# UNITED STATES TAX COURT

> Briefs, arguments, decisions, and more.

URL: https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A0bf648df776ce30b

## Record

- **Collection:** Agency decision
- **Document type:** Agency decision

## Text

RECORDED
2RVICE

S1AT. |
JUDGE

| FILES

T.C. Memo. 2005-296

UNITED STATES TAX COURT

ESTATE OF WINIFRED HUGHES, DECEASED, DEAN McBRIDE, EXECUTOR AND
TRUSTEE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No.

21395-03.

Filed December 27, 2005.

David S. Grossman, for petitioner.
Julie L. Payne, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COLVIN, Judge:

Respondent determined a deficiency of

$175,801 in the estate's estate tax.

Decedent's husband, George Robert Hughes (Bob Hughes),
founded Bob Hughes Motors,

Leasing).

Inc., d.b.a. Advance Leasing (Advance

Bob Hughes died in 1996.

Winifred Hughes (decedent)

SERVED

DEC 2 7 2005

-

2

-

was the sole owner of the stock of Advance Leasing from 1996

until she died in 1999.

After Bob Hughes died, Dean McBride

(McBride) became the sole officer and director of Advance
Leasing.

Decedent issued a durable power of attorney to McBride

in 1996.

In 1997, McBride executed an agreement and a promissory note
on behalf of decedent and Advance Leasing which stated that

decedent promised to pay $400,000 to Advance Leasing on demand in
exchange for 4,000 shares of Advance Leasing's common stock.
Advance Leasing issued a stock certificate to decedent for the
4,000 shares.

McBride paid the $400,000 to Advance Leasing after

decedent died in 1999.

The issues for decision are:
1.

Whether $400,000 is deductible under section

2053(a)(3)¹ as a claim against decedent's gross estate based on
the $400,000 promissory note.

2.

We hold that it is not.

Whether interest of $21,782 owed to decedent by Advance

Leasing on certain promissory notes when decedent died is

included in decedent's gross estate.

We hold that it is not.

¹ Section references are to the Internal Revenue Code as in
effect as of the date of decedent's death, unless stated
otherwise. Rule references are to the Tax Court Rules of
Practice and Procedure.

- 3 FINDINGS OF FACT

Some of the facts have been stipulated and are so found.
A.

Dean McBride

McBride, the executor of decedent's estate, resided in
Phoenix, Arizona, when the petition was filed.
longtime friend of Bob Hughes and decedent.
April 10, 1996.

McBride was a

Bob Hughes died on

McBride was the executor of his estate.

McBride

became trustee or manager of the family trust and other entities
(discussed more fully below) that Bob Hughes and decedent

established to hold almost all of their property.
B.

Decedent and Bob Hughes
Decedent and Bob Hughes were married around 1950 and lived

near Seattle, Washington for most of their lives.
children during their marriage:

They had two

Mark Hughes and Billy Hughes.

Decedent had another son, and Bob Hughes had two children from

prior marriages.

Decedent and Bob Hughes had 13 grandchildren.

Bob Hughes owned automobile dealerships for many years in Burien,
Washington, approximately 20 miles south of Seattle.
On April 27, 1972, Bob Hughes and decedent established the

George R. Hughes Family Trust (GRH Trust) and other entities to
hold almost all of their property.

Bob Hughes was the trustee or

manager of GRH Trust and other entities that he and decedent had
established.

After Bob Hughes died on April 10,

1996, decedent

was the sole current beneficiary of GRH Trust, the children and

_ 4 _

grandchildren of Bob Hughes and decedent and certain charities
were future beneficiaries.

McBride became the trustee or manager

of GRH Trust and the other entities that Bob Hughes and decedent
had established.

Decedent issued a durable power of attorney to McBride on
August 20, 1996.

At that time decedent was lucid and knew what

assets she owned and who her family members were.

Decedent moved

to an assisted living facility in Peoria, Arizona, on May 19,
1998.

She was soon diagnosed with Alzheimer's disease.

She

lived there until she died on July 25, 1999.
C.

Advance Leasing

1.

Organization and Operation

Bob Hughes founded Advance Leasing around 1971.

He and

decedent originally owned all of the stock in Advance Leasing.
They transferred their stock to GRH Trust when they formed it in
1972.

Advance Leasing's office was in Burien, Washington.

Advance Leasing sold used cars from 1971 through April 10,

1996.

It began buying cars to lease to third parties some time after
1971 but before April 10,

1996.

Billy Hughes and Jeff Ross were independent contractors and

salespersons for Advance Leasing.
selling and leasing cars.

They earned commissions from

Bob Hughes hoped that Billy Hughes

would eventually own a car dealership.

Billy Hughes was a very

good salesman but had alcohol and drug problems.

- 5. Advance Leasing financed its purchases of cars with loans it
obtained from other entities established by Bob Hughes and
decedent.

At the end of 1994, 1995, and 1996, Advance Leasing

owed $755,640,

$861,069, and $964,257, respectively, to Bob

Hughes and the other entities.

When Bob Hughes died, decedent became the sole beneficial
owner of the stock of Advance Leasing, all of which was held by
GRH Trust.

Decedent was never involved in the business of

Advance Leasing.
The Estate of Bob Hughes reported on the Federal estate tax
return that was filed on July 9, 1997, that the stock of Advance

Leasing had a fair market value of zero as of April 10, 1996, and
that its liabilities exceeded assets.

McBride signed that return

as executor for the Estate of Bob Hughes.
2.

.Advance Leasing's Financial Statements for 1994-99

Advance Leasing had the following amounts of gross sales,
cost of goods sold, operating income, expenses, and net loss for
1994-99:

- 6 1994

Gross sales-Used car retail sales

1995

1996

1997

1998

1999

$94,553

$129,188

$64,350

$115,868

$68,416

$9,066

1,100,376
1,194,929

999,448
1,128,636

1,318,741
1,383,091

1,846,700
1,962,568

1,100,987
1,169,403

107,153
116,219

$91,873

$66,400

$108,628

1,208,813

1,649,438

2.897

$117,059
883,066
--

--

--

$64,449
997,423
--

$17,305
108,348
--

1,103,544

1,000,125

1,275,213

1,758,066

1,061,872

125,653

Combined used car retail

$91,385

$128,511

$107,878

$204,502

$107,531

($9,434)

and wholesale sales
income/ (sales loss)
Car lease income

43,699

40,122

40,747

34,553

27,099

15,447

Capital gain income/

24,492

5,391

19,949

288

39,734

(647)

Used car wholesale sales

Cost of goods sold- -

Used car retail sales
Used car wholesale sales
Reconditioning costs

1,008,774

Total operating income--

(Capital loss)
Dividend income
Interest income
Miscellaneous income
Other income
Other rental income
Total expenses
Net profit/(net loss)

--

.

290

--

--

19,675

34,180

33,732

1,051

-74
6,050

--6,050

-550
4,950

-267
--

193,243

194,373

279,573

213,600

6,684

$240,178

$244,238

$234,899

$300,448

$214,846

$125,717

($66,672)

($50,995)

($40,526)

($20,875)

($1,246)

($119,033)

13,380

12,229

550
---

--6,700

173,506

'

4

--

Advance Leasing had the following amounts of assets,2
liabilities, capital, and net worth³ for 1994-99:
Year Ended
Dec. 31

Assets

Liabilities

Capital

Net
Worth

1994
1995
1996
1997
1998
1999

$447,310
581,322
633,931
772,194
750, 526
657,782

$756,819
941,825
1,035,165
1,194,304
1,173, 882
800,170

($309,508)
(360,503)
(401,234)
(422,110)
(423, 356)
(142,388)

($309,508)
(360,503)
(401,234)
(422,110)
(423, 356)
(142,388)

2 As discussed in par. E, below, Advance Leasing's
financial statements for 1997 and 1998 did not refer to the 4,000
shares of Advance Leasing stock issued to decedent or decedent' s
$400,000 promissory note.
3

any) .

Net worth equals assets minus liabilities and capital (if

- 7 Advance Leasing owed the following to Bob Hughes, George R.
Hughes Enterprise Limited Partnership (HELP),4 H & R Properties,'
and the Trus t :
Creditor

Year ended Dec. 31
1996
1997

1994

1995

----

$10,000
350
10,350

----

$755,640
-755,640

$100,000
4,754
104,754

----

Note payable

Accrued int.
Total
Grand total

Bob Hughes-

Note payable
Accrued int.
Total

1998

1999

----

----

----

$100,000
-100,000

$100,000
5,480
105,480

$100,00.0
10,960
110,960

$100,000
16,440
$116,440

$707,640
38,325
745,965

$782,640
81,617
864,257

$832,640
126,676
959,316

$782,640
170,735
953,375

$382,640
208,628
591,268

--

--

--

--

$50,000

---

---

---

---

5,000
55,000

$755,640

$861,069

$964,257

H & R Props. Note payable
Accrued int.
Total
HELP042
Note payable
Accrued int.
Total

Trust-

$1,064,796

$1,119,335

$50,000

.

9,500
59,500

$767,208

Advance Leasing reported $29,663 of taxable income before
net operating loss deductions on its 1997 income tax return.
D.

HELP

GRH Trust was a general partner of HELP.

Children and

042
grandchildren of decedent and her husband were the limited
partners.

GRH Trust, as general partner, held a .581-percent

interest in HELP, and the children and grandchildren (the limited
partners) held a 99.419-percent interest.

Advance Leasing

4 George R. Hughes Enterprise Limited Partnership is
described in par. D, below.

5 H & R Properties was a Schedule C business owned by Bob
Hughes and decedent.

- 8 borrowed money from HELP, and owed HELP $953,375 by the end of
1998.

E.

The Stock Subscription Agreement and the $400,000 Promissory
Note
McBride knew it was important to decedent that Billy Hughes

always have a place to work.

On April 29, 1997:

(1) McBride,

acting under a power of attorney from decedent and as president

of Advance Leasing, signed a stock subscription agreement under
which decedent agreed·to pay Advance Leasing $400,000 on demand
and Advance Leasing agreed to issue to decedent an additional
4,000 shares of Advance Leasing's common stock; and (2) Advance
Leasing issued a stock certificate to decedent for the 4,000
shares.

The terms of the stock subscription agreement were not

negotiated, and Advance Leasing's business was not appraised.
The promissory note was not paid while decedent was alive.
Neither the $400,000 promissory note nor the 4,000 shares
were identified on Advance Leasing's 1997 and 1998 financial
statements or on its 1997 and 1998 corporate income tax returns.

Neither Advance Leasing's bookkeeper nor its certified public
accountant, whose accounting firm had prepared Advance Leasing's
tax returns and reviewed its financial statements since the early
1990s, knew about the stock subscription agreement or the

$400,000 promissory note.

F.

Events Following Decedent's Death
Decedent died on July 25,. 1999.

McBride, as trustee of GRH

Trust, transferred $400,000 to Advance Leasing on September 20,
1999.

Advance Leasing had not previously demanded payment of the

promissory note.

During 1999, Advance Leasing used the $400,000

it received for the promissory note to repay $400,000 to HELP.
In 1998, Billy Hughes's wife filed for divorce, his
substance abuse problems worsened, and he stopped working for
Advance Leasing.

He entered a rehabilitation center for

treatment late in 1998.

Advance Leasing ceased operating around

2000.

G.

Decedent's Estate Tax Return
Decedent's estate reported on the estate tax return that her

gross estate included $150,000 of principal Advance Leasing owed
on its notes to H & R Properties and GRH Trust, entities owned by
decedent, but did not include $21,782 of interest Advance Leasing
owed on those notes as of July 25, 1999, decedent's date of
death.

Also on that return, decedent's estate deducted $400,000

as a claim against the estate based on the $400,000 promissory
note.

Decedent's estate reported on that return that the stock of
Advance Leasing had no value on decedent's date of death because

liabilities exceeded the fair market value of assets.
signed the return for decedent's estate.

McBride

- 10 OPINION

A.

Whether $400,000 Is Deductible Under Section 6653(a)(1) as a
Claim Against Decedent's Gross Estate Based on the $400,000
Promissory Note
1.

Deductibility of Claims Against an Estate

Tax may be imposed on the transfer of the taxable estate of

every decedent who is a citizen or resident of the United States.
Sec. 2001(a).

The decedent's taxable estate is the value of the

decedent's gróss estate reduced by various deductions.

2051.

Sec.

One of those deductions is for claims against the estate

that are enforceable under State law.

Sec. 2053(a)(3); Propstra

v. United States, 680 F.2d 1248, 1254-1255

(9th Cir. 1982).

An estate may deduct the value of a claim based on a
decedent's promise to pay only if the liability was contracted
bona fide and for full and adequate consideration in money or
money's worth.
Commissioner,

Sec. 2053(c)(1)(A); Estate of Scholl v.
88 T.C.

1265,

1279

(1987); Estate of Davis v.

Commissioner, 57 T.C. 833, 835 (1972).

This requirement prevents

an individual from reducing her or his taxable estate through
transactions that are in substance gifts.
Porter,

92 F.2d 426, 428

(2d Cir.

Commissioner v.

1937), affg. 34 B.T.A.

798

(1936).

2.

The Estate's Contentions

The estate contends that the estate may deduct $400,000 on
the basis of its obligation to pay the·promissory note.

The

- 11 -

estate contends that the note was the result of a bona fide
contract for full and adequate consideration in money or money's
worth as required under section 2053(c)(1)(A).

The estate also

contends that decedent received full and adequate consideration
for her promise to pay Advance Leasing $400,000 because she
received 4,000 shares of stock in a corporation that appeared
ready to become profitable.
The estate argues that by April 29,

had experienced a dramatic turnaround.

1997, Advance Leasing

The estate points out

that, in contrast to its losses for 1994, 1995, and 1996, Advance
Leasing reported $29,663 of taxable income before net operating
loss deductions on its 1997 income tax return.
3.

Whether Decedent Received Full and Adequate
Consideration for the Stock Subscription Agreement

We first decide whether decedent's receipt of 4,000 shares
of Advance Leasing stock on April 29, 1997, was full and adequate
consideration for her agreement to pay $400,000 to Advance
Leasing under the stock subscription agreement.6
The estate contends the 4,000 shares of stock were adequate
consideration because Advance Leasing's financial situation

improved dramatically from 1996 to 1997.

Advance Leasing

reported $29,663 of taxable income before net operating loss

6 The estate contends that the burden of proof in this case
is shifted to respondent under sec. 7491(a).
We need not decide
that issue because we decide this case on the basis of the
preponderance of evidence without regard to the burden of proof.

- 12 -

deductions on its 1997 income tax return.

However, that return

is not consistent with its financial statements, which show a net

loss of $20,875 before net operating losses are considered.
The estate contends the funds from the stock subscription
agreement reduced Advance Leasing's debt obligations, made the
balance sheet cleaner, and made it easier for the company to
secure outside financing.

Despite this claim, Advance Leasing

did not receive the funds until after decedent died.
Advance Leasing's financial situation remained poor on April
29, 1997.

James McBride (an attorney for Advance Leasing and the

brother of McBride) testified that Advance Leasing and its
business had negligible, if any, value when the stock
subscription agreement was entered into on April 29, 1997.

James

McBride advised his brother regarding the stock subscription

transaction, and he drafted the stock subscription agreement and
the $400,000 promissory note.

James McBride stated that it would

have been futile for HELP to demand full payment by Advance
Leasing because Advance Leasing lacked the ability to repay the
more than $864,000 it owed to HELP at the end of 1996.

James

McBride testified that HELP wanted Advance Leasing to survive in

the hope that it would generate income and repay its debt to
HELP.

James McBride's testimony is corroborated by the estate tax
return for the Estate of Bob Hughes and the Advance Leasing

- 13 -

financial statements.

According to the estate tax return for the

Estate of Bob Hughes, the stock of Advance Leasing had a fair
market value of zero as of April 10, 1996.
net losses of $66,672 for 1994,

1996.

Advance Leasing had

$50,995 for 1995, and $40,526 for

Even taking into account decedent's $400,000 note, Advance

Leasing had a negative total net worth of $22,110 at the end of
1997 and $23,356 at the end of 1998.7

Advance Leasing used the entire $400,000 it received in 1999

from decedent to repay some of the more than $900,000 it then
owed to HELP.

Thus, the $400,000 payment to HELP directly

benefited decedent's children and grandchildren.

-

We do not believe that the value of Advance Leasing's stock
increased from zero on April 10, 1996

(as reported on the estate

tax return for Bob Hughes which McBride signed) to $400,.000 on
April 29, 1997, and then fell to zero on July 25, 1999 (the date
decedent died, as reported on decedent's estate tax return also
signed by McBride).

We conclude that the 4,000 shares issued to

decedent had little or no value when McBride signed the stock

subscription agreement on April 29, 1997.8

Thus, decedent did not

receive full and adequate consideration as required by section

As discussed supra, Advance Leasing's 1997 and 1998
financial statements did not reflect the additional 4,000 shares
issued to decedent and the $400,000 stock subscription agreement
note payable to Advance Leasing.

8 Neither party offered expert testimony on the value of
Advance Leasing stock on Apr. 29, 1997.

- 14 -

2053(c)(1) (A) for the $400,000 she agreed to pay Advance Leasing
in exchange for the 4,000 additional shares.
4.

Whether the Stock Subscription Transaction Was
Contracted Bona Fide

The estate contends that the $400,000 stock subscription
agreement (the agreement to pay $400,000 in exchange for 4,000
shares of Advance Leasing common stock) was contracted bona fide.
We disagree.
"Contracted bona fide" means made in good faith and
bargained for at arm's length.

Secs. 20.2043-1(a), 20.2053-4,

Estate Tax Regs.; see Bank of New York v. United States, 526 F.2d
1012,

1015

T.C.

408,

(3d Cir.
418

1975); Estate of Morse v. Commissioner,

(1997), affd.

625 F.2d 133

(6th Cir.

1980).

69
When

family members adopt a course of action with the intent to pass
on wealth, a deduction for the amount transferred is.not

permitted under section 2053 unless there was a bargained-for
exchange.

Estate of Huntington v. Commissioner, 16 F.3d 462, 467

(1st Cir.

1994), affg.

100 T.C.

313

(1993).

McBride was

decedent's attorney in fact and Advance Leasing's sole director
and officer; thus, he was on both sides of the stock subscription
transaction.
scrutiny.

That transaction must be subjected to enhanced

See Bank of New York v. United States,

1017; Estate of Woody v. Commissioner, 36 T.C.

supra at 1016-

900,

903

(1961).

·The estate contends that the stock subscription agreement

was bona fide because:

(1) Decedent wanted Advance Leasing to

- 15 -

continue to operate so that Billy Hughes would have a place to

work;

(2) McBride conducted business in the same way that Bob

Hughes did;

(3) owners of small businesses typically operate

other than at arm's length; and (4) James McBride advised McBride

about fiduciary obligations.
Those points do not convince us that the stock subscription
agreement was bona fide.

McBride's engaging in conduct similar

to that of Bob Hughes does not show that the stock subscription
agreement was at arm's length or bona fide without a showing that
Bob Hughes always acted at arm's length when dealing with his
related entities.

In addition, whether or not the related

entities dealt with each other at arm's length, section

2053(c)(1)(A) provides that the estate is not allowed a deduction
in this case unless the claim against the estate was contracted
bona fide and for adequate and full consideration.

We have no

reason to question McBride's intent to act properly or the
quality of the legal advice he received; however, that does not
determine whether the stock subscription was at arm's length.
The following facts show that the stock subscription

agreement, made on April 29, 1997, was not bona fide:

(1) The

terms of the stock subscription agreement were not negotiated at

arm's length;

(2) Advance Leasing's business was not appraised,

and Advance Leasing had annual net losses and a negative net
worth in 1996,

1997, and 1998 both before and after the April 29,

- 16 -

1997, stock subscription transaction;

(3) the 4,000 shares and

the $400,000 demand note payable to Advance Leasing were not

reflected on Advance Leasing's 1997 and 1998 financial statements
or on its 1997 and 1998 tax returns;

(4) Advance Leasing's

bookkeeper and its certified public accountant did not know about

the stock subscription agreement and the $400,000 note payable,
and (5) Advance Leasing and McBride (its sole officer and

director) did not demand payment of the $400,000 before August
20,

1999.

After decedent died, Advance Leasing received and used the
proceeds to repay $400,000.to HELP, the family partnership in
which certain children and grandchildren of decedent and
decedent's husband collectively held a 99.419-percent interest.
Considering all the circumstances, we conclude that the stock
subscription agreement was a substitute for a testamentary

disposition to decedent's children and grandchildren.'

9 The estate contends that we should not treat the $400,000
payment as a testamentary disposition because, if decedent had so
intended, she could have reduced her estate by $140,000 per year
by giving $10,000 to each of her 14 children and grandchildren
each year.
Regardless of how decedent might have done things
differently, we evaluate the facts before us.
See Commissioner
v. Natl. Alfalfa Dehydrating & Milling Co., 417 U.S; 134, 148-149
(1974).

- 17 -

5.

Conclusion

We conclude that the estate may not deduct $400,000 from
decedent's gross estate as a claim against her estate under
section 2053(a)(3) based on the $400,000 promissory note.¹°

B.

Whether Decedent's Gross Estate Includes $21,782 of Accrued
Interest Owed by Advance Leasing on Certain Notes
Decedent's estate included in the gross estate $150,000

representing the principal amount that Advance Leasing owed on
its notes to H & R Properties and the Trust.

However, the estate

042
did not include in the gross estate $21,782 representing accrued
interest that Advance Leasing owed on those notes when decedent
died.¹¹
The gross estate includes the value, at the time of death,

of all property in which decedent had an interest.
2031(a), 2033.

Secs.

The $21,872 of accrued interest is included in

decedent's gross estate to the extent that it had value at the
time of her death.

See secs.

2031(a),

2033.

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

¹° In light of this holding, we need not decide
respondent's other arguments that the note was not bona fide or
enforceable against decedent's estate under Washington law or
that decedent lacked competence to execute the power of attorney.
¹¹ The estate did not elect the alternate valuation date
under sec. 2032.

- 18 having reasonable knowledge of relevant facts.'"
v. Cartwright, 411 U.S.

546,

551

20.2031-1(b), Estate Tax Regs.).

(1973)

United States

(quoting section

The fair market value of a note

is generally the amount of the unpaid principal, plus interest
accrued to the date of a decedent's death, unless the executor
establishes that the value is lower or that the note is
worthless.

Sec. 20.2031-4, Estate Tax Regs.

The fair market

value of the accrued interest is the amount of unpaid accrued
interest as of the date of decedent's death unless the executor
establishes a lower value.

See id.

Respondent contends that decedent's estate includes $21,782
of accrued interest owed by Advance Leasing because:

(1) Advance

Leasing could have used the $400,000 to pay $21,782 of accrued
interest; or (2) decedent could have reduced the $400,000 owed
under the stock subscription agreement note against the $21,782.
We disagree.

We believe that the fair market value of the

accrued interest is zero because:

(1) Advance Leasing was

insolvent;12 and (2) we do not believe that a willing buyer with
knowledge of Advance Leasing's financial situation would pay any
amount for the $21,872 of accrued interest owed by Advance
Leasing.

We conclude that the $21,782 of accrued interest had no

¹² Respondent acknowledges that Advance Leasing was
insolvent and that its liabilities exceeded its assets during
1999.

-

19

-

value on the date of decedent's death and is not included in her
gross estate.
To reflect the foregoing,
Decision will be
entered under Rule 155.

---

Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A0bf648df776ce30b. Public record. Not legal advice.