# ESTATE OF H.A. TRUE v. COMMISSIONER > United States Tax Court · July 6, 2001 · 82 T.C.M. 27 URL: https://www.frixlaw.com/law-library/cases/4333360 ## Case - **Full name:** ESTATE OF H.A. TRUE, JR., H.A. TRUE, III, PERSONAL REPRESENTATIVE, AND JEAN D. TRUE v. COMMISSIONER OF INTERNAL REVENUE - **Court:** United States Tax Court - **Decided:** July 6, 2001 - **Citations:** 82 T.C.M. 27; 2001 T.C. Memo. 167; 2001 Tax Ct. Memo LEXIS 199 - **Precedential status:** Unpublished - **Opinion:** Opinion - **Judges:** Beghe - **Cited by:** 1 later opinions in the Frix Law Library ## Citator (automated) - No negative treatment found by the automated citator. That is not the same as a confirmation that the case is good law; read the citing cases. - Full citator and citing cases: https://www.frixlaw.com/law-library/cases/4333360 ## How later opinions describe it (automated extraction) - applying thirty percent marketability discount to interests in True Oil, by taking into account that interests were less marketable than actively traded interests, and that interests were subject to state law transfer restrictions - applying ten percent marketability discount to interests in Eighty-Eight Oil, recognizing family’s intent to keep partnership privately owned, as well as limits imposed on interests by virtue of state partnership law - applying thirty percent marketability discount to True Ranches, recognizing family interest in keeping partnership private, as well as acknowledging impact state partnership laws might have on interests - applying twenty-seven percent marketability discount to Jean True’s interests in Belle Fourche Pipeline in part because of family’s commitment to keeping corporation privately owned ## Opinion text T.C. Memo. 2001-167 UNITED STATES TAX COURT ESTATE OF H.A. TRUE, JR., DECEASED, H.A. TRUE, III, PERSONAL REPRESENTATIVE, AND JEAN D. TRUE, ET AL.1, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 10940-97, 3408-98, Filed July 6, 2001. 3409-98. Buford P. Berry, Emily A. Parker, and Ronald M. Morris, for petitioners. Richard D. D’Estrada and Robert A. Varra, for respondent. MEMORANDUM FINDINGS OF FACT AND OPINION Contents Introduction . . . . . . . . . . . . . . . . . . . . . . . . . 8 1 Cases of the following petitioners are consolidated herewith: Jean D. True, docket No. 3408-98 and Estate of H.A. True, Jr., Deceased, H.A. True, III, Personal Representative, docket No. 3409-98. - 2 - Issue 1. Does Book Value Price Specified in Buy-Sell Agreements Control Estate and Gift Tax Values of Subject Interests in True Companies? . . . . . . . . . . 10 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 10 I. Background . . . . . . . . . . . . . . . . . . . . 11 A. True Family . . . . . . . . . . . . . . . . . 11 B. Formation and Growth of True Companies . . . . 12 1. Reserve Drilling . . . . . . . . . . . . . 12 2. True-Brown Partnerships . . . . . . . . . . 13 3. True Oil and True Drilling . . . . . . . . 14 4. Belle Fourche Pipeline Co. . . . . . . . . 15 5. Black Hills Oil Marketers, Inc./True Oil Purchasing Co./Eighty-Eight Oil Co./Black Hills Trucking, Inc. . . . . . . . . . . 18 6. True Ranches . . . . . . . . . . . . . . . 20 7. White Stallion Ranch, Inc. . . . . . . . . 21 8. Other True Companies . . . . . . . . . . . 22 C. Methods of Accounting Used by True Companies . 23 D. Family Members’ Employment in True Companies . 24 E. Family Gift Giving and Business Financing Practices . . . . . . . . . . . . . . . . . 27 II. True Family Buy-Sell Agreements . . . . . . . . . 28 A. Origin and Purpose . . . . . . . . . . . . . . 28 B. First Transfers of Interests in Belle Fourche, True Oil, and True Drilling to True Children . . . . . . . . . . . . . . . 30 C. Wyoming U.S. District Court Cases on Belle Fourche and True Oil Transfers . . . . . . . 35 D. Tamma Hatten’s Withdrawal From True Companies . 39 E. Use of Similar Buy-Sell Agreements in All True Companies Except White Stallion; Amendments and Waivers . . . . . . . . . . . 42 F. Unique Provisions of White Stallion Buy-Sell Agreement . . . . . . . . . . . . . . . . . 48 G. Future of True Family Buy-Sell Agreements . . . 50 III. Transfers in Issue . . . . . . . . . . . . . . . . 51 A. 1993 Transfers of Partnership Interests by Dave True . . . . . . . . . . . . . . . . . 51 B. 1994 Estate Transfers . . . . . . . . . . . . . 53 C. 1994 Transfers by Jean True . . . . . . . . . . 55 IV. Subsequent Income Tax Litigation Regarding Ranchland Exchange Transactions . . . . . . . . 55 - 3 - OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 59 I. Do Family Buy-Sell Agreements Control Estate Tax Value? . . . . . . . . . . . . . . . 59 A. Framework for Analyzing Estate Tax Valuation Issues . . . . . . . . . . . . . . . . . . . 59 B. Development of Legal Standards . . . . . . . . 61 1. Case Law Preceding Issuance of Regulations . 62 2. Regulatory Authority and Interpretive Rulings . . . . . . . . . . . . . . . . . 67 3. Case Law Following Issuance of Regulations and Revenue Ruling 59-60 . . . . . . . . 70 a. Was Agreement Entered Into for Bona Fide Business Reasons? . . . . . . . . . . 71 b. Was Agreement a Substitute for Testamentary Dispositions? . . . . . . 72 1. Testamentary Purpose Test . . . . . . 73 2. Adequacy of Consideration Test . . . . 74 4. Statutory Changes . . . . . . . . . . . . . 79 II. Do 1971 and 1973 Gift Tax Cases Have Preclusive Effect? . . . . . . . . . . . . . . . . . . . . . 81 A. Petitioners’ Collateral Estoppel Argument . . . 81 B. Legal Standards for Applying Collateral Estoppel . . . . . . . . . . . . . . . . . . . 82 C. Collateral Estoppel Impact of 1971 and 1973 Gift Tax Cases . . . . . . . . . . . . . . . . 85 1. Bona Fide Business Arrangement Issue . . . . 86 2. Whether Book Value Equaled Fair Market Value as of Agreement Date Issue . . . . . 87 III. Do True Family Buy-Sell Agreements Control Estate Tax Values? . . . . . . . . . . . . . . . 90 A. Was the Offering Price Fixed and Determinable Under the Agreements? . . . . . . . . . . . . 91 B. Were Agreements Binding During Life and at Death? . . . . . . . . . . . . . . . . 91 C. Were Agreements Entered Into for Bona Fide Business Reasons? . . . . . . . . . . . 99 D. Were Agreements Substitutes for Testamentary Dispositions? . . . . . . . . . . . . . . . . 101 1. Testamentary Purpose Test . . . . . . . . . 101 a. Decendent’s Health When He Entered Into Agreements . . . . . . . . . . . . . . 101 b. No Negotiation of Buy-Sell Agreement Terms . . . . . . . . . . . . . . . . . 102 c. Enforcement of Buy-Sell Agreement Provisions . . . . . . . . . . . . . . . 107 - 4 - d. Failure To Seek Significant Professional Advice in Selecting Formula Price . . . 109 e. Failure To Obtain or Rely on Appraisals in Selecting Formula Price . . . . . . . 112 f. Exclusion of Significant Assets From Formula Price . . . . . . . . . . . . . 114 g. No Periodic Review of Formula Price . . . 115 h. Business Arrangements With True Children Fulfilled Dave True’s Testamentary Intent . . . . . . . . . . . . . . . . . 118 2. Adequacy of Consideration Test . . . . . . . 120 a. Petitioners’ Brodrick v. Gore/Golsen Argument . . . . . . . . . . . . . . . 121 b. Petitioners’ Assertion That Respondent Impermissibly Applied Section 2703 Retroactively . . . . . . . . . . . . . 124 c. Did Tax Book Value Pricing Formula Represent Adequate and Full Consideration? . . . . . . . . . . . . 128 3. True Family Buy-Sell Agreements Were Substitutes for Testamentary Dispositions 140 E. Conclusion: True Family Buy-Sell Agreements Do Not Determine Estate Tax Values . . . . . 141 IV. Do True Family Buy-Sell Agreements Control Gift Tax Values? . . . . . . . . . . . . . . . . 144 A. Framework for Analyzing Gift Tax Valuation Issues . . . . . . . . . . . . . . . . . . . 145 B. Buy-Sell Agreements Do Not Determine Value for Gift Tax Purposes . . . . . . . . . . . . 146 C. Application of Gift Tax Rules to Lifetime Transfers by Dave and Jean True . . . . . . . 149 1. True Family Buy-Sell Agreements Do Not Control Gift Tax Values . . . . . . . . . 149 2. Lifetime Transfers by Dave and Jean True Were Not in Ordinary Course of Business . 151 V. Impact of Noncontrolling Buy-Sell Agreements on Estate and Gift Tax Valuations . . . . . . . 153 Issue 2. If True Family Buy-Sell Agreements Do Not Control Values, What Are Estate and Gift Tax Values of Subject Interests? . . . . . . . . . . . 155 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 155 I. True Oil . . . . . . . . . . . . . . . . . . . . . 156 - 5 - II. Belle Fourche . . . . . . . . . . . . . . . . . . 158 III. Eighty-Eight Oil . . . . . . . . . . . . . . . . . 161 IV. Black Hills Trucking . . . . . . . . . . . . . . . 164 V. True Ranches . . . . . . . . . . . . . . . . . . . 166 VI. White Stallion . . . . . . . . . . . . . . . . . . 168 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 169 I. Expert Opinions . . . . . . . . . . . . . . . . . 169 II. Experts and Their Credentials . . . . . . . . . . 171 A. Petitioners’ Expert, John H. Lax . . . . . . . 171 B. Petitioners’ Expert, Curtis R. Kimball . . . . 172 C. Petitioners’ Expert, Dr. Robert H. Caldwell . . 173 D. Petitioners’ Expert, Michael S. Hall . . . . . 174 E. Respondent’s Expert, John B. Gustavson . . . . 174 III. Preliminary Matters Regarding Valuation . . . . . 175 A. Respondent’s Alleged Concessions Regarding Valuation Discounts . . . . . . . . . . . . 175 B. Role of Burdens and Presumptions in Cases at Hand . . . . . . . . . . . . . . . 180 C. Petitioners’ Aggregation and Offset Argument . 183 IV. Valuations of True Companies in Dispute . . . . . 186 A. True Oil . . . . . . . . . . . . . . . . . . . 186 1. Marketable Minority Interest Value . . . . 186 a. Kimball Reports . . . . . . . . . . . . . 186 b. Final Lax Report . . . . . . . . . . . . 191 c. Gustavson Report and Respondent’s Position . . . . . . . . . . . . . . . 193 d. Court’s Analysis . . . . . . . . . . . . 196 2. Marketability Discounts . . . . . . . . . . 204 a. Kimball Reports . . . . . . . . . . . . . 204 b. Final Lax Report . . . . . . . . . . . . 207 c. Gustavson Report/Rebuttals and Respondent’s Position . . . . . . . . . 207 d. Court’s Analysis . . . . . . . . . . . . 208 3. Summary of Proposed Values and Court’s Determinations of Values of Interests in True Oil . . . . . . . . . . . . . . . . 215 B. Belle Fourche . . . . . . . . . . . . . . . . 217 1. Value of Total Equity on a Marketable Basis . . . . . . . . . . . . . . . . . . 217 - 6 - a. Kimball Report . . . . . . . . . . . . . 217 b. Initial and Final Lax Reports . . . . . . 218 c. Gustavson Report and Respondent’s Position . . . . . . . . . . . . . . . 221 d. Court’s Analysis . . . . . . . . . . . . 224 2. Marketability Discounts . . . . . . . . . . 233 a. Kimball Report . . . . . . . . . . . . . 233 b. Initial and Final Lax Reports . . . . . . 235 c. Respondent’s Position . . . . . . . . . . 235 d. Court’s Analysis . . . . . . . . . . . . 236 3. Summary of Proposed Values and Court’s Determinations of Values of Interests in Belle Fourche . . . . . . . . . . . . 240 C. Eighty-Eight Oil . . . . . . . . . . . . . . . 241 1. Marketable Minority Interest Value . . . . 241 a. Kimball Reports . . . . . . . . . . . . . 241 b. Final Lax Report . . . . . . . . . . . . 241 c. Respondent’s Position . . . . . . . . . . 242 d. Court’s Analysis . . . . . . . . . . . . 243 2. Marketability Discounts . . . . . . . . . . 246 a. Kimball Reports . . . . . . . . . . . . . 246 b. Final Lax Report . . . . . . . . . . . . 247 c. Respondent’s Position . . . . . . . . . . 247 d. Court’s Analysis . . . . . . . . . . . . 247 3. Summary of Proposed Values and Court’s Determinations of Values of Interests in Eighty-Eight Oil . . . . . . . . . . . 250 D. Black Hills Trucking . . . . . . . . . . . . . 252 1. Value of Total Equity on a Marketable Basis . . . . . . . . . . . . . . . . . . 252 a. Kimball Report . . . . . . . . . . . . . 252 b. Initial and Final Lax Reports . . . . . . 253 c. Respondent’s Position . . . . . . . . . . 255 d. Court’s Analysis . . . . . . . . . . . . 256 2. Marketability Discounts . . . . . . . . . . 261 a. Kimball Report . . . . . . . . . . . . . 261 b. Initial and Final Lax Reports . . . . . . 262 c. Respondent’s Position . . . . . . . . . . 262 d. Court’s Analysis . . . . . . . . . . . . 263 3. Summary of Proposed Values and Court’s Determinations of Values of Interests in Black Hills Trucking . . . . . . . . . 266 E. True Ranches . . . . . . . . . . . . . . . . . 268 1. Marketable Minority Interest Values . . . . 268 a. H&H Report . . . . . . . . . . . . . . . 268 b. Kimball Reports . . . . . . . . . . . . . 270 c. Final Lax Report . . . . . . . . . . . . 270 d. Respondent’s Position . . . . . . . . . . 272 - 7 - e. Court’s Analysis . . . . . . . . . . . . 273 2. Marketability Discounts . . . . . . . . . . 274 a. Kimball Reports . . . . . . . . . . . . . 274 b. Final Lax Report . . . . . . . . . . . . 275 c. Respondent’s Position . . . . . . . . . . 275 d. Court’s Analysis . . . . . . . . . . . . 275 3. Summary of Proposed Values and Court’s Determinations of Values of Interests in True Ranches . . . . . . . . . . . . . 278 F. White Stallion . . . . . . . . . . . . . . . . 280 1. Marketable Minority Interest Values . . . . 280 a. Kimball Report . . . . . . . . . . . . . 280 b. Initial and Final Lax Reports . . . . . . 280 c. Respondent’s Position . . . . . . . . . . 281 d. Court’s Analysis . . . . . . . . . . . . 281 2. Marketability Discounts . . . . . . . . . . 284 a. Kimball Report . . . . . . . . . . . . . 284 b. Initial and Final Lax Reports . . . . . . 284 c. Respondent’s Position . . . . . . . . . . 285 d. Court’s Analysis . . . . . . . . . . . . 285 3. Summary of Proposed Values and Court’s Determinations of Values of Interests in White Stallion . . . . . . . . . . . . 287 Issue 3. Did Jean True Make Gift Loans When She Transferred Interests in True Companies to Sons in Exchange for Interest-Free Payments Received Approximately 90 Days after Effective Date of Transfers? . . . . . . 288 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 289 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 297 I. Summary of Arguments . . . . . . . . . . . . . . . 297 II. Jean True’s Sales Were Completed on Notice Dates . 300 III. Sections 483 and 1274 Do Not Prevent Below-Market Loan Treatment Under Section 7872 . . . . . . . 308 IV. Deferred Payment Arrangements Are Below-Market Gift Loans Subject to Section 7872 . . . . . . . 313 A. Loan . . . . . . . . . . . . . . . . . . . . . 313 B. Below-Market Loan . . . . . . . . . . . . . . . 314 C. Gift Loan . . . . . . . . . . . . . . . . . . . 315 V. Amounts of the Gifts--Application of Section 7872 . 317 - 8 - Issue 4. Are Petitioners Liable for Valuation Understatement Penalties Under Section 6662(a), (g), and (h)? . 320 FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . 320 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 322 Appendix . . . . . . . . . . . . . . . . . . . . . . . . . . 334 Schedule 1 . . . . . . . . . . . . . . . . . . . . . . . 334 Schedule 2 . . . . . . . . . . . . . . . . . . . . . . . 335 Schedule 3 . . . . . . . . . . . . . . . . . . . . . . . 336 BEGHE, Judge: Respondent determined Federal gift and estate tax deficiencies and accuracy-related penalties under sections 6662(a), (g), and (h)2 in the following amounts: Docket No. Tax Year Deficiency Penalties 10940-97 Gift 12/31/93 $15,201,984 $6,080,794 3409-98 Estate 06/04/941 43,639,111 17,455,644 3408-98 Gift 12/31/94 17,094,788 6,791,715 Totals 75,935,883 30,328,153 1 Date of death. Introduction In each of these consolidated cases, respondent determined a gift or estate tax deficiency and penalty arising from a gross valuation understatement. The deficiencies and penalties relate to valuations of ownership interests in various corporations and partnerships (collectively, the True companies), subject to buy- sell agreements, transferred individually in 1993 by H.A. True, 2 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect as of the date of Dave True’s death (for estate tax purposes) or dates of Dave and Jean True’s alleged gifts (for gift tax purposes). All Rule references are to the Tax Court Rules of Practice and Procedure. - 9 - Jr., deceased, (docket No. 10940-97),3 reported by the Estate of H.A. True, Jr., H.A. True, III, personal representative (estate) by reason of H.A. True, Jr.’s death in 1994 (docket No. 3409-98), or transferred by Jean True individually in 1994 (docket No. 3408-98) (collectively, petitioners).4 Petitioners timely filed petitions with this Court contesting the deficiencies and penalties and claiming a refund of whatever overpayment of estate tax might arise from payments of administration expenses not claimed on the estate tax return. After concessions, the following issues are to be decided: 1. Does the book value price specified in the buy-sell agreements control estate and gift tax values of the subject interests in the True companies (buy-sell agreement issue); 2. If the True family buy-sell agreements do not control values, what are the estate and gift tax values of the subject interests (valuation issue); 3 Jean True is a party to docket No. 10940-97 solely because she elected to be treated as donor of one-half of the gifts H.A. True, Jr. made during 1993. See sec. 2513. 4 We include the estate in the collective term, petitioners, for ease of reference only. This reference does not suggest whether we regard the personal representatives’ residences, or the decedent’s domicile at death, to be controlling for appellate venue purposes under sec. 7482(b)(1). See Estate of Clack v. Commissioner, 106 T.C. 131 (1996). The issue is not implicated in the cases at hand because Dave True and the estate’s personal representatives were all domiciled in the same jurisdiction (Wyoming) at all relevant times. See infra pp. 11-12. - 10 - 3. Did Jean True make gift loans when she transferred interests in the True companies to her sons in exchange for interest-free payments received approximately 90 days after the effective date of the transfers (gift loan issue); and 4. Are petitioners liable for valuation understatement penalties under section 6662(a), (g), and (h) (penalty issue)? We hold in respondent’s favor that the buy-sell agreements do not control estate and gift tax values. We value the subject interests at amounts greater than the prices paid under the buy- sell agreements and hold that understatement penalties apply to parts of the resulting deficiencies. We hold for respondent on the gift loan issue. For convenience and clarity, findings of fact and opinion are set forth separately under each issue. The findings of fact regarding any issue incorporate, by this reference, the facts as found with respect to any issue previously addressed. Issue 1. Does Book Value Price Specified in Buy-Sell Agreements Control Estate and Gift Tax Values of Subject Interests in True Companies? FINDINGS OF FACT Some of the facts have been stipulated by the parties and are so found. The stipulation of facts, supplemental stipulation of facts, associated exhibits, and oral stipulations are incorporated by this reference. - 11 - I. Background A. True Family Henry Alphonso True, Jr. (known as H.A. True, Jr. or Dave True) was born June 12, 1915, and resided in Casper, Wyoming, from 1948 until his death on June 4, 1994, 1 week before his 79th birthday. He was survived by his wife, Jean True, his children, Tamma True Hatten (Tamma Hatten), H.A. True, III (Hank True), Diemer D. True (Diemer True), and David L. True (David L. True) (collectively, the True children), his grandchildren, and great- grandchildren. The Natrona County, Wyoming, probate court (probate court) appointed Jean True, Hank True, Diemer True, and David L. True (personal representatives) as co-personal representatives of the estate. After approving the estate’s final accounting, the probate court discharged the personal representatives on December 13, 1995. Dave True’s Last Will and Testament, dated September 14, 1984 (will), provided that the residue of his estate should be paid to the trustees under the H.A. True, Jr. Trust dated September 14, 1984 (living trust), as amended. Under the living trust, Jean True, Hank True, Diemer True, and David L. True were appointed as first successor trustees (trustees) upon Dave True’s death. - 12 - The personal representatives, trustees, and Jean True individually, resided in Casper, Wyoming, at the times they filed their petitions with this Court. B. Formation and Growth of True Companies 1. Reserve Drilling Dave True graduated from college and married Jean True in 1938. During the next 10 years, he worked in the oil and gas business for the Texas Co. (later known as Texaco) in various positions, eventually becoming Wyoming State superintendent of drilling and production, based in Cody, Wyoming. During this time, Tamma (1940), Hank (1942), and Diemer (1946) were born. In 1948, Dave True left the Texas Co., moved his family to Casper, Wyoming, and became manager of Reserve Drilling Co. (Reserve Drilling), a one-rig contract drilling business. Dave and Jean True’s youngest child, David L. True, was born in 1950. By 1951, Dave True owned 15 percent of Reserve Drilling, Doug Brown, an attorney, owned 10 percent, and unrelated companies owned the remaining interests. Reserve Drilling generated substantial profits and acquired additional rigs under Dave True’s management. Eventually, the unrelated companies sold their interests to Dave True and Doug Brown, who financed their purchases with borrowed funds. - 13 - 2. True-Brown Partnerships Dave True and Doug Brown jointly pursued other business ventures (collectively, True-Brown partnerships). Among them was True & Brown Drilling Co., a partnership formed in 1951 that engaged in contract drilling and also acquired working interests in oil and gas properties. Dave True worked long hours in the field on the drilling rigs, while Doug Brown worked regular hours in the Casper office. Dave True came to believe that he was contributing more than 50 percent of the efforts required to run the company. In 1954, Dave True offered to sell his interest, or to buy Doug Brown’s interest, at a stated price. Doug Brown chose to sell his interests in all the True-Brown partnerships, and Dave True financed his purchase through an oil payment (bank loan payable out of oil production).5 These experiences influenced Dave True’s business philosophy and generated his interest in using buy-sell agreements. Dave True decided that he never again would incur outside debt to finance acquisitions and that he would allow only family members to be his partners in future business ventures. 5 Other than intimations that the purchases and sales of the outsiders’ interests in Reserve Drilling and the True-Brown partnerships were at arm’s length, there is no indication in the record how the purchase prices in these transactions were established. See infra pp. 16-17 with respect to purchases- redemptions of outside shareholders’ interests in Belle Fourche Pipeline Co. - 14 - 3. True Oil and True Drilling Following termination of the True-Brown partnerships in 1954, Dave and Jean True formed True Oil Co. (True Oil) and True Drilling Co. (True Drilling). These were Wyoming general partnerships in which Dave and Jean True initially owned 95- percent and 5-percent interests, respectively. True Oil acquired working interests in oil and gas properties and looked for new reserves. In general, True Oil would do farm-in deals (do exploratory drilling on prospects identified by others) rather than develop its own deals. Dave True was an operator, who actually drilled and operated wells and arranged to sell production, rather than a promoter, who sells non-operating royalty interests to third parties. True Oil’s customers included both related and unrelated parties; however, on average, about half of its production was purchased by related entities. True Drilling owned and operated drilling rigs and performed contract drilling services for related and unrelated customers. True Oil was one of True Drilling’s largest customers. Dave True was a “wildcatter”. He enjoyed the challenge of drilling exploratory wells on leased acreage far from established fields, rather than drilling developmental wells on established fields. True Oil’s early efforts were rewarded with discoveries of fields in the Rocky Mountain region (Wyoming, North Dakota, - 15 - Montana). Dave True was also a pioneer in the successful use of water flooding to increase recoverable reserves. Dave True believed that the only way to perpetuate his business would be to find and develop replacement reserves and that doing so would require substantial exploration and development outlays. True Oil expended considerable funds without generating substantial additional production. From 1972 to 1998, True Oil spent approximately $174 million on exploration and drilling costs that resulted in dry holes.6 Dave True’s continuing commitment to exploration for new reserves, and his aversion to incurring outside debt, required the partners to channel their profits from True Drilling and other True companies into True Oil in order to finance continued exploration activities. Effective August 1, 1973, Dave True gave each of his children 8-percent general partnership interests in True Oil and True Drilling. The owners and ownership percentages immediately after the gifts were: Dave True (63 percent), Jean True (5 percent), and each of the four True children (8 percent). 4. Belle Fourche Pipeline Co. In 1957, Dave True and other Wyoming operators organized Belle Fourche Pipeline Co. (Belle Fourche) as a Wyoming 6 True Oil’s total intangible drilling costs from 1972 through 1998 were $301,016,235, which included costs of drilling on proven properties, developmental drilling, and exploratory drilling. Fifty-eight percent of total intangible drilling costs (approximately $174 million) were spent on nonproductive wells. - 16 - corporation to build and operate a gathering system for the Donkey Creek field in the Powder River Basin. Dave True and the other local operators organized Bell Fourche because they had encountered difficulty in getting their crude oil to market from newly discovered, remote fields. They therefore decided to build their own pipeline, rather than transport crude oil by truck to trunk lines or connect new wells to existing gathering pipelines owned by others. In later years, Belle Fourche substantially expanded its operations to serve other fields as a common carrier gathering system with multiple outlets to trunk lines. Belle Fourche generated substantial cash-flow from fees for transporting crude oil. Its customers included both True companies and unrelated entities. However, the majority of its business was from unrelated entities. In the 1960's, Dave and Jean True acquired full ownership of the shares of Belle Fourche through redemptions of the share interests of the other holders.7 There were no buy-sell agreements that would have dictated the redemption prices for Belle Fourche stock. All but one of the redemptions were at preceding yearend book value (determined on a GAAP basis, see 7 Petitioners’ direct testimony characterized these transactions as stock purchases by Dave and Jean True, while the appraisal of Standard Research Consultants (SRC)(see infra pp. 37-39) characterized them as corporate redemptions. The SRC appraisal provided more detailed information regarding the transactions and appears to be more reliable. - 17 - infra p. 23); the exception, which amounted to 24 percent8 of the total shares initially issued, was for more than book value. In 1967, after having acquired all outstanding shares, the Trues caused Belle Fourche to make an S corporation election. Belle Fourche relied on shareholder loan, rather than equity, as its main source of financing after electing S status. Between March 31, 1971 (the company’s fiscal yearend), and June 15, 1971, Dave and Jean True received earnings distributions of approximately $2.8 million,9 thereby reducing reported book value from $99.90 to $38.69 per share. In August 1971, the True children each purchased a 1-percent interest in Belle Fourche from the corporation. The True family’s accountant, Cloyd Harris (Mr. Harris), advised the True children also to lend money to Belle Fourche so that each stockholder’s pro rata share of outstanding loans to the corporation would reflect his or her percentage interest. This was intended to preserve Belle Fourche’s S corporation status by avoiding the appearance of a second class of stock. The True children paid $38.69 per share to purchase the stock (476 shares each) and lent the company $127.26 per share at 8-percent 8 29,244 shares (redeemed December 1962 at $17/share vs. book value of $13.13/share) divided by 120,004 shares (issued at formation) equals approximately 24 percent (rounded). 9 $4,569,000 (book value at 3/31/71) less $1,769,500 (45,734 shares outstanding x $38.69 book value/share at 6/15/71) equals $2,800,000 (rounded) decrease in book value due to distributions made within 2-1/2 months after fiscal yearend. - 18 - interest, payable on demand. The children financed the transaction with cash gifts from their parents over the years and with earnings distributions from their prior investments in other True companies. The owners and ownership percentages immediately after the purchases were: Dave True (91 percent), Jean True (5 percent), and each of the four True children (1 percent). 5. Black Hills Oil Marketers, Inc./True Oil Purchasing Co./Eighty-Eight Oil Co./Black Hills Trucking, Inc. Black Hills Oil Marketers, Inc. (Black Hills Oil), was formed by Dave True in 1963 to market and transport crude oil. Initially, the activities of Black Hills Oil centered on supporting Belle Fourche’s pipeline operation by moving and accumulating marketable quantities of oil. However, Black Hills Oil’s business quickly expanded to include purchasing oil from unrelated parties and providing shipping services. Black Hills Oil’s marketing activities consisted of buying crude oil from lease operators, shipping it through a pipeline while retaining title, and reselling it with a markup at the other end. In the late 1970's, the True family began conducting oil marketing activities through True Oil Purchasing Co. (TOPCO) rather than through Black Hills Oil. In 1980, one of TOPCO’s customers could not fulfill a purchase obligation and filed for bankruptcy. The Trues became concerned that this default might adversely affect TOPCO’s ability to meet its own obligations. - 19 - They therefore liquidated TOPCO and transferred its crude oil marketing business to a preexisting Wyoming general partnership, Eighty-Eight Oil Co. (Eighty-Eight Oil). Dave and Jean True owned 95 percent and 5 percent, respectively, of Eighty-Eight Oil when they formed it in 1956. In 1975, the four True children each purchased an 8-percent general partnership interest from Dave True, which reduced his partnership interest to 63 percent. The crude oil marketing business operated by Eighty-Eight Oil and its predecessors generated considerable cash-flows; the Trues regarded it as a “cash cow”. Eighty-Eight Oil often served its partners as a repository of excess cash. At times, due to disproportionate capital contributions or withdrawals, the capital accounts of the partners varied widely from their interests in profits and losses. During the 1990's, Eighty-Eight Oil transacted most of its business with unrelated parties. Black Hills Trucking, Inc. (Black Hills Trucking), began as a division of Black Hills Oil that transported crude oil to pipelines. Its services grew to include moving drilling rigs and hauling water, livestock, products, and pipe for related and unrelated customers. As a result of the expansion of the activities of Black Hills Trucking, and regulatory price caps imposed on Black Hills Oil, the True family decided to make Black Hills Trucking a separate entity. - 20 - In 1977, Black Hills Trucking was organized as a Wyoming corporation; it was initially owned by Dave True (63 percent), Jean True (5 percent), and the four True children (8 percent each). The company elected S corporation status in December 1977. The market for trucking services was competitive and depended heavily on demand from the oil industry. As a result, Black Hills Trucking generally lost money after the drop in oil prices that occurred in the mid-1980's. 6. True Ranches Dave True individually owned and operated cattle ranches as early as 1957. In 1976, the True family incorporated the ranches and their operations as True Ranches, Inc., a Wyoming corporation that elected to be treated as an S corporation from its formation (ranching S corporation). The True children each purchased a 1- percent interest in the ranching S corporation on formation. Later, the True family formed Double 4 Ranch Co., a Wyoming partnership, to engage in ranching operations in Australia. The initial partners and ownership percentages were: Dave True (63 percent), Jean True (5 percent), and the True children (8 percent each). In 1983, the partnership’s name was changed to True Ranches, a Wyoming partnership (ranching partnership), and it began leasing ranching assets from the ranching S corporation. The ranching S corporation was dissolved in 1986; thereafter, all ranching activities were conducted by the ranching partnership. - 21 - True Ranches operated on 350,000 acres of owned and leased land in Wyoming. It is a vertically integrated cattle operation, running herds of cows and their offspring from conception through finishing ready for slaughter. True Ranches also operated feedlots and farmed to produce feed for its own cattle, including grass hay, alfalfa hay, and corn. True Ranches maintained a year-round breeding herd on eight operational units and cross-bred three breeds of cattle, Angus, Charolais, and Hereford. The weaned, heavier steer calves went into one of the feedlots for finishing, while the lighter steers were wintered on hay and energy feeds and were subsequently sent to feedlots at heavier weights. When finished cattle were ready for slaughter, True Ranches would sell them to the packers directly, without using auctions or third parties. Besides finishing all its own raised cattle, True Ranches also purchased outside cattle to maximize the use of its feedlot capacity. 7. White Stallion Ranch, Inc. White Stallion Ranch, Inc. (White Stallion), an Arizona S corporation, was formed in 1965 to operate a dude ranch. Initially, the stock was owned by Dave True (47.5 percent) and Jean True (2.5 percent), and by Dave True’s brother, Allen True (25 percent), and his wife, Cynthia True (25 percent). The shareholders contracted to restrict the transfer of White Stallion stock outside the families of Allen True - 22 - (designated Group 1) and Dave True (designated Group 2). The contract required the transferring shareholder first to offer any shares for sale to the remaining member of his group. If no such member remained, the transferring shareholder had to offer the shares to members of the other group, equally. In all cases, the purchase price was book value (excluding intangibles), which was to be determined by White Stallion’s certified public accountant. In 1982, the True children each purchased 4-percent interests from Dave True at book value, thereby becoming members of Group 2. In the same year, Allen True and Cynthia True gave 12.5- percent interests to each of their two children, who then became members of Group 1. 8. Other True Companies The True family owned and operated at least 19 other businesses, including a bank holding company (Midland Financial Corp.), a drilling supplies wholesaler (Toolpushers Supply Co.), and an environmental cleanup company (True Environmental Remediating LLC). Those that were formed as corporations were incorporated under the laws of Wyoming, except for Midland Financial Corp., a Delaware corporation. Those that were formed as general partnerships (and limited liability companies) were also organized under Wyoming law. - 23 - C. Methods of Accounting Used by True Companies Most of the True companies maintained their books and records on a tax basis and not in accordance with generally accepted accounting principles (GAAP). There were two exceptions: (1) Belle Fourche had GAAP basis books before the Trues obtained 100-percent ownership, and (2) Midland Financial Corp. kept its books according to bank regulatory requirements, which approximated GAAP. For certain True companies, there were substantial differences between book value computed on a tax basis and book value computed on a GAAP basis. For Black Hills Trucking and Belle Fourche, the differences resulted primarily from deducting accelerated depreciation of tangible personal property for income tax purposes. No significant tax to GAAP differences existed for Eighty-Eight Oil (and its predecessors) because the bulk of the assets held after spinning off the trucking division consisted of cash and cash equivalents. True Oil’s tax to GAAP discrepancies resulted from: (1) Deduction of intangible drilling costs for tax purposes versus capitalization under either the successful - 24 - efforts10 or full cost11 methods permitted by GAAP and (2) deduction of the higher of cost or percentage depletion for tax purposes. In the case of True Ranches, tax to GAAP differences arose primarily from the deduction of prepaid feed expenses for tax purposes. Because feed expenses and other costs of raising livestock were deducted in the years paid, no cost basis was allocated to raised (as opposed to purchased) livestock. True Oil maintained a qualified profit-sharing plan. The contribution formula required that intangible drilling costs not be deducted in computing annual profit for plan purposes. Without this adjustment, True Oil might never have reported a profit and therefore, would not have been required to make any contributions to the plan to provide retirement benefits for employees. D. Family Members’ Employment in True Companies Jean True worked in the family businesses in various capacities. She coordinated construction, renovation, and maintenance of the True companies’ buildings and managed customer 10 The successful efforts method capitalizes oil and gas exploration costs if they produce commercial reserves but otherwise currently deducts the cost of dry holes. See Brock et al., Petroleum Accounting Principles, Procedures, & Issues, at 224-225 (3d ed. 1990). 11 The full cost method capitalizes all oil and gas exploration costs whether or not they result in dry holes. An annual (downward) adjustment may be required if such capitalized costs exceed the market value of underlying reserves. See id. at 230, 337-338, 350. - 25 - and employee relations. She attended business meetings and industry functions with Dave True, entertained customers and business associates in their home, and administered various employee awards programs. The True children, and sometimes grandchildren and children’s spouses, also worked for the True companies over the years. From junior high school through college, the True sons spent summers, holidays, and weekends working as roustabouts and lease scouts in the oil fields, roughnecks on the drilling rigs, and ranch hands on the family ranch. After graduating from college, the True sons worked full time for the family businesses in various capacities. In 1973, Hank True became the manager of Black Hills Oil, and eventually assumed responsibility for Belle Fourche, Eighty-Eight Oil, and True Environmental Remediating LLC. Diemer True went to work for Black Hills Oil’s trucking division in 1971, and thereafter managed Black Hills Trucking as a separate company. He also took charge of Toolpushers Supply Co. in 1980. David L. True graduated from college in 1973 and became manager of True Ranches in 1976 and of True Drilling in 1980. While Dave True yielded operating responsibilities to his sons over time, he retained overall decision-making authority. However, he exercised this authority by building consensus through discussions with his wife and sons rather than by edicts. - 26 - After Dave True died, the True sons added joint management responsibility for True Oil to their other duties. Tamma Hatten briefly worked for the True companies as personnel coordinator. Her husband, Donald Hatten (Don Hatten), worked full time for the True companies from 1973 to 1984. His positions included assistant drilling superintendent and assistant treasurer of True Drilling. The True children (including Tamma Hatten before her withdrawal, see infra pp. 39-42) always owned equal percentage interests in each True company, regardless of the extent of their individual participation in managing the various businesses. Starting as high school students, the True children participated in the True companies’ annual supervisors’ meetings and semiannual family business meetings. Once they became owners, the True children and their spouses began attending monthly Partners, Officers, Directors, and Shareholders meetings (PODS meetings). The PODS meetings followed an agenda and kept the family informed of the True companies’ operations. All the True children had children of their own by the time Dave True died; Tamma Hatten and Diemer True also had grandchildren. Only two of Diemer True’s children, out of all of the grandchildren and great-grandchildren, worked full time for the True companies. - 27 - E. Family Gift Giving and Business Financing Practices Dave and Jean True made gifts to some or all of their children (and their children’s spouses) every year but one between 1955 and 1993; gifts were not made in 1984 due to the oversight of an in-house accountant-bookkeeper. They gave cash or ownership interests in various True companies valued at the maximum allowable amount that would not trigger gift tax (except for 1973, the only year in which taxable gifts occurred). When the True children were minors, the gifts were administered through a guardianship arrangement established by Dave True, as guardian. In later years, cash gifts to True children and their spouses were deposited into business bank accounts that were separately designated by recipient. Gifts to a spouse were first lent to the True child, and then those combined funds were invested in the True companies, either by purchasing ownership interests or by making interest-bearing loans, or both. The True companies’ bookkeepers maintained detailed records of these transactions. The True children and their spouses never received their gifts as cash in hand; however, the donees were generally aware that their gifts were being invested on their behalf. They had no specific knowledge of how or when they acquired their earliest interests in the True companies. - 28 - II. True Family Buy-Sell Agreements A. Origin and Purpose The True-Brown partnership experience convinced Dave True not to own businesses with outsiders. He therefore used buy-sell provisions to restrict a related owner’s ability to sell outside the True family. Such provisions were included in partnership agreements, for True companies that were partnerships, and in stockholders’ restrictive agreements, for those that were corporations (collectively, buy-sell agreements). The original Eighty-Eight Oil, True Oil, and True Drilling partnership agreements, entered into by Dave and Jean True in the mid-1950's, prohibited a partner from transferring or encumbering his or her interest. In addition, they provided that if Jean True were to die or become disabled, Dave True would be obligated to purchase her interests at book value. Alternatively, the partnership would terminate with Dave True’s death or disability. These agreements served as prototypes for later buy-sell agreements. Dave True incorporated the provisions restricting transfers to outsiders and setting the transfer price at book value into all subsequent versions of the True companies’ corporate and partnership buy-sell agreements (except for White Stallion--see infra p. 48). Dave True also felt strongly that owners should actively participate in the family business to avoid any divergence of - 29 - interests between active and passive owners. He had witnessed the conflicts that arose in other families when active owners wanted to retain profits and grow the business, while passive owners sought to distribute and consume profits. Accordingly, in 1973, after all the True children (or their spouses) were working full time in the business, Dave True incorporated an active participation requirement into the True family buy-sell agreements. In general, the active participation requirement provided that if an owner (or owner’s spouse) ceased to devote all or substantial time to the business, he or she would be deemed to have withdrawn from the business, absent unanimous agreement to the contrary by the active owners. Dave True’s philosophy was further memorialized in the August 1988 “Policy for the Perpetuation of the Family Business” (policy), which was executed by the then-active participants and spouses. The policy articulated and adopted Dave True’s goal “to perpetuate the family business by providing for ownership succession through family members who qualify as active participants”. The policy defined “active participants” as follows: Active participants are those family member-owners who actively participate in the decision-making process for family business decisions and policies or who work full time in the businesses. The goal in designating active participants is to avoid fragmentation of the family business in future generations and to meld it into a rational business organization. A family member who limits their involvement principally to disbursing - 30 - dividends or cash payments to him or herself or other family members shall not be an active participant nor retain ownership. * * * A non-active family member- owner may designate his or her spouse who does work full time in the business to be considered for qualification of the family member-owner as an active participant. * * * B. First Transfers of Interests in Belle Fourche, True Oil, and True Drilling to True Children In the early 1970's, the True children acquired interests in three True companies: Belle Fourche, True Oil, and True Drilling. Dave True’s purpose in enabling his children to acquire these interests was to perpetuate the family businesses by fostering the children’s interest in owning and managing them. Dave True was in good health in 1971 and 1973 when he orchestrated these acquisitions by his children. In August 1971 (as described supra pp. 17-18), Belle Fourche sold stock, representing a 1-percent ownership interest, to each True child for a combination of cash and loans made to the corporation by the child.12 At that time, the True children ranged from approximately 21 to 31 years of age. The purchase price ($38.69 per share) was based on Belle Fourche’s book value as of the end of the preceding fiscal year, less dividends paid within 2-1/2 months thereafter. Subsequently, the stockholders 12 Mr. Harris testified that Dave True sold 1-percent interests in Belle Fourche to each of his four children. However, the minutes of the Belle Fourche Board of Directors meeting and the SRC appraisal indicate that the company sold its stock to the children. - 31 - executed a Stockholders’ Restrictive Agreement (corporate buy- sell agreement), which provided that if a stockholder died or otherwise wished to sell stock, the remaining stockholders would purchase it in amounts directly proportional to their preexisting holdings. The purchase price was to be the book value of the stock at the end of the preceding fiscal year, less any dividends paid to stockholders within 2-1/2 months immediately following the fiscal yearend. The corporate buy-sell agreement stated that it was binding upon the heirs and executors of a deceased stockholder. It did not include an active participation requirement because David L. True was still in college when the agreement was executed. Effective August 1, 1973, Dave True gave each of his children an 8-percent interest in True Oil and in True Drilling. At that time, the True children ranged from approximately 23 to 33 years of age. As a result of these gifts, the new partners made the following identical amendments (among others) to both companies’ partnership agreements (partnership buy-sell agreements): 5. No partner shall in any way attempt to dispose of, sell, encumber, or hypothecate his interest in the partnership except in accordance with the provisions of the Partnership Agreement relating to withdrawal or death of a partner, or, except in the normal course of business, any of the assets thereof. 6. If any partner shall resign, become legally disabled or bankrupt, assign his interest in the partnership for the benefit of his creditors, or - 32 - institute any proceedings for temporary or permanent relief from his liabilities, or shall suffer an attachment or execution to be levied on his share or interest in the partnership, or a judgment shall be entered against him and stay of execution thereupon shall expire, or if he shall attempt to encumber or hypothecate his partnership interest, he shall be deemed to have filed a Notice of Intent to Withdraw, and his interest in the partnership shall be disposed of as provided in this Agreement. 7. In the event of the death of a partner or the filing with the partnership by a partner of Notice of Intent to Withdraw (the deceased partner or the partner filing such notice shall hereinafter be referred to as the “Selling Partner”), the Selling Partner shall be obligated to sell and the remaining partners shall be obligated to purchase the Selling Partner’s interest in the partnership for the purchase price described herein. The remaining partners shall purchase the Selling Partner’s interest in proportion to their respective shares in the net profits of the partnership and the purchase price shall be payable within six months after death or the filing of the Notice of Intent to Withdraw. The purchase price of the Selling Partners’s interest shall be the book value of the partnership multiplied by the Selling Partner’s percentage interest in the net profits of the partnership, [13] said book value to be determined as of the end of the month immediately preceding the date of the death or filing of Notice of Intent to Withdraw less any withdrawals made by the partners subsequent to end of the preceding month. The book value of the partnership shall be determined in accordance with the accounting methods and principles customarily followed by the partnership. Appropriate adjustments shall be made for over or under withdrawals by a partner. 8. The partnership shall continue in business and shall not be terminated unless the holders of 50% or more of the total interest in partnership capital and profits sell their interests as provided herein, or unless all of the partners agree to such termination. 13 See infra p. 47 and note 20. - 33 - 9. In the event that a partner or partner’s spouse ceases to devote all or a substantial part of his time to the business of the partnership, he shall be deemed to have filed with the partnership a Notice of Intent to Withdraw, unless the remaining partners unanimously agree to permit such partner to continue as a partner. The True children received no independent legal or accounting advice when they entered into the buy-sell agreements. They did not know who drafted the agreements or why, in the case of Belle Fourche, they were required to structure the purchase with a combination of stock and debt. However, the True children, having been exposed from childhood to Dave True’s business philosophy, understood his reasons for including the active participation and book value purchase price requirements in the buy-sell agreements. Dave True consulted with Mr. Harris, the family’s longtime accountant and principal tax and economic adviser, and C.L. Tangney (Mr. Tangney), Mr. Harris’s employer, before entering into the buy-sell agreements. On one occasion, Dave True also discussed the True Oil and True Drilling buy-sell agreements with Claude Maer (Mr. Maer), an attorney who was assisting the True companies on an unrelated income tax matter. Dave True mainly consulted with Mr. Harris regarding using a tax book value purchase price formula under the buy-sell agreements. Mr. Harris was not a professional appraiser and had no significant practical experience in valuing businesses. - 34 - The buy-sell agreements did not provide a mechanism for periodic review or adjustment to the book value purchase price formula, other than what would occur as a result of changes in book value. Messrs. Harris and Tangney recommended that Dave True obtain an appraisal of True Oil’s oil and gas reserves contemporaneously with the gifts to the children because they expected the book value gift valuation to be challenged by the Internal Revenue Service (IRS). Either the True Companies or Dave and Jean True, personally, had been audited for income tax purposes regularly in all tax years preceding the gifts. The appraisal was prepared by Bernie Allen14 (B. Allen report), an engineer from Casper, Wyoming, before Dave True made the gifts of True Oil interests to his children. No appraisal of Belle Fourche was prepared contemporaneously with the sale of 1-percent interests to the True children. The B. Allen report indicated that as of August 1, 1973, True Oil had reserves of 5,297,528 barrels of proved developed oil and 8,551,994 thousand cubic feet (Mcf) of proved developed gas, and that the fair market value of its oil and gas properties 14 The B. Allen report was not admitted into evidence because it could not be located at the time of trial. However, the SRC appraisal prepared for purposes of the subsequent True Oil gift tax case cited valuation data derived from the B. Allen report. We assume that the information contained in the SRC appraisal accurately reflects the data set forth in the B. Allen report. - 35 - (including leases) was $9,941,000. The results of the B. Allen report were generally discussed at True family meetings; however, there is no evidence in the record that the True children reviewed the report in detail before signing the True Oil buy- sell agreement. Mr. Harris did not use the B. Allen report to advise members of the True family (at the time of signing the True Oil buy-sell agreement) that tax book value was the appropriate standard; he reviewed the report only in connection with subsequent gift tax litigation. C. Wyoming U.S. District Court Cases on Belle Fourche and True Oil Transfers Dave True timely filed a 1973 Federal gift tax return reporting gifts of an 8-percent interest in True Oil and in True Drilling to each of his children. Jean True consented to treat the gifts as having been made one-half by each spouse. Each True Oil gift was reported to have a fair market value of $54,653, which represented the tax book value of an 8-percent interest as of August 1, 1973. The 1971 transfers of Belle Fourche stock to the True children (valued at $38.69 per share) had not been reported on a gift tax return because they were structured as sales by the corporation. The Commissioner determined gift tax deficiencies against Dave and Jean True for the 1971 Belle Fourche transfers. The Trues paid the gift taxes assessed and filed a refund suit in the U.S. District Court for the District of Wyoming, designated as - 36 - True v. United States, Docket No. C79-131K (D. Wyo., Oct. 1, 1980) (1971 gift tax case). On October 1, 1980, after a trial, the District Court (Judge Kerr) issued Findings of Fact and Conclusions of Law that stated: “Taking into consideration all of the facts and circumstances including the reasonable inferences to be drawn therefrom, * * * the fair market value of the stock in question as of the date of August 2, 1971 was $38.69 per share”, the book value price at which the sales to the True children had been made. Judgment was entered accordingly, and the United States did not appeal. The Commissioner also determined gift tax deficiencies against Dave and Jean True for the 1973 gifts to the True children of partnership interests in True Oil and True Drilling. However, the Commissioner conceded the deficiency relating to True Drilling. The Trues paid the True Oil gift tax deficiencies and filed a refund suit with the same court as the 1971 gift tax case, designated as True v. United States, Docket No. C81-158, reported as 547 F. Supp. 201 (D. Wyo. 1982) (1973 gift tax case). On September 27, 1982, after a trial, Judge Kerr issued a Memorandum Opinion that concluded: Taking into consideration all the facts and circumstances and the reasonable inferences to be drawn therefrom, * * * the method of valuation used by the plaintiffs in this case offers a more complete and fair estimation of the fair market value to be used in the valuation of the 8% interests given as gifts to plaintiffs’ children. Application of plaintiffs’ valuation method results in a finding * * * that the - 37 - fair market value of each 8% interest was properly determined at $54,653. Judgment was entered accordingly, and the United States did not appeal. Although members of the True family asserted at trial that they believed that the book value buy-sell provisions were valid and enforceable as a result of the favorable outcomes of the 1971 and 1973 gift tax cases, neither they nor Dave True engaged counsel to advise them of the legal effects of those cases on future transfers pursuant to the buy-sell agreements. In fact, as described infra pp. 51-52, Dave True saw the 1993 transfers as his opportunity to test the ability of the buy-sell agreements to fix Federal gift tax value. In preparing for litigation of the 1971 and 1973 gift tax cases, Dave True obtained appraisals for the transferred interests in Belle Fourche (valued as of August 2, 1971) and True Oil (valued as of August 1, 1973) from Standard Research Consultants (SRC). The SRC appraisals supported the True family positions in the 1971 and 1973 gift tax cases. After evaluating Belle Fourche’s historical performance, along with overall economic and industry trends, SRC used the earnings and book value approaches to derive a “freely traded value” for the transferred stock. The earnings approach required determining various price-earnings multiples for comparable public companies, adjusting them for Belle Fourche’s unique - 38 - characteristics, and applying them to Belle Fourche’s actual earnings data. Similarly, the book value approach analyzed rates of return on common stock equity and price-to-book value ratios of comparable public companies and applied them (after adjustments) to Belle Fourche’s actual book value at the valuation date. After assigning more weight to the earnings approach, SRC derived a freely traded value for Belle Fourche stock of $120 per share. SRC explained that the freely traded value “would have been * * * [the] fair market value on the valuation date * * * had there been an active public market for the stock at that time.” SRC opined that, because Belle Fourche lacked a public market for its stock and the transferred shares represented minority interests, a willing, knowledgeable buyer would demand a discount from the freely traded value. While SRC examined average marketability discounts15 used in public company transactions, it did not use this information in its analysis. Instead, SRC concluded that, because the minority interest shareholders (the True children) could never look forward to a public market and were limited to the sales price fixed in the 15 SRC described the transferred interests’ lack of marketability and control as being “infirmities” that must be accounted for in any sale to a hypothetical purchaser. However, SRC’s analysis seemed to blend the two concepts, and, ultimately, referred only to a marketability discount and not to a minority discount. - 39 - buy-sell agreement, the fair market value of their shares on August 2, 1971, was the book value calculated under the buy-sell agreement, or $38.69 per share. SRC generally followed the same methodology in valuing the partnership interests in True Oil transferred by Dave True as of August 1, 1973. However, instead of using the book value approach, SRC used the net asset value (NAV) approach combined with the earnings approach. This required a two-step process: (1) Marking the balance sheet to market to derive NAV, and (2) applying a discount to NAV based on comparable public companies’ ratios of price to NAV. After again assigning greater weight to the earnings approach, SRC determined the freely traded value of an 8-percent interest in True Oil to be $535,000 (rounded) on the valuation date. Finally, SRC applied the same lack of public market rationale, as in its Belle Fourche appraisal, to disregard the freely traded value and to conclude that fair market value was limited to the buy-sell agreement formula price, or $54,653 for an 8-percent interest. D. Tamma Hatten’s Withdrawal From True Companies Tamma Hatten had never shown an avid interest in participating in the True family businesses, and her husband had played a relatively minor role in the management of the True companies. On July 23, 1984, when Tamma Hatten was 44 years old, she notified her family (in writing) of her intent to withdraw - 40 - from and sell her interests in the True companies, as required under the buy-sell agreements. She and her husband were eager to purchase and independently run their own ranching operation. Tamma Hatten did not seek separate legal or other professional counsel in connection with the sale of her interests in the True Companies. Instead, she relied on Dave True and his advisers to determine the sales prices of all those interests under the buy- sell agreements and to structure the methods of payment. Dave True’s legal advisers drafted the Agreement for Purchase and Sale of Assets, dated August 10, 1984, which outlined the terms for sale of Tamma Hatten’s business holdings (including partnership interests, corporate stock, notes, and lease interests). The total purchase price was $8,571,296.22, composed of a cash payment of $4,234,000 and payment to a specially created escrow account for the balance. The escrow, established by Dave True and his advisers, deviated from the requirements of the True companies’ buy-sell agreements. Its purpose was to provide security for payment of Tamma Hatten’s share of accrued contingent liabilities (if any) and a management vehicle for her investments. Tamma Hatten received over $8.5 million in aggregate value for her True companies’ interests, but that amount included certain offsets. For example, both Eighty-Eight Oil and True Oil had negative book values at the buy-sell agreements’ valuation - 41 - dates; as a result, Tamma Hatten in effect was required to pay the other owners in order to dispose of her interests in those companies (i.e., her overall sales proceeds were reduced). The negative offsets were $1,405,449.35 for Eighty-Eight Oil and $466,560.35 for True Oil. In the case of True Oil, the negative book value was attributable to the deductions, which had been taken for tax purposes, of intangible drilling and development costs. After the sale, Tamma and Don Hatten moved from Casper to Thermopolis, Wyoming, where they bought a ranch and were no longer involved in True family business activities. Dave and Jean True thereafter ceased making annual gifts to Tamma and amended their wills (and other estate planning documents) to delete any specific provision for Tamma Hatten and her family.16 This was done because the Trues believed that Tamma Hatten was financially secure as a result of the sale. Moreover, Dave True believed that his estate should go to his sons so that they might invest the assets in the family businesses. One of Dave True’s testamentary documents entitled “Appointment of Trust Estate” (appointment document), see infra p. 53, characterized the circumstances as follows: 16 However, under sec. 5.3 of the Appointment of Trust Estate dated Sept. 14, 1984, if Dave True were to have been predeceased by his wife, sons, and his sons’ lineal descendants, then Tamma Hatten would have been the taker in default of Dave True’s estate. - 42 - 2.5 Advancement. Prior to the time of execution [of this Appointment], my daughter, Tamma T. Hatten, * * * severed her financial ties with the True companies, and thus her potential inheritance has been fully satisfied during my lifetime. There is no current expectation by Tamma Hatten, her mother, or her brothers, that Jean True or any other member of the True family will make any further financial provision for Tamma or her family.17 E. Use of Similar Buy-Sell Agreements in All True Companies Except White Stallion; Amendments and Waivers The buy-sell agreements (and related amendments) used by the True family were substantially identical, except for White Stallion. In general, the partnership buy-sell agreements mirrored True Oil’s partnership agreement, and the corporate buy- sell agreements mirrored Belle Fourche’s Stockholders’ Restrictive Agreement. The buy-sell agreements were not tailored to the specific type of business or industry in which each True company operated, and they all shared the following attributes: (1) Transfer restrictions, (2) mandatory purchase and sale requirements, (3) book value purchase price formulas derived using the company’s customary accounting methods (tax basis), and (4) active participation (by owner or spouse) requirements. 17 The only exception is the True Family Education Trust, created by Dave and Jean True in 1983 (before Tamma Hatten’s withdrawal) for the benefit of all the True children’s descendants. Dave and Jean True contributed to this trust, which is irrevocable, after their daughter’s withdrawal. Therefore, Tamma Hatten’s descendants have continued to derive financial benefits from this trust. - 43 - Over the years, the buy-sell agreements were amended on several occasions. Generally applicable amendments included: (1) Clarifying that owners could transfer their interests to qualified revocable living trusts without triggering the buy-sell provisions, (2) applying the buy-sell provisions to sales of partial interests, and (3) making special allowances for an owner’s legal disability. In addition, the Belle Fourche buy- sell agreement was amended as of August 1, 1973, to include, inter alia, an active participation requirement that previously had been omitted due to David L. True’s status as a student at the time of the original sales to the children in 1971. All the preexisting buy-sell agreements were amended and restated as of August 11, 1984 (1984 amendments), to reflect, among other things, Tamma Hatten’s withdrawal from the True companies.18 In most cases, the 1984 amendments were the last amendments made to the buy-sell agreements before Dave True’s death.19 The parties to the corporate buy-sell agreements, as amended and restated by the 1984 amendments, were: Dave and Jean True, the True sons, and the subject corporation. The amended 18 Except White Stallion, which was amended on Sept. 20, 1984. 19 True Environmental Remediating LLC’s operating agreement was not entered into until June 30, 1992. However, its provisions were consistent with the 1984 amendments to the other True companies’ buy-sell agreements. - 44 - corporate buy-sell agreements included the following relevant provisions: 1. Restriction of Stock. a. Until termination of this agreement none of the stock of the company shall pass or be disposed of in any manner whatsoever, whether by voluntary or involuntary action, to any person, partnership or corporation except in accordance with the terms of this agreement; * * *. * * * b. Each share of stock shall remain subject to this agreement, and each corporation (including the Company), partnership, trust, and person who now holds or may acquire any of the stock, in any manner, nevertheless shall hold it subject to the provisions of this agreement whenever and as often as any of the sales events herein mentioned may occur. 2. Events requiring the mandatory sale and purchase include any attempt to pass or dispose of the stock in any manner whatsoever, whether by voluntary or involuntary act, specifically including, but not limited to, the following events (hereinafter called “sales events”): 2a. Sale. In the event any Shareholder desires at any time to sell all or part of his or her stock in the Company, he or she shall so notify the Purchasing Shareholders in writing. * * * Thereafter, the Selling Shareholders shall sell and the Purchasing Shareholders shall purchase such stock in accordance with the terms of paragraphs 3, 4, and 5 hereof. Such sale and purchase shall be consummated within six (6) months after receipt by the Purchasing Shareholders of such written notice. 2b. Death of Shareholder. In the event of the death of any one of the * * * [Shareholders], the deceased Shareholder, as the Selling Shareholder, shall sell and the Purchasing Shareholders shall purchase all the stock of the Selling Shareholder in accordance with paragraphs 3, 4, and 5 hereof. This agreement shall be binding upon the heirs and personal representatives of such decedent and the trustees of any qualified trust, all of which shall be included in the term “Selling Shareholder.” The actual transfer relating to such sale and purchase as herein provided shall be made - 45 - within six (6) months after such Shareholder’s death. * * * * * * * * * * 2d. Shareholders’ Required Activities. In the event a Shareholder or his or her spouse ceases to devote all or a substantial part of his or her time to the business of the company or any one of its affiliates for any reason, * * * such Shareholder shall be deemed to be the Selling Shareholder and to have notified the other Shareholders of a desire to sell his or her stock as provided in paragraph 2a unless the remaining Shareholders unanimously agree to permit such a Shareholder to continue as a Shareholder. 3. Buy and Sell Agreement. The parties hereto agree that on the occurrence of each and every sale event, the Selling Shareholder, shall sell to the Purchasing Shareholders, and the Purchasing Shareholders shall purchase, in direct proportion to the interest which each owns in said corporation represented by stock ownership in the company * * * all of the shares of stock owned by or for the benefit of the Selling Shareholder or all of the shares offered for sale by the Selling Shareholder for the purchase price as set forth in paragraph 4 below. 4. Price. The price of any shares sold hereunder shall be the book value of the stock at the end of the preceding fiscal year, less any and all dividends paid to the Shareholders prior to the effective date of sale, plus income computed in accordance with the Internal Revenue regulations generally requiring allocation on a per share, per day basis. The book value of the stock shall be determined in accordance with the accounting methods and principles customarily followed by the corporation. [Emphasis added.] 5. Effective Date. The effective date for the determination of purchase price and transfer of stock will be the earliest of (A) the date of death of the Selling Shareholder * * * or (C) the date of notice of desire to sell as herein defined. Except that for purposes of (A) * * * above, if such date falls within two and one-half (2-1/2) months following the end of a fiscal year, the effective date will be two and one- half (2-1/2) months after the end of that fiscal year. - 46 - 6. Termination. This agreement shall remain in force until death of the survivor of the Shareholders * * * and shall then terminate. Before the 1984 amendments, the book value price formula in the corporate buy-sell agreements was different. Formerly, the price was computed by taking the stock’s book value at the end of the preceding fiscal year less dividends paid within 2-1/2 months immediately following the fiscal yearend. Furthermore, there was no reference to a per share, per day allocation of income before the 1984 amendments. The partnership buy-sell agreements, as amended and restated by the 1984 amendments, included substantively identical provisions to those cited above. However, the following modifications, which were unique to partnerships, were included: 20. Price. The price of any partnership interest or portion thereof shall be the book value of the Selling Partner’s capital account as of the close of business of the day immediately preceding the sales event. The book value of such capital account shall be determined in accordance with the accounting methods and principles customarily followed by the partnership, and in accordance with the Internal Revenue Code and appropriate regulations relating to the determination of the Partner’s distributive share of income, expenses and other partnership items. [Emphasis added.] 21. Effective Date. The effective date for the transfer of partnership interest shall be the date of death of a Partner, * * * or the date of an event requiring a mandatory sale and purchase. 22. Termination of Partnership. The partnership shall continue in business and shall not be terminated unless the holders of 50% or more of the total interest in partnership capital and profits sell their interests within the same year as provided herein, or unless all - 47 - of the Partners agree to such termination. In such event, the interest of the Partners shall be settled and adjusted in the same manner, and upon the same basis as provided in the death or disability of a Partner. Before the 1984 amendments, the book value price formula in the partnership buy-sell agreements was different. Formerly, the purchase price was determined as of the end of the month immediately preceding the sales event and was computed by multiplying the book value of the partnership (less any withdrawals made by the partners after the end of the preceding month) by the Selling Partner’s percentage interest in partnership net profits (percentage of total partners’ capital formula).20 At times, members of the True family formally waived their purchase rights under the various True companies’ buy-sell agreements. For example, in connection with the merger of Black Hills Oil into Black Hills Trucking in 1980, the True family agreed to waive any Black Hills Trucking buy-sell provision that would restrict the exchange of stock between the two companies. In April 1981, the True family waived the Belle Fourche buy-sell provision requiring all purchases to be in proportion to the 20 The percentage of total partners’ capital formula first appeared in the amended partnership agreement between Dave True, Jean True, and the True children dated Aug. 1, 1973. However, the original partnership agreement between Dave and Jean True dated June 1, 1954, calculated the purchase price based on the selling partner’s capital account balance at the close of the month closest to the sales event. - 48 - owners’ preexisting ownership percentages in order to allow Jean True and the True children (but not Dave True) to purchase additional shares from the company. Similarly, Jean True waived her purchase rights under the Rancho Verdad buy-sell agreement in July 1983, when Dave True sold 8-percent interests to each of the True children, thereby allowing them to enter that partnership. Lastly, in October 1985, the True family waived their purchase rights under the Toolpushers buy-sell agreement to allow the trustee of the True Companies Employees’ Profit Sharing Trust (Employees’ Trust) to sell its Toolpushers stock back to the company.21 F. Unique Provisions of White Stallion Buy-Sell Agreement In July 1982, the original White Stallion buy-sell agreement, see supra p. 22, was amended to reflect the admission as stockholders of Dave and Jean True’s children and Allen and Cynthia True’s children. While the White Stallion buy-sell agreement shared some of the common characteristics of other True company agreements, it also contained certain unique provisions. For example, under the provision entitled “Buy and Sell Agreement”, if a stockholder were to die, become legally disabled, or desire to sell all or part of his stock, the 21 Under the Nov. 20, 1976, Toolpushers Stockholders’ Restrictive Agreement, Employees’ Trust was specifically exempted from the buy-sell restrictions. As a result, the October 1985 purchase price for Employees’ Trust’s shares was not limited to, and in fact exceeded, book value. - 49 - remaining members of his group (Allen True’s family comprised group 1, and Dave True’s family comprised group 2) were obligated to purchase the stock on a pro rata basis. The stockholder, his heirs, and trustees, etc., were likewise obligated to sell to those group members. Similar to the other True companies’ buy- sell agreements, the purchase price reflected the transferred shares’ book value at the end of the preceding fiscal year, less dividends paid within 2-1/2 months of such fiscal yearend. An additional restriction, found only in White Stallion’s buy-sell agreement, provided: 13. First Right of Refusal. If the Shareholders holding 100% of the stock held in either Group 1 or Group 2, above, desire to transfer by lifetime sale all of the interests held by Shareholders comprising that group (hereinafter “Selling Group”) to someone other than the Shareholders comprising the other group (hereinafter “Nonselling Group”), the Selling Group shall not do so without first offering in writing to sell such interests to the Shareholders comprising the Nonselling Group on the same terms and conditions as any bona fide offer received (in writing) by the Selling Group for its interests. The Nonselling Group shall have thirty (30) days from the date the written offer and proof of the bona fide offer are mailed to the Nonselling Group within which to accept such offer in writing. Each Shareholder comprising the Nonselling Group shall have the right to purchase the Selling Group’s interest, in the ratio that his or her stock bears to the total stock held by the Nonselling Group. If a Shareholder in the Nonselling Group declines to exercise his or her rights to purchase a portion of the Selling Group’s stock interest, the remaining Shareholders comprising the Nonselling Group desiring to purchase such portion shall have an additional fifteen (15) days to do so in the ratio that their stock ownership bears to the total stock ownership of the Shareholders comprising the Nonselling Group exercising such right to purchase. - 50 - This provision was included in the White Stallion buy-sell agreement at Allen True’s request. The White Stallion buy-sell agreement was amended and restated again on September 20, 1984, to reflect, inter alia, Tamma Hattan’s withdrawal from the partnership. G. Future of True Family Buy-Sell Agreements After Dave True’s death and Jean True’s subsequent sale of most of her interests ,see infra pp. 53-55, the True sons alone owned a majority of the True companies,22 and they have continued the preexisting buy-sell agreements. Under those agreements, upon a brother’s death, his estate would be required to sell, and the surviving brothers would be required to purchase, the deceased brother’s interest at book value. At the death of the last surviving brother, the beneficiaries of his estate would receive 100-percent ownership of the True companies. This scenario assumes that none of the True sons’ children become actively participating owners of the True companies, which may or may not happen in the future. The True sons have considered this problem and discussed it with Mr. Harris. They have decided to wait until the conclusion of this litigation before making any changes to the buy-sell agreements. 22 Jean True retained her interests in only True Drilling, White Stallion, and Smokey Oil Co. - 51 - III. Transfers in Issue A. 1993 Transfers of Partnership Interests by Dave True Effective January 1, 1993, Dave True sold part of his ownership interest in all True companies that were partnerships to his wife and sons, pursuant to the buy-sell agreements. Before the transfers, Dave True held a greater than 50-percent general partnership interest in each company. Mr. Harris recommended that Dave True reduce his ownership interest to less than 50 percent, in order to avoid termination of the partnerships (for income tax purposes) at his death. Mr. Harris was concerned that as a result of such termination, the partnership agreements, which embodied the buy-sell provisions, would become subject to new valuation rules under Chapter 14 of the Internal Revenue Code (Chapter 14).23 To prevent this from happening, Dave True sold enough of his interests to reduce his and Jean True’s combined ownership to below 50 percent. Although Dave True had health issues before the 1993 transfers, including back problems and a chronic pulmonary insufficiency that required him to be on oxygen full time, the True family and Mr. Harris did 23 The parties stipulated that the True companies’ existing partnership agreements and shareholders’ restrictive agreements were entered into before Oct. 9, 1990 (effective date for Chapter 14 rules), and were not substantially modified after Oct. 8, 1990. - 52 - not consider Dave True’s ailments to be life threatening or his death to be imminent at the time of his 1993 transfers.24 Dave True timely filed a 1993 Federal gift tax return (Jean True signed as consenting spouse) disclosing the transfers but treating them as sales, thereby reporting no taxable gifts. Mr. Harris expected the return to be audited and the transaction to be challenged by the IRS. Dave True saw this risk as his opportunity to test (through litigation) the existing buy-sell agreements’ ability to fix transfer tax value of the True companies. On March 3, 1997, respondent issued to the estate and to Jean True, individually, duplicate Notices of Deficiency (collectively, 1993 gift tax notice), determining that the values of interests transferred by Dave True in 1993 were higher than reported book value.25 However, since issuing the original 1993 gift tax notice, respondent has conceded the reported values of interests in Rancho Verdad and True Drilling that were transferred by Dave True in 1993. Appendix schedule 1, infra, 24 In response to a question from the Court, Mrs. True testified that Dave True had been a smoker, but that he hadn’t smoked for some time before his death. Mrs. True had previously testified that Dave True was “on oxygen for chronic bronchitis for about 2-1/2 years before he died.” 25 Jean True’s notice of deficiency was identical to the estate’s and was issued solely because she consented to split gifts made by Dave True for calendar year 1993. - 53 - lists the transferred interests and compares the 1993 gift tax notice values to amounts paid by the purchasers. B. 1994 Estate Transfers Dave True died of a heart attack on June 4, 1994. Before his death, he had transferred substantially all his assets to his living trust. Under section 5.2 of the living trust, Dave True reserved the power to appoint the trust estate at the time of his death to “such persons, corporations or other entities and in such shares and interests as I may specify by appropriate provisions in any instrument executed and acknowledged by me and delivered to the [trustees of the living trust].” On September 14, 1984, Dave True had exercised his power of appointment by executing the appointment document. Under the appointment document Dave True bequeathed to his sons the maximum amount that could pass without estate tax by reason of the unified credit (equally and free of trust) and the remainder of the trust estate to a qualified terminable interest property trust (QTIP trust) for Jean True. At Jean True’s death (or from the beginning, had Jean predeceased Dave), the balance of the trust estate and any tangible personalty was to be divided equally among his sons or their heirs. However, before these bequests were funded, and pursuant to the terms of the buy-sell agreements, the trustees of the living trust sold Dave True’s interests in the True companies to Jean True, Hank True, Diemer - 54 - True, and David L. True at book value effective June 3, 1994. The sales were effected by a closing that occurred on or about September 20, 1994. On March 3, 1995, the estate timely filed a Federal estate tax return (estate tax return) reflecting, inter alia, the cash proceeds received from the sale of the True companies under the heading “H.A. True, Jr. Irrevocable [sic] Trust”. On January 20, 1998, respondent issued the estate a notice of deficiency (estate tax notice) determining that the underlying values of the True companies that were reported on the estate tax return were higher than book value. However, since issuing the estate tax notice, respondent has conceded the reported values of Dave True’s interests in Rancho Verdad, True Drilling, Toolpushers Supply Co., Midland Financial Corp., Smokey Oil Co., Inc., and Roughrider Pipeline Co. that were sold by the estate in 1994. Appendix schedule 2, infra, lists Dave True’s interests and compares the estate tax notice values to amounts paid by the purchasers. In addition, respondent has stipulated that the estate would be entitled to an increased marital deduction under section 2056 if the value of interests in the True companies that were sold to Jean True was determined to be greater than the purchase prices under the buy-sell agreements. - 55 - C. 1994 Transfers by Jean True After Dave True died, Jean True no longer wished to be actively involved in all the True companies. Accordingly, on June 30 and July 1, 1994, she gave notice to her sons of her intent to sell most of her interests in the True companies. Jean True sold her interests to her sons at book value, pursuant to the terms of the buy-sell agreements. Jean True timely filed a 1994 Federal gift tax return disclosing the transactions but treating them as sales, thereby reporting no taxable gifts. On January 20, 1998, respondent issued to Jean True a notice of deficiency (1994 gift tax notice), determining that the values of interests she sold in 1994 were higher than reported book values. However, since issuing the 1994 gift tax notice, respondent has conceded the reported values of interests in Roughrider Pipeline Co., Rancho Verdad, Toolpushers Supply Co., and Midland Financial Corp. that were sold by Jean True in 1994. Appendix schedule 3, infra, lists the interests sold and compares the 1994 gift tax notice values to amounts paid by the purchasers. IV. Subsequent Income Tax Litigation Regarding Ranchland Exchange Transactions During the 1980's, the True family (except Tamma Hatten) purchased land and operating assets to add to their ranching operations. Each purchase took place through the same series of - 56 - steps, described as follows (generally, ranchland exchange transactions): First, instead of True Ranches directly acquiring the ranchlands, the True family arranged for Smokey Oil Co. (Smokey Oil) to purchase the parcels of real property for an aggregate purchase price of over $6.8 million, while True Ranches acquired the operating assets of each ranch. At the time, Smokey Oil (a Wyoming S corporation) was owned by Dave True (72.3935 percent), Jean True (24.1316 percent), and the True sons (1.1583 percent each). Second, Smokey Oil transferred the ranchlands to True Oil in exchange for selected productive oil and gas leases, which the parties treated as a like-kind, tax-free exchange under section 1031. Third, True Oil immediately distributed the newly acquired ranchlands to the individual partners of True Oil (Dave and Jean True and the True sons) as tenants in common. Fourth, the partners then contributed their undivided interests in the ranchlands to True Ranches by general warranty deed. The partnership distribution and contribution transactions were treated as nonrecognition transactions under sections 721 and 731. The intent of the True family in carrying out this series of acquisitions, transfers, and exchanges was to create income tax benefits. Through the operation of section 1031(d), which essentially provides that the basis of property received in a nonrecognition exchange is the same as the basis of property - 57 - transferred, Smokey Oil received depletable oil and gas leases with the same cost basis as the nondepreciable ranchlands it had transferred in the exchange with True Oil. This allowed Smokey Oil to claim cost depletion deductions for the leases on its tax returns for 1989 and 1990 under section 612, which, if sustained, would have resulted in substantial income tax savings to the True family. True Oil, on the other hand, received the nondepreciable ranchlands with a zero basis because the oil and gas leases it exchanged pursuant to section 1031 were fully cost depleted. Through subsequent transfers, True Ranches acquired the ranchlands with the same zero basis as True Oil’s oil and gas leases. By so doing, the True family intended to reap the tax benefits of turning nondepreciable assets (ranchlands) into cost- depletable assets (oil and gas leases) in the hands of Smokey Oil. In addition, the ranchland exchange transactions rid True Oil of fully cost-depleted assets (oil and gas leases) and gave True Ranches a zero basis in otherwise nondepreciable assets (ranchlands). If these transactions had been effective for income tax purposes, they would also have created transfer tax benefits by reducing the prices payable under the True Ranches and Smokey Oil buy-sell agreements. They would have reduced the book value of the ranchlands to zero and thereby reduced the book value formula prices to be paid for partnership interests in True Ranches under - 58 - the terms of the True Ranches buy-sell agreement. Because of the transfer of basis to the depletable oil and gas properties, the ultimate prices to be paid for interests in Smokey Oil under its buy-sell agreement would have been expected to be reduced to less than the costs of the purchased ranchlands. On audit of the True Oil, Smokey Oil, and True Ranches tax returns for 1989 and 1990, the IRS determined that the substance- over-form and step transaction doctrines required that the various intermediate steps of these transactions be collapsed and that they be viewed as a unitary transaction in which True Ranches acquired directly the land and depreciable assets of the ranch properties. Because Smokey Oil was deemed not to have acquired the ranchlands, the IRS treated these transactions as if there had been no exchange between Smokey Oil and True Oil. The IRS disallowed Smokey Oil’s cost depletion deductions claimed on the leases received in the exchanges, and it allocated the income from those leases back to True Oil. The True family paid the deficiencies and filed administrative claims for refund. After the IRS disallowed the refund claims, the True family filed a refund suit in U.S. District Court for the District of Wyoming. The Government filed motions for partial summary judgment, contending (inter alia) that under the step transaction doctrine the ranchland exchange transactions were a single transaction in which True Ranches - 59 - alone acquired all the ranch property (real property and operating assets). The District Court granted the Government’s motion for summary judgment, designated as True v. United States, No. 96-CV-1050-J, (Nov. 12, 1997), and held that the step transaction doctrine required the recharacterization of the ranchland exchange transactions as the IRS had determined. On appeal, the Court of Appeals for the Tenth Circuit affirmed the District Court’s decision regarding the ranchland exchange transactions. See True v. United States, 190 F.3d 1165, 1177- 1180 (10th Cir. 1999). On November 15, 1999, the Court of Appeals for the Tenth Circuit denied petitioners’ petition for rehearing and rehearing en banc. OPINION I. Do Family Buy-Sell Agreements Control Estate Tax Value? Case law and regulatory authority have interpreted the general estate tax valuation provisions of section 2031 to include special rules that allow qualifying buy-sell agreements to control estate tax fair market value. A. Framework for Analyzing Estate Tax Valuation Issues Federal estate tax is imposed on the transfer of the taxable estate of every United States citizen or resident. See sec. 2001(a); U.S. Trust Co. v. Helvering, 307 U.S. 57, 60 (1939). The taxable estate is defined as the gross estate less prescribed deductions. See sec. 2051. All property interests owned by the - 60 - decedent at death are included in the gross estate; the value of the gross estate generally is determined as of the date of death. See secs. 2031(a), 2033; sec. 20.2031-1(b), Estate Tax Regs. Fair market value is the standard for determining value of transfers of property subject to Federal estate tax. See United States v. Cartwright, 411 U.S. 546, 550 (1973). Fair market value 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.” Id. at 551; see sec. 20.2031-1(b), Estate Tax Regs. The willing buyer and seller are hypothetical persons, rather than specific individuals or entities, and their characteristics are not necessarily the same as those of the actual buyer or seller. See Estate of Newhouse v. Commissioner, 94 T.C. 193, 218 (1990) (citing Estate of Bright v. United States, 658 F.2d 999, 1006 (5th Cir. 1981)). The hypothetical willing buyer and seller are presumed to be dedicated to achieving the maximum economic advantage. As stated in Estate of Newhouse, 94 T.C. at 218: “This advantage must be achieved in the context of market conditions, the constraints of the economy, and the financial and business experience of the corporation existing at the valuation date.” Generally, the shares of a closely held corporation for which there is no public market, in the absence of recent arm’s- - 61 - length sales, are to be valued by taking into account the company’s net worth, prospective earning power, dividend-paying capacity, and other relevant factors.26 See Estate of Andrews v. Commissioner, 79 T.C. 938, 940 (1982); sec. 20.2031-2(f)(2), Estate Tax Regs.; Rev. Rul. 59-60, 1959-1 C.B. 237. Similarly, the valuation of partnership interests requires (1) a fair appraisal (as of the valuation date) of all assets of the business, tangible and intangible, including goodwill, (2) an analysis of the business’ demonstrated earning capacity, and (3) consideration of other “relevant factors” noted in the stock valuation rules. See sec. 20.2031-3, Estate Tax Regs. The value of property as of the decedent’s date of death is a question of fact requiring the trier of fact to weigh all relevant evidence of value and to draw appropriate inferences. See Estate of Newhouse v. Commissioner, supra; Hamm v. Commissioner, 325 F.2d 934, 938 (8th Cir. 1963), affg. T.C. Memo. 1961-347. B. Development of Legal Standards The legal standards for allowing buy-sell agreements to determine estate tax value have developed over time. Some cases 26 “Other relevant factors” listed in the regulation include: (1) Goodwill of the business, (2) economic outlook in the particular industry, (3) company’s position in the industry and its management, (4) degree of control represented by block of stock to be valued, and (5) values of securities of corporations engaged in the same or similar lines of business that are listed on a stock exchange. See sec. 20.2031-2(f)(2), Estate Tax Regs. - 62 - laid out fundamental objective requirements that, if met, permitted the formula price provided by a buy-sell agreement to establish fair market value under predecessors of section 2031. Other cases and the estate tax regulations have expanded those requirements to address such subjective concerns as whether the buy-sell agreement was a bona fide business arrangement and not merely a device to make a testamentary disposition at a bargain price. 1. Case Law Preceding Issuance of Regulations Before the issuance of regulations under section 2031, courts addressed the effect of option contracts or buy-sell agreements on the valuation of business interests by examining whether restrictions in the agreement put a ceiling on the price the owner (or his estate) could receive at disposition. Specifically, buy-sell agreements were required (1) to be enforceable against the parties, (2) to specify a price, and (3) to bind transferors both during life and at death in order to be given dispositive effect for estate tax valuation purposes. See Lomb v. Sugden, 82 F.2d 166, 167 (2d Cir. 1936); Wilson v. Bowers, 57 F.2d 682, 683 (2d Cir. 1932); Estate of Salt v. Commissioner, 17 T.C. 92, 99-100 (1951) (generally, the Wilson- Lomb test). Although these requirements were developed in the context of corporate buy-sell agreements, they were also applied to partnership buy-sell agreements. See Brodrick v. Gore, 224 - 63 - F.2d 892, 896 (10th Cir. 1955); Estate of Weil v. Commissioner, 22 T.C. 1267, 1273-1274 (1954); Hoffman v. Commissioner, 2 T.C. 1160, 1178-1180 (1943), affd. sub nom. Giannini v. Commissioner, 148 F.2d 285 (9th Cir. 1945). In addition, courts developed other tests to help decide whether buy-sell agreements controlled estate tax value. In Bensel v. Commissioner, 36 B.T.A. 246 (1937), affd. 100 F.2d 639 (3d Cir. 1938), the arm’s-length nature of the agreement convinced the Court that a corporate buy-sell agreement controlled estate tax value. In Bensel, 36 B.T.A. at 247, a majority shareholder (father) had granted employee (son) an option to purchase father’s stock at his death for a fixed price, in order to retain son’s valuable services. Father and son were estranged at all relevant times. See id. When son exercised the option at father’s death, the fair market value of the stock exceeded the option price. See id. at 249-250. The Commissioner argued, in the alternative, for inclusion in the gross estate at date of death value under the theory that decedent (1) retained an interest to alter, revoke, or amend under section 302(d) of the Revenue Act of 1926, ch. 27, 44 Stat. 71, or (2) made a transfer in contemplation of death under section 302(c). See Bensel v. Commissioner, 36 B.T.A. at 251. However, the hostilities and constant bargaining between father and son convinced the Court that son was not the natural object - 64 - of father’s bounty and that the option price was what adverse parties dealing at arm’s length would have agreed to. See id. at 252-253. Accordingly, the Court concluded that the option was neither a substitute for a testamentary disposition, nor a device for avoiding estate tax, so that section 302(c) and (d) did not apply. See id. at 253-254. Instead, son’s exercise of the option was either a bona fide sale for adequate and full consideration or, like Wilson and Lomb, completely outside the scope of section 302 of the Revenue Act of 1926. See id. at 254. Similarly, we stated in Estate of Littick v. Commissioner, 31 T.C. 181 (1958), that if “for the purpose of keeping control of a business in its present management, the owners set up in an arm’s-length agreement * * * the price at which the interest of a part owner is to be disposed of by his estate to the other owners, that price controls for estate tax purposes, regardless of the market value of the interest to be disposed of”. Id. at 187 (emphasis added). Other facts that courts considered in evaluating whether buy-sell agreements should determine estate tax value included: (1) Tax avoidance motives for entering into buy-sell agreements, see May v. McGowan, 194 F.2d 396, 397 (2d Cir. 1952); Estate of Littick, 31 T.C. at 186, (2) that the purchasers under the buy- sell agreement were natural objects of the decedent-seller’s bounty, see Hoffman v. Commissioner, 2 T.C. at 1179, and (3) that - 65 - the buy-sell agreement’s price, when originally fixed, represented full and adequate consideration and was not a testamentary substitute, see id.; Bensel v. Commissioner, 36 B.T.A. at 254; Baltimore Natl. Bank v. United States, 136 F. Supp. 642, 654 n.7 (D. Md. 1955). The Court of Appeals for the Tenth Circuit indicated, in Brodrick v. Gore, supra, that if a partnership buy-sell agreement were entered into in bad faith, that could jeopardize the ability of the agreement to control value for estate tax purposes. In Brodrick v. Gore, 224 F.2d at 894, a father and his two sons agreed to sell their interests in an oil and gas partnership, during life or at death, only to each other at book value. After the father’s death, the sons petitioned the probate court to be compelled, as executors, to sell the father’s interest to themselves at book value. See id. After a hearing, the probate court found that the partnership agreement was valid, the estate was obligated to sell at book value, the sons were obligated to purchase, and book value27 was correctly calculated. See id. at 895. The Commissioner determined a deficiency in estate tax on the ground that the fair market value of the father’s interest 27 Neither the published report of Brodrick v. Gore, 224 F.2d 892, 896 (10th Cir. 1955), nor the briefs, which we have reviewed, specify the basis on which book value was to be computed (e.g., financial statement, tax, or cash basis) under the partnership buy-sell agreement. - 66 - exceeded book value on his date of death. See id. at 895. The sons paid the deficiency, brought a District Court refund suit, and prevailed on a motion for summary judgment. See id. The Commissioner appealed to the Court of Appeals for the Tenth Circuit, which affirmed the judgment in favor of the executor- sons. See id. at 897. Applying the Wilson-Lomb test, the Court of Appeals for the Tenth Circuit held that the estate tax value was properly limited to book value because the sale to the sons at book value was required under a reciprocal and enforceable agreement. See id. at 896. The Court of Appeals held the probate court’s prior judgment to be a binding determination that: (1) The executors were obligated to sell to the surviving partners at book value and (2) the calculation of book value was correct. See id. The Court noted that if the Commissioner had pleaded affirmatively that the partnership agreement was executed in “bad faith,” or that the probate court proceeding was collusive or nonadversarial, there might have been a genuine issue of material fact. See id. at 897. However, as stated by the Court: “With no such issues of fact joined, the question whether the estate tax should be computed on the basis of the book value or the market value was one of law.” Id. - 67 - 2. Regulatory Authority and Interpretive Rulings In 1958, the Treasury issued final regulations under section 2031, concerning the valuation of stocks and bonds for estate tax purposes, applicable to estates of decedents dying after August 16, 1954. See sec. 20.2031-2, Estate Tax Regs. In particular, section 20.2031-2(h) addresses the valuation of securities owned by a decedent at death subject to an option or contract to purchase held by another person. See sec. 20.2031-2(h), Estate Tax Regs. The regulation states that the effectiveness of the agreement to determine the value of securities for estate tax purposes depends on the circumstances of the case. See id. For instance, the option or contract price is accorded little weight if it did not bind the decedent equally during life and at death. See id. The regulation further states: Even if the decedent is not free to dispose of the underlying securities at other than the option or contract price, such price will be disregarded in determining the value of the securities unless it is determined under the circumstances of the particular case that the agreement represents a bona fide business arrangement and not a device to pass the decedent’s shares to the natural objects of his bounty for less than an adequate and full consideration in money or money’s worth. [Id.; emphasis added.] Although the regulation as a whole, and this subsection in particular, have been subsequently amended, the changes do not affect the cases at hand.28 Cases applying the regulation have 28 Sec. 20.2031-2, Estate Tax Regs., was amended June 14, 1965 by T.D. 6826, 1965-2 C.B. 367; Apr. 26, 1974 by T.D. 7312, (continued...) - 68 - interpreted the “bona fide business arrangement” and “not a testamentary device” tests to be conjunctive (i.e., both tests must be satisfied independently to give the agreement dispositive effect). See Dorn v. United States, 828 F.2d 177, 182 (3d Cir. 1987); St. Louis County Bank v. United States, 674 F.2d 1207, 1210 (8th Cir. 1982); Estate of Lauder v. Commissioner, T.C. Memo. 1992-736 (Lauder II). This means that a buy-sell agreement can be both a bona fide business arrangement and a testamentary device, with the result that it will not be given dispositive effect for estate tax valuation purposes. See Lauder II. In 1959, the Commissioner issued Revenue Ruling 59-60, which was intended to “outline and review in general the approach, methods and factors to be considered in valuing shares of the capital stock of closely held corporations for estate tax and gift tax purposes.” Rev. Rul. 59-60, 1959-1 C.B. 237. Revenue Ruling 59-60 has been widely accepted as setting forth the appropriate criteria to consider in determining fair market value. See Estate of Newhouse v. Commissioner, 94 T.C. at 217. Section 8 of the ruling addresses the effect of agreements 28 (...continued) 1974-1 C.B. 277; Sept. 30, 1974 by T.D. 7327, 1974-2 C.B. 294; Sept. 13, 1976 by T.D. 7432, 1976-2 C.B. 264, and Jan. 28, 1992 by T.D. 8395 (1992 amendment), 1992-1 C.B. 816. Only the 1992 amendment affected subsec. 20.2031-2(h), Estate Tax Regs., by adding a cross-reference to sec. 2703 (and the regulations thereunder) for special rules involving options and agreements (including contracts to purchase) entered into (or substantially modified after) Oct. 8, 1990. See infra pp. 79-81. - 69 - restricting the sale or transfer of stock on estate and gift tax value. See Rev. Rul. 59-60, 1959-1 C.B. at 243. First, the ruling describes a situation in which stock was acquired by a decedent subject to an option reserved by the issuing corporation to repurchase at a certain price. The ruling states that the option price usually will be accepted as fair market value for estate tax purposes, under the rubric of Revenue Ruling 54-76. See id.; Rev. Rul. 54-76, 1954-1 C.B. 194. However, Revenue Ruling 59-60 further states that the option price does not control fair market value for gift tax purposes. See Rev. Rul. 59-60, 1959-1 C.B. at 244. Second, the ruling provides another formulation of the Wilson-Lomb test. It states that if the option or buy-sell agreement (1) resulted from voluntary action by the stockholders and (2) was binding during life and at death of the stockholders, then the agreement may or may not, depending on the circumstances of each case, fix the value for estate tax purposes. See id. The ruling adds, however, that the agreement would be a factor to evaluate with other relevant factors in determining fair market value. See id. Third, the ruling lists factors that must always be considered in valuing closely held stock “to determine whether the agreement represents a bonafide business arrangement or is a device to pass the decedent’s shares to the natural objects of - 70 - his bounty for less than an adequate and full consideration in money or money’s worth.” Id. The factors mentioned are: The relationship of the parties, the relative number of shares held by the decedent, and other material facts. See id. 3. Case Law Following Issuance of Regulations and Revenue Ruling 59-60 Cases decided after the issuance of section 20.2031-2(h), Estate Tax Regs., and Revenue Ruling 59-60, supra, reflect new expressions of the Wilson-Lomb test. Specifically, the formula price under a buy-sell agreement was considered binding for Federal estate tax purposes if: (1) The offering price was fixed and determinable under the agreement; (2) the agreement was binding on the parties both during life and after death, (3) the agreement was entered into for bona fide business reasons,29 and (4) the agreement was not a substitute for a testamentary disposition30 (generally, the Lauder II test). See Lauder II 29 We refer to this requirement as the business purpose prong of the Lauder II test. See Estate of Lauder v. Commissioner, T.C. Memo. 1992-736 (Lauder II). This is equivalent to the requirement of sec. 20.2031-2(h), Estate Tax Regs., that the agreement represent a bona fide business arrangement. See Lauder II (using the terminology of this Court and the regulation interchangeably); sec. 20.2031-2(h), Estate Tax Regs. 30 We refer to this requirement as the nontestamentary disposition prong of the Lauder II test. This is equivalent to the requirement of sec. 20.2031-2(h), Estate Tax Regs., that the agreement not be a device to pass the decedent’s shares to the natural objects of his bounty for less than an adequate and full consideration in money or money’s worth. See Lauder II (using the terminology of this Court and the regulation interchangeably); sec. 20.2031-2(h), Estate Tax Regs. - 71 - (tracing the origins of the test through case law and regulations). The first two prongs of the Lauder II test had been addressed directly by the courts in the Wilson-Lomb line of cases. However, after the issuance of section 20.2031-2(h), Estate Tax Regs., the attention of the courts shifted to the last two prongs, which had only been adverted to in some early cases. a. Was Agreement Entered Into for Bona Fide Business Reasons? In several cases, courts considered whether parties had bona fide business reasons for entering into buy-sell agreements. For example, instituting a buy-sell agreement to maintain exclusive family control over a business repeatedly has been found to be a bona fide business purpose. See Estate of Bischoff v. Commissioner, 69 T.C. 32, 39-40 (1977); Estate of Littick v. Commissioner, 31 T.C. at 187; Lauder II; Estate of Seltzer v. Commissioner, T.C. Memo. 1985-519; Estate of Slocum v. United States, 256 F. Supp. 753, 755 (S.D.N.Y. 1966). In addition, using buy-sell agreements to assure continuity of company management policies and to retain key employees also have been held to be bona fide business purposes. See Estate of Reynolds v. Commissioner, 55 T.C. 172, 194 (1970); Bommer Revocable Trust v. Commissioner, T.C. Memo. 1997-380. However, as we noted in Lauder II: “legitimate business purposes are often ‘inextricably mixed’ with testamentary objectives where * * * the parties to a restrictive stock agreement are all members of the same immediate - 72 - family.” Lauder II, T.C. Memo. 1992-736, 64 T.C.M. (CCH) 1643, 1657, 1992 T.C.M. (RIA) par. 92,736, at 92,3731 (quoting 5 Bittker, Federal Taxation of Income, Estates & Gifts, par. 132.3.10, at 132-54 (1984)). As a result, courts required taxpayers independently to satisfy both the business purpose and nontestamentary disposition prongs of the Lauder II test. b. Was Agreement a Substitute for Testamentary Dispositions? In evaluating whether buy-sell agreements were substitutes for testamentary dispositions, greater scrutiny was applied to intrafamily agreements restricting stock transfers in closely held businesses than to similar agreements between unrelated parties. See Dorn v. United States, 828 F.2d. 177, 182 (3d Cir. 1987); Lauder II; Hoffman v. Commissioner, 2 T.C. at 1178-1179 (“The fact that the option is given to one who is the natural object of the bounty of the optionor requires substantial proof to show that it rested upon full and adequate consideration.”). Courts analyzed several factors and employed various tests to ascertain whether buy-sell agreements were meant to serve as substitutes for testamentary dispositions. In Lauder II, we organized the analysis into two categories: (1) Factors indicating that a buy-sell agreement was not the result of arm’s- length dealing and was designed to serve a testamentary purpose (testamentary purpose test), and (2) tests to determine whether a buy-sell agreement’s formula price reflected full and adequate - 73 - consideration in money or money’s worth (adequacy of consideration test). No particular factor or test was weighted more heavily than another; but rather, courts considered all circumstances to determine whether buy-sell agreements were adopted for the principal purpose of achieving testamentary objectives. See St. Louis County Bank v. United States, 674 F.2d at 1210-1211; Lauder II; Estate of Carpenter, T.C. Memo. 1992- 653. 1. Testamentary Purpose Test Under the testamentary purpose test, factors indicating that a buy-sell agreement was not the result of arm’s-length dealing and was designed to serve a testamentary purpose included (1) the decedent’s ill health when entering into the agreement, see St. Louis County Bank v. United States, 674 F.2d at 1210; Estate of Lauder v. Commissioner, T.C. Memo. 1990-530 (Lauder I); Estate of Slocum v. United States, 256 F. Supp. at 755, (2) lack of negotiations between the parties before executing the agreement, see Bommer Revocable Trust v. Commissioner, T.C. Memo. 1997-380; Lauder II; Bensel v. Commissioner, 36 B.T.A. at 253 (finding no testamentary purpose due to evidence of hostile negotiations), (3) lack of (or inconsistent) enforcement of buy-sell agreements, see St. Louis County Bank v. United States, 674 F.2d at 1211; Estate of Bischoff v. Commissioner, 69 T.C. at 42 n.10 (finding that agreement was not a testamentary substitute due, in part, to - 74 - enforcement when son died),31 (4) failure to obtain comparables or appraisals to determine the buy-sell agreement’s formula price, see Bommer Revocable Trust v. Commissioner, supra; Lauder II, (5) failure to seek professional advice in selecting the formula price, see Bommer Revocable Trust v. Commissioner, supra; Lauder II, (6) lack of provision in buy-sell requiring periodic review of a stated fixed price, see Bommer Revocable Trust v. Commissioner, supra, (7) exclusion of significant assets from the formula price, see Lauder II (finding that omission of all intangible assets from book value formula suggested testamentary purpose), and (8) acceptance of below market payment terms for purchase of decedent’s interest, see Bommer Revocable Trust v. Commissioner, supra. 2. Adequacy of Consideration Test Before determining whether the formula price in a buy-sell agreement represented full and adequate consideration in money or money’s worth, courts were required to decide, as a preliminary matter, when and how the adequacy of consideration test would be applied. For example, would the adequacy of consideration be tested when the buy-sell agreement was adopted or when the buy- sell restrictions were invoked at the decedent-stockholder’s death? In addition, the term “adequate and full consideration”, 31 But see Bommer Revocable Trust v. Commissioner, T.C. Memo. 1997-380 (disagreeing with the taxpayer’s contention that record of prior enforcement requires that buy-sell agreement be respected for estate tax purposes). - 75 - which was not defined in section 20.2031-2(h), Estate Tax Regs., required interpretation. In general, courts evaluated the adequacy of consideration as of the date the buy-sell agreement was executed, rather than at the date for valuing property to be included in the decedent- shareholder’s gross estate. See St. Louis County Bank v. United States, 674 F.2d at 1210; Lauder II; Estate of Bischoff v. Commissioner, 69 T.C. at 41 n.9; Bensel v. Commissioner, 36 B.T.A. at 253. However, in exceptional circumstances, courts examined the adequacy of consideration and conduct of parties after the buy-sell agreement date if intervening events within the parties’ control caused a wide disparity between the buy-sell agreement’s formula price and fair market value. See St. Louis County Bank v. United States, 674 F.2d at 1211; Estate of Rudolph v. United States, 93-1 USTC par. 60,130, at 88449-88450, 71 AFTR 2d 93-2169, at 93-2176-93-2177 (S.D. Ind. 1993). In St. Louis County Bank, supra at 1209, the intervening event (conversion from moving, storage, and delivery business to real estate rental business) “had a significant, adverse impact” on the stock’s value as computed under the buy-sell agreement’s formula price (computed as 10 times average annual net earnings per share for 5 preceding years).32 32 The moving business generated substantial yearly income (high in 1968 of $1,061.15 per share; low in 1970 of $597 per share), as defined under the stock purchase agreement’s formula. (continued...) - 76 - In Estate of Reynolds v. Commissioner, 55 T.C. at 194, we considered whether the ultimate disparity between unrestricted market price per share and the formula price could have been predicted by the parties at the time they executed a voting trust agreement. In that case, we found that the restrictive provisions of the voting trust agreement were not determinative of estate or gift tax value and were at most a factor to be considered in valuing the voting trust certificates.33 See id. at 191. The decedents’ family entered into the voting trust agreement to maintain the family’s controlling interest in the Kansas City Life Insurance Co., a publicly traded company. See id. at 174-175. At the voting trust agreement date in 1946, the unrestricted, over-the-counter market price of the underlying stock was 2-1/2 times the voting trust formula price (25 times the average annual cash dividend paid on a share of common stock of the company over the preceding 3-year period). See id. at 32 (...continued) However, while engaged in the rental real estate business, the company’s stock value under the formula went down to $0 per share from 1971 to 1975. See St. Louis County Bank v. United States, 674 F.2d 1207, 1209 (8th Cir. 1982). 33 The restrictive provisions were held not to fix estate and gift tax values because (1) the voting trust certificates could have been freely given or bequeathed without triggering the restrictive provisions and (2) this Court considered inapplicable the approach of the Court of Appeals for the Second Circuit in the Wilson-Lomb line of cases because of the lack of regard for the “retention value” of the voting trust certificates. See Estate of Reynolds v. Commissioner, 55 T.C. 172, 188-192 (1970); see infra p. 148 regarding gift tax valuation implications of retention value. - 77 - 193-194. By 1962 (year of death), the ratio of unrestricted market price to voting trust formula price had become 10 to 1. See id. at 194. The Commissioner argued that the restrictive provisions should be disregarded in valuing the shares because the voting trust agreement in Reynolds represented a device and was not a bona fide business arrangement under section 20.2031- 2(h), Estate Tax Regs. See id. However, we found that there were bona fide business reasons for the Reynolds voting trust agreement, and that “the large discrepancy between market price per unrestricted share and formula price per unit was not the result of any cleverly devised plan to lower the testamentary value of [decedents’] * * * investments in the company”. Id. at 194-195. Therefore, the voting trust agreement was factored into the determination o [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/4333360. Public record. Not legal advice.