UNITED STATES TAX COURT
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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,
3409-98.
Filed July 6, 2001.
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
1
. . . . . . . . . . . . . . . . . . . . . . . . . 8
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? . . . . . . . . . .
FINDINGS OF FACT
I.
II.
III.
IV.
10
. . . . . . . . . . . . . . . . . . . . . .
10
Background . . . . . . . . . . . . . . . . . . . .
A. True Family
. . . . . . . . . . . . . . . . .
B. Formation and Growth of True Companies . . . .
1. Reserve Drilling
. . . . . . . . . . . . .
2. True-Brown Partnerships . . . . . . . . . .
3. True Oil and True Drilling
. . . . . . . .
4. Belle Fourche Pipeline Co.
. . . . . . . .
5. Black Hills Oil Marketers, Inc./True Oil
Purchasing Co./Eighty-Eight Oil Co./Black
Hills Trucking, Inc.
. . . . . . . . . .
6. True Ranches
. . . . . . . . . . . . . . .
7. White Stallion Ranch, Inc.
. . . . . . . .
8. Other True Companies
. . . . . . . . . . .
C. Methods of Accounting Used by True Companies .
D. Family Members’ Employment in True Companies .
E. Family Gift Giving and Business Financing
Practices
. . . . . . . . . . . . . . . . .
11
11
12
12
13
14
15
True Family Buy-Sell Agreements . . . . . . . . .
A. Origin and Purpose . . . . . . . . . . . . . .
B. First Transfers of Interests in Belle
Fourche, True Oil, and True Drilling to
True Children
. . . . . . . . . . . . . . .
C. Wyoming U.S. District Court Cases on Belle
Fourche and True Oil Transfers . . . . . . .
D. Tamma Hatten’s Withdrawal From True Companies .
E. Use of Similar Buy-Sell Agreements in All
True Companies Except White Stallion;
Amendments and Waivers . . . . . . . . . . .
F. Unique Provisions of White Stallion Buy-Sell
Agreement
. . . . . . . . . . . . . . . . .
G. Future of True Family Buy-Sell Agreements . . .
28
28
Transfers in Issue . . . . . . . . . . . . . . . .
A. 1993 Transfers of Partnership Interests by
Dave True
. . . . . . . . . . . . . . . . .
B. 1994 Estate Transfers . . . . . . . . . . . . .
C. 1994 Transfers by Jean True . . . . . . . . . .
51
Subsequent Income Tax Litigation Regarding
Ranchland Exchange Transactions . . . . . . . .
18
20
21
22
23
24
27
30
35
39
42
48
50
51
53
55
55
- 3 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . .
I.
Do Family Buy-Sell Agreements Control
Estate Tax Value? . . . . . . . . . . . . . . .
A. Framework for Analyzing Estate Tax Valuation
Issues . . . . . . . . . . . . . . . . . . .
B. Development of Legal Standards . . . . . . . .
1. Case Law Preceding Issuance of Regulations .
2. Regulatory Authority and Interpretive
Rulings . . . . . . . . . . . . . . . . .
3. Case Law Following Issuance of Regulations
and Revenue Ruling 59-60
. . . . . . . .
a. Was Agreement Entered Into for Bona Fide
Business Reasons?
. . . . . . . . . .
b. Was Agreement a Substitute for
Testamentary Dispositions? . . . . . .
1. Testamentary Purpose Test . . . . . .
2. Adequacy of Consideration Test . . . .
4. Statutory Changes . . . . . . . . . . . . .
II. Do 1971 and 1973 Gift Tax Cases Have Preclusive
Effect? . . . . . . . . . . . . . . . . . . . . .
A. Petitioners’ Collateral Estoppel Argument . . .
B. Legal Standards for Applying Collateral
Estoppel . . . . . . . . . . . . . . . . . . .
C. Collateral Estoppel Impact of 1971 and 1973
Gift Tax Cases . . . . . . . . . . . . . . . .
1. Bona Fide Business Arrangement Issue . . . .
2. Whether Book Value Equaled Fair Market
Value as of Agreement Date Issue . . . . .
III.
59
59
59
61
62
67
70
71
72
73
74
79
81
81
82
85
86
87
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
I.
. . . . . . . . . . . . . . . . . . . . . . 155
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.
10940-97
3409-98
3408-98
Totals
1
Tax
Gift
Estate
Gift
Year
12/31/93
06/04/941
12/31/94
Deficiency
$15,201,984
43,639,111
17,094,788
75,935,883
Penalties
$6,080,794
17,455,644
6,791,715
30,328,153
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 buysell 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 buysell 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 greatgrandchildren.
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 purchasesredemptions 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 95percent 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.
initial partners and ownership percentages were:
The
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).
exceptions:
There were two
(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.
resulted from:
True Oil’s tax to GAAP discrepancies
(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.
charge of Toolpushers Supply Co. in 1980.
He also took
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 memberowner 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:
Drilling.
Belle Fourche, True Oil, and True
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.
12
Subsequently, the stockholders
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 buysell 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 buysell 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 buysell 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 buysell 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 onehalf (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 costdepletable 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 substanceover-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.
States v. Cartwright, 411 U.S. 546, 550 (1973).
See United
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.”
Estate Tax Regs.
Id. at 551; see sec. 20.2031-1(b),
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.
26
Some cases
“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 WilsonLomb 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.
estranged at all relevant times.
See id.
Father and son were
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.
252-253.
See id. at
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 buysell 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 executorSee id. at 897.
sons.
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.
at 896.
See id.
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.
Tax Regs.
See sec. 20.2031-2(h), Estate
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
28
Cases applying the regulation have
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.
3.
See id.
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.
Lauder II:
However, as we noted in
“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’slength 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. 1992653.
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 buysell restrictions were invoked at the decedent-stockholder’s
death?
31
In addition, the term “adequate and full consideration”,
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 decedentshareholder’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
at 191.
See id.
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.
id. at 174-175.
See
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 20.20312(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”.
194-195.
Id. at
Therefore, the voting trust agreement was factored into
the determination of fair market value, rather than being
completely disregarded.
To apply the adequacy of consideration test, courts were
required to determine the meaning of the phrase “adequate and
full consideration in money or money’s worth” used in section
20.2031-2(h), Estate Tax Regs.
In Estate of Bischoff v.
Commissioner, 69 T.C. at 41 n.9, we concluded that consideration
was adequate because the formula price to be paid for a
partnership interest represented the fair market value of
partnership assets.
In Dorn v. United States, 828 F.2d at 181,
the Court of Appeals for the Third Circuit observed that
“Although few cases have relied on Treasury Regulation
- 78 §20.2031(h) [sic] for support, those which do discuss it support
the position that the option price affects the value of the gross
estate only if the option was granted at arm’s length.”
In
Bensel v. Commissioner, 36 B.T.A. at 253-254, the adequacy of
consideration test was met when the agreement was entered into
because “the price agreed upon between the father and son was not
too low.
That is, it was not lower than the price at which
persons with adverse interests dealing at arm’s length might have
been expected to have agreed.”
Similarly, in Estate of Carpenter
v. Commissioner, T.C. Memo. 1992-653, we held that a book value
price was reasonable (i.e., adequate and full) because it was the
result of arm’s-length negotiations conducted at the time the
buy-sell agreement was created.
An instructive articulation of the adequacy of consideration
test was presented in Lauder II, 64 T.C.M. (CCH) 1643, 1660, 1992
T.C.M. (RIA) par. 92,736, at 92-3733 through 92-3734, in which we
stated:
Notably, the phrase “adequate and full consideration” is not specifically defined in section 20.20312(h), Estate Tax Regs. In defining the phrase, we
begin with the proposition that a formula price may
reflect adequate and full consideration notwithstanding
that the price falls below fair market value. See,
e.g., Estate of Reynolds v. Commissioner, 55 T.C. 172,
194 (1970). In this light, the phrase is best
interpreted as requiring a price that is not lower than
that which would be agreed upon by persons with adverse
interests dealing at arm’s length. Bensel v.
Commissioner, supra. Under this standard, the formula
price generally must bear a reasonable relationship to
the unrestricted fair market value of the stock in
question.
- 79 In summary, to satisfy the adequacy of consideration test,
given the greater scrutiny applied to intrafamily agreements
restricting transfers of closely held businesses interests, the
formula price under the buy-sell agreement must be comparable to
what would result from arm’s-length dealings between adverse
parties, and it must bear a reasonable relationship to the
unrestricted fair market value of the interest in question.
4.
Statutory Changes
In 1990, Congress enacted the Chapter 14 special valuation
rules.
See secs. 2701-2704 (Chapter 14); Omnibus Budget
Reconciliation Act of 1990 (OBRA), Pub. L. 101-508, sec.
11602(a), 104 Stat. 1388-491, 1388-500 (1990).
These rules were
enacted to replace the complex, overly broad estate freeze rules
of recently enacted section 2036(c)34 with targeted rules that
were designed to assure more accurate valuation of property
subject to transfer taxes.
See S. 3209, 101st Cong. 2d Sess.
(1990), 136 Cong. Rec. 30538.
Chapter 14 includes section 2703, which codifies rules
regarding the impact of restrictions (options, agreements, rights
to acquire or use property at less than fair market value, or
limitations on sale or use of property) on valuation for estate
and gift tax purposes.35
See sec. 2703.
New section 2703
34
See Omnibus Budget Reconciliation Act of 1987, Pub. L.
100-203, sec. 10402, 101 Stat. 1330-431.
35
SEC. 2703. CERTAIN RIGHTS AND RESTRICTIONS DISREGARDED.
(continued...)
- 80 applied to agreements, options, rights, or restrictions entered
into, granted, or substantially modified after October 8, 1990.36
See OBRA sec. 11602(e)(1)(A)(ii), 104 Stat. 1388-500.
The Senate bill (S. 3209) explained that the rules requiring
options, rights, or restrictions (1) to be bona fide business
arrangements and (2) not to be devices to transfer property to
members of the decedent’s family for less than full and adequate
consideration in money or money’s worth, see secs. 2703(b)(1) and
35
(...continued)
(a) General Rule.--For purposes of this subtitle, the
value of any property shall be determined without regard
to-(1) any option, agreement, or other right to
acquire or use the property at a price less than the
fair market value of the property (without regard to
such option, agreement, or right), or
(2) any restriction on the right to sell or use
such property.
(b) Exceptions.--Subsection (a) shall not apply to any
option, agreement, right, or restriction which meets each of
the following requirements:
(1) It is a bona fide business arrangement.
(2) It is not a device to transfer such property
to members of the decedent’s family for less than full
and adequate consideration in money or money’s worth.
(3) Its terms are comparable to similar
arrangements entered into by persons in an arms’ length
transaction.
36
We summarize sec. 2703 to complete our analysis of the
evolution of legal standards on the ability of buy-sell
agreements to control estate tax value. However, the parties
have stipulated that the provisions of sec. 2703 do not apply to
the cases at hand. See supra note 23.
- 81 (2), were similar to those contained in section 20.2031-2(h),
Estate Tax Regs.
See S. 3209, supra at 30540-30541.
S. 3209
also emphasized that the business arrangement and device
requirements were independent tests.
See id.
Further, S. 3209
explained that OBRA added a third requirement, that the terms of
the option, agreement, right, or restriction must be comparable
to similar arrangements entered into by persons in an arm’slength transaction.
See id.
According to S. 3209, this
requirement was not found in prior law.
II.
See id.
Do 1971 and 1973 Gift Tax Cases Have Preclusive Effect?
A.
Petitioners’ Collateral Estoppel Argument
Petitioners argue that under the doctrine of collateral
estoppel, or issue preclusion, we are bound by certain
determinations of the U.S. District Court for the District of
Wyoming in the 1971 and 1973 gift tax cases.
In petitioners’
view, the District Court found, as to True Oil and Belle Fourche,
that (1) their buy-sell agreements were bona fide business
arrangements and (2) book value of the transferred interests
equaled fair market value as of the agreement dates.37
37
Petitioners explain that the District Court explicitly
determined that book value equaled fair market value for the two
companies, describing this as an “ultimate” fact in the 1971 and
1973 gift tax cases and an “evidentiary” fact in the cases at
hand. In contrast, petitioners contend that the District Court
implicitly held that the buy-sell agreements were bona fide
business arrangements, because the District Court took the
agreements into account in determining fair market value of the
True Oil and Belle Fourche transferred interests. Petitioners
(continued...)
- 82 Petitioners assert that the requirements for applying
collateral estoppel articulated in Peck v. Commissioner, 90 T.C.
162, 166-167 (1988), affd. 904 F.2d 525 (9th Cir. 1990), have
been met; therefore, respondent is precluded from relitigating
those two issues.
We disagree.
Moreover, petitioners
acknowledge that respondent is not estopped from arguing that the
True companies’ buy-sell agreements were testamentary devices
that were not controlling for estate tax purposes.
B.
We agree.
Legal Standards for Applying Collateral Estoppel
The doctrine of collateral estoppel provides that, once an
issue of fact or law is “actually and necessarily determined by a
court of competent jurisdiction, that determination is conclusive
in subsequent suits based on a different cause of action
involving a party to the prior litigation.”
Montana v. United
States, 440 U.S. 147, 153 (1979) (quoting Parklane Hosiery Co. v.
Shore, 439 U.S. 322, 326 n.5 (1979)).
Collateral estoppel is a
judicial doctrine designed to protect parties from unnecessary
and redundant litigation, to conserve judicial resources, and to
37
(...continued)
characterize this as an “evidentiary” fact in the 1971 and 1973
gift tax cases and an “ultimate” fact in the cases at hand. An
evidentiary fact is a fact that is necessary for or leads to the
determination of an ultimate fact. See Black’s Law Dictionary
611 (7th ed. 1999). An ultimate fact is a fact essential to the
claim or the defense. See id. at 612. In Meier v. Commissioner,
91 T.C. 273, 283-286 (1988), the Tax Court regarded the
distinction between ultimate and evidentiary facts as irrelevant
in applying collateral estoppel. See infra pp. 84-85.
- 83 foster certainty in and reliance on judicial action.
v. Commissioner, 109 T.C. 235, 240 (1997).
See Monahan
This Court, in Peck
v. Commissioner, supra at 166-167, prescribed the following five
conditions that must be satisfied before applying collateral
estoppel to a current factual dispute (the Peck requirements):
(1) The issue in the second suit must be identical
in all respects with the one decided in the first suit.
(2) There must be a final judgment rendered by a
court of competent jurisdiction.
(3) Collateral estoppel may be invoked against
parties and their privies to the prior judgment.
(4) The parties must actually have litigated the
issues and the resolution of these issues must have
been essential to the prior decision.
(5) The controlling facts and applicable legal
rules must remain unchanged from those in the prior
litigation. [Citations omitted.]38
Collateral estoppel may be used in connection with matters
of law, matters of fact, and mixed matters of law and fact.
Meier v. Commissioner, 91 T.C. 273, 283 (1988).
See
Moreover, its
focus is on the identity of issues, not the identity of legal
proceedings, so that it may apply to issues of fact or law
previously litigated even though the claims differ.
See Bertoli
v. Commissioner, 103 T.C. 501, 508 (1994)(citing Meier v.
Commissioner, 91 T.C. at 286).
38
Collateral estoppel cannot apply
The Court of Appeals for the Tenth Circuit used a similar
test to determine whether collateral estoppel applied. See Klein
v. Commissioner, 880 F.2d 260, 262-263 (10th Cir. 1989).
- 84 if the party against whom it is asserted did not have a full and
fair opportunity to litigate the issue in the earlier proceeding.
See Meier v. Commissioner, 91 T.C. at 286 (citing Allen v.
McCurry, 449 U.S. 90 (1980)).
To determine whether the issue to
be precluded in case 2 was identical to an essential issue
actually litigated in case 1 (Peck requirements 1 and 4), early
cases disagreed over whether the facts found in case 1 had to be
ultimate facts or instead, included both ultimate and evidentiary
facts.
See Meier v. Commissioner, 91 T.C. at 284 (citing The
Evergreens v. Nunan, 141 F.2d 927, 928-929 (2d Cir. 1944)
(Evergreens)).
In Amos v. Commissioner, 43 T.C. 50 (1964), affd.
360 F. 2d 358 (4th Cir. 1965), this Court adopted the Evergreens
“ultimate facts” test, which limited the use of collateral
estoppel to ultimate facts found in the second case.
However,
more recent cases and commentators have criticized the Evergreens
approach and its limitation of collateral estoppel to ultimate
facts.
In Meier v. Commissioner, supra at 284-286, we abandoned
the Evergreens approach and adopted the rationale of Comment j,
Restatement, Judgments 2d, section 27 (1982), which focuses not
on whether the facts to be precluded from being relitigated were
evidentiary or ultimate, but on whether the parties recognized
the issue as important and necessary to the first judgment.39
39
The Restatement reads as follows:
(continued...)
- 85 C.
Collateral Estoppel Impact of 1971 and 1973 Gift Tax
Cases
We now evaluate the 1971 and 1973 gift tax cases and the
cases at hand, in light of the Peck requirements, to determine
whether we are precluded from deciding whether True Oil’s and
Belle Fourche’s (1) buy-sell agreements were bona fide business
39
(...continued)
Determinations essential to the judgment. It is
sometimes stated that even when a determination is a
necessary step in the formulation of a decision and
judgment, the determination will not be conclusive
between the parties if it relates only to a “mediate
datum” or “evidentiary fact” rather than to an
“ultimate fact” or issue of law. It has also been
stated than [sic] even a determination of “ultimate
fact” will not be conclusive in a later action if it
constitutes only an “evidentiary fact” or “mediate
datum” in that action. Such a formulation is
occasionally used to support a refusal to apply the
rule of issue preclusion when the refusal could more
appropriately be based on the lack of similarity
between the issues in the two proceedings. If applied
more broadly, the formulation causes great difficulty,
and is at odds with the rationale on which the rule of
issue preclusion is based. The line between ultimate
and evidentiary facts is often impossible to draw.
Moreover, even if a fact is categorized as evidentiary,
great effort may have been expended by both parties in
seeking to persuade the adjudicator of its existence or
nonexistence and it may well have been regarded as the
key issue in the dispute. In these circumstances the
determination of the issue should be conclusive whether
or not other links in the chain had to be forged before
the question of liability could be determined in the
first or second action.
The appropriate question, then, is whether the
issue was actually recognized by the parties as
important and by the trier as necessary to the first
judgment. If so, the determination is conclusive
between the parties in a subsequent action * * *.
[Restatement, Judgments 2d, sec. 27 (1982).]
- 86 arrangements and (2) book values equaled their fair market values
on the agreement dates.
We preface the inquiry by noting that petitioners properly
raised the collateral estoppel issue in their petition.
39.
See Rule
The jurisdictional competency of the District Court in the
1971 and 1973 gift tax cases has not been questioned.
were entered, and the Government did not appeal.
Judgments
The parties to
the cases at hand were also parties to the 1971 and 1973 gift tax
cases (i.e., both petitioners and respondent were parties or
privies in the earlier gift tax cases and were bound by those
decisions).40
In sum, conditions (2) and (3) of the Peck
requirements are satisfied.
1.
Bona Fide Business Arrangement Issue
Petitioners argue that we are precluded from deciding
whether the True Oil and Belle Fourche buy-sell agreements
represented bona fide business arrangements under section
20.2031-2(h), Estate Tax Regs., because the District Court
implicitly made this determination in the 1971 and 1973 gift tax
cases.
40
We disagree with petitioners, because the issue was not
Specifically, the taxpayers in the 1971 and 1973 gift tax
cases were: Dave True, Jean True, Tamma Hatten, Hank True,
Diemer True, and David L. True. Petitioners in the cases at hand
are: Dave True’s estate (considered his privy) and Jean True.
The fact that the True children are not parties, in their own
right, to the cases at hand does not cause the remaining parties
to fail Peck requirement 3. See Peck v. Commissioner, 90 T.C.
162, 166-167 (1988), affd. 904 F.2d 525 (9th Cir. 1990).
- 87 actually litigated and decided in the 1971 and 1973 gift tax
cases and was not essential to those decisions (flunking Peck
requirement 4).
Therefore, we proceed independently to determine
whether the True companies’ buy-sell agreements were entered into
for bona fide business reasons.
2.
See discussion infra pp. 99-101.
Whether Book Value Equaled Fair Market
Value as of Agreement Date Issue
The District Court’s findings that tax book value equaled
fair market value for the True Oil and Belle Fourche interests
transferred as of the buy-sell agreement dates in 1971 and 1973
also do not have preclusive effect in the cases before us.
This
is because the issues in these cases (the fair market value of
the interests in question many years later) are not identical to,
and were not actually litigated in or essential to the District
Court’s decisions in the 1971 and 1973 gift tax cases.
In the 1971 and 1973 gift tax cases, the District Court
determined the fair market values (as of the agreement dates) of
transferred interests in Belle Fourche and True Oil, explicitly
taking into account the depressive effect that the buy-sell
agreements had on value.
In those cases, the District Court
independently determined that fair market value equaled book
value at the agreement dates without finding that the buy-sell
agreements controlled transfer tax value under a Lauder II type
- 88 of analysis.41
Without a finding that the agreements were
testamentary devices, the District Court was free to consider the
buy-sell restrictions along with other relevant factors in
determining fair market value.
See Rev. Rul. 59-60, 1959-1 C.B.
at 244.
In the cases at hand, we also must determine, as part of our
evidentiary findings, fair market value on the agreement dates to
help us decide whether the True companies’ buy-sell agreements
were testamentary devices.
However, in so doing, we would not
take into account any depressive effect that the buy-sell
agreements might have had on value; to do otherwise would be to
indulge in circular reasoning that would assume the answer at the
outset of the inquiry.
Therefore, the facts we must find in the
cases at hand (fair market value at agreement dates without
considering impact of buy-sell restrictions on value) were not
required to be found by the District Court in the 1971 and 1973
gift tax cases, leaving the matter open to our examination in the
cases at hand.
We analyze the differences between a formula price under a
buy-sell agreement and fair market value on the agreement date to
41
The District Court’s approach was similar to that employed
in Estate of Hall v. Commissioner, 92 T.C. 312 (1989), where we
did not decide whether the price determined under an adjusted
book value formula price was dispositive for estate tax purposes.
Instead we held, after reviewing the expert reports, that the
actual date of death fair market value of the shares did not
exceed the formula price. See discussion infra pp. 141-144.
- 89 help expose any lack of arm’s-length dealings or presence of
testamentary intent.
See Estate of Bischoff v. Commissioner, 69
T.C. at 41 n.9; Bensel v. Commissioner, 36 B.T.A. at 253; Lauder
II.
If the buy-sell agreement is found to be a testamentary
device, it is to be disregarded for purposes of determining
estate and gift tax value.
See discussion infra p. 153.
Accordingly, it would be incorrect to account for a buy-sell
agreement’s effect on value in deriving an evidentiary fact (fair
market value at agreement date) that will be used to decide
whether the agreement should have an effect on value at a later
date.
In Estate of Bischoff v. Commissioner, supra at 35-36, 41
n.9., we compared the buy-sell formula price to the fair market
value of the underlying partnership assets on the date they were
transferred to the partnership (which was close to the agreement
date), and found consideration to be adequate and the buy-sell
agreement price to be equal to fair market value.
We did not
consider any depressive effect that the buy-sell agreement might
have had on underlying asset values at the agreement date.
In Lauder II, we analyzed various experts’ valuations,
finding the comparative valuation approach that emphasized
price/earnings ratios of industry competitors to be the most
reliable basis for valuing the decedent’s stock at the buy-sell
agreement dates.
We then allowed a discount for lack of
- 90 liquidity in computing fair market value; however, we did not
attribute the lack of liquidity to the buy-sell agreements.
See
id.
In summary, the 1971 and 1973 gift tax cases determined fair
market value of the True Oil and Belle Fourche transferred
interests at the dates of agreement by taking into account the
depressive effect the buy-sell agreements had on value.
The
District Court in those cases did not analyze whether the buysell agreements served as substitutes for testamentary
dispositions and therefore was allowed to consider their effect
on value.
This issue is not the same as the one in the cases
before us, as we are required to disregard the buy-sell
agreements in determining value at the relevant dates in order to
make our determination of whether the True family buy-sell
agreements were substitutes for testamentary devices.
Therefore,
we are not bound by the District Court’s determinations that tax
book value equaled fair market value for the True Oil and Belle
Fourche interests transferred as of the buy-sell agreement dates.
III.
Do True Family Buy-Sell Agreements Control Estate Tax
Values?
We now apply the Lauder II test to the True family buy-sell
agreements to determine whether the agreements control Federal
estate tax value.
Because most of the buy-sell agreements at
issue in these cases were modeled on the True Oil partnership
agreement or the Belle Fourche stockholders’ restrictive
- 91 agreement, we focus attention on the facts surrounding the
creation and implementation of those agreements.
Petitioners assert that the True family buy-sell agreements
satisfy all four prongs of the Lauder II test, while respondent
contends that they flunk two of the four prongs.
A.
Was the Offering Price Fixed and Determinable Under the
Agreements?
The parties agree that the formula price set forth in the
True family buy-sell agreements (tax basis book value) was both
fixed and determinable.42
Thus, the first prong of the Lauder II
test is satisfied.
B.
Were Agreements Binding During Life and at Death?
Petitioners divide this test into two components:
the
agreements must be enforceable under State law and must bind the
transferors both during life and at death.
The True family buy-
sell agreements must satisfy both of these components to fulfill
the second prong of the Lauder II test.
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, 99100 (1951); Lauder II.
First, respondent argues that the True companies’ buy-sell
agreements were not enforceable under Wyoming law.
42
We disagree.
However, respondent challenges the propriety of using tax
basis book value as a measure of fair market value.
- 92 Restrictions on transfers of corporate stock are valid and
enforceable if authorized by statute.
17-16-627(b) (Michie 1999).
See Wyo. Stat. Ann. sec.
Authorized restrictions include
those that (1) serve a reasonable purpose and (2) are not against
public policy.
See Wyo. Stat. Ann. sec. 17-16-627(c)(iii)
(Michie 1999); Hunter Ranch Inc. v. Hunter, 153 F.3d 727 (10th
Cir. 1998), 1998 W.L. 380556 (unpublished opinion).
Respondent
equates this requirement with the business purpose and
nontestamentary disposition prongs of the Lauder II test (i.e.,
transfer restrictions must fulfill a business purpose and must
not contravene public policy by serving as substitutes for
testamentary dispositions).
However, respondent provides no
authority for his interpretation of the Wyoming statute, and it
is not self-evident that a Wyoming court would consider transfer
restrictions that served both business and testamentary purposes
to violate public policy.
In fact, the District Court in the
1971 and 1973 gift tax cases treated the Belle Fourche and True
Oil buy-sell agreements as enforceable by factoring the transfer
restrictions into the computation of fair market value.
Under the Wyoming Uniform Partnership Act (WUPA),
partnership agreements govern relations among partners and
between partners and the partnership.
As such, the WUPA provides
only default rules if the partnership agreement is silent.
Wyo. Stat. Ann. sec. 17-21-103(a) (Michie 1999).
However,
See
- 93 certain rights cannot be varied by the partnership agreement.
See id. at sec. 17-21-103(b).
Such non-variable rights do not
include the right to impose transfer restrictions on partnership
interests.
See id.
Respondent further argues that the buy-sell agreements
should be set aside as unconscionable contracts of adhesion.
Respondent points to Tamma Hatten’s lack of legal representation
when she acquired interests in the True companies and entered
into the buy-sell agreements and withdrew from the True
companies, her lack of control over the buy-sell agreement terms,
and her inferior bargaining position to support his
unconscionability argument.
A “contract of adhesion” is a
“standard-form contract prepared by one party, to be signed by
the party in a weaker position, usu. a consumer, who has little
choice about the terms.”
1999).
Black’s Law Dictionary 318-319 (7th ed.
Under Wyoming law, unconscionability is tested at the
time of the agreement and “is considered as a form of fraud
recognized in equity, but such fraud should be ‘apparent from the
intrinsic nature and subject of the bargain itself; such as no
man in his senses and not under delusion would make on the one
hand, and no honest and fair man would accept on the other’”.
re Estate of Frederick, 599 P.2d 550, 556 (Wyo. 1979).
In
We do not
believe that conditions present at the inception of the True
companies buy-sell agreements would meet these definitions.
The
- 94 buy-sell agreements were not boilerplate documents and, in all
likelihood, the weaker parties (the True children, according to
respondent) would benefit the most from the non-arm’s-length
terms.
The fact that Tamma Hatten may ultimately have suffered
financial detriment because she withdrew from the True companies
at the time she did has no bearing on whether the agreements were
unconscionable at inception or would be so regarded as of the
times they were given effect in 1993 and 1994.
Accordingly, we
conclude that the True family buy-sell agreements were
enforceable under Wyoming law.
Second, respondent asserts that the buy-sell agreements,
although binding by their explicit terms, were often modified and
were not always followed by the parties, suggesting that they did
not actually bind the parties during life.
On the contrary, we
find that the amendments to and waivers of the buy-sell
provisions were formally documented and were consistent with the
terms and general intent of the agreements (i.e., to maintain
family ownership).
For example, waivers to allow non pro rata
purchases of interests by True family members, exchanges of stock
incident to a merger, and sales of stock by the Toolpushers’
Employees’ Trust back to the company were normal responses to
business exigencies.
Similarly, amendments allowing transfers to
owners’ revocable living trusts, clarifying the mechanics of the
buy-sell provisions, and introducing the active participation
- 95 requirement were all in keeping with the general purpose of
maintaining control of the True companies among family members
who were active in the businesses.
Moreover, the invocation of
the buy-sell provisions when Tamma Hatten withdrew from the True
companies is persuasive evidence that the parties treated the
agreements as binding.
69 T.C. at 42 n.10.
See Estate of Bischoff v. Commissioner,
Accordingly, the waivers and amendments do
not jeopardize the binding nature of the buy-sell agreements.
See Lauder II.
Third, respondent suggests that the corporate buy-sell
agreements (except the White Stallion agreement) are not binding
because Dave True had substantial power, as controlling
shareholder, to alter their terms during his lifetime.
Petitioners counter that Dave True did not have the ability
unilaterally to alter the agreements by virtue of his majority
ownership of the corporations.
They argue that control of the
corporation is irrelevant because the buy-sell agreements were
agreements among the shareholders that could not be amended or
terminated without the shareholders’ unanimous consent.
Respondent and petitioners cited no cases to support their
positions on this matter.
For the reasons stated below, we agree
with petitioners.
In Bommer Revocable Trust v. Commissioner, T.C. Memo. 1997380, we found that a buy-sell agreement was not binding on the
- 96 decedent during his lifetime because it explicitly gave the
decedent unilateral power to alter or amend its terms, and the
natural objects of the decedent’s bounty were the other
shareholders.
In the cases at hand, we agree with petitioners
that Dave True could not unilaterally terminate the agreements
because, by their terms, the buy-sell agreements would not
terminate until the death of the last surviving shareholder.
However, contrary to petitioners’ assertions, we note that each
corporation was listed as a party to its own amended and restated
buy-sell agreement dated August 11, 1984.
Notwithstanding this inconsistency, we believe that Dave
True’s controlling ownership did not give him unilateral
authority to alter or amend the corporate buy-sell agreements so
that they would be considered non-binding.
First, the agreement
in Bommer explicitly conferred on the decedent the unilateral
power to amend.
See id.
This is not true in the cases at hand.
Second, it appears that the primary parties to the instant
agreements were the shareholders and that the corporation was
included only to ensure that the stock certificates were marked
with transfer restrictions.
Therefore, contrary to respondent’s
assertions, we conclude that Dave True’s majority ownership of
the True corporations did not confer on him the unilateral
authority to alter or amend the buy-sell agreements, which would
- 97 have been sufficient to render the agreements non-binding for
estate tax purposes.
However, we note that the White Stallion buy-sell agreement
allowed a different pricing formula for certain types of lifetime
transfers, and thereby did not equally bind transferors during
life and after death.
Specifically, under the “Buy and Sell
Agreement” provision, if a stockholder were to die, become
legally disabled, or desire to sell all or part of his stock, the
remaining members of his group would be obligated to purchase the
stock on a pro rata basis for a price equal to book value at the
end of the preceding fiscal year, less dividends paid within 21/2 months of such fiscal yearend.
The transferring stockholder,
his heirs, trustees, etc., reciprocally would be obligated to
sell to those group members.
Alternatively, under the “First
Right of Refusal” provision, if all the shareholders of one group
(selling group) wanted to transfer all their interests by
lifetime sale to a third party who was unaffiliated with the
other shareholder group (nonselling group), they could do so at
any price.
But, the selling group would be required first to
offer the nonselling group the opportunity to purchase the stock
on the same terms and conditions as any bona fide third party
offer received by the selling group.
Thus, a lifetime sale of
all the selling group’s stock could generate a higher price than
would a transfer at death under the book value formula price.
- 98 Section 20.2031-2(h), Estate Tax Regs., states:
“Little
weight will be accorded a price contained in an option or
contract under which the decedent is free to dispose of the
underlying securities at any price he chooses during his
lifetime.”
Similarly, in Estate of Weil v. Commissioner, 22 T.C.
1267, 1274 (1954), we explained:
where the agreement made by the decedent and the
prospective purchaser of his property fixed the price
to be received therefor by his estate at the time of
his death, but carried no restriction on the decedent’s
right to dispose of his property at the best price he
could get during his lifetime, the property owned by
decedent at the time of his death would be included as
a part of his estate at its then fair market value.
[Citations omitted; see also United States v. Land, 303
F.2d 170, 173 (5th Cir. 1962); Baltimore Natl. Bank v.
United States, 136 F. Supp at 654.]
In the cases at hand, a complete, lifetime buy-out of one
family group’s interests in White Stallion could be achieved at
the highest price the market would bear, while a transfer at
death (or during life by less than all group members) would be
limited to a book value purchase price.
This runs afoul of the
Lauder II requirements.
Because the buy-sell agreements for the True companies other
than White Stallion were enforceable under State law and were
binding on the transferors both during life and at death, we find
that the second prong of the Lauder II test is satisfied as to
those companies.
However, the White Stallion buy-sell agreement
- 99 fails to satisfy the second prong of the Lauder II test because
it was not equally binding during life and at death.
C.
Were Agreements Entered Into for Bona Fide Business
Reasons?
The buy-sell agreements in these cases were adopted and
maintained to ensure continued family ownership and control of
the True Companies.
Dave True’s experiences of owning and
operating businesses with outsiders (and then having to buy them
out) motivated him to use buy-sell provisions (even when Jean
True was his only co-owner) to restrict a related owner’s ability
to sell outside the family.
As previously stated, courts
consistently have recognized the goal of maintaining exclusive
family control over a business to be a bona fide business
purpose.
See supra p. 71.
By maintaining family control and ownership, Dave True was
able to continue his policy of channeling profits from the True
companies into True Oil to fund the costs of searching for
additional reserves through exploratory drilling.
In addition,
the buy-sell agreements were used to secure active participation
from owners of the True family businesses, because Dave True
feared that passive owners would not share his long-term vision
for the success and perpetuation of the True companies.
Under
the buy-sell agreements, an owner who with his or her spouse
ceased to devote all or a substantial part of his or her time to
the business would be required to sell his or her interest in the
- 100 business.
Thus, the buy-sell agreements enforced the active
ownership requirements that played a central role in Dave True’s
business philosophy.
In this regard, courts have found that
using buy-sell agreements to assure continuity of company
management policies or to retain key employees are bona fide
business purposes that satisfy this prong of the Lauder II test.
See supra pp. 71-72.
The parties generally agree that the True family buy-sell
agreements were entered into for bona fide business reasons.43
Thus, for the reasons stated above, we find that the third prong
(business purpose prong) of the Lauder II test is satisfied.
43
However, respondent disagrees with petitioners’ suggestion
that a finding of business purpose could preclude a finding of
testamentary intent. Petitioners cite dicta in St. Louis County
Bank v. United States, 674 F.2d 1207, 1210 (8th Cir. 1982), which
stated that the “fact of a valid business purpose could, in some
circumstances, completely negate the alleged existence of a taxavoidance testamentary device as a matter of law”. Petitioners’
brief states: “In this case, the business purposes for the
agreements are sufficient to establish that the agreements are
bona fide business arrangements. Petitioners do not rely solely
on those business purposes, however, to show that the agreements
are bona fide business arrangements.”
We agree with respondent that established case law and
regulatory authority require that the bona fide business purpose
and nontestamentary disposition prongs of the Lauder II test must
be satisfied independently. However, we acknowledge that in some
instances, the presence of a business purpose (e.g., a desire to
vest control of a company in an employee who is not related to
the testator by blood or marriage) may indicate that testamentary
motives are absent. This is not the situation in the cases at
hand. Alternatively, if the business purpose is to keep control
within the family, it is fully consistent with a testamentary
objective. In such a case, the presence of a business purpose
does not negate the testamentary purposes.
- 101 D.
Were Agreements Substitutes for Testamentary
Dispositions?
We now consider whether the True companies’ buy-sell
agreements were adopted for the purpose of achieving testamentary
objectives.
As previously stated, greater scrutiny applies to
intrafamily agreements restricting stock transfers in closely
held businesses.
This analysis requires us to apply the
appropriate common law tests (along with other relevant factors)
to the particular facts of the cases at hand.
No one test or
factor is determinative; rather, we must consider all relevant
factors to decide whether the buy-sell agreements were used as
substitutes for testamentary dispositions.
1.
Testamentary Purpose Test
Respondent argues that the True companies’ buy-sell
agreements were not the result of arm’s-length dealings and were
designed to serve testamentary purposes.
After evaluating the
following factors, we agree with respondent that Dave True had
testamentary objectives (conflated with the legitimate business
reasons mentioned above) for adopting and maintaining the True
family buy-sell agreements.
a.
Decedent’s Health When He Entered Into
Agreements
Dave True was in good health when he entered into the first
buy-sell agreements (Belle Fourche, True Oil, True Drilling) with
his children in 1971 and 1973.
However, by the time he made the
- 102 1993 transfers in issue, Dave True had a history of back problems
and a chronic pulmonary insufficiency that required him to be on
oxygen full time.
Courts have found that a decedent’s ill health at the time
he entered into a restrictive agreement indicated that he had
testamentary purposes for doing so.
See, e.g., St. Louis County
Bank v. United States, 674 F. 2d at 1210; Lauder I; Estate of
Slocum v. United States, 256 F. Supp. at 755.
Therefore, Dave
True’s good health in 1971 and 1973 does not lead to any
inference of testamentary motive for his entry into those
agreements.
The subsequent decline in Dave True’s health has no
direct bearing on the likelihood of testamentary purpose when the
agreements were originally entered into.
b.
No Negotiation of Buy-Sell Agreement Terms
Petitioners have provided little evidence to show that the
parties negotiated the terms of the buy-sell agreements.
Although the True children in their testimony consistently
characterized communications with their father regarding the buysell agreements as discussions, rather than as negotiations,
there is no evidence that any changes were made to the buy-sell
agreements as a result of those discussions.
The True children
did not receive independent legal or accounting advice when they
entered into the agreements, nor did they know who drafted them.
Further, certain facts suggest that the buy-sell agreement terms
were determined unilaterally by Dave True, based on his strong
- 103 beliefs concerning how his family should own and operate their
businesses, beliefs that he ingrained in his children so that
they readily consented to any ownership conditions proposed by
their father.
Dave True’s control over his children’s interests in the
True companies indicates that he had absolute discretion to set
the buy-sell agreement terms.
Before the True children had
reached majority, Dave True transferred gifts of cash and minor
interests in the True companies to the children’s guardianship
accounts, which he managed for their benefit.
The children were
unaware of how or when they acquired those early interests in the
True companies.
When the True children were in their early 20's
and 30's, Dave True transferred to them (either by gift or sale)
interests in three principal True companies, Belle Fourche, True
Drilling, and True Oil.
The True children’s purchases of their
interests in Belle Fourche were financed with cash gifts from
their parents over the years and with earnings distributions from
other True companies.
They did not know why, in connection with
their stock purchase, they also had to lend money to Belle
Fourche.
Although the True children (except Tamma Hatten)
received gifts from Dave and Jean True every year but one between
1955
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