Estate of Albert Strangi v. Commissioner

115 T.C. No. 35
UNITED STATES TAX COURT
ESTATE OF ALBERT STRANGI, DECEASED, ROSALIE GULIG, INDEPENDENT
EXECUTRIX, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 4102-99. Filed November 30, 2000.
D formed a family limited partnership (SFLP) and
transferred assets, including securities, real estate,
insurance policies, annuities, and partnership
interests, to SFLP in return for a 99-percent limited
partnership interest. Held: (1) The partnership was
valid under State law and will be recognized for estate
tax purposes. (2) Sec. 2703(a), I.R.C., does not apply
to the partnership agreement. (3) The transfer of
assets to SFLP was not a taxable gift. (4) R’s
expert’s opinion as to valuation discounts is accepted.
Norman A. Lofgren and G. Tomas Rhodus, for petitioner.
Deborah H. Delgado, Gerald L. Brantley, Sheila R. Pattison,
and William C. Sabin, Jr., for respondent.
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COHEN, Judge: On December 1, 1998, respondent determined a
$2,545,826 deficiency in the Federal estate tax of the estate of
Albert Strangi, Rosalie Gulig, independent executrix. In the
alternative, respondent determined a Federal gift tax deficiency
of $1,629,947.
After concessions by the parties, the issues for decision
are (alternatively): (1) Whether the Strangi Family Limited
Partnership (SFLP) should be disregarded for Federal tax purposes
because it lacks business purpose and economic substance;
(2) whether the SFLP is a restriction on the sale or use of
property that should be disregarded pursuant to section
2703(a)(2); (3) whether the transfer of assets to SFLP was a
taxable gift; and (4) if SFLP is not disregarded, the fair market
value of decedent’s interest in SFLP at the date of death.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect as of the date of decedent’s
death, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated
facts are incorporated in our findings by this reference. Albert
Strangi (decedent) was domiciled in Waco, Texas, at the time of
his death, and his estate was administered there. Rosalie
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Strangi Gulig (Mrs. Gulig) resided in Waco, Texas, when the
petition in this case was filed.
Decedent was a self-made multimillionaire. He married
Genevieve Crowley Strangi (Genevieve Strangi) in the late 1930's
and had four children--Jeanne Strangi, Albert T. Strangi, John
Strangi, and Mrs. Gulig, collectively referred to herein as the
Strangi children. In 1965, the marriage between decedent and
Genevieve Strangi was terminated by divorce, and decedent
remarried Irene Delores Seymour (Mrs. Strangi). Mrs. Strangi had
two daughters from a previous marriage, Angela Seymour and Lynda
Seymour.
In 1975, decedent sold his company, Mangum Manufacturing, in
exchange for Allen Group stock, and he and Mrs. Strangi moved to
Fort Walton Beach, Florida. Mrs. Gulig married Michael J. Gulig
(Mr. Gulig) in 1985. Mr. Gulig was an attorney in Waco, Texas,
with the law firm of Sheehy, Lovelace and Mayfield, P.C.
Mr. Gulig has done a substantial amount of estate planning and is
proficient in that field.
On February 19, 1987, decedent and Mrs. Strangi executed
wills that named the Strangi children, Angela Seymour, and Lynda
Seymour as residual beneficiaries in the event that either
decedent or Mrs. Strangi predeceased the other. These wills were
prepared by the law offices of Tobolowsky, Prager & Schlinger in
Dallas, Texas. Mrs. Strangi also executed the Irene Delores
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Strangi Irrevocable Trust (the Trust). Decedent was designated
as the executor of Mrs. Strangi’s will and as the trustee of the
Trust.
Mrs. Strangi’s will provided that her personal effects were
to be left to decedent and that life insurance proceeds, employee
benefits, and the residuary of her estate should be distributed
to the Trust. The first codicil to Mrs. Strangi’s will provided
that property she owned in Dallas, Texas, should be distributed
to the Jeanne Strangi Brown Trust. The Trust provided that
lifetime distributions would be made to Mrs. Strangi and that,
upon her death, (1) her property in Florida should be distributed
to Angela Seymour and Lynda Seymour, (2) $50,000 should be
distributed to Mrs. Strangi’s sister, and (3) the residuary
should be distributed to decedent provided that he survived her.
In 1987 and 1988, Mrs. Strangi suffered a series of serious
medical problems. In 1988, decedent and Mrs. Strangi moved to
Waco, Texas. Sylvia Stone (Stone) was hired as decedent’s
housekeeper. She also provided assistance with the care of
Mrs. Strangi. On July 19, 1988, decedent executed a power of
attorney, naming Mr. Gulig as his attorney in fact.
On July 31, 1990, decedent executed a new will, naming his
children as the sole residual beneficiaries if Mrs. Strangi
predeceased him. This will also named Mrs. Gulig and Ameritrust
Texas, N.A. (Ameritrust), as coexecutors of decedent’s estate.
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On December 27, 1990, Mrs. Strangi died in Waco, Texas. Her will
was admitted to probate in Texas and was not contested.
In May 1993, decedent had surgery that removed a cancerous
mass from his back. That summer, Mr. Gulig took decedent to
Dallas to be examined by a physician in the neurology department
of Southwest Medical School. Decedent was then diagnosed with
supranuclear palsy, a brain disorder that would gradually reduce
his ability to speak, walk, and swallow. In September 1993,
decedent had prostate surgery.
Formation of Limited Partnership
After decedent’s prostate surgery, Mr. Gulig took over the
affairs of decedent pursuant to the 1988 power of attorney.
Mr. Gulig consulted a probate judge regarding concerns he had
about decedent’s affairs. On August 11, 1994, Mr. Gulig attended
a seminar in Dallas, Texas, provided by Fortress Financial Group,
Inc. (Fortress). Fortress trains and educates professionals on
the use of family limited partnerships as a tool to (1) reduce
income tax, (2) reduce the reported value of property in an
estate, (3) preserve assets, and (4) facilitate charitable
giving. The Fortress Plan recommends contributing assets to a
family limited partnership with a corporate general partner being
created for control purposes. The Fortress Plan also suggests
that shares of stock of the corporate general partner or an
interest in the family limited partnership be donated to a
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charity. To facilitate the plan, Fortress licenses the use of
copyrighted limited partnership agreements and shareholders’
agreements.
Following the Fortress seminar, on August 12, 1994,
Mr. Gulig, as decedent’s attorney in fact, formed SFLP, a Texas
limited partnership, and its corporate general partner, Stranco,
Inc. (Stranco), a Texas corporation. Mr. Gulig handled all of
the details of the formation, executing the limited partnership
agreement and shareholders’ agreement using Fortress documents,
as well as drafting articles of incorporation and bylaws for
Stranco.
The partnership agreement provided that Stranco had the sole
authority to conduct the business affairs of SFLP without the
concurrence of any limited partner or other general partner.
Thus, limited partners could not act on SFLP’s behalf without the
consent of Stranco. The partnership agreement also allowed SFLP
to lend money to partners, affiliates, or other persons or
entities.
Mr. Gulig filed the SFLP certificate of limited partnership
and the Stranco articles of incorporation with the State of
Texas. He also drafted asset transfer documents, dated
August 12, 1994, assigning decedent’s interest in specified real
estate, securities, accrued interest and dividends, insurance
policies, annuities, receivables, and partnership interests
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(referred to collectively herein as the contributed property) to
SFLP for a 99-percent limited partnership interest in SFLP. All
of the contributed property was reflected in decedent’s capital
account. The fair market value of the contributed property was
$9,876,929. Approximately 75 percent of that value was
attributable to cash and securities.
Mr. Gulig invited decedent’s children to participate in SFLP
through an interest in Stranco, the corporate general partner of
SFLP. Decedent purchased 47 percent of Stranco for $49,350, and
Mrs. Gulig purchased the remaining 53 percent of Stranco for
$55,650 on behalf of Jeanne Strangi, John Strangi, Albert T.
Strangi, and herself. To purchase the Stranco shares, Jeanne
Strangi, John Strangi, and Albert T. Strangi each executed
unsecured notes dated August 12, 1994, to Mrs. Gulig, with a face
amount of $13,912.50 and interest at 8 percent. Stranco
contributed $100,333 to SFLP in exchange for a 1-percent general
partnership interest. Subsequently, as a result of the downward
adjustment of the value of decedent’s contributed property,
Stranco’s capital contribution was reduced on its books by $1,000
to $99,333, and a receivable was recorded indicating $1,000 due
from SFLP.
Decedent and the Strangi children made up the initial board
of directors of Stranco, and Mrs. Gulig served as president. On
August 17, 1994, the Strangi children and Mr. Gulig met to
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execute the Stranco shareholders’ agreement, bylaws, and a
Consent of Directors Authorizing Corporate Action in Lieu of
Organizational Meeting that was effective as of August 12, 1994.
They also executed a Unanimous Consent of Directors in Lieu of
Special Meeting to employ Mr. Gulig to manage the day-to-day
affairs of SFLP and Stranco, dated August 12, 1994. Stranco
never had formal meetings. All corporate actions were approved
by unanimous consent agreements in lieu of actual meetings. On
August 18, 1994, McLennan Community College Foundation accepted a
gift of 100 Stranco shares from decedent’s children “in honor of
their father”.
From September 1993 until his death, decedent required
24-hour home health care that was provided by Olsten Healthcare
(Olsten) and supplemented by Stone. During this time, Stone
injured her back. This injury resulted in Stone’s having back
surgery, and SFLP paid for the surgery. On October 14, 1994,
decedent died of cancer at the age of 81.
On December 7, 1994, Peter Gross, an attorney from the law
firm of Prager & Benson, P.C., as a representative of decedent’s
estate, requested that Texas Commerce Bank (TCB), successor in
interest to Ameritrust, resign as coexecutor of decedent’s
estate. The Strangi children also requested that TCB decline to
serve as coexecutor and agreed to indemnify TCB for claims
related to the estate if it declined to serve as coexecutor.
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Accordingly, TCB declined to serve as coexecutor of decedent’s
estate and renounced its right to appoint a successor
coindependent executor. When decedent’s will was admitted to
probate on April 12, 1995, Mrs. Gulig was appointed as the sole
executor of decedent’s estate.
Angela Seymour consulted two attorneys regarding the
validity of Mrs. Strangi’s will during 1994. She never intended
to contest decedent’s will, and, ultimately, no claim or will
contest was filed against decedent’s estate.
Partnership Activities
Following the formation of SFLP, various distributions were
made by SFLP to decedent’s estate and the Strangi children. When
distributions were made, corresponding and proportionate
distributions were made to Stranco either in cash or in the form
of adjusting journal entries. In July 1995, SFLP distributed
$3,187,800 to decedent’s estate for State and Federal estate and
inheritance taxes. Also in 1995 and in 1996, SFLP distributed
$563,000 to each of the Strangi children. The distributions were
characterized as distributions to decedent’s estate.
In May 1996, SFLP divided its primary Merrill Lynch account
into four separate accounts in each of the Strangi children’s
names, giving them control over a proportionate share of the
partnership assets. The partnership also extended lines of
credit to John Strangi, Albert T. Strangi, and Mrs. Gulig for
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$250,000, $400,000, and $100,000, respectively. In January 1997,
SFLP increased John Strangi’s line of credit to $350,000 and
Albert T. Strangi’s line of credit to $650,000. In November
1997, SFLP advanced to decedent’s estate $2.32 million to post
bonds with the Internal Revenue Service and the State of Texas in
connection with the review of decedent’s estate tax return. In
1998, SFLP made distributions of $102,500 to each of the Strangi
children. The Strangi children had received $2,662,000 in
distributions from SFLP as of December 31, 1998.
Estate Tax Return
On January 16, 1996, decedent’s Form 706, United States
Estate (and Generation Skipping Transfer) Tax Return (estate tax
return), was filed by Mr. Gulig. On the estate tax return,
decedent’s gross estate was reported as $6,823,582. This
included a $6,560,730 fair market value for SFLP. For purposes
of the estate tax return, SFLP was valued by Appraisal
Technologies, Inc., on an “ongoing business”, “minority interest
basis”. The valuation report arrived at a value before discounts
and then applied minority interest discounts totaling 33 percent
for lack of marketability and lack of control.
The estate tax return also indicated that decedent had
$43,280 in personal debt and other allowable deductions totaling
$107,108, leaving a reported taxable estate of $6,673,194. The
estate tax return reported a transfer tax due of $2,522,088. The
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property that was held by SFLP as of the date of death had
increased in value to $11,100,922 due to the appreciation of
securities, particularly the Allen Group stock.
OPINION
We must decide whether the existence of SFLP will be
recognized for Federal estate tax purposes. Respondent argues
that, under the business purpose and economic substance
doctrines, SFLP should be disregarded in valuing the assets in
decedent’s estate. Petitioner contends that the business purpose
and economic substance doctrines do not apply to transfer tax
cases and that SFLP had economic substance and business purpose.
Taxpayers are generally free to structure transactions as
they please, even if motivated by tax-avoidance considerations.
See Gregory v. Helvering, 293 U.S. 465, 469 (1935); Yosha v.
Commissioner, 861 F.2d 494, 497 (7th Cir. 1988), affg. Glass v.
Commissioner, 87 T.C. 1087 (1986). However, the tax effects of a
particular transaction are determined by the substance of the
transaction rather than by its form. In Frank Lyon Co. v. United
States, 435 U.S. 561, 583-584 (1978), the Supreme Court stated
that “a genuine multiple-party transaction with economic
substance * * * compelled or encouraged by business or regulatory
realities, * * * imbued with tax-independent considerations, and
* * * not shaped solely by tax avoidance features” should be
respected for tax purposes. “[T]ransactions which have no
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economic purpose or substance other than the avoidance of taxes
will be disregarded.” Gregory v. Helvering, supra at 469-470;
see also Merryman v. Commissioner, 873 F.2d 879 (5th Cir. 1989),
affg. T.C. Memo. 1988-72.
Family partnerships must be closely scrutinized by the
courts because the family relationship “so readily lends itself
to paper arrangements having little or no relationship to
reality.” Kuney v. Frank, 308 F.2d 719, 720 (9th Cir. 1962);
accord Frazee v. Commissioner, 98 T.C. 554, 561 (1992); Harwood
v. Commissioner, 82 T.C. 239, 258 (1984), affd. without published
opinion 786 F.2d 1174 (9th Cir. 1986); Estate of Kelley v.
Commissioner, 63 T.C. 321, 325 (1974); Estate of Tiffany v.
Commissioner, 47 T.C. 491, 499 (1967); see also Helvering v.
Clifford, 309 U.S. 331, 336-337 (1940). Family partnerships have
long been recognized where there is a bona fide business carried
on after the partnership is formed. See, e.g., Drew v.
Commissioner, 12 T.C. 5, 12-13 (1949). Mere suspicion and
speculation about a decedent’s estate planning and testamentary
objectives are not sufficient to disregard an agreement in the
absence of persuasive evidence that the agreement is not
susceptible of enforcement or would not be enforced by parties to
the agreement. Cf. Estate of Hall v. Commissioner, 92 T.C. 312,
335 (1989).
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The estate contends that there were “clear and compelling”
nontax motives for creating SFLP, including the provision of a
flexible and efficient means by which to manage and protect
decedent’s assets. Specifically, the estate argues that its
business purposes for forming SFLP were (1) to reduce executor
and attorney’s fees payable at the death of decedent, (2) to
insulate decedent from an anticipated tort claim and the estate
from a will contest (by creating another layer through which
creditors must go to reach assets conveyed to the partnership),
and (3) to provide a joint investment vehicle for management of
decedent’s assets. We agree with respondent that there are
reasons to be skeptical about the nontax motives for forming
SFLP.
We are skeptical of the estate’s claims of business purposes
related to executor and attorney’s fees or potential tort claims.
Mr. Gulig testified that, on various social occasions, he
consulted with a former probate judge about decedent’s
anticipated estate. Those consultations, however, were not
related in time or purpose to the formation of SFLP. In our
view, the testimony about consultation is similar to the evidence
described in Estate of Baron v. Commissioner, 83 T.C. 542, 555
(1984), affd. 798 F.2d 65 (2d Cir. 1986), to wit, the
“‘consultation’ was mere window dressing to conceal tax motives.”
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We are not persuaded by the testimony that SFLP was formed
to protect assets from will contests by Angela or Lynda Seymour
or from a potential tort claim by Stone. The Seymour claims were
stale when the partnership was formed, and they never
materialized. There was no direct corroboration that Stone was
injured by decedent while she was caring for him or any
indication that Stone ever threatened litigation.
We also do not believe that a “joint investment vehicle” was
the purpose of the partnership. Mr. Gulig took over control of
decedent’s affairs in September 1993, under the 1988 power of
attorney, and Mr. Gulig continued to manage decedent’s assets
through his management responsibilities in Stranco. Petitioner
concedes, in disputing respondent’s alternative claim of gift tax
liability, that “directly or indirectly, the Decedent ended up
with 99.47% of the Partnership, having put in essentially 99.47%
of the capital.”
The formation and subsequent control of SFLP were
orchestrated by Mr. Gulig without regard to “joint enterprise”.
He formed the partnership and the corporation and then invited
Mrs. Gulig’s siblings, funded by her, to invest in the
corporation. The Strangi children shared in managing the assets
only after and to the extent that the Merrill Lynch account was
fragmented in accordance with their respective beneficial
interests.
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The nature of the assets that were contributed to SFLP
supports the conclusion that management of those assets was not
the purpose of SFLP. There were no operating business assets
contributed to SFLP. Decedent transferred cash, securities, life
insurance policies, annuities, real estate, and partnership
interests to SFLP. The cash and securities approximated
75 percent of the value of the assets transferred. No active
business was conducted by SFLP following its formation.
The actual control exercised by Mr. Gulig, combined with the
99-percent limited partnership interest in SFLP and the
47-percent interest in Stranco, suggest the possibility of
including the property transferred to the partnership in
decedent’s estate under section 2036. See, e.g., Estate of
Reichardt v. Commissioner, 114 T.C. 144 (2000). Section 2036 is
not an issue in this case, however, because respondent asserted
it only in a proposed amendment to answer tendered shortly before
trial. Respondent’s motion to amend the answer was denied
because it was untimely. Applying the economic substance
doctrine in this case on the basis of decedent’s continuing
control would be equivalent to applying section 2036(a) and
including the transferred assets in decedent’s estate. As
discussed below, absent application of section 2036, Congress has
adopted an alternative approach to perceived valuation abuses.
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SFLP was validly formed under State law. The formalities
were followed, and the proverbial “i’s were dotted” and “t’s were
crossed”. The partnership, as a legal matter, changed the
relationships between decedent and his heirs and decedent and
actual and potential creditors. Regardless of subjective
intentions, the partnership had sufficient substance to be
recognized for tax purposes. Its existence would not be
disregarded by potential purchasers of decedent’s assets, and we
do not disregard it in this case.
Section 2703(a)(2)
Section 2703(a) provides as follows:
SEC. 2703. (a) General Rule.--For purposes of
this subtitle, the value of any property shall be
determined without regard to–-
(1) any option, agreement, or other right to
acquire or use the property at a price less than
the fair market value of the property (without
regard to such option, agreement, or right), or
(2) any restriction on the right to sell or
use such property.
Noting that a right or restriction may be implicit in the capital
structure of an entity, see sec. 25.2703-1(a)(2), Gift Tax Regs.,
respondent argues that section 2703(a)(2) applies to disregard
SFLP for transfer tax purposes. Respondent further argues that
the SFLP agreement does not satisfy the “safe harbor” exception
in section 2703(b).
Respondent’s brief states:
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Congress recognized substantial valuation abuse in
the law as it existed prior to the enactment of I.R.C.
sec. 2036(c) in 1987. In 1990 Congress replaced
section 2036(c) with a new Chapter 14, including
sections 2701 through 2704, which sets out special
valuation rules for transfer tax purposes. It intended
these new sections to target transfer-tax valuation
abuses in the intra-family transfers more effectively
while relieving taxpayers of section 2036(c)’s broad
sweep. It wanted to value property interests more
accurately when they were transferred, instead of
including previously transferred property in the
transferor’s gross estate. “Discussion Draft” Relating
to Estate Valuation Freezes: Hearing Before the House
Comm. on Ways and Means, 101st Cong. 2d Sess. 102
(April 24, 1990) [House hearing]; Estate Freezes:
Hearing on “Discussion Draft” Before the Subcomm. on
Energy and Agricultural Taxation and Subcomm. on
Taxation and Debt Management of the Senate Comm. on
Finance, 101st Cong. 1233 (June 27, 1990) [Senate
hearing].
The new special valuation rules in Chapter 14
departed substantially from the hypothetical willing
buyer-willing seller standard. The Treasury Department
recognized that valuing nonpublicly traded assets in
family transactions for transfer tax purposes presented
a significant problem. It testified to Congress that
applying the hypothetical standard of a willing buyer-
willing seller to family transactions allowed
significant amounts to escape taxation. Senate hearing
at 15.
Congress enacted section 2703(a) to address
abusive intra-family situations. Section 2703(a)(1)
addresses burdening a decedent’s property with options
to purchase at less than fair market value. Section
2703(a)(2), which applies to this case, addresses other
restrictions that reduce the value of a decedent’s
property for estate tax purposes but not in the hands
of the beneficiary. Congress contemplated that the
section would apply to “any restriction, however
created,” including restrictions implicit in the
capital structure of a partnership or contained in a
partnership agreement, articles of incorporation,
corporate bylaws or a shareholders’ agreement.
Informal Senate Report on S. 3209, 101st Cong., 2d
Sess. (1990), 136 Cong. Rec. S15777 (October 18, 1990).
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Thus, it intended the word “restriction” in section
2703(a)(2) to be read as broadly as possible. See
Treas. Reg. sec. 25.2703-1 (a lease from a father to
son will to be disregarded for transfer tax valuation
purposes because it is not similar to arm’s-length
transactions among unrelated parties. [Fn. ref.
omitted.]
Respondent next argues that the term “property” in section
2703(a)(2) means the underlying assets in the partnership and
that the partnership form is the restriction that must be
disregarded. Unfortunately for respondent’s position, neither
the language of the statute nor the language of the regulation
supports respondent’s interpretation. Absent application of some
other provision, the property included in decedent’s estate is
the limited partnership interest and decedent’s interest in
Stranco.
In Kerr v. Commissioner, 113 T.C. 449 (1999), the Court
dealt with a similar issue with respect to interpretation of
section 2704(b). Sections 2703 and 2704 were enacted as part of
chapter 14, I.R.C., in 1990. See Omnibus Budget Reconciliation
Act of 1990, Pub. L. 101-508, 104 Stat. 1388. However, as we
indicated in Kerr v. Commissioner, supra at 470-471, and as
respondent acknowledges in the portion of his brief quoted above,
the new statute was intended to be a targeted substitute for the
complexity, breadth, and vagueness of prior section 2036(c); and
Congress “wanted to value property interests more accurately when
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they were transferred, instead of including previously
transferred property in the transferor’s gross estate.” Treating
the partnership assets, rather than decedent’s interest in the
partnership, as the “property” to which section 2703(a) applies
in this case would raise anew the difficulties that Congress
sought to avoid by repealing section 2036(c) and replacing it
with chapter 14. We conclude that Congress did not intend, by
the enactment of section 2703, to treat partnership assets as if
they were assets of the estate where the legal interest owned by
the decedent at the time of death was a limited partnership or
corporate interest. See also Estate of Church v. United States,
85 AFTR 2d 2000-804, 2000-1 USTC par. 60,369 (W.D. Tex. 2000).
Thus, we need not address whether the partnership agreement
satisfies the safe harbor provisions of section 2703(b).
Respondent did not argue separately that the Stranco
shareholders’ agreement should be disregarded for lack of
economic substance or under section 2703(a).
Gift at the Inception of SFLP
Respondent determined in the statutory notice and argues in
the alternative that, if the partnership is recognized for estate
tax purposes, decedent made a gift when he transferred property
to the partnership and received in return a limited partnership
interest of lesser value. Using the value reported by petitioner
on the estate tax return, if decedent gave up property worth in
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excess of $10 million and received back a limited partnership
interest worth approximately $6.5 million, he appears to have
made a gift equal to the loss in value. (Petitioner now claims a
greater discount, as discussed below.) In analogous
circumstances involving a transfer to a corporation, the Court of
Appeals in Kincaid v. United States, 682 F.2d 1220 (5th Cir.
1982), held that there was a taxable gift and awarded summary
judgment to the Government. The Court of Appeals rejected the
discounts claimed by the taxpayer, stating that no business
person “would have entered into this transaction, * * * [thus]
the ‘moving impulse for the * * * transaction was a desire to
pass the family fortune on to others’”. Id. at 1225 (quoting
Robinette v. Helvering, 318 U.S. 184, 187-188 (1943)). The Court
of Appeals in Kincaid concluded that, while there may have been
business reasons for the taxpayer to transfer land to a family
corporation in exchange for stock, “there was no business
purpose, only a donative one, for Mrs. Kincaid to accept less
value in return than she gave up.” Id. at 1226.
In this case, the estate claims that the assets were
transferred to SFLP for the business purposes discussed above.
Following the formation of SFLP, decedent owned a 99-percent
limited partnership interest in SFLP and 47 percent of the
corporate general partner, Stranco. Even assuming arguendo that
decedent’s asserted business purposes were real, we do not
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believe that decedent would give up over $3 million in value to
achieve those business purposes.
Nonetheless, in this case, because we do not believe that
decedent gave up control over the assets, his beneficial interest
in them exceeded 99 percent, and his contribution was allocated
to his own capital account, the instinctive reaction that there
was a gift at the inception of the partnership does not lead to a
determination of gift tax liability. In a situation such as that
in Kincaid, where other shareholders or partners have a
significant interest in an entity that is enhanced as a result of
a transfer to the entity, or in a situation such as Shepherd v.
Commissioner, 115 T.C. __, __ (2000) (slip. op. at 21), where
contributions of a taxpayer are allocated to the capital accounts
of other partners, there is a gift. However, in view of
decedent’s continuing interest in SFLP and the reflection of the
contributions in his own capital account, he did not transfer
more than a minuscule proportion of the value that would be
“lost” on the conveyance of his assets to the partnership in
exchange for a partnership interest. See Kincaid v. United
States, supra at 1224. Realistically, in this case, the
disparity between the value of the assets in the hands of
decedent and the alleged value of his partnership interest
reflects on the credibility of the claimed discount applicable to
the partnership interest. It does not reflect a taxable gift.
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Valuation of Decedent’s Limited Partnership Interest
For the reasons stated above, resolution of this case
requires that we determine the fair market value of decedent’s
limited partnership interest in SFLP. For reasons stated above
and below, we do not believe that the discounts claimed by
petitioner in this case are reasonable.
Fair market value is the price at which property would
change hands between a willing buyer and a willing seller,
neither being under any compulsion to buy or to sell and both
having reasonable knowledge of relevant facts. See United States
v. Cartwright, 411 U.S. 546, 551 (1973); sec. 20.2031-1(b),
Estate Tax Regs. Under the hypothetical willing buyer-willing
seller standard, decedent’s interest cannot be valued by assuming
that sales would be made to any particular person. See Estate of
Bright v. United States, 658 F.2d 999, 1001 (5th Cir. 1981). On
the other hand, transactions that are unlikely and plainly
contrary to the economic interest of a buyer or seller are not
reflective of fair market value. See Estate of Curry v. United
States, 706 F.2d 1424, 1429 (7th Cir. 1983); Estate of Newhouse
v. Commissioner, 94 T.C. 193, 232 (1990); Estate of Hall v.
Commissioner, 92 T.C. 312, 337 (1989); Estate of O’Keeffe v.
Commissioner, T.C. Memo. 1992-210.
The trier of fact determining fair market value must weigh
all relevant evidence and draw appropriate inferences. See Hamm
- 23 -
v. Commissioner, 325 F.2d 934, 938 (8th Cir. 1963), affg. T.C.
Memo. 1961-347; Estate of Andrews v. Commissioner, 79 T.C. 938
(1982). Reviewing the facts of this case, at the date of death,
decedent owned a 99-percent limited partnership interest in SFLP
and a 47-percent interest in Stranco, the 1-percent owner and
general partner of SFLP. Approximately 75 percent of the
partnership’s value consisted of cash and securities. It is
unlikely and plainly contrary to the interests of a hypothetical
seller to sell these interests separately and without regard to
the liquidity of the underlying assets. SFLP was not a risky
business or one in which the continuing value of the assets
depended on continuing operations.
Each of the parties in this case presented expert valuation
testimony. The experts agreed that the appropriate methodology
was the “net asset value” approach. Each expert determined and
applied a minority interest discount and a marketability discount
to the net asset value of the partnership assets.
Both petitioner’s expert and respondent’s expert determined
that a 25-percent lack of marketability discount was appropriate.
Only respondent’s expert, however, considered decedent’s
ownership of Stranco stock. We agree with respondent that the
relationship between the limited partnership interest and the
interest in Stranco cannot be disregarded. The entities were
- 24 -
created as a unit and operated as a unit and were functionally
inseparable.
In valuing decedent’s 99-percent limited partnership
interest on the date of death, respondent’s expert applied an
8-percent minority interest discount and a 25-percent
marketability discount, to reach a combined (rounded) discount of
31 percent. Respondent’s expert valued decedent’s 47-percent
interest in Stranco by applying a 5-percent minority interest
discount and a 15-percent marketability discount, to reach a
combined (rounded) discount of 19 percent. Petitioner’s expert
applied a 25-percent minority interest discount and a 25-percent
marketability discount, resulting in an effective total discount
of 43.75 percent to the partnership. He did not value
petitioner’s interest in Stranco because he believed that the
relationship was irrelevant. In our view, his result is
unreasonable and must be rejected.
Respondent’s expert selected the lower minority interest
discount after considering the effective control of the limited
partnership interest and the interest in Stranco and considering
the detailed provisions of the partnership agreement and the
shareholders’ agreement. He examined closed-end funds, many of
which are traded on major exchanges, and determined the range of
discounts from net asset value for those funds. He selected a
discount toward the lower end of the range. His analysis was
- 25 -
well documented and persuasive. As respondent notes, normally a
control premium would apply to an interest having effective
control of an entity.
Petitioner argues that consideration of the stock interest
in Stranco in valuing the limited partnership interest is
erroneous because the shareholders’ agreement granted the
corporation and the other shareholders the right to purchase a
selling shareholder’s stock. While the shareholders’ agreement
may be a factor to be considered in determining fair market
value, it does not persuade us that a hypothetical seller would
not market the interest in the limited partnership and the
interest in the corporation as a unit or that a transaction would
actually take place in which only the partnership interest or the
stock interest was transferred. Under the circumstances, the
shareholders’ agreement is merely a factor to be taken into
account but not to be given conclusive weight. Cf. Estate of
Hall v. Commissioner, 92 T.C. 312, 335 (1989); Estate of Lauder
v. Commissioner, T.C. Memo. 1994-527.
In view of our rejection of respondent’s belated attempt to
raise section 2036 and respondent’s request that we disregard the
partnership agreement altogether, we are constrained to accept
the evidence concerning discounts applicable to decedent’s
interest in the partnership and in Stranco as of the date of
death. We believe that the result of respondent’s expert’s
- 26 -
discounts may still be overgenerous to petitioner, but that
result is the one that we must reach under the evidence and under
the applicable statutes.
We have considered the other arguments of the parties, and
they do not affect our analysis. To reflect the foregoing and
the stipulated adjustments,
Decision will be entered
under Rule 155.
Reviewed by the Court.
CHABOT, WHALEN, COLVIN, HALPERN, CHIECHI, and THORNTON, JJ.,
agree with this majority opinion.
LARO, J., concurs in this opinion.
- 27 -
WELLS, C.J., concurring: Respectfully, although I concur in
the result reached by the majority in the instant case, I wish to
express my disagreement with the majority’s application of the
economic substance doctrine. The majority rejects the alleged
business purposes underlying the formation of the disputed
partnership but then concludes that the partnership "had
sufficient substance to be recognized for tax purposes", majority
op. p. 16, because the partnership was validly formed under State
law, which altered the legal relationships between the decedent
and others.
I believe that the majority’s stated reasons for holding
that the partnership had substance misapplies the economic
substance doctrine. In cases such as ACM Pshp. v. Commissioner,
157 F.3d 231 (3d Cir. 1998), affg. in part and revg. in part on
another issue T.C. Memo. 1997-115, where the economic substance
doctrine is applied to deny income tax benefits, the doctrine is
applied regardless of the validity of the partnership under State
law. Because the majority has rejected the alleged business
purposes underlying the formation of the partnership in issue in
the instant case, a proper application of the economic substance
doctrine, if it were to apply, would ignore the partnership and
disallow the discounts for minority interest and lack of
marketability.
- 28 -
I believe that, rather than holding that the economic
substance doctrine is satisfied in the instant case, the Court
should conclude that the economic substance doctrine does not
apply to disregard a validly formed entity where the issue is the
value for Federal gift and estate tax purposes of the interest
transferred in that entity. In that regard, I agree with Judge
Foley's concurring opinion in Knight v. Commissioner, 115 T.C.
___, ___ (2000).
FOLEY, J., agrees with this concurring opinion.
- 29 -
PARR, J., dissenting: The majority, citing Frank Lyon Co.
v. United States, 435 U.S. 561, 583-584 (1978), states: "the tax
effects of a particular transaction are determined by the
substance of the transaction rather than by its form." Majority
op. p. 11. The majority also cites a long line of cases, see
Helvering v. Clifford, 309 U.S. 331, 336 (1940); Kuney v. Frank,
308 F.2d 719, 720 (9th Cir. 1962); Frazee v. Commissioner, 98
T.C. 554, 561 (1992); Harwood v. Commissioner, 82 T.C. 239, 258
(1984), affd. without published opinion 786 F.2d 1174 (9th Cir.
1986); Estate of Kelly v. Commissioner, 63 T.C. 321, 325 (1974);
Estate of Tiffany v. Commissioner, 47 T.C. 491, 499 (1967), that
require the Court to closely scrutinize family partnerships
"because the family relationship 'so readily lends itself to
paper arrangements having little or no relationship to reality.'"
Majority op. p. 12 (quoting Kuney v. Frank, 308 F.2d 719, 720
(9th Cir. 1962)).
The majority is "skeptical of the estate's claims of
business purposes related to executor and attorney's fees or
potential tort claims", majority op. p. 13, is not persuaded that
SFLP was formed to protect assets from will contests, does not
believe that a joint investment vehicle was the purpose of the
partnership, found that the formation and control of SFLP were
orchestrated by Mr. Gulig without regard to joint enterprise, and
- 30 -
found that the management of the assets contributed to SFLP was
not the purpose of SFLP.
In this case, the facts clearly demonstrate that the paper
arrangement, the written partnership agreement, had no
relationship to the reality of decedent's ownership and control
of the assets contributed to the partnership. Although under the
partnership agreement a limited partner could not demand a
distribution of partnership capital or income, the partnership
(1) paid for Stone's surgery when she injured her back while
caring for decedent, (2) distributed $3,187,800 to decedent's
estate for State and Federal estate and inheritance taxes, (3)
distributed $563,000 in 1995 and 1996 and $102,500 in 1998 to
each of the Strangi children, (4) divided its primary Merrill
Lynch account into four separate accounts in each of the Strangi
children's names, (5) extended lines of credit to John Strangi,
Albert T. Strangi, and Mrs. Gulig, and (6) advanced to decedent's
estate $3.32 million to post bonds with the Internal Revenue
Service. It is clear that, contrary to the written partnership
agreement, decedent and his successor in interest to his
partnership interest (decedent's estate) had the ability to
withdraw funds at will. If a hypothetical third party had
offered to purchase the assets held by the partnership for the
full fair market value of those assets, there is little doubt
- 31 -
that decedent could have had the assets distributed to himself to
complete the sale.
The majority, however, holds that, because the formalities
were followed and SFLP was validly formed under State law, the
partnership had sufficient substance to be recognized for tax
purposes. The majority then values decedent's partnership
interest as if the restrictions in the written partnership
agreement were actually binding on the partners. The majority
states, "The actual control exercised by Mr. Gulig, combined with
the 99-percent limited partnership interest in SFLP and the 47-
percent interest in Stranco, suggest the possibility of including
the property transferred to the partnership in decedent's estate
under section 2036." Majority op. p. 15. It seems incongruous
that for purposes of section 2036 this Court could look to the
actual control decedent exercised over the assets of the
partnership, but for purposes of determining the appropriate
discounts for valuing decedent's interest in the partnership this
Court is limited to the written partnership agreement.
Assuming, arguendo, that the partnership must be recognized
for Federal estate tax purposes, I would value the interest under
the agreement that existed in fact, rather than under the written
partnership agreement that had no relationship to the reality of
decedent's ownership and control of the assets contributed to the
partnership.
- 32 -
A person who maintains control over the ultimate disposition
of property is, in practical effect, in a position similar to the
actual owner of the property. See, e.g., Estate of Kurz v.
Commissioner, 101 T.C. 44, 50-51, 59-60 (1993), supplemented by
T.C. Memo. 1994-221, affd. 68 F.3d 1027 (7th Cir. 1995). The
Court should not allow a taxpayer who is not in fact limited by
an agreement to claim a discount that is premised on that very
limitation. A minority discount is allowed because a limited
partner cannot cause the partnership to make distributions.
Decedent and decedent's estate in fact caused the partnership to
make distributions at will. The minority discount is not
appropriate in this case.
Additionally, a discount for lack of marketability is
allowed because a hypothetical third party would pay less for the
partnership interest than for the assets. But in this case,
under the actual partnership arrangement, decedent could have had
all the assets distributed to himself and then sold them directly
to the buyer. The lack of marketability discount, therefore,
also is inappropriate in this case. Because the actual
partnership arrangement provided for distributions at will, I
would value the partnership interest at the value of the
partnership's assets without any discount.
For the above reasons, I respectfully dissent.
BEGHE and MARVEL, JJ., agree with this dissenting opinion.
- 33 -
RUWE, J., dissenting: Decedent transferred property to a
newly formed partnership in return for a 99-percent limited
partnership interest. This was done 2 months before he died, as
part of a plan to reduce tax on his estate. The estate presented
testimony to support its argument that these actions were taken
for business purposes. The trial judge clearly rejects these
arguments and describes the testimony offered by the estate as
“mere window dressing to conceal tax motives.” Majority op. p.
13. Tax savings was the only motivating factor for transferring
property to the partnership. Nevertheless, the majority
validates this scheme by valuing decedent’s 99-percent
partnership interest at 31 percent below the value of the
property that decedent transferred to the partnership.
Respondent argues that if the partnership interest that
decedent received is to be valued at 31 percent less than the
value of the property that decedent transferred to the
partnership, then the difference should be considered to be a
gift. The majority rejects respondent’s gift argument.1
1
One of the reasons given by the majority for rejecting
respondent’s gift argument is “we do not believe that decedent
gave up control over the assets”. Majority op. p. 21. This
finding is inconsistent with the majority’s allowance of a 31
percent discount. If decedent owned assets worth $9,876,929,
transferred legal title to those assets to a partnership in which
he had a beneficial interest that exceeded 99 percent, and
thereafter retained control over the transferred assets, how
could the value of his property rights be 31 percent less after
(continued...)
- 34 -
Respondent’s gift tax argument is supported by the
applicable statutes, regulations, and controlling opinions. If
the value of the property that decedent transferred to the
partnership was more than the value of the consideration that he
received, and the transfer was not made for bona fide nontax
business reasons, then the amount by which the value of the
property transferred exceeds the value of the consideration is
deemed to be a gift pursuant to section 2512(b).
Section 2512(b) provides:
SEC. 2512. VALUATION OF GIFTS.
(b) Where property is transferred for less than an
adequate and full consideration in money or money’s
worth, then the amount by which the value of the
property exceeded the value of the consideration shall
be deemed a gift, and shall be included in computing
the amount of gifts made during the calendar year.
Section 25.2512-8, Gift Tax Regs., provides:
Sec. 25.2512-8. Transfers for insufficient
consideration.--Transfers reached by the gift tax are
not confined to those only which, being without a
valuable consideration, accord with the common law
concept of gifts, but embrace as well sales, exchanges,
and other dispositions of property for a consideration
to the extent that the value of the property
transferred by the donor exceeds the value in money or
money’s worth of the consideration given therefor.
* * *
1
(...continued)
the transfer? Certainly, a hypothetical willing buyer and seller
with reasonable knowledge of the relevant facts would be aware
that decedent’s property interests included control over the
assets. The majority’s analysis fails to adequately explain this
apparent anomaly.
- 35 -
Transactions made in the ordinary course of business are exempt
from the above gift tax provisions. Thus, section 25.2512-8,
Gift Tax Regs., provides:
However, a sale, exchange, or other transfer of
property made in the ordinary course of business (a
transaction which is bona fide, at arm’s length, and
free from any donative intent), will be considered as
made for an adequate and full consideration in money or
money’s worth. * * *
The Supreme Court has described previous versions of the
gift tax statutes (section 501 imposing the tax on gifts and
section 503 which is virtually identical to present section
2512(b)) in the following terms:
Sections 501 and 503 are not disparate provisions.
Congress directed them to the same purpose, and they
should not be separated in application. Had Congress
taxed “gifts” simpliciter, it would be appropriate to
assume that the term was used in its colloquial sense,
and a search for “donative intent” would be indicated.
But Congress intended to use the term “gifts” in its
broadest and most comprehensive sense. H. Rep. No.
708, 72d Cong., 1st Sess., p.27; S. Rep. No. 665, 72d
Cong., 1st Sess., p.39; cf. Smith v. Shaughnessy, 318
U.S. 176; Robinette v. Helvering, 318 U.S. 184.
Congress chose not to require an ascertainment of what
too often is an elusive state of mind. For purposes of
the gift tax it not only dispensed with the test of
“donative intent.” It formulated a much more workable
external test, that where “property is transferred for
less than an adequate and full consideration in money
or money’s worth,” the excess in such money value
“shall, for the purpose of the tax imposed by this
title, be deemed a gift...” And Treasury Regulations
have emphasized that common law considerations were not
embodied in the gift tax.
To reinforce the evident desire of Congress to hit
all the protean arrangements which the wit of man can
devise that are not business transactions within the
- 36 -
meaning of ordinary speech, the Treasury Regulations
make clear that no genuine business transaction comes
within the purport of the gift tax by excluding “a
sale, exchange, or other transfer of property made in
the ordinary course of business (a transaction which is
bona fide, at arm’s length, and free from any donative
intent).” Treas. Reg. 79 (1936 ed.) Art. 8. Thus on
finding that a transfer in the circumstances of a
particular case is not made in the ordinary course of
business, the transfer becomes subject to the gift tax
to the extent that it is not made “for an adequate and
full consideration in money or money’s worth.” See 2
Paul, Federal Estate and Gift Taxation (1942) p. 1113.
[Commissioner v. Wemyss, 324 U.S. 303, 306 (1945); fn.
ref. omitted; emphasis added.]
In light of what the Supreme Court said, the estate
attempted to portray the transfer of property to the partnership
as a business transaction. The majority soundly rejects this as
a masquerade. Indeed, it is clear that the transfer was made to
reduce the value of decedent’s assets for estate tax purposes,
while at the same time allowing the full value of decedent’s
property to pass to his children.
The Supreme Court has described the objective of the gift
tax as follows:
The section taxing as gifts transfers that are not made
for “adequate and full [money] consideration” aims to
reach those transfers which are withdrawn from the
donor’s estate. * * * [Commissioner v. Wemyss, supra at
307.]
Under the applicable gift tax provisions and Supreme Court
precedent, it is unnecessary to consider what decedent’s children
received on the date of the transfer in order to determine the
value of the deemed gift under section 2512(b). Indeed, it is
- 37 -
not even necessary to identify the donees. Section 25.2511-2(a),
Gift Tax Regs., provides:
Sec. 25.2511-2. Cessation of donor’s dominion and
control.--(a) The gift tax is not imposed upon the
receipt of the property by the donee, nor is it
necessarily determined by the measure of enrichment
resulting to the donee from the transfer, nor is it
conditioned upon ability to identify the donee at the
time of the transfer. On the contrary, the tax is a
primary and personal liability of the donor, is an
excise upon his act of making the transfer, is measured
by the value of the property passing from the donor,
and attaches regardless of the fact that the identity
of the donee may not then be known or ascertainable.
In Robinette v. Helvering, 318 U.S. 184 (1943), the taxpayer
argued that there could be no gift of a remainder interest where
the putative remaindermen (prospective unborn children of the
grantor) did not even exist at the time of the transfer. The
Supreme Court rejected this argument stating that the gift tax is
a primary and personal liability of the donor measured by the
value of the property passing from the donor.
This case involves an attempt by a dying man (or his
attorney) to transfer property to a partnership in consideration
for a 99-percent partnership interest that would be valued at
substantially less than the value of the assets transferred to
the partnership, while at the same time assuring that 100 percent
of the value of the transferred assets would be passed to
decedent’s beneficiaries. Assuming, as the majority has found,
that decedent’s partnership interest was worth less than the
- 38 -
property he transferred,2 section 2512(b) should be applied.
Pursuant to that section the excess of the value of the property
decedent transferred to the partnership over the value of the
consideration he received is “deemed a gift” subject to the gift
tax. By failing to apply section 2512(b) in this case, the
majority thwarts the purpose of section 2512(b) which the Supreme
Court described as “the evident desire of Congress to hit all the
protean arrangements which the wit of man can devise that are not
business transactions”. Commissioner v. Wemyss, supra at 306.
PARR, BEGHE, GALE, and MARVEL, JJ., agree with this
dissenting opinion.
2
The majority’s allowance of a 31-percent discount is in
stark contrast to its rejection of respondent’s gift argument on
the ground that decedent did not give up control of the assets
when he transferred them to the partnership. See majority op. p.
21. While the basis for finding that decedent did not give up
control of the assets is not fully explained, it appears not to
be based on the literal terms of the partnership agreement which
gave control to Stranco, the corporate general partner. Decedent
owned only 47 percent of the Stranco stock. Since the majority
also rejects respondent’s economic substance argument, the only
other conceivable basis for concluding that decedent retained
control over the assets that he contributed to the partnership is
that the partnership arrangement was a factual sham. If that
were the case, the partnership arrangement itself would be “mere
window dressing” masking the true facts and the terms of the
partnership arrangement should be disregarded. In an analogous
situation the Court of Appeals for the Tenth Circuit disregarded
the written terms of a transfer document as fraudulent. See
Heyen v. United States, 945 F.2d 359 (10th Cir. 1991).
- 39 -
BEGHE, J., dissenting: Having joined the dissents of Judges
Parr and Ruwe, I write separately to describe another path to the
conclusion that SFLP had no effect on the value of Mr. Strangi’s
gross estate under sections 2031 and 2033. In my view, the
property to be valued is the property originally held by Mr.
Strangi, the so-called contributed property. Notwithstanding
that the property in question may have been contributed to a
partnership formed on Mr. Strangi’s behalf in exchange for a 99-
percent limited partnership interest, we’re not bound to accept
the estate’s contention that the property to be valued is its
interest in SFLP, subject to all the disabilities and resulting
valuation discounts entailed by ownership of an interest in a
limited partnership. Instead, the facts of this case invite us
to use the end-result version of the step-transaction doctrine to
treat the underlying partnership assets--the property originally
held by the decedent--as the property to be valued for estate tax
purposes.
The value of property for transfer tax purposes is the price
at which the property would change hands between a willing buyer
and a willing seller, neither being under any compulsion to buy
or to sell and both having reasonable knowledge of relevant
facts. See United States v. Cartwright, 411 U.S. 546, 550-551
(1973); sec. 20.2031-1(b), Estate Tax Regs.; sec. 25.2512-1, Gift
Tax Regs. The majority state that SFLP’s existence “would not be
- 40 -
disregarded by potential purchasers of decedent’s assets”; the
majority also suggest that this is why the partnership should not
be disregarded as a substantive sham. See majority op. p. 16.
I support the use of substance over form analysis to decide
whether a transaction qualifies for the tax-law defined status
its form suggests. A formally correct transaction without a
business purpose may not be a “reorganization”, and a title
holder of property without an economic interest may not be the
tax “owner”. However, I share the majority’s concerns about
using substance over form analysis to alter the conclusion about
a real-world fact, such as the fair market value of property,
which the law tells us is the price at which the property
actually could be sold.1
1
Against the grain of the majority’s conclusions that the
SFLP arrangements were neither a factual sham nor a substantive
sham, I would observe that another “conceivable basis for
concluding that decedent retained control over the assets that he
contributed to the partnership” (Ruwe, J., dissenting opinion
page 38 note 2) are the multiple roles played by Mr. Gulig, who
had decedent’s power of attorney and caused himself to be
employed by Stranco to manage the affairs of SFLP, and the tacit
understanding of the other family members that he would look out
for their interests. Although I would agree with the majority
that use of substantive sham analysis may not be appropriate in
transfer tax cases, I believe that factual sham analysis can be
used in appropriate cases in the transfer tax area and that the
case at hand is one of those cases; the terms of the SFLP
partnership agreement should be disregarded because the parties
to the agreement didn’t pay any attention to them. Cf. Heyen v.
United States, 945 F.2d 359 (10th Cir. 1991). To adapt to the
case at hand the hypothetical posed by the Court of Appeals in
Citizens Bank & Trust Co. v. Commissioner, 839 F.2d 1249, 1254-
(continued...)
- 41 -
Although my approach to the case at hand employs a step-
transaction analysis, which is a variant of substance over form,
I do not use that analysis to conclude anything about fair market
value. Instead, I use it to identify the property whose transfer
is subject to tax. Step-transaction analysis has often been used
in transfer tax cases to identify the transferor or the property
transferred.
The step-transaction doctrine is a judicially created
concept that treats a series of formally separate “steps” as a
single transaction if those steps are “in substance integrated,
interdependent and focused toward a particular end result.”
Penrod v. Commissioner, 88 T.C. 1415, 1428 (1987). The most far-
reaching version of the step-transaction doctrine, the end-result
test, applies if it appears that a series of formally separate
steps are really prearranged parts of a single transaction that
are intended from the outset to reach the ultimate result. See
Penrod v. Commissioner, 88 T.C. 1429, 1430 (citing Helvering
v. Alabama Asphaltic Limestone Co., 315 U.S. 179 (1942); South
Bay Corp. v. Commissioner, 345 F.2d 698 (2d Cir. 1965); Morgan
Manufacturing Co. v. Commissioner, 124 F.2d 602 (4th Cir. 1941);
1
(...continued)
1255 (7th Cir. 1988), the magic marker the Guligs used to paint
the mustache on the Mona Lisa was filled with disappearing ink.
However, the discussion in the text is presented as an
alternative to a factual sham analysis.
- 42 -
Heintz v. Commissioner, 25 T.C. 132 (1955); Ericsson Screw
Machine Prods. Co., v. Commissioner, 14 T.C. 757 (1950); King
Enters., Inc. v. United States, 189 Ct. Cl. 466, 475, 418 F.2d
511, 516 (1969)). The end-result test is flexible and grounds
tax consequences on what actually happened, not on formalisms
chosen by the participants. See Penrod v. Commissioner, supra.
The sole purpose of the transactions orchestrated by Mr. and
Mrs. Gulig was to reduce Federal transfer taxes by depressing the
value of Mr. Strangi’s assets as they passed through his gross
estate, to his children, via the partnership. The arrangement
merely operated to convey the assets to the same individuals who
would have received the assets in any event under Mr. Strangi’s
will. Nothing of substance was intended to change as a result of
the transactions and, indeed, the transactions did nothing to
affect Mr. Strangi’s or his children’s interests in the
underlying assets except to evidence an effort to reduce Federal
transfer taxes. The control exercised by Mr. Strangi and his
children over the assets did not change at all as a result of the
transactions. For instance, shortly after Mr. Strangi’s death
SFLP made substantial distributions to the children, the Merrill
Lynch account was divided into 4 separate accounts to allow each
child to control his or her proportionate share of SFLP assets,
and distributions were made to the estate to enable it to pay
death taxes and post a bond. Mr. Strangi’s testamentary
- 43 -
objectives are further evidenced by his practical incompetency
and failing health at formation and funding of SFLP and Stranco
and the short time between the partnership transactions and Mr.
Strangi’s death.
The estate asserts that property with a stated value of
$9,876,929, in the form of cash and securities, when funneled
through the partnership, took on a reduced value of $6,560,730.
It is inconceivable that Mr. Strangi would have accepted, if
dealing at arm’s length, a partnership interest purportedly worth
only two-thirds of the value of the assets he transferred. This
is especially the case given Mr. Strangi’s age and health,
because it would have been impossible for him ever to recoup this
immediate loss.
It is also inconceivable that Mr. Strangi (or his
representatives) would transfer the bulk of his liquid assets to
a partnership, in exchange for a limited interest (plus a
minority interest in the corporate general partner) that would
terminate his control over the assets and their income streams,
if the other partners had not been family members. See Estate of
Trenchard v. Commissioner, T.C. Memo. 1995-121; there the Court
found “incredible” the assertion of the executrix that the
decedent’s transfer of property to a family corporation in
exchange for stock was in the ordinary course of business. It is
clear that the sole purpose of SFLP was to depress the value of
- 44 -
Mr. Strangi’s assets artificially for a brief time as the assets
passed through his estate to his children. See Estate of Murphy
v. Commissioner, T.C. Memo. 1990-472, in which this Court denied
decedent’s estate a minority discount on a 49.65-percent stock
interest because the prior inter vivos transfer of a 1.76-percent
interest did “not appreciably affect decedent’s beneficial
interest except to reduce Federal transfer taxes.” Estate of
Murphy v. Commissioner, supra, 60 T.C.M. 645, 661, 1990
T.C.M. (RIA) par. 90,472, at 90-2261.
Thus, under the end-result test, the formally separate
steps of the transaction (the creation and funding of the
partnership within 2 months of Mr. Strangi’s death, the
substantial outright distributions to the estate and to the
children, and the carving up of the Merrill Lynch account) that
were employed to achieve Mr. Strangi’s testamentary objectives
should be collapsed and viewed as a single integrated
transaction: the transfer at Mr. Strangi’s death of the
underlying assets.
In many cases courts have collapsed multistep transactions
or recast them to identify the parties (usually the donor or
donee) or the property to be valued for transfer tax purposes.
See, e.g., Estate of Bies v. Commissioner, T.C. Memo. 2000-338
(identifying transferors for purposes of gift tax annual
exclusions); Estate of Cidulka v. Commissioner, T.C. Memo. 1996-
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149 (donor’s gift of minority stock interests to shareholders
followed by a redemption of donor’s remaining shares treated as
single transfer of a controlling interest); Estate of Murphy v.
Commissioner, supra (decedent’s inter vivos transfer of a
minority interest followed by a testamentary transfer of her
remaining shares treated as an integrated plan to transfer
control to decedent’s children); Griffin v. United States, 42 F.
Supp. 2d 700 (W.D. Tex. 1998) (transfer of 45 percent of donor’s
stock to donor’s spouse followed by a transfer by spouse and
donor of all their stock to a trust for the benefit of their
child treated as one gift by donor of the entire block).2
The reciprocal trust doctrine, another application of
substance over form, has been used in the estate and gift tax
area to determine who is the transferor of property for the
purposes of inclusion in the gross estate. See United States v.
Grace, 395 U.S. 316, 321 (1969) (applying the reciprocal trust
doctrine in the estate tax context to identify the grantor, and
quoting with approval Lehman v. Commissioner, 109 F.2d 99, 100
(2d Cir. 1940): “The law searches out the reality and is not
concerned with the form.”). More recently, Sather v.
Commissioner, T.C. Memo. 1999-309, applied the reciprocal trust
2
In Griffin v. United States, 42 F. Supp. 2d 700, 706 n.4
(W.D. Tex. 1998), the court distinguished Estate of Frank v.
Commissioner, T.C. Memo. 1995-132, where this Court declined to
integrate the steps of the transaction.
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doctrine to cut down the number of present interest annual
exclusions for gift tax purposes:
We must peel away the veil of cross-transfers to
seek out the economic substance of the foregoing series
of transfers. * * *
* * * * * * *
We are led to the inescapable conclusion that the
form in which the transfers were cast, i.e., gifts to
the nieces and nephews, had no purpose aside from the
tax benefits petitioners sought by way of inflating
their exclusion amounts. The substance and purpose of
the series of transfers was for each married couple to
give to their own children their Sathers stock. After
the transfers, each child was left in the same economic
position as he or she would have been in had the
parents given the stock directly to him or her. Each
niece and nephew received an identical amount of stock
from his or her aunts and uncles and was left in the
same economic position in relation to the others. This
was not a coincidence but rather was the result of a
plan among the donors to give gifts to their own
children in a form that would avoid taxes. * * *
[Sather v. Commissioner, T.C. Memo. 1999-309, 78 T.C.M.
(CCH) 456, 459-460, 1999 T.C.M. (RIA) par. 99,309, at
99-1964-99-1965.]
All this is set out most clearly in our reviewed opinion in
Bischoff v. Commissioner, 69 T.C. 32 (1977), as explained by the
Court of Appeals for the Federal Circuit in Exchange Bank & Trust
Co. v. United States, 694 F.2d 1261, 1269 (Fed. Cir. 1982):
“We agree with the majority in Bischoff and the appellee in this
action [the United States] that the reciprocal trust doctrine
merely identifies the true transferor, but the actual basis for
taxation is founded upon specific statutory authority.”
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In Estate of Montgomery v. Commissioner, 56 T.C. 489 (1971),
affd. 458 F.2d 616 (5th Cir. 1972), an elderly decedent, who was
otherwise uninsurable, purchased a single premium annuity and was
thereby able to obtain life insurance that he assigned to trusts.
The Court held that the arrangement was not life insurance within
the meaning of the parenthetical exception contained in section
2039, and therefore, the proceeds of the policies were includable
in decedent’s gross estate. In so holding, the Court used the
language of step transactions to find that the annuity and
insurance were part of a single investment agreement.
Daniels v. Commissioner, T.C. Memo. 1994-591, applied the
step-transaction doctrine in a gift tax case in favor of the
taxpayers to conclude that an outright gift of common stock to
children and a simultaneous exchange of some common for preferred
were parts of the same gift. As a result, the Commissioner’s
belated attempt to tax the imbalance in values on the common-
preferred exchange was barred by the statute of limitations.
My conclusion that the property to be valued for estate tax
purposes should be the property transferred to SFLP is further
supported by the decision of Citizens Bank & Trust Co. v.
Commissioner, 839 F.2d 1249 (7th Cir. 1988), affg. Northern Trust
Co. v. Commissioner, 87 T.C. 349 (1986). There, the Court of
Appeals for the Seventh Circuit held that the taxable value of a
gift is not altered by the terms of the conveyance; therefore,
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“restrictions imposed in the instrument of transfer are to be
ignored for purposes of making estate or gift tax valuations”.
Id. at 1252-1253. I conclude that the formation of SFLP and
subsequent distributions of partnership assets should be treated
as parts of a single, integrated transaction, and that the SFLP
agreement is properly viewed as a restriction included in the
testamentary conveyance to the Strangi children. Accordingly,
under Citizens Bank & Trust Co. v. Commissioner, supra, and the
other authorities previously discussed, any reduction in values
allegedly caused by the SFLP agreement should be disregarded;
under sections 2031 and 2033, the contributed property is the
property to be included and valued in the gross estate.
PARR, J., agrees with this dissenting opinion.