decedent’s estate to more easily meet its burdens by
taking advantage of the increasing value of the stock.”
B. Arguments of the Parties
Petitioner argues that the loan from Black LP was necessary
“to solve Mrs. Black’s Estate’s liquidity dilemma”; i.e., to
provide the funds needed to pay estate taxes and administration
expenses. He stresses that the amount of the loan was reasonable
and that, because prepayment of principal and interest was
prohibited, the amount of interest on the loan was fixed and
capable of calculation when the promissory note was executed, not
“vague or uncertain” within the meaning of section 20.2053-
1(b)(3), Estate Tax Regs. Petitioner concludes that, under the
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foregoing authorities, the interest on the note to maturity was
deductible in full on the Form 706 filed by Mrs. Black’s estate.
In reaching that conclusion, petitioner argues that, under such
cases as Estate of Todd v. Commissioner, supra, petitioner, as
executor of Mrs. Black’s estate, “exercised reasonable business
judgment” when he borrowed the necessary funds rather than cause
Black LP either to distribute those funds to the estate or to
redeem a portion of the estate’s interest (through the marital
trust) in Black LP. Petitioner further notes that, pursuant to
the partnership agreement, Black LP was not required to make a
distribution to or redeem an interest from Mrs. Black’s estate to
fund the estate’s tax liabilities. Petitioner also argues that,
although petitioner acted on behalf of both the borrowers and the
lender, he “did not stand alone or unrestricted on either side of
the transaction” because he had fiduciary responsibilities to
both, particularly to the other partners in Black LP. Lastly,
petitioner argues that, under both the objective test and the
“economic reality” test set forth in Geftman v. Commissioner, 154
F.3d 61, 70, 75 (3d Cir. 1998), revg. in part and vacating in
part T.C. Memo. 1996-447, the loan to Mrs. Black’s estate was
bona fide because (1) there was a note, security, interest
charges, a repayment schedule, actual repayment of the loan, and
other factors that indicate an unconditional obligation to repay,
and (2) the economic realities surrounding the relationship
between the borrowers and the lender demonstrate that there was a
reasonable expectation or enforceable obligation of repayment.
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Respondent counters that the loan (and, hence, the payment
of interest) was neither necessary nor bona fide. In arguing
that the loan was unnecessary, respondent states that “there was
no liquidity problem that would justify the loan.” In support of
that position, respondent stresses that petitioner, as executor
of both Mr. and Mrs. Black’s estates and as managing and majority
partner in Black LP, was in a position to distribute Erie stock
held by Black LP to Mrs. Black’s estate by way of either a
partial, pro rata distribution to the partners of Black LP or a
partial redemption of the estate’s interest, neither of which
would have adversely affected the interests of the charitable
trust partners. In support of his argument that the transfer of
funds was not a bona fide loan, respondent states that the
transaction had no economic effect other than to generate an
estate tax deduction for the interest on the loan. According to
respondent, that is because the only way the borrowers can repay
the alleged loan is to have Black LP make an actual or deemed
distribution of Erie stock (or proceeds from the sale thereof) to
them (whether or not in partial redemption of their partnership
interest) followed by an actual or deemed repayment of the stock
(or proceeds) to Black LP in discharge of the note, which would
result in a circular flow of either the Erie stock or the
proceeds from its sale by Black LP. Respondent concludes:
“Other than the favorable tax treatment resulting from the
transaction (a sec. 2053 deduction for interest expense that the
parties are essentially paying to themselves), it is difficult to
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see what benefit was derived from this circular transfer of
funds.” Lastly, respondent argues that, contrary to petitioner’s
argument, the transaction did not satisfy the prerequisites for
bona fide loan status as set forth in Geftman v. Commissioner,
supra, and in Estate of Rosen v. Commissioner, T.C. Memo. 2006-
115. In particular, respondent argues that by providing for
payment “no earlier than November 30, 2007”, the note lacked a
fixed maturity date, and that Mr. Cullen’s “vague testimony that
an installment arrangement will be worked out in the future
[because of the borrowers’ inability to repay the entire
principal on November 30, 2007]18 hardly confirms an intent that
the loan be repaid.”
C. Analysis
We find that the $71 million loan from Black LP to Mrs.
Black’s estate and the revocable trust, and the borrowers’
payment of interest thereon, was unnecessary. Therefore the
interest is not deductible. See sec. 20.2053-3(a), Estate Tax
Regs.
The only significant asset in Mrs. Black’s estate was the
Black LP partnership interest to be transferred from the
revocable trust to the marital trust. Between 1994 and 2001,
Black LP’s total income was less than $28 million, and its total
distributions to partners were less than $26 million. Even
assuming equivalent income and distributions to partners between
February 25, 2003, the date of the loan, and November 30, 2007,
18
See supra note 9.
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the purported due date for repayment of the loan, timely
repayment by the borrowers of the $71 million loan principal out
of partnership distributions (derived almost entirely from
dividends on Black LP’s Erie stock) was, on the date of the loan,
inconceivable. Thus, the borrowers knew (or should have known)
that, on the loan date, payment of the promissory note, according
to its terms, could not occur without resort to Black LP’s Erie
stock attributable to the borrowers’ class B limited partnership
interests in Black LP.19
Petitioner argues that the borrowers had no right under the
partnership agreement to require a distribution to them of assets
(i.e., Erie stock) either as part of a pro rata distribution to
partners or in partial redemption of their partnership interests.
But the partnership agreement provided for the modification
thereof, and a modification permitting either a pro rata
distribution of Erie stock to the partners or a partial
redemption of the borrowers’ partnership interests would not have
violated petitioner’s fiduciary duties, as managing partner, to
any of the partners.
Assuming additional sales or pro rata distributions of Erie
stock would have been considered undesirable, the only feasible
19
Our 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.
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means of repaying the loan by the purported due date of November
30, 2007, would have been for Black LP to make an actual or
deemed distribution of Erie stock to the borrowers in partial
redemption of their interests in the partnership and for the
borrowers to make an actual or deemed return of the stock to
Black LP in discharge of the promissory note. That transaction,
had it, in fact, occurred, would have demonstrated that the loan
was unnecessary because the parties thereto would have been in
exactly the same position as they would have been had Black LP
used Erie stock to redeem part of the partnership interests of
the estate and revocable trust, and, in 2003, to pay the debts of
the estate, had they sold that Erie stock (e.g., by means of a
secondary offering identical, except for the identity of the
seller, to the one that actually occurred).20 The only
distinction between the loan scenario and the partial redemption
scenario is that the former gave rise to an immediate estate tax
deduction for interest in excess of $20 million, offset by a
substantially smaller income tax expense (because of the
passthrough of interest income) to the Black LP partners. That
the loan scenario, like the partial redemption scenario, required
a sale of Erie stock to discharge the debts of Mrs. Black’s
estate, i.e., that Erie stock was available and actually used for
20
Alternatively, 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.
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that purpose, negates petitioner’s contention that the loan was
needed to solve a “liquidity dilemma”. The loan structure, in
effect, constituted an indirect use of Erie stock to pay the
debts of Mrs. Black’s estate and accomplished nothing more than a
direct use of that stock for the same purpose would have
accomplished, except for the substantial estate tax savings.
Those circumstances distinguish these cases from the cases on
which petitioner relies in which loans from a related, family-
owned corporation to the estate were found to be necessary to
avoid a forced sale of illiquid assets, see Estate of Todd v.
Commissioner, 57 T.C. 288 (1971); Estate of Graegin v.
Commissioner, T.C. Memo. 1988-477, or to enable the estate to
retain the lender’s stock for future appreciation, McKee v.
Commissioner, T.C. Memo. 1996-362. In none of those cases was
there a sale of either the stock or assets of the lender to pay
debts of the estate borrower, as occurred in these cases.
Moreover, as respondent points out, the principal beneficiary of
the estate, petitioner, was also the majority partner in Black
LP. Thus, he was on both sides of the transaction, in effect
paying interest to himself. As a result, those payments effected
no change in his net worth, except for the net tax savings.
Having found that the interest on the purported loan from
Black LP to Mrs. Black’s estate and the revocable trust was not
“necessarily incurred in the administration of the decedent’s
estate”, as required by section 20.2053-3(a), Estate Tax Regs.,
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we do not address the issue of whether the transaction resulted
in a bona fide loan.
D. Conclusion
The $20,296,274 interest expense incurred by Mrs. Black’s
estate did not constitute a deductible administration expense
under section 2053(a)(2).21
VI. The Fee Deductibility Issues
A. Background
Respondent seeks to deny to Mrs. Black’s estate a deduction
for (1) any portion of the $980,625 the estate paid to Black LP
as reimbursement for the latter’s reimbursement of Erie for costs
incurred in connection with the secondary offering of Black LP’s
Erie stock,22 (2) any portion of the $1,155,000 executor fee paid
to petitioner in excess of $500,000, and (3) any portion of the
$1,155,000 in legal fees paid to MacDonald Illig in excess of
$500,000. Mrs. Black’s estate deducted each of the foregoing
payments on Schedule L, Net Losses During Administration and
21
Because 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 $20
million bequest to Penn State Erie (an obligation of Mr. Black’s
estate) should be treated as nondeductible.
22
Although 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.
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Expenses Incurred in Administering Property Not Subject to
Claims, as expenses incurred in administering nonprobate
property. Petitioner argues that Mrs. Black’s estate is entitled
to deduct each of those expenditures in its entirety.
B. General Principles
Section 2053(b), entitled “Other administrative expenses”,
generally provides a deduction for expenses incurred in
administering nonprobate property, to the same extent as they
would be deductible under section 2053(a); i.e., if incurred in
administering probate property.23 Thus, such expenses must be
“actually and necessarily incurred in the administration of the
decedent’s estate; that is, in the collection of assets, payment
of debts, and distribution of property to the persons entitled to
it.”24 Sec. 20.2053-3(a), Estate Tax Regs.
23
Because such expenses relate to nonprobate 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.”
24
The evidence indicates that some portion of each of the
fees in question relates to activities that necessarily involve
the administration of both probate and nonprobate 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.
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C. Analysis and Conclusions
1. Reimbursement of Costs Incurred in Connection
With the Secondary Offering: $982,070
Petitioner argues that the secondary offering of Black LP’s
Erie stock followed by a loan of a portion of the proceeds was a
legitimate means of paying the estate tax liability and the
obligations under the revocable trust of Mrs. Black’s estate, and
that its reimbursement of Erie’s expenses related to the
secondary offering was a “reasonable and necessary” and,
therefore, deductible cost of Mrs. Black’s estate. Respondent
argues that the reimbursement was not “necessary” within the
meaning of section 20.2053-3(a), Estate Tax Regs., because the
Erie stock belonged to Black LP, not Mrs. Black’s estate, and
that Black LP sold the stock.
To the extent the secondary offering of Erie stock generated
funds needed and used to discharge debts of Mrs. Black’s estate,
Black LP’s obligation to reimburse Erie for costs associated with
that offering was related to and occasioned by Mrs. Black’s
death, and, for that reason, the reimbursement might be
deductible by her estate under section 2053. Accord sec.
20.2053-8(d) Example (1), Estate Tax Regs.; see Burrow Trust v.
Commissioner, 39 T.C. 1080, 1089 (1963) (holding that, where a
revocable inter vivos trust paid its own trustee’s fees, the
settlor’s estate could nonetheless deduct those fees under
section 2053 because the trustees’ services “were primarily
occasioned by the death of the decedent”), affd. 333 F.2d 66(10th Cir. 1964). Moreover, the payment at issue is the estate’s
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reimbursement of Black LP pursuant to the loan agreement, not
Black LP’s reimbursement of Erie. Therefore, the payment may
qualify as an expense related to a sale “necessary in order to
pay the decedent’s debts, expenses of administration, or taxes”
within the meaning of section 20.2053-3(d)(2), Estate Tax Regs.,
despite the fact that the property sold was, technically,
property owned by Black LP rather than by the estate. We find
that the estate’s indirect ownership, through its interest in
Black LP, of the Erie stock is sufficient to bring the sale of
that stock within the cited regulation, which concerns the
deductibility of expenses of selling “property of the estate”.
The flaw in petitioner’s argument is that only a portion of
the funds the secondary offering generated was used on behalf of
Mrs. Black’s estate. Of the $98 million realized from Black LP’s
sale of Erie stock, only $71 million was made available to the
estate, and of that $71 million, $20 million was used to fulfill
Mr. Black’s bequest, through the revocable trust, to Penn State
Erie. That bequest was an obligation of Mr. Black’s estate.
After subtracting the approximately $3.3 million of fees at issue
herein, it appears that approximately $48 million ($31,736,527
for Federal estate taxes,25 $15,700,000 for Pennsylvania
25
Petitioner 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 2003
Form 4768, Application For Extension of Time to File a Return
and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes.
(continued...)
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inheritance and estate taxes, and $581,349 for Federal and
Pennsylvania fiduciary income taxes resulting from capital gain
on the sale of Black LP’s Erie stock in connection with the
secondary offering) or approximately 49 percent of the $98
million the secondary offering raised was actually used to
discharge debts of Mrs. Black’s estate. Therefore, we find that
Mrs. Black’s estate is entitled to deduct $481,000 of its
$982,070 reimbursement of costs related to the secondary
offering.
2. Executor’s Fee Paid to Petitioner: $1,155,000
Petitioner claims that the executor’s fee constituted
payment for his services related to raising funds to pay the
estate tax, responding to audit requests, marshaling assets of
Mrs. Black’s estate, and gathering materials and information
necessary to prepare the estate tax return for Mrs. Black’s
estate, including materials and information necessary to enable
the appraiser to determine the value of the assets in Mrs.
Black’s estate. Much of that effort consisted of gathering
information and materials for the appraisal of the class B
25
(...continued)
There is no explanation in the record for the more than $22
million 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 $20
million 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.
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limited partnership interest that was to constitute the corpus to
the marital trust, and effort associated with the secondary
offering. Petitioner argues that all his efforts related to
nonprobate property included in Mrs. Black’s gross estate and
that, therefore, his fee was deductible by the estate under
section 2053(b). Respondent argues that $650,000 of petitioner’s
fee related to services performed for Mr. Black’s estate, the
revocable trust, and Black LP “for which no deduction is
permitted to Mrs. Black’s estate.”
We find that petitioner’s fee, insofar as it related to his
efforts in connection with the secondary offering of Erie stock,
is deductible to the same extent as is the estate’s reimbursement
of Erie’s costs related to that sale; i.e., to the extent that
the funds raised thereby were used to discharge debts of Mrs.
Black’s estate. Thus, approximately 49 percent of that portion
of the fee is deductible.
We find that petitioner’s gathering of information for
appraisers represented effort on behalf of both Mr. and Mrs.
Black’s estates. A lengthy appraisal of the date-of-death value
of the Black LP interest included in the gross estate of each
decedent was attached to the Federal estate tax return filed on
behalf of each estate. The two appraisals were conducted by the
same appraisal company, appraised the same type of interest (an
interest in Black LP), used the identical appraisal methodology,
were approximately the same length, and, to a great extent,
contained identical language. Therefore, to assume that whatever
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information petitioner supplied to the appraiser pertained more
or less equally to each appraisal is reasonable. For that
reason, we find that the portion of the executor’s fee
attributable to petitioner’s services related to the appraisals
should be divided equally between the two estates so that Mrs.
Black’s estate may deduct only one-half of that amount.
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.
The same is true of whatever portion of the executor’s fee
may be said to have compensated petitioner for his efforts in
responding to respondent’s audit requests. Both estates were
under audit so that a 50-50 split between the estates also
appears to be appropriate in connection with that effort.
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Lastly, we agree with respondent that no more than a de
minimis portion (e.g., 1 percent) of the executor fee should be
allocated to petitioner’s marshaling of assets on behalf of Mrs.
Black’s estate. As respondent states, the estate consisted of
assets worth only $39,709 in addition to the Erie stock in the
marital trust, which was valued by the estate’s own appraiser at
over $100 million.
According to the foregoing we find that one-half of the
$1,155,000 executor’s fee paid to petitioner was attributable to
his efforts on behalf of Mrs. Black’s estate. Therefore, that
estate is entitled to a deduction of $577,500 for the executor’s
fee.
3. Legal Fees Paid to MacDonald Illig: $1,155,000
Mr. Cullen testified that the legal fees related to
“[e]verything in connection with the death of Mrs. Black,
including the administration of her estate, the [marital] trust,
preparation of [estate and fiduciary] tax returns, participation
in the secondary [offering], everything.” The “everything” also
included services (assisting petitioner) in connection with the
estate tax audit. Mr. Cullen further testified that 80 percent
of his firm’s time was spent on matters relating to the marital
trust, which included services related to the secondary offering,
and 20 percent on matters relating to Mrs. Black’s estate,
including estate and fiduciary return preparation and payment of
the taxes owed.
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Respondent argues that Mrs. Black’s estate “should be
allowed to deduct fees only in the amount of $500,000, and that
$650,000 should be disallowed as being related to services
rendered to entities other than the marital trust.” Thus,
respondent does not challenge the overall reasonableness of the
fee charged for legal services on behalf of the two estates and
the marital trust. He challenges only petitioner’s treatment of
the entire fee as a charge to Mrs. Black’s estate.
For the reasons stated supra, in connection with our
consideration of the deductibility of petitioner’s fee, we find
that Mrs. Black’s estate may deduct 49 percent of whatever
portion of the legal fees is attributable to services related to
the secondary offering and one-half of the portion attributable
to services related to the marital trust and the Federal estate
tax audit. Similarly, because each estate filed a Federal gift
tax and a Federal estate tax return, we find that a 50-50 split
of the portion of the legal fees attributable to MacDonald
Illig’s services in preparing those returns is appropriate.
Only Mrs. Black’s estate filed fiduciary income tax returns.
Therefore, her estate may deduct the portion of the legal fees
attributable to the preparation and filing of those returns. The
record does not contain copies of those returns. If, as Mr.
Cullen testified, those returns reflected only the capital gain
passed through to Mrs. Black’s estate on Black LP’s sale of Erie
stock in connection with the secondary offering, the returns
could not have been particularly complex. Thus, the fee
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attributable to the preparation of those returns should be
relatively small.26
As in the case of petitioner’s fee, we find that one-half of
the $1,155,000 in legal fees was attributable to services
rendered to Mrs. Black’s estate. Therefore, that estate is
entitled to a deduction of $577,500 for legal fees.27
To reflect the foregoing,
Decisions will be entered
under Rule 155.
26
The 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.
27
No 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.