ESTATE OF TURNER v. COMMISSIONER OF INTERNAL REVENUEDocket No. 18911-08.
T.C. Memo. 2011-209
ESTATE OF CLYDE W. TURNER, SR., DECEASED, W. BARCLAY RUSHTON, EXECUTOR, Petitioner,
COMMISSIONER OF INTERNAL REVENUE, Respondent.
COMMISSIONER OF INTERNAL REVENUE, Respondent.
United States Tax Court.
Filed August 30, 2011.
Charles E. Hodges II, for petitioner.
Caroline R. Krivacka, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined a Federal estate tax deficiency of $659,912 with respect to the Estate of Clyde W. Turner, Sr. (estate). The primary issue for decision is whether the value of property Clyde W. Turner, Sr. (Clyde Sr.) transferred to Turner & Co., a family limited partnership, is included in his gross estate under section 2035, 2036, or 2038.
FINDINGS OF FACT
Some of the facts have been stipulated. We incorporate the stipulation of facts, the first supplemental stipulation of facts, and the second supplemental stipulation of facts into our findings by this reference.
Clyde Sr. resided in Georgia when he died testate on February 4, 2004. Clyde Sr.'s longtime accountant, W. Barclay Rushton (Mr. Rushton), was appointed executor of the estate. When the petition on behalf of the estate was filed, Mr. Rushton resided in Georgia.
Clyde Sr. was survived by his wife of nearly 60 years, Jewell H. Turner (Jewell). Clyde Sr. and Jewell had four children: Clyde Turner, Jr. (Clyde Jr.), Betty T. Crane (Betty), Joyce T. Crumley (Joyce), and Janna T. Lovell (Janna).
Clyde Sr. and His Family
Clyde Sr. was born in 1920 in Union City, Georgia, and grew up in White County, Georgia. He was drafted into the U.S. Army during World War II and was stationed in the Philippine Islands. Upon completing his military service, Clyde Sr. returned home to Georgia and went into the lumber business.
Clyde Sr. was the oldest of 10 children, and he enjoyed close, lifelong relationships with his brothers and sisters. In the late 1950s Clyde Sr. and his four brothers formed Mt. Yonah Lumber Co. (Mt. Yonah). Over the years several members of Clyde Sr.'s family worked for or became shareholders in Mt. Yonah, including Clyde Jr. and Clyde Jr.'s two sons, Marc Turner (Marc) and Travis Turner (Travis).
Clyde Jr. had a domineering personality, and he adopted a negative, unpleasant attitude toward his sisters and their husbands. Moreover, Clyde Jr.'s involvement with Mt. Yonah created jealousy and resentment among his sisters and caused them to suspect that their parents favored Clyde Jr. Clyde Sr. was disappointed that his children did not have the kind of close relationship with one another that he enjoyed with his own siblings.
In 1993 Joyce died, leaving behind two teenaged sons: Riley Crumley III (Trey) and Rory Crumley (Rory). Rory dropped out of high school a year or two after his mother's death and began abusing illegal drugs. As of the trial date, he had been arrested at least 26 times. Clyde Sr., Jewell, and the Turner children were aware of Rory's problems with drugs. Nevertheless, Rory maintained a close relationship with Jewell, and Jewell gave him money from time to time.
Clyde Sr.'s and Jewell's Assets
Regions Bank Stock
Clyde Sr. and Jewell acquired Regions Bank stock throughout their lives, and by 2002 they owned more than 170,000 shares. Clyde Sr. acquired some of the stock from his father, Ollie Turner, who was the first depositor to Peoples Bank in Cleveland, Georgia. (Peoples Bank became Regions Bank following a series of mergers in the 1980s and 1990s.) Jewell also acquired a large amount of Regions Bank stock from her father, Millard Holcombe, who served on the board of directors and was the first president of Peoples Bank. Clyde Sr. also served on the board of directors of Peoples Bank.
Because of the family ties to Regions Bank, the stock had sentimental value to Clyde Sr. and Jewell, and they sold few, if any, shares over the years. Moreover, the stock had greatly appreciated in value, paid dividends for many years, and was a cornerstone to Clyde Sr.'s and Jewell's accumulation of wealth.
Clyde Sr. and Jewell maintained several bank and investment accounts, owned their home in Cleveland, Georgia, and owned investment real estate in North Carolina. Clyde Sr. occasionally bought and sold stock, but he did not follow any particular investment strategy. Clyde Sr. also invested in real estate from time to time with Janna's husband, John Lovell (Mr. Lovell), a professional real estate developer, and with Larry Bramblett (Mr. Bramblett), a property developer whom Clyde Sr. met in the 1990s.
On January 7, 1992, Clyde Sr. established the Irrevocable Trust of Clyde W. Turner, Sr. (Clyde Sr.'s Trust) to own life insurance policies for the benefit of his children and grandchildren. Clyde Jr. and Betty were named trustees of the trust. In 2000-2003 Clyde Sr.'s Trust had 12 beneficiaries, consisting of Clyde Sr.'s then-living children and grandchildren.
In 1992 Clyde Sr.'s Trust purchased a life insurance policy from Jackson National Life Insurance Co. In 1997 Clyde Sr.'s Trust purchased a life insurance policy from Sun Financial Life. On a date that is not disclosed in the record, Clyde Sr.'s Trust purchased a State Farm life insurance policy.
Item 3 of Clyde Sr.'s Trust agreement provided that Clyde Sr., as well as others, had the right to add to the trust at any time by, inter alia, depositing money, insurance policies, or any other property with the trustees. Clyde Sr. did not transfer money to the trustees of Clyde Sr.'s Trust to pay the life insurance premiums in 2000-2003. Instead, Clyde Sr. paid the premiums directly from a joint checking account he shared with Jewell.
Item 3 of Clyde Sr.'s Trust agreement provided that after each direct or indirect transfer to the trust that was treated as a gift for Federal gift tax purposes, each beneficiary, i.e., each then-living child and grandchild of Clyde Sr., had the absolute right and power to withdraw from the trust the lesser of (1) $20,000 ($10,000 if the beneficiary was not married at the time of the withdrawal), minus the total amounts previously withdrawn by that beneficiary during the same calendar year, or (2) the amount of the transfer, divided by the number of beneficiaries. A beneficiary wishing to make a withdrawal from Clyde Sr.'s Trust was required to give notice of his exercise of the withdrawal right within 30 days of the transfer to the trust giving rise to such right. Upon timely receipt of a request for withdrawal, the trustees of Clyde Sr.'s Trust were required to distribute from the trust the amount necessary to satisfy the request. For this purpose, the trustees were authorized to distribute cash or any other trust property or to borrow against the cash value of any insurance policy to obtain cash for the distribution. There is no evidence in the record that any of the beneficiaries ever requested or made withdrawals from Clyde Sr.'s Trust before Clyde Sr.'s death.
Management of Clyde Sr. and Jewell's Finances
In approximately 1994 Marc began helping Clyde Sr. and Jewell with their bookkeeping and finances. Sometime in 2001 Clyde Sr. and Jewell called Marc and asked him to meet with them to discuss their assets. Marc recalled the meeting as follows:
Soon after the meeting between Marc and his grandparents, Marc and Travis contacted an attorney at Stewart, Melvin & Frost, a Gainesville, Georgia, law firm that had previously done estate planning work for Clyde Sr. and Jewell. In early 2002 Clyde Sr., Jewell, Marc, and Travis met with attorneys from the firm. Clyde Sr. was in his early eighties at the time of the meeting, and Jewell was in her late seventies, but both were in good health. Clyde Jr., Betty, and Janna did not attend the meeting.
On March 27, 2002, James Coyle (Mr. Coyle), an attorney from Stewart, Melvin & Frost, sent a letter to Clyde Sr. and Jewell regarding formation of a family limited partnership and the contribution of assets to the partnership. Mr. Coyle explained in the letter that "A key element to a gifting plan is the need of a sound appraisal of the partnership for tax purposes".
Turner & Co.
On April 15, 2002, Clyde Sr. and Jewell established Turner & Co. as a Georgia limited liability partnership by filing a certificate of limited partnership. The Agreement of Limited Partnership of Turner & Company, L.P. (partnership agreement), provided that Clyde Sr. and Jewell each would own a 0.5-percent general partnership interest and a 49.5-percent limited partnership interest.
After Clyde Sr.'s death, the Turner family held meetings, on November 5, 2004, and November 19, 2005, to discuss Turner & Co.'s past performance and future investment plans. The meetings also included discussions of Clyde Sr.'s estate and the provisions of his will.
In 2002 Clyde Sr. and Jewell each contributed assets to Turner & Co. with a fair market value of $4,333,671 (total value $8,667,342). The list of assets to be contributed was not finalized until at least July 2002, and the transfers were not completed until at least December 2002.
The contributed assets consisted of: (1) Cash, (2) shares of Regions Bank common stock, (3) shares of NBOG Bancorporation stock, (4) shares of Friends Bank stock, (5) shares of Southern Heritage Bancorp stock, (6) 21 certificates of deposit at Habersham Bank, (7) one certificate of deposit at Regions Bank, (8) five certificates of deposit at United Community Bank, (9) assets held in an account at Morgan Keegan with an account number ending in 5768,
The Turner & Co. partnership interests that Clyde Sr. and Jewell received in exchange for their contributions of property were proportionate to the fair market value of the assets contributed. All of the assets that Clyde Sr. and Jewell contributed to Turner & Co. were properly titled in the name of Turner & Co.
Clyde Sr. and Jewell retained more than $2 million of assets that were not contributed to Turner & Co., including but not limited to their residence in Cleveland, Georgia, investment real estate in North Carolina, cash and certificates of deposit, and 24,012 shares of Regions Bank stock. The retained assets, together with Social Security income, generated annual income of at least $90,000—more than enough to pay Clyde Sr. and Jewell's living expenses.
Partnership Agreement Provisions
The partnership agreement listed three general purposes for creation of Turner & Co.: (1) To make a profit, (2) to increase the family's wealth, and (3) to provide a means whereby family members can become more knowledgeable about the management and preservation of the family's assets. To facilitate the general purposes, the partnership agreement listed nine specific purposes for formation of Turner & Co.:
The partnership agreement was modeled on a standard form that Stewart, Melvin & Frost used when drafting partnership agreements. Consequently, some of the purposes listed in the partnership agreement did not apply to the Turner family,
Other pertinent provisions of the partnership agreement were as follows.
• Section 4.1 provided that "the General Partner shall be the sole manager of the Partnership and have sole authority in the conduct and management of the business of the Partnership."
• Section 4.4 provided that the general partner would manage the partnership in a businesslike manner and that the general partner shall maintain complete and accurate books and records with respect to the partnership and furnish reports to the limited partners.
• Section 4.6 provided that the general partner, and not the partnership, would pay all operating expenses of the partnership (other than interest expenses) including but not limited to organizational expenses, legal fees, investment fees, management charges, accounting fees, and other operating costs. In consideration of the general partner's payment of such obligations, the general partner was entitled to a special allocation of income in an amount to be determined in good faith by the general partner. In addition, the general partner was entitled to "a reasonable management charge".
• Section 4.7 provided that in the event of death or incapacity of either of the general partners, i.e., Clyde Sr. or Jewell, the surviving general partner would become the sole general partner. Thereafter, in the event of the death or incapacity of the surviving general partner, Marc and Travis, or the survivor between them, would become the new general partner.
• Section 8.1 provided:
• Section 8.2 provided that the partnership could make distributions in kind of partnership assets, in the sole and absolute discretion of the general partner, in accordance with and pursuant to section 1.704-1(b)(2)(iv)(e)(1), Income Tax Regs.
• Section 9.1 provided that the general partner could terminate or dissolve the partnership, but only after the sale or disposition of all or substantially all partnership assets.
• Section 9.2 provided that upon a termination or dissolution of the partnership the general partner would distribute the proceeds from the sale or distribution of partnership assets in the following order of priority: (1) Payments to creditors, in the order of priority provided by law; (2) payments to limited partners with respect to their share of partnership profits; (3) payments to limited partners with respect to their capital contributions; (4) payments to the general partners other than for capital and profits; (5) payments to the general partners with respect to profits; and (6) payments to the general partners with respect to capital.
• Section 11.1 provided that the general partner could amend the partnership agreement at any time without the consent or approval of the limited partners.
On or about April 24, 2002, Clyde Sr. and Jewell, as the general partners of Turner & Co., signed a Management Fee Agreement of Turner & Company, L.P. (management fee agreement). The management fee agreement provided that the general partners would allocate $500 per month of their management fee to each of Marc and Travis in exchange for Marc's and Travis' providing daily management services to Turner & Co. The management fee agreement described Marc's and Travis' daily management services as "any and all tasks and duties assigned to Marc and Travis by the General Partner."
Turner & Co. made payments to Marc and Travis of $2,500 each in 2002, $5,500 each in 2003, and $7,000 each in 2004. Clyde Sr. signed those checks on behalf of Turner & Co. through September 2003.
In January 2003 Clyde Sr. submitted a statement to Mr. Rushton that the payments to Marc and Travis should be classified as "a gift of appreciation." After January 2003 Clyde Sr. wrote the word "gift" on the memo line of each of the checks he wrote to Marc and Travis. Turner & Co. did not treat the payments to Marc and Travis as deductible expenses and did not issue a Form W-2, Wage and Tax Statement, or a Form 1099-MISC, Miscellaneous Income, to Marc or Travis in 2002-04. Marc and Travis did not report the payments as income on their 2002-04 Federal income tax returns.
Gifts of Limited Partnership Interests and Amendments to Partnership Agreement
On December 31, 2002, and January 1, 2003, Clyde Sr. and Jewell gave limited partnership interests in Turner & Co. to their three children and to Joyce's children. According to the gift transfer documents, the aggregate fair market values of the partnership interests transferred on December 31, 2002, and January 1, 2003, were $1,652,315 and $474,315, respectively. The values were derived from a valuation by Willis Investment Counsel dated May 18, 2004, and were added to the gift transfer documents on or after that date. No values appeared on the gift transfer documents when the documents were signed.
Because of their concerns about Rory's drug addiction and legal problems, Clyde Sr. and Jewell established the Irrevocable Trust f/b/o Rory Crumley (Rory's Trust) to own assets for Rory's benefit. Habersham Bank was appointed trustee of Rory's Trust. Rory's limited partnership interest in Turner & Co. was immediately transferred to Rory's Trust.
Turner & Co. had the following ownership structure before and after the gifts of limited partnership interests:
On October 13, 2004, Mr. Rushton filed gift tax returns on behalf of the estate with respect to Clyde Sr.'s transfers of limited partnership interests in Turner & Co. to his children and grandchildren. The values of the gifts reported on the returns were derived from the valuation by Willis Investment Counsel dated May 18, 2004. On the Forms 709 the estate did not make gift-splitting elections under section 2513.
One day before the first of the transfers, on December 30, 2002, Clyde Sr., Jewell, Clyde Jr., Betty, and Janna signed an amendment to the partnership agreement. Betty and Janna insisted on the amendment because they were uncomfortable with Marc's and Travis' becoming the successor general partners of Turner & Co. and playing such a large role in the partnership.
The amendment provided, in relevant part, that Clyde Jr., Janna, and Betty would become the successor general partners of Turner & Co. following the death of the last to die of Clyde Sr. and Jewell. The amendment further provided that Clyde Jr. could appoint Marc or Travis, or both, to serve as a general partner in his place. However, if Clyde Jr. appointed Marc and Travis they would have only one vote combined, while Betty and Janna would have one vote each. Finally, the amendment provided that at any time following the death of the last to die of Clyde Sr. and Jewell, any of the following individuals could require Turner & Co. to undergo a tax-free reorganization to create five separate partnerships: Clyde Jr., Betty, Janna, Trey, and Habersham Bank, as trustee for Rory's Trust. In that event, the amendment required that Turner & Co.'s liquid assets be divided among the separate partnerships pro rata and that any illiquid assets be sold and the proceeds divided pro rata.
In 2002-04 Turner & Co. maintained investment accounts at the GMS Group, Morgan Keegan, and Wachovia Securities and a checking account at United Community Bank. Turner & Co.'s GMS Group account statements reflect no change in the securities held between December 2002 and Clyde Sr.'s death in February 2004. The Morgan Keegan account statements reflect that dividends paid to Turner & Co. with respect to the assets held in that account were reinvested in a money market fund between January and September 2003. The Morgan Keegan account statements also reflect a handful of asset purchases and sales. For example, in January 2003 Turner & Co. purchased 1,941 shares of Ford Motor Credit preferred stock for $49,981. In June 2003 Turner & Co. purchased 10,000 additional shares of Ford Motor Credit preferred stock for a total purchase price of $259,000. Turner & Co. also purchased $250,000 of GMAC Notes in August and September 2003, and $50,000 of General Electric notes on September 11, 2003. Turner & Co. did not make any purchases or sales in the Morgan Keegan account between October 2003 and Clyde Sr.'s death. Turner & Co.'s Wachovia Securities account statements reflect a purchase of $5,000 of GMAC Notes on December 26, 2002,
Turner & Co. did not sell any Regions Bank stock in 2002-04 because Clyde Sr. and Jewell had a sentimental attachment to the stock and Marc and Travis could not convince them to sell it. Regions Bank paid cash dividends with respect to its stock in 2002-04, and Turner & Co. invested most or all of the dividends in money market funds.
Turner & Co.'s checking account statements reflect multiple payments to Stewart, Melvin & Frost in 2002-04. Most of the payments related to legal work performed by the law firm for Turner & Co. However, at least some of the payments related to legal services provided to Clyde Sr. and Jewell with respect to their estate planning.
In 2002 and 2003 Turner & Co. participated in two real estate transactions. On August 23, 2002, Turner & Co., Mr. Lovell, and Mr. Bramblett purchased adjoining parcels of land in Jackson County, Georgia (the Jackson County property). Mr. Bramblett found the Jackson County property and did all the legwork necessary to get the property ready for sale. Mr. Lovell's role in the deal was to find a developer to purchase the property.
The Jackson County property consisted of 71.25 acres of land with improvements. The total purchase price for the Jackson County property was $399,011. To finance the purchase, Turner & Co. borrowed $171,025 from United Community Bank. The loan was secured by two certificates of deposit owned by Turner & Co. Turner & Co. used partnership assets to fund the balance of the purchase price. Mr. Lovell and Mr. Bramblett each signed a security deed notice for $100,224, representing their portions of the purchase price. Also on August 23, 2002, Turner & Co., Mr. Lovell, and Mr. Bramblett sold a 22.6-percent interest in the Jackson County property for a profit to Mahmoud Mohamed (Mr. Mohamed).
On September 9, 2002, Clyde Sr. paid Turner & Co.'s $171,543 outstanding debt to United Community Bank from his personal checking account. Neither Clyde Sr. nor Turner & Co. executed a written agreement regarding Clyde Sr.'s payment of the partnership's debt. Marc and Travis did not inform Turner & Co.'s accountant, Sally Walden-Crowe (Ms. Walden-Crowe), or anyone else at her firm that Clyde Sr. had personally repaid a partnership loan. Ms. Walden-Crowe, who was gravely ill and was out of the office for several months, did not learn that Clyde Sr. had repaid the loan until October 2003, at which point she updated Turner & Co.'s general ledger to reflect a $171,543 debt owed to Clyde Sr.
On February 17, 2003, Turner & Co., Mr. Lovell, Mr. Bramblett, and Mr. Mohamed sold the Jackson County property for $605,642. Mr. Bramblett and Mr. Lovell used their shares of the proceeds to repay the security deed notes, plus accrued interest.
On February 5, 2003, Turner & Co., Mr. Lovell, and Mr. Bramblett purchased 17.01 acres on Lake Hartwell (the Lake Hartwell property) in Hart County, Georgia, for $363,188. Once again, Mr. Bramblett found the property and did all the legwork necessary to prepare the property for sale, and Mr. Lovell's role was to find a developer to purchase the property.
Turner & Co. was unable to obtain a loan by the date of the closing. As a result, Clyde Sr. attended the closing and wrote a personal check for $363,188 to fund the purchase. The following day, Turner & Co. received a loan disbursement of $363,238 from Habersham Bank and immediately repaid Clyde Sr. Turner & Co. received Deeds to Secure Debt from Mr. Lovell and Mr. Bramblett in the amounts of $127,729 and $107,729, respectively, to secure their shares of the purchase price. Mr. Bramblett paid $20,000 for the removal of a boat dock on the Lake Hartwell property. On February 18, 2003, Turner & Co. used its share of the proceeds from the sale of the Jackson County property to repay the loan to Habersham Bank.
The Lake Hartwell property was developed into a subdivision consisting of five 1.25-acre lots with lake access and one 10-acre lot with no lake access. Turner & Co. sold one of the 1.25-acre lots on June 2, 2003, for $92,500, and Mr. Lovell's and Mr. Bramblett's shares of the proceeds were applied to reduce their outstanding notes to Turner & Co. Two additional 1.25-acre lots were sold on June 20, 2003, and Mr. Lovell's and Mr. Bramblett's shares of the proceeds were again applied to reduce their debt to Turner & Co. Finally, on December 28, 2004, Turner & Co. sold the 10-acre lot and another 1.25-acre lot for $180,000, and Mr. Lovell's and Mr. Bramblett's shares of the proceeds were applied to satisfy their liability to Turner & Co., including accrued interest.
Partnership Payments to Clyde Sr. and Jewell
Turner & Co. made the following payments to Clyde Sr. in 2002:
Turner & Co. did not make any payments to Jewell in her capacity either as a general partner or as a limited partner, or to any other limited partner in 2002. The 2002 Schedules K-1, Partner's Share of Income, Credits, Deductions, etc., reflected distributions to Clyde Sr., as general partner, of $235; Jewell, as general partner, of $235; Clyde Sr., as limited partner, of $23,277; and Jewell, as limited partner, of $23,276.
Turner & Co. made the following payments to Clyde Sr. and Jewell in 2003:
Turner & Co. did not make any payments to any other limited partners in 2003. As indicated above, the $46,170 payment to Clyde Sr. on January 13, 2003, was intended to pay Federal and State tax attributable to Clyde Sr.'s and Jewell's income from Turner & Co.
Turner & Co.'s 2003 Form 1065 did not report any distributions to any of the general or limited partners. Instead, Turner & Co. took the position that all payments to Clyde Sr. and Jewell in 2003 reduced the balance of the loan that was recorded on the partnership books to reflect Clyde Sr.'s payment of Turner & Co.'s $171,542 debt to United Community Bank.
Turner & Co. made the following payments in 2004:
Clyde Sr.'s Death
Clyde Sr. became seriously ill and was hospitalized in October 2003. He died on February 4, 2004. The estate obtained an appraisal of the 0.5-percent general partnership interest and the 27.8-percent limited partnership interest in Turner & Co. that Clyde Sr. owned at his death. On Schedule F, Other Miscellaneous Property Not Reportable Under Any Other Schedule, of the estate tax return, the estate reported the general and limited partnership interests had values of $30,744 and $1,578,240, respectively.
On or about August 4, 2008, respondent issued a notice of deficiency to the estate in which he determined that the values of the assets Clyde Sr. transferred to Turner & Co. were included in his gross estate under sections 2035, 2036, and 2038. In the notice of deficiency respondent determined that Turner & Co.'s net asset value as of February 4, 2004, was $9,488,713 and that one-half of that amount was included in Clyde Sr.'s gross estate. The parties now appear to agree that Turner & Co.'s net asset value as of February 4, 2004, was as follows:
In the notice of deficiency respondent also reduced the total adjusted taxable gifts reported on the Form 706, United States Estate (and Generation Skipping Transfer) Tax Return, by the amounts of Clyde Sr.'s gifts of limited partnership interests to his children and grandchildren. Respondent included in the total adjusted taxable gifts the premiums paid on life insurance policies owned by Clyde Sr.'s Trust for the benefit of Clyde Sr.'s children and grandchildren.
Burden of Proof
In general, the Commissioner's determinations are presumed correct, and the taxpayer bears the burden of proving that they are incorrect. Rule 142(a);
Petitioner argues that section 7491(a) shifts the burden to respondent because petitioner has introduced credible evidence with respect to every factual issue. Respondent counters that section 7491(a) does not apply because petitioner did not comply with respondent's reasonable requests for information during informal discovery, which necessitated the use of formal discovery procedures. We need not decide whether section 7491(a) applies to the material factual issues in this case because our resolution of the issues is based on the preponderance of the evidence rather than on the allocation of the burden of proof. See
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." The taxable estate, in turn, is defined as "the value of the gross estate", less applicable deductions. Sec. 2051. Section 2031(a) provides that the gross estate includes "all property, real or personal, tangible or intangible, wherever situated", to the extent provided in sections 2033 through 2046.
Section 2033 broadly provides that the value of the gross estate includes the value of all property to the extent of the decedent's interest in that property at the time of death. Sections 2034 through 2036 require inclusion in the gross estate of several specific classes of assets. Section 2036(a), which is one such specific section, provides:
The purpose of section 2036(a) is to include in a decedent's gross estate the values of inter vivos transfers that were "essentially testamentary" in nature. See
Section 2036(a) applies when three conditions are satisfied: (1) The decedent made an inter vivos transfer of property, (2) the decedent's transfer was not a bona fide sale for adequate and full consideration, and (3) the decedent retained an interest or right enumerated in section 2036(a)(1) or (2) or (b) in the transferred property that he did not relinquish before his death. Sec. 2036(a);
Whether There Was a Section 2036(a) Transfer
Clyde Sr. made an inter vivos transfer of property when he transferred assets to Turner & Co. in exchange for a 0.5-percent general partnership interest and a 49.5-percent limited partnership interest.
Whether the Transfer Was a Bona Fide Sale for Adequate and Full Consideration
Congress excepted from section 2036(a) any transfer of property otherwise subject to that section that is a bona fide sale for adequate and full consideration (the bona fide sale exception).
We analyze the bona fide sale exception under two prongs: (1) Whether the transaction qualifies as a bona fide sale; and (2) whether the decedent received adequate and full consideration.
Whether the Transaction Was a Bona Fide Sale
Whether a sale is bona fide is a question of motive. We must determine whether the record supports a finding that Clyde Sr. had a legitimate and significant nontax reason for forming Turner & Co. Petitioner argues that Clyde Sr. had several nontax reasons for creating Turner & Co. Respondent argues that tax savings were the primary motivation for the transfer.
The Turner & Co. partnership agreement lists three general reasons and nine specific reasons for the formation of the partnership. However, the reasons listed in the partnership agreement were taken from a form partnership agreement and do not necessarily reflect Clyde Sr. and Jewell's actual reasons for establishing Turner & Co.
Petitioner argues that Clyde Sr. and Jewell created Turner & Co. for at least one of the following legitimate and significant nontax reasons:
The objective facts in the record fail to establish that any of these reasons was a legitimate and significant reason for formation of Turner & Co.
Asset Consolidation and Centralized Management Pursuant to a Formal Strategy
Consolidated asset management may be a legitimate and significant nontax purpose.
Most of the cases in which we have held that consolidated asset management is a legitimate nontax purpose have involved assets requiring active management or special protection.
Unlike the decedent in
Petitioner points to Turner & Co.'s real estate activity to suggest that Clyde Sr. and Jewell contributed passive assets to provide Marc and Travis with the ability to start an active and profitable real estate development business. Petitioner contends that such a real estate business was a crucial component of a more aggressive investment strategy. Yet the objective evidence in the record suggests that the handful of real estate deals were of the same kind and with the same individuals as Clyde Sr.'s real estate activity before the formation of Turner & Co. In other words, Turner & Co.'s real estate activity was the same type of activity as that which Clyde Sr. engaged in before forming Turner & Co. This record does not support a finding that Marc and Travis started a real estate development business by investing in these real estate deals. Rather, the record supports a more limited finding that, if real estate deals came Clyde Sr.'s way, they were channeled through Turner & Co.
In reaching our conclusion that asset management was not a significant nontax purpose, we rely on our finding that Turner & Co.'s portfolio of marketable securities did not change in a meaningful way. Regents Bank stock continued to dominate the portfolio from the time of the partnership formation until Clyde Sr.'s death. Whatever assets Turner & Co. added to the portfolio had a risk/return profile similar to the profile of the assets Clyde Sr. and Jewell contributed to the partnership. For example, the account statements for Turner & Co.'s Wachovia Securities account reflect only four purchases up to the date of Clyde Sr.'s death: GMAC Notes, Morgan Stanley preferred stock, Ford Motor preferred stock, and Suburban Propane Partners common stock. The account statements of Turner & Co.'s Morgan Keegan accounts also show only a few purchases. According to those statements, Turner & Co. purchased Ford Motor Credit preferred stock (three purchases), GMAC Notes, GMAC Smart Notes, and General Electric notes. With the exception of common stock of Suburban Propane Partners, Turner & Co. therefore generally added to its portfolio fixed-income investments. Turner & Co. therefore continued to hold a portfolio consisting of common stock of mostly bank companies, preferred stock, bonds, cash, and cash equivalents, similar to what Clyde Sr. and Jewell held individually. As a consequence, handing management over the assets to Marc and Turner had no material impact on the profit potential of the portfolio.
Petitioner points to the fact that Turner & Co. opened and closed certificates of deposit at various banks to support petitioner's claim of active investing. Yet certificates of deposit are akin to cash equivalents, and renewing certificates of deposit can hardly be considered pursuing a diversified strategy. The objective facts in the record do not support petitioner's argument that Turner & Co. was formed to consolidate Clyde Sr. and Jewell's assets and allow for centralized management pursuant to a formal investment strategy or to pursue a more aggressive investment strategy.
Petitioner's argument regarding more efficient management also fails in the light of the fact that Marc already had significant responsibilities with respect to his grandparents' finances before Turner & Co. was formed, and it is not clear what nontax advantages the family limited partnership offered. See
Resolution of Family Discord
Petitioner argues that Turner & Co. also was formed to resolve disputes among Turner family members through equal sharing of information. Although resolution of family disputes or promotion of family harmony may be a legitimate and significant nontax purpose for creation of a family limited partnership, see
The ill will among the Turner children was not about money, per se, and there is no evidence that the Turner children ever expressed a particular interest in managing their parents' assets. Instead, the bad feelings among the Turner children stemmed from the fact that Clyde Jr. had a domineering personality and had an unpleasant attitude toward his sisters and their husbands. Moreover, Clyde Jr.'s and his sons' involvement in Mt. Yonah caused Betty and Janna to resent their brother and to believe that their parents were treating them unfairly.
Given the source of the Turner family tension, we are not convinced that Clyde Sr.'s and Jewell's transfer of most of their wealth to a partnership managed by Clyde Jr.'s sons was intended to resolve family discord. Indeed, when Betty and Janna learned that Marc and Travis were managing Turner & Co., they demanded changes to the partnership agreement, including removal of Marc and Travis as the successor general partners. Petitioner's argument appears to be little more than an after-the-fact, hypothetical justification for the creation of Turner & Co.
Protection of Jewell From Rory and Rory From Himself
Finally, petitioner argues that Turner & Co. was formed to protect Jewell from Rory and Rory from himself. Although asset protection may be a legitimate and significant nontax reason for formation of a family limited partnership, see, e.g.,
When Turner & Co. was formed, Jewell was in her late seventies but was in good health physically and mentally. She had a close relationship with Rory, and she gave him money from time to time. Whatever concerns she, Clyde Sr., or other Turner family members had regarding Rory's drug problems, there is no evidence that Jewell's gifts to Rory were anything but voluntary, nor is there any credible evidence in the record that Jewell wanted or needed protection from Rory. In the absence of such evidence, we can perceive no reason Jewell needed to be protected from spending her own money however she saw fit.
Moreover, Turner & Co. did not, in fact, protect Jewell from Rory because Clyde Sr. and Jewell retained more than $2 million outside the partnership and Jewell still had access to money she could give to Rory. Petitioner argues that Turner & Co. created the appearance of protection because after formation of the partnership Jewell could tell Rory that she did not have money to give him and Rory would accept that. If Rory could be so easily misled, Clyde Sr. and Jewell did not have to go through the trouble of creating a limited partnership, transferring most of their assets to the partnership, and incurring legal, accounting, and other fees.
Finally, petitioner's argument that Turner & Co. protected Rory from himself lacks merit. Before the creation of Turner & Co. and the gifts of limited partnership interests, Rory had no assets to protect; all of the assets at issue belonged to Clyde Sr. and Jewell. Moreover, Rory's Trust adequately protected any assets that Clyde Sr. and Jewell wished to transfer to Rory, either during their lives or upon their deaths. Petitioner failed to explain how placing the assets in a limited partnership, as opposed to transferring the underlying assets to Rory's Trust, provided any meaningful additional protection. Accordingly, we conclude that the transfers fail the bona fide sale prong of the bona fide sale exception.
Factors Indicating the Transfers Were Not Bona Fide Sales
Several additional factors indicate that the transfers to Turner & Co. were not bona fide sales. First, Clyde Sr. stood on both sides of the transaction, and he created Turner & Co. without any meaningful bargaining or negotiation with Jewell or with any of the other anticipated limited partners; i.e., his children and grandchildren. See
Whether Clyde Sr. Received Partnership Interests in Turner & Co. That Were Proportionate to the Value of the Property Transferred
The parties stipulated that the partnership interests Clyde Sr. received were proportionate to the fair market values of the assets he contributed to Turner & Co. and that the assets Clyde Sr. contributed to Turner & Co. were properly credited to his capital accounts. Consequently, we conclude that Clyde Sr. satisfied the full and adequate consideration prong of the bona fide sale exception.
The Bona Fide Sale Exception Does Not Apply
On the basis of the foregoing, we conclude that the formation of Turner & Co. falls short of meeting the bona fide sale exception. Rather, Clyde Sr. changed the form in which he held the interest in the contributed assets, and the formation of Turner & Co. was a part of a testamentary plan. Accordingly, the bona fide sale exception of section 2036(a) does not apply to Clyde Sr.'s transfer of property to Turner & Co. We therefore consider whether Clyde Sr. retained for his life the possession or enjoyment of the transferred property.
Possession or Enjoyment of Transferred Property
Property is included in a decedent's gross estate if the decedent retained, by express or implied agreement, possession, enjoyment, or the right to income from the transferred property. Sec. 2036(a)(1);
Factors indicating that a decedent retained an interest in transferred assets under section 2036(a)(1) include a transfer of most of the decedent's assets, continued use of transferred property, commingling of personal and partnership assets, disproportionate distributions to the transferor, use of entity funds for personal expenses, and testamentary characteristics of the arrangement.
We turn to the record and examine it for what it shows about Clyde Sr.'s possession and enjoyment of the assets he transferred to Turner & Co. We start with the partnership agreement. The partnership agreement expressly provides that the general partner is entitled to a "reasonable" management fee, and Clyde Sr. and/or Jewell chose to receive a management fee of $2,000 per month without any apparent regard for the nature and scope of their actual management duties. There is nothing in the record to suggest that a $2,000 management fee was reasonable. The record does not disclose what, if anything, Clyde Sr. and Jewell did to manage the partnership. In fact, some of the evidence suggests that Clyde Sr. and Jewell did not manage the partnership at all. The so-called management fee was paid under circumstances suggesting that no management services were actually provided. This is not indicative of a business or investment activity conducted for profit. Rather, it resembles an investment account from which withdrawals could be made at will. This impression is reenforced by a provision in the partnership agreement that gave Clyde Sr. the right, as general partner, to amend the partnership agreement at any time without the consent of the limited partners.
We turn now to an examination of the factors that tend to show an agreement to retain possession and enjoyment of the transferred assets. Nearly all of the facts point to an implied agreement. Clyde Sr. transferred most of his assets to Turner & Co. Nearly 60 percent of the value of all property that Clyde Sr. and Jewell contributed to Turner & Co. consisted of Regions Bank common stock. Because of his and Jewell's sentimental attachment to the Regions Bank stock, Turner & Co. did not sell the Regions Bank stock. Although he and Jewell retained sufficient assets outside of the partnership to meet their living expenses, they opted to receive management fees from Turner & Co. for few or no management services and took distributions from Turner & Co. at will. As discussed above, Clyde Sr. used Turner & Co. funds to make personal gifts to Marc and Travis, to pay life insurance premiums on policies held by Clyde Sr.'s Trust for the benefit of his children and grandchildren, and to pay legal fees related to his estate planning. He also commingled personal and partnership funds when he personally paid Turner & Co.'s debt to Habersham Bank, purchased the Lake Hartwell property on behalf of Turner & Co., and reimbursed Turner & Co. for its purchase of GMAC Notes.
Most importantly, contrary to petitioner's assertions, we find that the purpose of Turner & Co. was primarily testamentary. When Clyde Sr. purportedly approached Marc about creating a vehicle to consolidate his assets, he allegedly stated that he and Jewell were not getting any younger. Petitioner's own witnesses testified that when Clyde Sr. met with attorneys at Stewart, Melvin & Frost, he said that he wanted to discuss estate planning. Many of the specific purposes Clyde Sr. purportedly outlined at the meeting were testamentary, e.g., providing for Jewell after his death, providing income for future generations, and protecting his children and grandchildren from creditors. We are particularly struck by the implausibility of petitioner's assertion that tax savings resulting from the family limited partnership were never discussed during a meeting focusing in part on estate planning. We do not find testimony to that effect to be credible, and that lack of credibility infects all of the testimony petitioner offered about what Clyde Sr. allegedly said or intended about the purpose of the family limited partnership. In our finding we rely partially on Mr. Coyle's letter to Clyde Sr. in which he wrote: "A key element to a gifting plan is the need of a sound appraisal of the partnership for tax purposes." And indeed such appraisal was the key to Clyde Sr.'s estate plan: both the gift tax and estate tax returns used substantial discounts despite the fact that the partnership assets at each relevant date consisted of, inter alia, cash, cash equivalents, and marketable securities. In summary, we conclude that the formation of Turner & Co. had testamentary characteristics and Clyde Sr. did not curtail his enjoyment of the transferred assets after formation of the partnership.
We now turn to section 2036(a)(2). Property is included in a decedent's gross estate under section 2036(a)(2) if the transferor retained "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." However, a transferor's retention of the right to manage transferred assets does not necessarily require inclusion under section 2036(a)(2). See
Clyde Sr. was, for all intents and purposes, the sole general partner of Turner & Co.,
In summary, we conclude that Clyde Sr. made an inter vivos transfer of property to Turner & Co., the transfer was not a bona fide sale for adequate and full consideration because it was not motivated by a legitimate and significant nontax purpose, and Clyde Sr. retained by both express and implied agreement the right to possess and enjoy the transferred property, as well as the right to designate which person or persons would enjoy the transferred property. Consequently, section 2036 includes the values of transferred property in Clyde Sr.'s gross estate.
Additional Taxable Gifts
Section 2501 imposes a tax on the transfer of property by gift by an individual. The tax imposed by section 2501 applies whether the transfer is in trust or otherwise, whether the gift is direct or indirect, and whether the property is real or personal, tangible or intangible. Sec. 2511.
The tax imposed by section 2001 is equal to the excess of the tentative tax on the sum of the amount of a decedent's taxable estate and the amount of adjusted taxable gifts, over the amount of tax that would have been payable as a gift tax with respect to gifts made by a decedent after December 31, 1976. Sec. 2001(b). The term "adjusted taxable gifts" means the total amount of taxable gifts (within the meaning of section 2503) made by the decedent after December 31, 1976, other than gifts which are includable in the gross estate of the decedent.
Section 2503(a) defines "taxable gifts" as the total amount of gifts made during the calendar year, less applicable deductions. Section 2503(b) provides that in computing gifts for the taxable year, the donor may exclude the first $10,000 of gifts,
Section 25.2503-3(b), Gift Tax Regs., defines a present interest as "An unrestricted right to the immediate use, possession, or enjoyment of property or the income from property (such as a life estate or term certain)". A transfer does not qualify as a gift of a present interest in property if the beneficiary's enjoyment of the gift is subject to the discretion of a third party. Sec. 25.2503-3(c),
In distinguishing present interests from future interests for Federal gift tax purposes, the test is not whether the beneficiary was likely to receive the present enjoyment of the property, but whether he or she had the legal right to demand it. As we explained in
The parties agree that Clyde Sr. made indirect gifts to the beneficiaries of Clyde Sr.'s Trust when he paid the premiums on life insurance policies for the benefit of his children and grandchildren. The parties disagree, however, on the nature of the gifts. Petitioner contends that the gifts were gifts of present interests (and therefore subject to the annual exclusion) because the beneficiaries had the absolute right and power to demand withdrawals of amounts transferred to Clyde Sr.'s Trust. Respondent contends that the gifts were gifts of future interests (and therefore not subject to the annual exclusion). Specifically, respondent argues the beneficiaries' withdrawal rights were illusory because Clyde Sr. did not deposit money with the trustees of Clyde Sr.'s Trust but instead paid the life insurance premiums directly and because the beneficiaries did not receive notice of the transfers. Consequently, respondent argues that the beneficiaries had no meaningful opportunity to exercise the right of withdrawal.
The terms of Clyde Sr.'s Trust gave each of the beneficiaries the absolute right and power to demand withdrawals from the trust after each direct or indirect transfer to the trust. The fact that Clyde Sr. did not transfer money directly to Clyde Sr.'s Trust is therefore irrelevant. Likewise, the fact that some or even all of the beneficiaries may not have known they had the right to demand withdrawals from the trust does not affect their legal right to do so. See
Respondent argues, in the alternative, that even if we conclude the premium payments were gifts of present interests, some of the gifts made in 2002 and 2003—specifically, the gifts made to Clyde Jr., Betty, Janna, Trey, and Rory—are still includable in Clyde Sr.'s taxable estate. This is so, respondent argues, because the transfers of limited partnership interests to Clyde Jr., Betty, Janna, Trey, and Rory in 2002 and 2003 used up their annual exclusions and any additional gifts to those beneficiaries during 2002 and 2003 are includable in Clyde Sr.'s estate. We disagree.
For the reasons discussed above, we have concluded that the value of property Clyde Sr. transferred to Turner & Co. is included in his gross estate under section 2036. Consequently, the gifts of limited partnership interests that the estate reported on Forms 706 and 709 must be disregarded for purposes of calculating Clyde Sr.'s adjusted taxable gifts. To do otherwise would result in the double inclusion of a significant part of the property transferred to Turner & Co. in Clyde Sr.'s estate.
In summary, we hold that the value of the property Clyde Sr. transferred to Turner & Co. is included in his gross estate under section 2036(a). Because section 2036 includes in a decedent's gross estate the fair market value of the transferred property, i.e., the underlying assets Clyde Sr. transferred to Turner & Co., no discount for lack of control or lack of marketability is appropriate. Instead, the parties should look to the fair market value of the assets Clyde Sr. contributed to Turner & Co. as of the date of Clyde Sr.'s death in determining the amount that is included in his gross estate.
We further hold that the premium payments Clyde Sr. made in 2000-2003 for life insurance policies held by Clyde Sr.'s Trust were gifts of present interests in property to the trust beneficiaries. By reason of the above, respondent must disregard the purported gifts of limited partnership interests in Turner & Co. in calculating Clyde Sr.'s adjusted taxable gifts in order to prevent double inclusion of the value of the property transferred to Turner & Co. for transfer tax purposes.
We have considered the remaining arguments of both parties for results contrary to those expressed herein and, to the extent not discussed above, find those arguments to be irrelevant, moot, or without merit.
To reflect the foregoing,
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