UNITED STATES TAX COURT
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STAT.
T.C. Memo.
008-278
FIJJs
UNITED STATES TAX COURT
ESTATE OF THELMA G. HURFORD, DECEASED,. DONØR, G. MICHAEL HURFORD,
INDEPENDENT EXECUTOR, Petitioner 'v .
COMMISSIONER OF INTERNA REVENUE, Resp'ondent
ESTATE OF THELMA G. HURFORD, -DECEASED, G. MICHAEL HURFORD,
INDEPENDENT EXECUTOR, Petitioner _v.
COMMISSIONER OF INTERNA REVENUE, Respondent
Docket Nos.
23954 04,
23964-0
042
Filed December 11,
2008.
William A. Roberts and Kyle Coleman, for petitioners.
Nancy B. Herbert, Richard J. Hassebrock, and Gary R. Shuler,
f or re spondent .
MRVED
11 MS
- 2 CONTENTS
FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
A.
The Hurford Family ...............................
E.
Execution of Garza's Plan - Phase I...............
1. Transfers to HI-1. . . . . . . . . . . . . . . . . . . . . . . . . . . .
2. Transfers to HI-2............................
3. Transfers to HI-3. . . . . . . . . . . . . . . . . . . . . . . . . . . .
B.
C.
D.
F.
3
3
Gary's Death. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Thelma's Diagnosis................................
Garza's Plan......................................
6
11
13
Execution of Garza' s Plan - Phase II . . . . . . . . . . . . .
28
1.
Value of the FLP Property. . . . . . . . . . . . . . . . . . . .
a. HI-l's Value............................
b.
c.
d.
HI-2's Value............................
HI-3's Value. . . . . . . . . . . . . . . . . . . . . . . . . . . .
Discounts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
16
19
25
27
28
29
30
31
31
2.
Creation of the Private Annuity. . . . . . . . . .«. . . .
3 . How the Hurford Private Annuity Worked. . . . . . .
Thelma Hurf ord' s Death and Tax Returns . . . . . . . . . . .
Estate and Gif t . Tax Returns ' Audit . . . . . . . . . . . . . . .
33
34
36
43
OPINION . . . . . . . . . . . . . . . .;. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
45
I.
What is .Includable in Thelma' s Estate? . . . . . . . . . . . . . . . .
45
A.
47
48
G.
H.
B.
Positions of the Parties.........................
The Private Annuity and the FLPs . . . . . . . . . . . . . . . . .
1.
Was the Private Annuity Effective to Remove
Assets from Thelma' s. Estate?
a.
b.
2.
. .-. . . . . . . . . . .
Was the Transfer of Thelma's Interest in
the FLPs for the Private Annuity Bona Fide
and for Adequate.and Full Consideration?.
Did Thelma Retain a Prohibited Interest
in the Property She Transferred to Her
children through the Private Annuity? . . .
Were the FLPs Valid?. . . . . . . . . . . . ... . . . . . . . . . .
a.
b.
Was the Creation of the FLPs Bona Fide and
for Adequate and Full Consideration? . . . . .
Did Thelma Retain the Possession or
Enjoyment of, or the Right to the Income
From, the Property She Transferred to the
52
58
61
61
The Family and Marital Trusts....................
Gif ts Thelma Made in February 2000 . . . . . . . . . . . . . . .
72
75
78
Attorney' s Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
· 78
FLPs in Violation of Section 2036
C.
D.
II .
52
(a) (1)?.
III. Negligence. . . . . . .,. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ..
MEMORANDUM FINDINGS O
HOLMES, Judge:
80
FACT AND OPINION
It is a truth universally acknowledged, that
a recently widowed woman in posses ion of a good fortune must-be
in want of an estate planner.
Thelma Hurford had devoted he
life to family and friends,
leaving the management of the .fina ces to her husband Gary.
When
he died suddenly, she had to learn what they owned and decide
what to do with.it.
While she str ggled -with this burden, she
was herself stricken with cancer and so had to arrange the
accelerated planning of her own estate.
Two attorneys vied for
her attention and she chose Joe B. Garza.
She lost her life to the cancer.
We must now decide how
much of! her estate will be lost" to taxes .
FINDINGS
A.
F FACT
The Hurford Family
Gary T.. Hurfòrd was born in W st Texas in unpromising
circumstances and went at a young
ge to work on oil rigs .
he met a petroleum e ginee
lean clothes and new car
whose
There
suggested to young Gary that education might lead to a better
life .
He soon gave up roughneck
University of Texas.
and enrolled at the
He discovered there that he had an aptitude
for engineering, and after gradua ion he was hired by the Hunt
Oil Company.
He rose steadily and after 25. years became the
company's first president not named Hunt.
He prospered and grew
rich.
Thelma also came from a modest background, the daughter of
immigrants .
She was an elementary school teacher when she met
Gary and they soon wed.
In due course, she became a mother and
devoted herself to working inside the home.
Much·of this work lay in rearing three children; all of whom
are now married with children of their own.
Michael Hurford, known as Michael.
The oldest is Gary
Michael grew up in Texas,
went to the University of Texas at Austin, and then to medical
school in San Antonio.
He became a psychiatrist and practices in
Kentucky, where he also was a resident when the petition was
filed.
David T. Hurford is the middle child.
David graduated from
Southwest Texas State University, but has struggled with
difficult personal problems, some of them severe, for much of his
life.
His parents and his siblings acknowledged this and have
tried to protect him, particularly in his finances.
While his
parents were alive, David stayed close by and worked for many
years on one of his dad's ranches--raising and selling cattle,
fixing fences, and cutting and baling hay.
The youngest Hurford is Michelle Hurford McCandless.
Michelle also graduated from the University of Texas at Austin,
andt shevworked in advertising until Octobêr of 1997, when Gary
hired her to help with the family s bookkeeping--especially the
preparation of the payroll for the eiïiployees whom Gary'hired to
work on the farms and ranches that he had bought over the years.
Michelle also kept the books for a 1 her parents' investments and
bank. accounts.
Michelle, out of duty and habit, took notes on nearly every
meeting! she attended and every phone3call she listened to that
involved Gary' s and The lma' s e s tate s .
She
uld al so
meticulously list the questions thä.t she planned to ask during
those meetings and calls.
It appears that she learned these
habits from her mother, who also kÈpt in her own planner detailed
notes of seemingly every meeting she had.
Michelle saved all
these notes and turned them over to the Commissioner during
discovery.
We view Michelle's action as a strong indicator of
her honesty and have used these notes extensively to reconstruct
what happened after Gary died.
But we use them with some caution.
They show a general lack
of undeirstanding--even some confusion--about the tax and estate-
planning concepts at .issue in this case. . This is entirely
understandable,
since neither Mich lle nor her mother had an
education in law or adcounting.
E t the confusion of Michelle.
and her siblings about these concepts, though it may have been
rooted in their inherent dif f icul
, was surely compounded by the
barrage of professional advice they both sought and had directed
against them.
B.
Gary's Death
On April 8, 1999, Gary died... He and Thelma had amassed a
considerable fortune as listed on Gary's estate tax return:1
Real estate
$2,020,800
Stocks and bonds
2,096/314
Mortgages,. notes, and cash.
.934,413
Life insurance
2,300,000
Miscellaneous property
1,342,880
Hunt oil phantom stock
5,552,377
Total
14,246,784
The real estate included farms and ranches, as well as two
houses:
their primary home in Arlington, Texas; and a second
home in Tyler that was closer to their agricultural property.
This agricultural property amounted to about 2000 acres divided
into 11 or 15 parcels--those records only sometimes combine those
parcels that were contiguous.
The stocks and bonds and other liquid investments were
strewn among many different accounts at several banks.
A large
chunk was in options to buy stock in Nabors Corporation Services,
Inc., which Gary had earned by serving on the Nabors board of
directors.
Another large chunk (by far the largest piece of the
1 Texas is a community-property state, and these numbers
reflect their total wealth, not just Gary's interest.
miscellaneouss property listed above) was $1.26 million in Gary's
Hunt Oil: retirement plah, which: Thelma rollediover to. an IRA un.
her name after his death.
But the single biggest asset in Gary and Thelma's .estate
was no ordinary.security. or ret ire ent plan, but something called
Hunt Oi L phäntom stock.4. This phant om stiock is not aátually
stock, but instead. a form of defer ed compensation ^that Hunt Oil
gave to employees--letting them sh re in the conípany's· growth
without the Hunt family's having
dil te their own equity.
Each ."share" of phantom stock was
lued at approximately the
price of a share of Hunt Oil commor stock,. as fixed by Hunt Oil
each year on December 31.
The dollar amount reported on Gary' s
estate tax return was its value on December 31,
Gary rece ved more from Hunt
these varied formã.
1998.
il than just compensation in
Among the perks imØortánt to this case were
tÃx-preparation and estate-planning services.
While Gary was
working,' Hunt Oil paid KPMG to pi'epare his 'tax returns; and Gary
retained Santo "Sandy" Bi'hignano, formårly a partner in the
respected Texas law firm of.Johnson & Gibbs, to plan his and
Thelma's estates.
The troubles that later entangl d the Hurfords
had.their roots in the wills that Bisignano had drafted for them
in 1993.
These wills were mirror images of each othef hrId^ took a
conservative ,approach to estate plánning.
This was Gary s
choicel-Bisignáno had suggest ed sl: ghtly more àggressivs
techniques such as irrevocable life insurance trusts (ILITs) ,
grantor-retained annuity trusts
partnerships (FLPs).2
(GRATs) , and family limited
Gary instead chose to divide most of his
estate into two trusts--a bypass trust and a qualified terminable
interest property (QTIP) trust.
According to the Hurfords'
wills, the property of whichever spouse died first would go into
the two trusts, with the exception of the Arlington home and any
personal effects, which would pass directly to the surviving
spouse .
The first trust set up in Gary's will was a bypass trust,
called the "Family Trust."
It was funded with $650,000, the
estate-tax-credit equivalent amount.3
The Family Trust's
.
2 An ILIT may remove life insurance proceeds from a
decedent's estate by transferring ownership of the policy to a
trust. Bittker, et al., Federal Estate and Gift Taxation 371
(9th ed.. 2005).
A GRAT is a tax-saving device in which a grantor transfers
assets into trust and retains an annuity payablë for a specified
term.
If the grantor survives the term and the assets enjoy a
higher rate of return than specified in tables prescribed by the
IRS, the "extra" appreciation passes to the trust' s beneficiaries
without incurring gift or estate tax.
Id. at 80-81.
A FLP allows members of a family to transfer partnership
interests to one another at a discount (usually claimed for lack
of marketability and lack of control) , which may reduce the tax
that they might otherwise owe on the transaction.
Id. at 136-37,
600-02.
3 This is the amount that could pass estate-tax free (thus
the description "bypass trust") to nonspouse beneficiaries in
1999.
Thelma's access to its assets was limited, but any money
remaining in the trust would not be taxed at her death.
immediate purpose was to provide for the education, health,
maintenance, or support of Thelma,
mother.
heir children, and Gary' s
But its ultimate purpose w s to shield from taxation at
Thelma' s death the original. Corpus of $650, 000
(or whatever' was
left after distributions) .
The rest of Gary' s estate went into a second trust called
the "Marital Trust."
paid to Thelma.
Income from the Marital Trust was to be
And* the principal was also available to her for
her education, health, maintenance, and support.
Gary' s will appointed Thelma executor of hisf estate 'and
trustee of both the Family and Marital Trusts .
Managing Gary' s
estate as .well as: her half of the marital. property was a
challenge for Thelma because Gary 1ad long tended» their finances
alone.
Thelma's children were similarly unfamiliar with how to
manage such a large estate,
so the
the advice of several professional .
banded together and sought
Advice from Bisignano and
KPMG was no longer free, because Hûnt Oil stopped paying their
bills after Gary died.
But BiÅignano and I{PMG at first remained
members of the Hurfords' team, and it was at Bisignano's
suggestion that they hired Chase Bank of Texas, N.A., to provide
investment advice.
Bisignano outlined for Thelma a plan to sett le GÅry' s
estate .
The first step ùas probating Gary' s will, which
Bisignano quickly began by April 15, 1999.
He then moved on to
- 10 -
identifying and valuing the assets..
This ended up taking a
while, but Bisignano credibly testified that his progress was
protracted by design, lest an inaccurate valuation of those
assets undermine his effort to accurately calculate--before he
prepared the tax return for Gary's estate--whether a QTIP
election was more valuable to Thelma than a credit for prior
transfers.4
As spring turned to summer in 1999, Thelma sought
Bisignano's advice on her own estate plan.
Bisignano again,took
a conservative and thoughtful approach, recommending that she
first make $225,000 gifts to Michael, David, and Michelle.
The
total of $675,000 in gifts equaled the'gift-tax exemption
amount.'
She decided to make these gifts·in February 2000.
He
4 Property passing from a deceased husband to his surviving
wife generally is deductible from his gross estate. Sec.
2056(a).
But this.deduction does not include property--for
example, a life estate with remainder to children--in which the
surviving spouse has an interest that could fail due to the lapse
of time or some other contingency.
Sec. 2056(b) (1).
Section
2056(b) (7) (A) creates an exception to this exception for .
qualified terminable interest property, treating it deductible at
the first spouse's death, but includable in the surviving
spouse's estate.
(The section references in this note and
throughout the opinion are to the Internal Revenue Code. Any
Rule references are to the Tax Court's Rules of Practice and
Procedure.)
' Federal gift and estate-tax law allows a credit which a
person can use either to reduce the tax on gifts made while the
donor is alive (under sections 2505(a) and 2503(b) (2)) or against
the estate tax imposed at death (under section 2010 (c)).
Thelma
used the credit amount available during 2000, which was $25,000
higher than the credit available to her husband in 1999, when his
(continued...)
_:11.
-
also. recommended thati she create a family limited partnership
(FLP) into which she coùld transfer the farm and ranch
properties, unifying:the land management within a single entity,
perhaps with the plausible purpose of reducing the risk of
liabïlity from. what:.were then actual operating businesses.
.
Bisignario later recommended a second FLP to hold Thelma s own
financial assets.
In August, Thelma also rolled Gary's
retiremepnt assets ihto an IRA in her own name.
Thelma, however, had little desire . to run the farms and
ranches"herselfuso Bisignano began drafting leases for those 042
properties, starting~ with a parcel in Navarro Countyt, dand5then
moving ón to#all the properties in
allas and Ellis counties .
And thot;tgh Thelma continued tio empl y her son David to work on a
ranch in Anderson-County until the
8
nd of January 2000, .even her
direct ·ìnvolvement in that. business ended when David received-his
$225,000 gift, which included a one-yèar lease for 754 .acres.' .
C.
Thel;ma' s Diagnosis
At the beginning of 2000, Thelma began. feeling back pain,
which became so severe that on
anuary 23 she went to an
5 (. . . continued)
death led. to the creation of the $650, 000 Family Trust.
lVfichael got flis $225, 000 in cash.
David got $133,134 in
cash and $91,866 in farm equipment, cattle, and lea 541es.
And
Michelle got $177, 386 in cash and the cancellation of a loan in
the amount of $47 , 164 .
Thelma alsd niade 'eight $10 , 0 0 0 cash gi f ts
in 2000 to her sisters, children, and daughters- and son-in-law.
.
- 12 -
emergency room.
The diagnosis was cancer, and Thelma decided to
have surgery in February 2000 .
Her surgeon classified her disease as being already at stage
three because it had already spread beyond its initial site to
the surface of her liver.
Surgery could not cure the disease,
but it did succeed in . reducing the cancer' s size, and Thelma
began chemotherapy immediately.
Near the end of January 2000, Bisignano had begun.to move
forward with Thelma's estate plan.
He started drafting documents
to create two.FLPs, one for the farm and ranch properties and
another for Thelma's cash and investment assets.
But by early
February, while Bisignano was still working on the FLPs, Michael
was already looking for a new attorney.
Thelma had become
dissatisfied with Bisignano, because (according to Michael) he
did not relate well to the family and would often speak over
their heads.
Thelma was also concerned that he was not
completing Gary' s estate tax return or her own estate plan
quickly enough and worried that he was. too expensive.
Michael
volunteered to take the lead in trying. to find a replacement for
Bisignano, but living in Louisville made this mission difficult
and he turned to his brother-in-law, an orthopedic surgeon living
near Houston," for advice.
This brother-in-law recommended Joe Garza.
Michael and
Michelle s'poke with him, asking Garza to critique Bisignano' s
- 13
proposed estate plan and make suggestions on what "he would ·do
differently
Their infatuatiòn with Garza Ñas understañdable.
.
We obsekved Bisignanò^ tò be' reserved and fastidious, and proud òf
the high quality of his workk but w1th a>mannèr that-on fi st
appearance is perhaps not the most anviting
Garza, in contrast,
is a model sof 'the amiable and pleasing man; and his :debut in the
notes :ofi Thelmá's meetings~with him show that she thought him one
of the. thost agreeable men (or, at least, lawyers) that she had
ever met .
Gar za ~ swif·tlyl persuaded
helma that his- es tate plan
was better for.her than Bisignano's and-she hired him on February
22,' 2000.
D.
Thelma dismissed Bisignano the very next day.
Garzals Plan
AcCording to Garzá, a "brilliant estate-planning strategy"
i*s one "that saves estate tax."
Thelma's, the Marital Trust's
three . groups:
(1)
cash,
His plant was to separate
and the Fainily Trust's assets into
stocks,
d bonds; 3 (2)
the Hunt Oil
phantom; stock; and (3 ) the f arm and ranch 'propert.ies .
Then; he
created three FLPs, one to rece1ve each group of assets? giúing
an interest' in each to' Thelma, 1Gar ' s. estateç Michael, David, and
Michelle .
Finally, Garza directed Thelma to sell her and'Gary' s
estate' s interests in each FLP to Michael
David
through a private annuitÿ agreement .
-
and Michelle
To understand Garza's plan,..we need tò step back.and explain
a bit about- FLPs and private annui ïes.
A FLPi uses two. entities:
.
- 14 -
a limited partnership and either..a limited liability company
(LLC) or a trust.
The LLC or trust serves as the general partner
of the limited partnership and thereby assumes any extraordinary
liabilities associated with the property owned by the
partnership.
The limited partners of the partnership are
typically family members who contribute something of value,'
either in goods or in services, to the partnership.in exchange
for their ownership share.
Once the partnership interests are
created, they are quickly rearranged by gift or will.
The first obstacle that an aggressive. planner meets is the
Code's insistence that property transferred either by will or by
gift must be taxed at its fair market value.
2032,
2512 and 25.2512-1, Gift Tax Regs.
See.secs. 2031,
A planner using a FLP
has to make sure that it is»not the assets in the partnership
that are being transferred among.family members, but only
interests in the partnership itself.
This is important because
due to factors such as lack of marketability and control, a
partner's interest in the partnership often has a lower fair
market value than the same partner's pro rata share of the
assets' own fair market value.
T.C.
12,
14,
19
See Holman v. Commissioner, 130
(2008); Senda v. Commissioner,
T.C. Memo.
2004-
160 (imposing a gift tax on the value of stock contributed to a
partnership rather than the transferred partnership interests
where partnership formalities were not respected), affd. 433 F.3d
- 15
1044
(8 h Cir
2006) . - This would
eem unusual--normal people
typically .don't, try to reciüce the
aîue of .their'hard-earned
wealth.
042
Like -FLPs,' private annuit-ies
planning tool.
re another còmmon estate-
A private annuity is a transfer of property from
one person to another in exchange for a þromise to make
p.ayments.
>eriodic
These'paymënts* can last for the rest of the
transferor's. life,-and the .IRS allows drafters. of private
annuities to calculate the transferor's life expectancy using
government-published actuarial tables.
In theory, the value of
the periodic-payment stream equals the value.of the transferred
property, so the private- annuity removes the transferred property
from the transferor s estate andigives-the transferee any
appreciation in the transferred property's value.
The usually
unspoken usefulness of this device is greatest when'those
arranging it know more about the particulars of their 'situation
7 Courts, including ,the circuit court to which this case may
be appealable, have nevertheless r cbgnized that such a reduction
in immediately realizable faïr mar et value might be sensible for
a ratioñal actor willing to pay fo the benefits bf management
expertise, preservat-ion of. assets,
nd avoidance of personal
liabilitpy.
Estate sðf Kimbell, 371
.3d át 257, 266.
And such
calcula$ions may also be seen in earlier forms of intergenerational wealth transfer.
See Völsunga Saga: the. Story of the
Volsungs and Niblungs 5-8,
11-123 .36-39,
50-51,
59; 64-67
(H.
Halliday Sparling ed. , Eirikr- Magnusson & William Morris trans . ,
Walter Scott Publg . Co. , Ltd. 1888) (bequeathing shards of . sword
to heir who reforges them into.new sword after waiting period,
noting "Fain .would' we keep all our wealth till thát day of
days" ) .
- 16 -
than is reflected in the actuarial tables or--to be blunt--when
children think their parent won't survive for very long.
Anticipating this, the Secretary has long had regulations
restricting use of the actuarial tables in cases of terminal
illness.8
E.
. Execution of Garza's Plan - Phase I
.
Garza got to work setting up the FLPs immediately after. he
was hired.
He first organized three limited partnerships and
three LLCs .
He named the LLCs Hurf ord Management No . 1, LLC (HM-
1) ;
Hurford Management No. 2, LLC (HM-2) ; and Hurford Management
No. 3, LLC (HM-3) .
For each LLC he filed a certificate of
organization and articles of organization with the secretary of
state of Texas on February 24, 2000.
He then prepared stock
certificates, regulations, employment,agreements, and minutes of
the organizational meetings.
Each of the Hurfords received a
one-fourth interest in each LLC.
The Hurfords held an
organizational meeting for each of the LLCs and elected Thelma
president, Michelle secretary and treasurer, and Michael and
David vice presidents.
According to the employment agreements,
each of the Hurfords was to receive compensation for serving as
8 The regulations define terminal illness to be an
"incurable illness or other deteriorating physical condition"
with at least a fifty-percent chance of death within a year.
See
sec . 1. 7520 -3 (b) ( 540)
, Income Tax Regs .
In such cases , the parties
to a private annuity must use the. transferor's actual life
expectancy to calculate payments . .Sec . 1. 7520 -3 (b) (4 ) , Example,
Income Tax Regs.
- 17
an officer, but these agreements -we:te never signed or used.
.And
no one signed the stock certifibaten, regulations, or
organizational minutes either.
To form ·the limited partnerships, Garza filed certificates
of limited partnership with the Texas seár tàry of state on
February 24, 2000.
He named these limited partnerships Hurford
Investments No. 1, LTD.
(HI-1) ; Hur: ord Investments No. 2,. LTD.
(HI-2)| |and Hurford Investments No.
3, LTD
(HI-3) .
On each
certificate, Garza named ,as general partner the LLC whose name
corresponded to the name of the partnership, e.g., HM 1 and HI-1.
Garza completed organizing the FLPs ons March 20, 2000, by having
the Hurfords sign agreements of limited partnership.
These
agreements show an unsteady draf ting ability to even an untrained
eye--a täble of contents pointing to incorrect page numbers, a
grant of a límited-parthership interest to the "Gary T. Hurford
Trust" When no such trust existed at the time, and signature
páges showing HM-1 as the general partner of all three
partnerships .
We find, howe er
that Garzafat 1 ast intend d to use the
same organizational structure for each of the FLPs, as shown by
the following diagram :where x = 1, 2, or 3:
- 18 -
Limited Partners
Gary T.
Thelma
Hurford
48%
Trust
48%
Michael
David
Michelle
1%
1%
1%
FLP
Hurford
Investments
No. X,
LTD
General Partner
Hurford
Management
No. X, LLC
1%
Members
Thelma
1000 Shares
Michael
1000 Sharès
Michelle
1000 Shares
David
1000 Shares
An unusual feature of Garza' s plan was that he created the
limited partnership interests before the partnerships were
funded2.
He testified that he did t his to avoid gift taxes when
+Iichael, David, and Michelle creceiýed their 1-percent interests.
Garza reasoned that by creating thë partnership interests first,
each partner would start with a zero balance in his capital
account and each capital account would .remain at rzero until that
partner made a contribution. . So when Thelma and Gary' s estate
funded the partnership, their.. capitial accounts were to have
increasted by the amourit' each contr buted.
Conversely, Michael,
David, and Michelle did .not contri ute anything to the
partnerships, so they held a 1-percent interèst in each
partnership but had capital account balances of zero.
1.
Transfers to HI-1
The Hurfords , created HI-1 to
eceive stock and cash assets
from Thelma, the Marital Trust, and the Fämily Trust.
To move
these assets into HI-1, Thelma sigr ed an undated letter drafted
by Garza.
Garza based this letter on a form that he used to fund
the FLPs, but he didn't customize it beyond,the names of the
accounts and the people arid e tities involved.
Irí the 1 tter,
Thelma asked Chase to . '.'transfer my above-referenced account with
you into the name of the Limited Partnership."
The accounts that
she listed were the Thelma G. Hurford Investment Management
Agency (THIMA),
the Marital Trust, and Family Trust accounts.
Thelma also requested. that . Chase ggi e 3herself, Michael; David,
and Michelle "signatory and withdra als authority" on the HI-1
'.
- 20 -
account.
At the end of March 2000, Thelma acting in-her capacity
as president of HM-1, signed an agreement with Chase to open the
accounts necessary to complete the transfers.
Chase then opened three accounts for HI-1, using.the same
names as the old accounts except that each was preceded by HI 1,
e.g.,..HI-1 THIMA.
Over the next three months, assets flowed into
the H-1 THIMA account:
Table 1: Transfers from THIMA to HI-1 THIMA
Date
·Amount
Originating Acct
Destination Acct
.HI-1 THIMA
4/12/00
$3,447,466 stocks
THIMA
4/13/00
$
471,949 cash
THIMA
HI-1.THIMA
5/01/00
$
(274,417)cash
HI-1 THIMA
THIMA ("to close
.
.
out")
6/27/00
$
273,275 stocks
THIMA
HI-1 THIMA
7/31/00
$
88,683 cash
THIMA
HI-1 THIMA
from house sale
7/31/00
$
1,561 cash
THIMA
HI-1 THIMA
10/2/00
$
351 cash
THIMA
HI-1 THIMA
1/31/01
$
1 cash
THIMA ("final
HI-1 THIMA
distribution")
Total
$3,720,741 stocks
$ 288,127 cash
THIMA
HI-1 THIMA
Thelma also set to work transferring the trusts' assets to
the new HI-1 accounts:
Tables 1 through 7, infra, shows the tax cost of the
stocks and bonds, not their fair market value on the transfer
date.
The parties did not remedy this peculiarity of Chase's
recordkeeping with summaries of the market price of those
securities on dates relevant to the case--for example, their
value on the. date Thelma signed the private annuity, or the dates
when payments under the annuity were made to her using those
securities.
.
- 21
Table 2: Tr'ansfers from the Marital Trust to HI-1 MT
Date
Amount
Originating Acct
Destination Acct
4/12/00
$
447,179 stocks
MT
HI-l MT
4 /13/00
$
72, 276 cash
MT
HI-1 ·MT
5/01/00
$
(1,198)cash
HI-1 1 T .
MT ("t-o close
out")
6/27/00
$
90 cash
MT
HI-1 MT
9/08/00
$
1 cash
MT
HI-1 MT
Total .
$
$
MT
HI-1 MT
.
447,179 stocks
71,169 cash
Table 3: Transfers from.·the "Family Trust to HI-1 FT
Date
Amount
Originating Acct
Destination Acct
HI-1 FT
4/12/00
$ . 570, 05"O stocks
FT
4/13/00
$
99,877 cash
FT
5/01/00
$
(6,098)cash
HI-1 FT
.
HI-1 FT
FT ("to close
out")
6/27/00
$
124 cash
FT
HI-1 FT
10/2/00
$
1 cash .
FT
HI-1 FT
Total
$
$
570, 050 stocks
93, 904 cash
FT
HI -1 FT
In late November or early Dece ber 2000, Thelma told Chase
to transfer over $1 million from thé Gary Hurford estate account
to HI-1.
Thelma's letter, however, did not specify into which
HI-1 account Chase should transfer t he funds .
Thelma' s request in a December 8,
2 00,
Chase acknowledged
fax that asked her to
sign an investment management agreement to complete the transfer.
- 22. -
After she signed the'agreement, Chase transferred the assets into
a new account named "Thelma G. Hurford, Executrix. of The Estate
of Gary T. Hurford, Deceased #1."
In February 2001, Chase
emptied this new estate account into the THIMA HI-1 account.
Thelma requested a liquidaticin of her IRA on December 28, 2000,
and asked that Chase transfer the funds from her IRA to HI-1.
Chase completed most of that transaction on December 28 and 29,
2000 .
These · various transfers can be understood bet ter in
tabular form:
Table 4: Transfers from GTH Estate Acct to GTH Estate Acct #1
Date
Amount
Originating Acct
Destination Acct
1.2/29/00
$1, 077, 934 stocks
GTH Estate
GTH Estate #1
1/03/01
$
GTH Estate
GTH Estate #1
Total
$1, 077, 934 stocks
$
4,364 cash
GTH Estate
GTH Estate #1
4, 364 cash
Table 5: Transfers from TGH's. IRA to HI-1 THIMA
Date
Amount
56, 063 cash
Originating Acct
Destination .Acct
TGH' s . IRA
HI-1 THIMA
HI -1 THIMA
12/28/00
$
12/29/00
$1, 092, 954 stocks
TGH' s IRA
3/15/01
$
TGH' s IRA
Total
$1, 092, 954 stocks
$
56,516 cash
453 cash
TGH' s IRA
.
HI-1 THIMA
HI -1 THIMA
Then in February 2001, Chase moved most of the assets in the
HI-1 MT, HI-1 FT, and Thelma G. Hurford, Executrix of The Estate
of Gary T. Hurford, Deceased #1 accounts into the HI-1 THIMA
account.
On the form Chase prepared to complete the transfer it
- 23 listed Thelma as the "Primary Clie
and/
"Beneficiary" for
the HI-1 MT account.
These last transfers are summarized in this table:
Table 6: Transfers from HI-1 MT, HI-1 FT,
.and GTH Estate Acct #1 to HI-1 THINA
Date
Amount
Originating Acct
Destination
2
.
Acct-
2/07/01
$
4, 574 cash
2/26/01
$
126, 534 bonds
HI
T
HI-1 THIMA
2/27/01
$
. 1,178 cash
HI-1 1 T
HI-1 THIMA
3/02/01
$
5 cash
HI-1 1
HI-1 THIMA
3/15/01
$
428, 763 stocks
HI-1 1 T
HIlí THIMA
Total
f rom
HI-1 .MT
$
$
$
428,763 stocks
12 6, 534 bonds
5,757 cash
HI-1
T
HI-1 TH1MA
2/07/01
$
10,873 cash
HI-1 FT
HI-1 THIMA
2/26/01
$
151,636 bonds.
HI-1 FT
HI-1 THIMA
2/27/01
$
1,164 cash
HI-1 FT
HIa1 THIMA
3/02/01
$
9 cash
HI-1 F
HI-1 THIMA
3/15/01
$
565 594 stocks
HI-1 F
HI-1 THIMA
Total
f rom
HI-1 FT
$.
$
$
565,594 stocks
151, 636 bonds
12,046 cash
HI-1 F
HI-1 THIMA
2/26/01
$1, 077, 934 stè>cks
GTH Es ate Acct- #1
HI-1 TH1MA
3/02/01
$
20 cash
GTH Estate Acct #1
HI-1 THIMA
3/15/01
$
225 cash
GTH Es ate Acct #1
HI-1 THIMA
4/06/01
$
63 cash
GTH Estate Acct #1
HI-1 THIMA
4/09/01
$
28 cash
GTH E
ate Adct #1
HI-1 THIMA
Total
$1,077,934 stocks
GTH Es ate Acct #1
HI-1 THIMA
from GTH
$
Estate
Acct #1
336 cash
HI-1 MT
042
HI-1 THIMA
.
- 24 -
The entire series of transfers is summed up in this diagram:
HI-1 Transfers
THIMA
HI-1 THIMA
TGH's
IRA .
Family
HI-1 Family
Trust
Trust
Marital
Trust
HI-1
Marital
Trust
GTH' s
Estate
Acct
.
).
GTH Estate
Acct No. 1
TGH Annuity
--
Acct
- 25
The Hurfords: acknowledge that there were problems with cthe
Chase HI÷l accounts .
The biggest
as .thst throughout the year .
before she died, Thelma remained thle'sole signatory on many of
these accounts, and kept pouring money 'and assets into them even
after they had supposedly been used to pay for the private
annuity.
The Hurford children blain that they tried on numerous
occasions to have Thelma' s name removed from the HI-1 accounts,
but were always unsuccessful.
Another serious problem was that
not all the transfers werefdeposits.90n April 14, 2000, just
days after she started moving money into 'the HI-1 accounts,
Thelma had Chase transfer $65,000*from "my Limitéd Partnership "#1
(TH) account . to the personal Chase [ hecking adcount] . "
Then a
few'days later,- ·she had Chase transfer $25,00û from "mydimited
Partnership #1 Account" to "myTBank ofs America checking account. "
Michelle credibly explained that Thelma s1gned these:transfers
because Chase was confused about who hÊd authörity under these
accounts, and that Thelma needed the money to make an estimated
tax payment .
There is no evidence
money benefited the HI-1 partnershi
2.
hat any of tlîis backwash of
itself in any way
Transfers to HI-2
The Hurfords created HI-2 tö receive the Hunt Oil phantoni
stock.
Garza preparedtanother of h s form letters to notify Hunt
Oil that Thelma wanted the phantom stock"moved to HI-2.
FRichard
Mashman, Hunt's transfer agent for,thebstock as well.as its vice
- 26 president and general counsel, received the letter on March 24,
2000, , and quickly sent Thelma a list of documents that he needed
before -he would okay the transfer:
1.
Letters testamentary identifying Thelma as
executrix;
2.
An excerpt from Gary's will identifying her
as the beneficiary;
3.
Documentation showing that the phantom stock
was transferred from Gary's estate to Thelma;
and
4.
An assignment from Thelma to HI-2.
Garza faxed Massman the letters testamentary in May, but then let
things slide--neither the Hurfords nor Garza communicated with
Massman again until that fall.
On October 20, 2000, Michael
called Massman to discuss the transfer of the phantom stock, and
Massman became concerned about Thelma's multiple roles as
beneficiary, executrix, and trustee.
To allay these concerns, he
asked Thelma for a letter stating that Thelma was approving the
transfer under all three roles.
As Massman himself credibly put
it, "we kind of operate on the bomb-throwing grandchild
principle"--meaning that he wanted to protect Hunt Oil from any
competing claims to the phantom stock.
This prompted Garza to send Massman an; indemnity letter on
November 18, 2000, but this letter was as sloppy as the other
paperwork he'd prepared, including a space on a signature line
for "Daniel" .instead of David.
Massman is a meticulous man, and
.
- 27
he wanted the alètter corrected.'
months to fïx his mistakes.
But it took Garza almost two
The second letter satisfied Massman,
though/ .and on January It5, 200L, M ssman responded with 'his own
letter stating that Hunt Oil recogni2ed HI-2'as the ownert of the
phantom'ÀÜock;
Even though Hunt di
necessary documents until Januar
not receive all the
2001
internal records that the transfer
it reported in its
ccurred on March 22, 2000,
the day Thelma' sent the first letter requesting the transfer.
3.
Transfers to HI-3
The Hurfords created HI-3 to receive the real property
(except for the houses 'in Arlington and Tyler) held by Thelma
the Marital Trust, and the Fathily T ust.
Toicomplete this chores,
Garza prepared twenty deeds for Thelma to sign.
We ' re not sure .
Why twenty?
We could not f igure out by examining the deeds
how eleven parcels (or fifteen, if. a couple contiguousï properties
were divided) had multiplied into t ehty i
patent piroblem with" the déeds .
There was also anothér
Gar a had draf tèd each deëd so
that it .conveyedsthe property to "Hu^rford No. 3,*Ltd." not
"Hurford Investments No. 3, LTD."
counties on March 23, 2000 ;
enough:
Garza'filed the deeds with the
But even twenty deeds were not
Garza failed to prepare ,a deed for a parcel that was in
both Ellis . and Dallas Counties . !
Garza waited until April 10.,
2002, and then mistakenly deeded th s parcel to "Hurford No. 3,
Ltd." too.
e
.
-
- 28 Thelma Hurford herself maintained the insurance policy on
the farm and ranch properties now lying (maybe) in HI 3.
The
Commissioner suggests that Thelma was paying for that insurance,
but the record is not clear.
We do find that she had a friendly
relationship with the insurance agent and spoke with him about
renewing the policy in July 2000.
We also find that Thelma's and.
Michelle's names remained on the Bank of America Farm Account
unti*l December 2000, when the account's name was finally changed
to "Hurford #3 DBA Hurford Farms."
F..
Execution of Garza's Plan - Phase II
Michael and Michelle took the next step in Garza's estate
plan and entered into a private annuity with Thelma on April 5,
2000, a bit more than two weeks after the FLPs had been formed,
but a week before even the first transfers of property from
Thelma and the Trusts to the FLPs.
Through.this agreement,
Thelma purported to sell Michael and Michelle a 96.25-percent
interest in HI-1, HI-2, and HI-3 for a "fixed annual income·for
the rest of her life."
David did not sign the private annuity
and the extent of his obligations under the agreement is a
problem we discuss below. See infra, p. 53.
1.
Value of the.FLP Property
One key to creating a private annuity capable of
withstanding audit is valuing the assets being sold so that the
amount of the annuity is accurate.
The values Garza used in his
- 29
calculations appear in two nearly identical unsigned létters that
he wrote on April 4, 2000
letters are the same
The-first two^sectioñs of both
lh those sections; Garza listed the totab
values for themässets tin each FDP
He,then calôulated the value
of Thelma' s inì 576erest
in each partne ship by multiplyirig the total
value of the FLP by. 96.25 percent.
The third section is where
the letters diverge. ,. In that section, GaÈza calculâted the
discounted value of Thelma' s intere t in, each:FLP by multiplying
the value of thàt interest by a dis ount factor, and then summing
them to get a "Grand Total Figure:.
however
In one of the letters, i 042
he used . lower dis count f act ors and 'inc luded sThelma ' s IRA
in the "Grand (Total Figure . " - The 042 Grand Total Figure
on this
letter was not -correct due to an ar thmetic error.h
a.
. HI l's Válue
In his April 4 letters, Gärzá separated H1-l's assets into
two classes.
He reported that the
tocks hand bonds were worth
$2, 115, '740 and. that the mortgage nó
s and cásh were valued at
$1,134,593.
a got these numbers -while
Wevdon't know where Ga
they are close :to those on Gary's es ate tax5return, they differ
by about $200,000.. They are ailso si nificantlyslower thanethe
minimum of.more than $5.5 million th t the Hurfords agree was
transferred into HI-1.f°
And they ir no way take into account
During the course of litigation, the estate hired an
appraiser, to determine the fair market value of the FLP interests
(continued: . ..).
- 30 -
the changes · in the composition of Gary' s and Thelma' s assets . in
the year after he died.
Assets in several accounts were moved to
Chase, .where normal trading further reduced the similarity of the
Hurfords' portfolio transferred to the FLPs and the.ir portfolio,
at the date of Gary' s death,
b.
HI-2's Value
In his April 4 letters, Garza valued the phantom stock at
$5, 552, 377 .
That is · the same value that he reported on Gary' s
estate tax return.
It comes from a letter that Massman had sent
Bisignano in May 1999 that included an estimated value for the
phantom'stock as of December 31,
1998.
Garza testified that he
used this value because it was the "most current information that
we had" and "it didn' t appear to me that the value was increasing
very much. "
But we know that the December 1998 value was already
out-of-date because Hunt Oil recalculated phantom-stock.values at
the end of each calendar year.. And we specifically find that the
value of the phantom. stock was increasing.
In February 2000,
Massman met with a Chase employee to discuss the phantom-stóck
plan and during that meeting he estimated that the phantom stock
was already worth $6 . 4 million, which we now f ind was its value
1° ( . . . continued)
after applying discounts.
The appraiser's letter listed the
value of assets contributed from Thelma and the "Gary T. Hurford
Trust" to the partnerships .
The appraiser determined the stated
value of . HI-l' s cash, stocks, bonds and mortgage notes was
$5,524,641 as of March 20, 2000.
.
when the FLPs were formed--as 'even tlhe estate s eNpert witness
conceded.
.
c.
t HI-3's Value
In his April 4 lettérs, Garza listed the value of HI-3. as
$2 020, 800 .
This was again based o
the -same valuatiof1 used to
report real estate values ion Garý' s estate táx rëturn.*' But using
the number from .the return was¼bong.1 Thòse real- estate values
came from an appraisal t-hat BÎsigna o had prepared and reflect
the properties' ·values on April 12h1999, the day Gary died,' and
Garza made noveffort to-cònsider an
the year thàt had'passed.
change in their values in
The $2,020,800 reported on Gary's
estate tax return also included the Arlirigton änd iTyler houses,
and* the Èllis7Dallas county pröpert , none òf-which was actually
transferred to HI-3.
Thls, necessar11y caused a misstat ement of
the value of thë property that Garz
was try r1g to move out of
Thelma's own estate.
d.
Discounts .
The method :that Garza used tò
ick the discount factors to
apply to the FLP intèrests was simi arly haphäzajd.
We know from
Michelle's notes thät Garza brägged that he had "experiérice
obtaining 50 percent discounts in s tt-lements»ons estates with
IRS, and also [he] had coached a la yer i,n Mississippi iny a
valuation battle with IRS, änd he got a 50 percent discount."
- 32 -
But Garza chose not to go for these maximum discounts with the
Hurfords.
Instead, he contacted several valuation appraisers.
Garza sent a letter to one of these appraisers on March 8,
2000, asking him to call and tell him his "general approach,
estimate of discount, and proposed fees."
After their
discussion, Garza noted in Thelma's file that the appraisals
would cost $6,500 and that "[h]is discount for.the marketable
securities would be 32-36
[percent,]
for Phantom stock, 36-44
[percent,] and for the real estate[,]
event, the.appraisals were never done.
36-48
[percent]."
In any
Garza chose instead to
use his own discount percentages, but even the precise
percentages that he chose are unclear from·the record.
They
fell, more likely than not, within the range bounded by the two
versions of his April 4 letteri
Partnership
Discount Taken for Lack of
Marketability and Lack of
Control
Hurford Investments No. 1, Ltd
25-32 percent
Hurford Investments No. 2, Ltd
25-36 percent
Hurford Investments.No. 3, Ltd
30-42 percent
We find with more confidence that Garza's calculations for the
value of the annuity are not transparent.
To clean up some of the problems, the estate offered two
expert witnesses--Mr. Preti and Mr. Henderson.
One testified
that the discount factors were within acceptable limits.
The
- 33 other testified that,1while Garza
ndervalued'the FLPs, the
$80', 000 monthly payménts exceed What the annuity payment would
have been had the FLPs been*correctly valued.
2.
"
Creation of thé. Private Annuity
WithT tlie FLP . values and discounts- set, Garza calculated the
amount òf the annuity two different ways.
He first consulted a
mortality table and published interesti rates included in a BNA
tax portfolio and made the calculat ån'by hando
Using this
method, he' computéd an annuity: paym nthslightly below $70, 000 a
month.
Then he used a computer*prohram .to redo the calculation
and decided that the annuity should instead be pegged at about
$80, 000 a month. tGarza advised the Hurfords that they should use
the higher ñumber because it was "tnore conservative . "
The private annuity that Garza prepared also had another .
peculiarity: « It completely omitted any mentionCof David Hurford,
listing only Michael ánd Mic:helle as purchasers of Thelma' s
interësts in HI±1, HI-2, sand ,HI-3 añd obligors' of the duty to
make ~the iñonthly payments tó her
11 who testified on this
point weré credible, 'and therefore
re find that Thelma wantéd to
transfer .one-third of her partnership interests to David.
But
she .also wanted: to protect both him and tl e asséts, so she
thought it best not to give him 's1.gmature authority.
Garza
testified that he knew what Thelmamintended, but he could not
explain how the agreement- he drafted reflected in any way
- 34 -
Thelma's intent to give each of her children an equal share.
Michael and Michelle claimed to believe that the private annuity
transferred one-third of. Thelma's partnership interests to David,
and that David would be obligated to make the payments ..
point, we do not find them credible.
On this
Instead we find that they
privately agreed to accomplish their mother's desire to give
David a third of the estate, but keep him away from
decisionmaking authority by keeping his name off the private
annuity--just promising themselves that they would distribute. to
him a third of the estate when the time came (i.e., when Thelma
died) .
On April 5, 2000, Thelma and Michelle signed the documents.
Michael was in Kentucky so the agreement was mailed to him.
signed them and mailed them back.
He
Neither David.Hurford nor
Chase reviewed the agreement before it was signed.
3.
O
How the Hurford Private Annuity Worked
To receive the annuity payments; Thelma opened an account
named "Thelma Hurford Annuity -Account"
(THAA). at Chase.
Michael
asked that Chase pay Thelma by transferring assets from the HI-l
THIMA account into the THAA account.
Thelma received her first
annuity payment in May 2000, but she did not want all of that
payment transferred into her THAA account.
She herself asked
that Chase transfer $40, 000 of cash into her account at Boston
Safe Deposit & Trust and $40, 000 in stocks to the THAA.
She
.
as ed t]2at- Chase make all
t her pa
ents by tran ZeÊring
securities from the .HI-1 account into sher THAA account.
Paymen
.
Table 7: Transfers r m HI 1 THIMA to
TGH' s Annuity Account (opened
540/17/00)
Date
Amou13t
1
5/15/00
$
39, 991 cash (deposited to Nations Fund)
1
5/19/00
$
30, 570 stocks
2
6/06/00
$
36, 420 sto ks
2
6/08/00
$
536 cash
3
7/03/00
$
3 casl
3
7/03/00
$
100,411 sto ks
4
8/01/00
$
98 cas
4
8/01/00
$
5
9/01/00
$
144 cash
5
9/01/00
$
87, 586 stoc}Ss
6
10/4/00
$
214 casl
90, 384 .
(or $105,636)
541to
] s (or $91, 512)
(or $91, 892)
,
The .Commissioner argues that the annuity payments didn' t
consistently total . $80, 000 each month.
It appears that he is
using the tax-cost numbers reflected on the Chase account
statements, instead of fair markèt alues.
For example, the
Commissioner argues that3in May 2000, payments totaled only
$70,561. We find, however, that the fair market value of stocks
transferred wass$39,397 and cash was $39,990, totaling $79,387.
In June, the Commissione¿ claims Thdlma received only $39, 956.
But the fair market value of additions ,to the account was over
$78,000, and in July it was approxiÈatelý. $78,000.
We therefore
find that there was not a significaÂt variation-in Thelma's
monthly annuity payments .
The problem of distinguishinc) cost and value numbers
which we've already noted, supra, note 9, is made more difficult
here, because the tax cost reported in HI-1 THIMA statements
doesn't match the tax cost reported tin the- annuity statements.
In this table, we list the annuity-statement value first, and the
HI-1 THIMA-values in parentheses .
- 36. 6
10/6/00
$
68,783 stocks
7
11/1/00
$
77 cash
'7
11/1/00
$
8
12/1/01
$
59 cash
8
12/1/00
$
75,290 stocks
9
1/02/01.
$
·75 cash
9
1/02/01
$
53,567 stocks
10
2/01/01
$
47 cash
10
2/01/01
$
81,529 stocks
TOTAL
$
658,520
G.
158,237 stocks
Thelma Hurford's Death and Tax Returns
Thelma's friends who testified were completely credible in
their description of how bravely Thelma struggled with her can'cer
and how positive her attitude remained throughout the multiple
surgeries and rounds of chemotherapy she endured.
But her cancer
never went into remission and,. while she was in the hospital
after her last surgery, she died on February 19, 2001.
After Gary died, Thelma had endured more than disease.
She
was also responsible in some way for numerous tax returns as
either an individual, executrix, trustee, "partner, or member of
an LLC.
KPMG had at first continued to prepare her tax returns,
but with Hunt Oil no longer paying the bill, she went to Ga za
and asked him in July 2000 to refer her to a new firm.
He
recommended two, and she hired one of them=-Turner & Stone.
Before the switch, KPMG had prepared four returns:
- 37
1999 Income Tax Return, Form 1041, Gary T. Hurford
Family Trust
042
1999 Income Tax Return, Form 1041, Estate of Gary T.
Hurford
1999 Income Tax Return,
Form 1041, Gary T. Hurford
Marital Trust
1999 Income Tax Return, Form 1040, Gary and Thelma
Hurford
Turner & Stone prepared the" foilowing returns
2000 Income Tax Return, Form 1041, Gary T. Hurford
Family Trust
2000 Income Tax Return,. Form 1041, Gary T. Hurford
Marital Trust
042 2000 2002 Partnership Ta
Management No 1,
Returns, Forms '1065, Hurford
LLC
042 2000-2002 Partnership Tax Returns, Forms 106$, Hurford
Management Nou2 i LLC
2000-2002 Partnership Tax Return,
Management No 3, LLC
e
Forms 1065, Hurford
2000-2002 Partnership Tax Returns, Forms 1065, Hurford
Investments No 1, LTD
2000-2002 Partnership Tax Returns, Forms 1065,, Hurford
Investments No 2, LTD
2000-2002 Partnersh.ip Tax Returns, Forms 1065, Hufford
Investments No 3,. LTD
2000 Income Tax Return, F rm 1041, Estate of Gary? T.
Hurford
2000 Gift Tax Return, For
709, Thelma Hurfor
2000 Income Tax Return, F rm 1Ó40, Thelma Hurford
042
2001 Income Tax Return, F rm 1041, Estate of Gary T.
Hurford
- 38 -
Garza prepared two returns:
042 Estate Tax Return for Gary T. Hurford, Form 706, signed
by Thelma as Executrix on 7/11/00
042
.
Estate Tax Return for Thelma G. Hurford, Form 706,
signed by Michael as Executor on 7/9/01
The first return relevant to this case is the estate tax
return for Gary's estate.
Garza himself prepared the Form 706
and Thelma signed it on July 11, 2000.
We note especially a
$6,543,236 deduction claimed on the return's "Schedule M-Bequests, etc., to Surviving Spouse."
Gary's estate took the.
deduction because it was electing to treat this sum as QTIP
property.
The problem is that we have no idea which property is
included in that number.
as "QTIP".
On the schedule M it is only described
At trial, when asked about the number, Garza replied
that he didn't remember how he computed it'..
Also on July 11, 2000, Thelma signed 1999 returns for
herself and the Marital Trust.
(Her 1999 return was actually a
joint.return, and she also signed it in her capacity as executrix
of Gary's estate.)
Both these returns were prepared by KPMG.
Then Turner & Stone entered the scene.
That-firm prepared
tax returns for each of the FLPs.
These returns were signed by
Michelle and filed on July 8, 2001.
The K-1s from each of the
returns show that, during 2000, Michael's, David's, and
Michelle's interest in each partnership went from 1 percent to 33
percent, while Thelma's and Gary's es.tate's interest -dwindled
O
from 48 to O percent.
The K-1s also sho
that Michael, David
and Michelle each made the followirig capital contributions to the
FLPs in 2000:
HI-1 Capital
Contribution
HI-2 Capital
. Contribut.ion
HI-3 Capital
Contribution
$1, 968, 957
$2, 088, 593
$556, 822
These numbers appear to be complete fictions--we specifically
find no evidence of money coming into or services provided for
any of the FLPs or LLCs from the; three Hurford children, much
less the millions of dollars, that Ti2rner & Stone report;ed.
. The
LLCs (1-percent owner of each FLP) reported these capital
contributions to the FLPs :
HI-1 Capital
Cont r ibution
.
HI-2 Capital
Cont r ibut ion
HIi3 Capital
Cont r ibut ion
$63, 291
$16, 872
$59, 665
On Thelma's and the estat
of Gary Hurford's K-1s the space for
"capital contributed during year" wäs left blank.
The schedule D for HI-2 shows a $6,411,000 capital gain on
the "phantom stock interest--Hunt Oil" and a sale date of
December 30, 2000, eten though the Hurfords claim that the
transfer was not a taxable event.
t trial, Michelle explained
that the gain was reported in 2000
ecause Chase had concerns
about the phant;om stock's ownershìp
The'concern was ·reasonable-
-Hunt Oil had not sent certificates to the Hurfords .showing that
ownership had passed to HI-2.
Garzd and Chase got together to
discuss the issue and decided that, if the Hurfords did not have
the certificates when it was time to file HI--2's return, they
would take the conservative approach and report that the phantom
stock had been distributed.
Turner & Stone also prepared the final tax returns .for the
Family and Marital Trusts on June 29, 2001, and they were signed
by Michael as successor trustee to his mother.
evidence that the trusts were terminated.
There is no other
Michelle believed that
Thelma terminated the trusts in early March 2000 by transferring
all their property to the FLPs.'
This cannot possibly be true,
since the bank records showed that Thelma didn't succeed in even
beginning to move money into the HI-1 accounts until a week after
those same accounts had supposedly been used to buy the private
annuity.
See supra p. 21, Tble. 2 & 3.
The tax returns for the LLCs--HM-1, HM-2, and HM-3--were
prepared by Turner & Stone and' signed by Michelle on July 3,
2001.
The K-1s from each of those returns show Michael's,
David' s ,
and Michelle ' s ownership in each. LLC was 33 . 333334
percent at the end of 2000.
Their K-1s also showed that each of
them made capital contributions to the LLCs in 2000:
HM-1 Capital
Contribution
HM-2 Capital
Contribution
HM-3 Capital
Contribution
$19, 888
$21, 097'
$5, 624
- 41
None .of the LLCs' returns included a K 1 f or the lma .
And none of
these capital cóntributions. was act ally made .
The estate tax return'for Thel a's estàte was signed by
Garza as preparer and by Michael as exe u or .on July 9, 2001,
though it was not filed until September 26, 2001. - On the .return
Garza answered "No" to the following four quéstions:
042 Did thà decedent, at the time of. déÀth, o r any
interest in a partnership * * * .or [a] closely
held corporation?
042 Did the decedent make any transfers described in
section 203.5, 2036, 2037, or 2038?
042 Were there in existence a the timel of the
decedent's death: Any tr sts created by the
decedent under which the lecedent possessed any
power, beneficial interes , or trusteeship?
042 Was the decedent ever the beneficiary of a trust
for which . a. deduction was claimed by the estate ,of
a pre-deceased spouse undèr section 2056(b) (7) and
which is not reported on his return?
Whether Garza correctly answer d. the first two of -these
questions is, as we shal11 see,, a ce tral issue in this.case.
Whether he answered the third quest on correctly is -also in
dispute:
Though.Thelma's, estate cl ims thatt transferring
property out .öf .the Maritäl and Fam ly Trusts>terminated them,
the· Commissioner argues tlÈat proper y»Was left._in the trusts by
Garza' s f aulty execution of his aplar
Garza's answer of "no" to the final question is just
egregiously false .
He
imself hàd prepared Gary' s -estate ·tax
return and should havé known thàt sec io
20Ê6 (b) (7) rÉfers to a
.
- 42 QTIP trust like the one for which he claimed a deduction on that
return."
The assets reported on Thelma's estate tax return were:
Arlington residence
$165,000
Thelma Hurford annuity account
348,296
Mortgages, notes, and cash
282,660
Life insurance
5,000
Miscellaneous property
45,710
Total
846,666
The estate reported that Thelma made no taxable gifts other than
gifts includable in her gross estate.
Thelma's estate took a
$45,000 deduction for attorney's fees
Michael, who was now executor for both his parents' estates,
signed and filed a 2000 Form 1041 prepared by Turner and Stone
for Gary's estate on July 12, 2001.
On this return, he reported
half the proceeds (the other half being Thelma's community
property) from the exercise of the optións for Nabors stock and
its subsequent sale as well as the sale of the house in Tyler
He also reported $194,921 in the "other income" section as the
estate's portion of the private annuity.
This is odd because,
even though Gary's estate owned 48 percent of each FLP, it was
not a party to the private annuity nor was it meant to be.
Gary's will directed the residuary of his estate to the
Marital Trust, which allowed for a QTIP election.
- 43
Michael also filed Thelma's 2000 gift-tax return using Form
2001.
709 on August 12
This retur
was also prepared by. Turner
& Stone, and they reported that Thelina made $775,000 in gifts,
$675, 000 of which were· taxable .
These included the $225, 000
gifts ;she had made to each of her âhildren; the $10., 000 gifts to
her children and other relatives, and two $10, 000 trusts^she
created for her grandchildren.
They also reported that she owed
no tax on these gifts because she whs using her-uñified credit.
The preparer answered "no" to the q estion " [h] ave you (the
donor) previouslys filed a Form 709
or any other year?
The final return was Thelma's Last individual income tax
return, which Michael filed on Auguht 12, 2001, after Turner &
Stone . prepared it .
. $238, 948 refund,
042They reported that the IRS owed Thelma a
though the refund had not been included as an
'I
asset on Thelma.' s estate- tax return
Most of .this reported
income came. from he
t in the proceeds from. the
n -half int
sale of the_ Nabors stock and herl accumulated income from the
private annuity.
H.
. Estate and Gift Tax Returns
Audit
On November(183 2004,. Thelma's estate received two.notices
of deficiency--one for her 2000. est te tax return and the other
for her 2000 gift tax return: s The
deficiencies and penalties:
otices set out large
- 44 -
Estate Tax Return
Gift Tax Return
Deficiency
$9,805,082
$8,314,283
Penalties
1,956,066
1,662,857
.
The notice of deficiency prompted by the gift tax return
characterized the $14,981,722 Thelma transferred under the guise
of the private annuity as gifts to Michael and Michelle because
the.annuity's real fair market value was $0.
The noticè of deficiency sent to the estate had a longer
list of adjustments:
042 The properties in Ellis and Dallas counties
should have been included in Thelma's estate.
042 The value of the THAA at Thelma's death was
$426,206 and not $348,296.
042 Thelma's estate should have included her one-half
interest in a Bank of America account and all of a
Deutsche. Bank account.
042 The private annuity was a sham and all the
property that she transferred to Michael and
Michelle should have been included in her estate.
042 The transfers to HI-1,=HI-2, and HI-3 should be
included in Thelma's estate under section 2035.
042 The estate failed to substantiate a $45,000
deduction for attorney fees.
042'
The $675,000 in gifts that Thelma made in 2000
are includable in her estate.
The penalties asserted in both notices were for negligence or
disregard of the rules and regulations.
Thelma's estate has conceded an increase in the estate's
value of $3,381,999 because Garza failed to report the money
.
45
Thelma received when she ligtíìdated her IRA, her -individual tax
refund, and?the proceeds from the sale of the' Nabors stock.
The
estate also concedes that the true value of +Thelma' s THAA account
was $426,206
The'main issue that we
re·left to decide is what
else should.have been incltided?-specifically, whether Thelma s
transfers to the FLPs and the subsequent private-annuitý
.
transaction were valid under 'sections 2035, 2036 and 2038.
Also
at issue:
What. is the effect -of t e QTIÈ election made on
Gary' s estate tax return;
Should the $675, 000 in gi ts that Thelma made in
2000 be excluded froth her estate tax return?;
May the estate' deduct $45 000 in.attorney's fees?;
Is Thelma's estate liablé for section 6662
penalties?
OPINION
I.
What is Includable In Thelma's Estate?
The Code imposes a tax on a de edent' s taxable estate, which
it defines as the value of the gross estate minus any allowed
deductions.
Secs. 2001(a), 2051.
The gross estate is the value
of the property in which a decedent had an interest at the time
of her death.
Sec. 2033.
Sections 2034 through 2045 tell us
what property to include in that estate .
In this case, the
Commissioner argues that sections 2635, 2036 and 2038 bring'back
into Thelma's estate the property tliat Garza tried to transfer
out of it via the FLPs and privat±e
nnuity.
- 46 -
Section 2036 (a) (1) includes in a decedent' s gross estate
property that she transferred to another but in which she keeps a
right to possession or enjoyment or income until death.
The
paradigm is a gift or low-bal'l sale from A to Brof property in
which A retains a life estate.
And the target is lifetime
transfers that are essentially testamentary in nature.
States v. Estate of Grace,
Bongard v. Commissioner,
395 U.S.
124 T.C.
316,
95, 112
320
United
(1969); Estate of
(2005) .
Section 2036 (a) (2) includes in the estate property in which
a decedent keeps until death a right to designate a person who
gets possession or enjoyment of, or the income from, the
transferred property.
It covers many of the same situations also
governed by section 2038 (a) (1) , Estate of Wall v. Commissioner,
101 T.C. 300, 313 (1993),. which includes in an estate any
property that a decedent transfers while keeping a right to
revoke or change the transfer.
Both sections 2036 and 2038
contain the same parenthetical exception for bona fide sales for
an adequate and full consideration.
Secs. 2036(a), 2038(a) (1).
The Commissioner also relies on section 2Ó35(a), which
requires us to reach back and include property in Thelma's estate
if section 2036 or 2038 would have included it in her estate but
for her terminating her retained interest within three years of
death.
Depending on how these s ctions affect 'what's included in
Thelma's grosswestate, we may also have to decidee what. property
should be included because of the QTIP election made on -Gary' s
estate tax retiurn and a potential rm1scalculation in the estatetax computation arlsing from the gifts Thelma.made during the
last several months of her 'life .
A.
Positions of the Parties
Apart from; some-comparatively
inor concessions, the estate
claims that Thelma's estate and gifì
tax returns were correct
It acknowledges Garza' s sloppiness bùt .argues that Thelma s
estate plan should be,respected desþite sall. the missteps.
On the major questions,g it açgues that sections 2035, 2036, and
2038 don't apply because Thelma,trausferred her property into the
FLPs and then _into the. private annu ty throùgh bona fide sales
for adequate and ; ful? consideratlon
of thes
It also contends that none
sectionä apply because The ma did.
ot retain possession
or enjoyment of, or the right to re ei e income from, the
property after it was transferred.
.
The Commissioner attacks the entire estate plan as nothing
more than a transparently thin subst itute. for a will.
He argues
first that the property transferred to the FLPs is includable in
Thelma's· estate because Thelma kept control over the assets after
the transfer, and,because,there was an implied agreement among
the.Hurfords for Thelma to do so.
He also argues that Thelma's
- 48 -
transfer of her property (and the property of the Trusts) in
exchange for an interest in the FLPs was neither bona fide nor
. done for adequate and full consideration.
The same is true for
the exchange, only two weeks later, of her interest in those FLPs
for the private annuity:
The- Commissioner argues that there is
grossly insufficient evidence that the exchange of Thelma's
interests in the FLPs for the private annuity was a bona fide
sale for adequate and full consideration, and also argues that
Thelma continued to control these assets well after~ the
transaction was complete.
He next contends that Garza mangled Gary's estate plan by
terminating the Family Trust,
leading to the inclusion of that
Trust's assets in Thelma's own taxable estate.
. Finally, the Commissioner argues that section 2044 requires
Thelma's estate to include the value of the property identified
on Gary's estate tax return as a QTIP deduction.
This is a
fallback position--if all his other arguments fail, he is
contending that at.least the approximately $6.5 million deduction
that Gary's estate took on its return for QTIP property must be
matched by an inclusion of $6.5 million on Thelma's estate tax
return.
B.
The Private Annuity and the FLPs
We begin with the language of the Code.
statest
Section 2036(a)
.
- 49 '-
SEC. 2036(a). General Rule.- The value of the gross
estate shall include the value of all property to the
extent of any. interest thereid of which the decedent
has at any time made a transfer (except in case of a
bona fide sale for an adequate and full consideration
in money or money's worth), by trust or otherwise,
under.which he has retained for his life or for any
period not ascertainable without reference to his death
or for any period which.does not in fact end before his
death-(T) the possession or enjoyment of, or
the right to the income from, the property,
or
(2) the right, either alone or in
conjunction with any persbn, to designate~the
persons who shall possess{ or enjoy the
property or the income therefrom.
(The italicized portions are the key phrases'for this case.)
In Estate of Boùqard, we said section 2036 pulls
transferred property back into a decedent's estate if:
(1) The
decedent -made an inter vivos transfèr of property·(no one doubts
Thelma did this);
(2) the decedent's transfer was not a bona fide
sale for adequate and full consideration; and (3) the decedent
kept an interest or right in the transferred property of the kind
listed in section: 2036(a) which she did not give up before she
died.
Estate of Bongard, 124 T C. at 112.
In other words, section 2036(a) has two exceptions to a
general rule that includes in her eÀtate all inter vivos
transfers of her property.
The first exception excludes assets
in a transfer if it is a- bona fide sale for adequate and full
consideration.
Hunting for the bona fides of a transfer is a
_ 50 -
question of motive--did Thelma have a legitimate and significant
nontax reason, established by the record, for . transferring her
property?
Deciding whether a transfer was for adequate and full
consideration is a question of value--did what Thelma give up
roughly equal the value of what she received?
Estate of Bongard,
124 T.C. at- 118."
The second exception--applicable even if the transfer is an
outright gift--takes the transferred property out of the estate
if the decedent did not retain either the
(1) possession, enjoyment or rights to the
transferred property, or (2) the right to
designate the persons who would possess or
enjoy the transferred property.
Kimbell v. United States,
371 F.3d 257,
261
(5th Cir.
2004).
Section 2038 says:
SEC. 2038(a).
In General.-=The value of the gross
estate shall include the value of all property-(1) Transfers after June 22, 1936.--To
the extent of any interest therein of which
Kimbell phrases the test somewhat differently, holding
that a sale is bona fide if the transferor "actually parted with
her interest in the assets transferred and the [transferee]
actually parted with the partnership interest in exchange;" .and a
sale is for adequate and full consideration if issued "the
exchange of assets * * * does not deplete the estate." Kimbell,
371 F.3d at 265.
If read in isolation, this might look like an
instruction pointing us to judge bonä fides purely in terms of
legal effectiveness.
But the Kimbell court also carefully noted
that "a transaction motivated solely by tax planning with no
business or corporate purpose is nothing more than a contrivance
without substance that is rightly ignored."
Id. at 264.
We
don't think, therefore, that Kimbell and Estate of Bongard stake
out different tests; but if they do, the series of deals in this
case fails both.
1
- 51 -
the decedent has at any time made a transfer
(except in case of a bona fide sale for an
adequate and full .corisideration in money orü
money's worth), by trust or otherwise, where
the enjoyment thereof was subject at the date
of his death to any chan
through the
exercise of a power (in* Whatever capacity
exercisable) by the decedent alone or by the
decedent in conjunction with any other person
(without regard to when o from what source
the decedent 'acquired such power) , to alter,
amend, revoke, or termìnate, or. where any
such power is relinquished during the 3-year *
period ending on the date of the decedent ' s
death.
In Estate of Mirowski v. Commissioner, T.C. Memo. 2008-74,
we framed section 2038 as pulling »t ansferred property back into
a decedent' s estate .if :
transfer of property;
(1) the decedent. made an: inter vivos
(2) the decedenti's transfer was not a bona
fide sale for adequate -and full con ideration; and (3) the
decedent kept an interest or right in the transferred property of
the kind. listed. in section .2038 (a)
hich she did not give up
before she died or which she relinqùished within the three-year
period ending on the date of her deáth.
There are two sets of transfers that we need to consider-transfers by Thelma of her own and t he Trusts' property in
exchange for interests in the FLPs, and her exchange of the FLPs
for the private annuity.
We address the validity of each
transaction separately because they have independent estate-
.
- 52 -
tax consequences.
The FLPs, if valid,. may well- entitle the
estate to value interests in them at a discount to the property
they hold.
The private annuity, if valid, would then remove
a very large part of the FLPs' value from the estate
altogether.
We start at the end, looking first to see if the exchange of
Thelma's interest in the.FLPs for the private annuity was bona
fide and supported by fair and adequate consideration.
Then we
look at what interest she retained in the assets exchanged for
the private annuity throughout the last year of her life.
.And we
do the same analysis for the transfers by Thelma (and the Trusts)
in exchange for interests in the FLPs.
1.
Was the Private Annuity Effective to Remove
Assets from Thelma's Estate?
a.
Was the Transfer of Thelma's Interest in the
FLPs for the Private Annuity Bona Fide and
for Adequate and Full Consideration?
Kimbell teaches that a court has to consider separately the
bona fides of a transfer and whether it was supported by adequate
and full consideration.
Kimbell, 371 F.3d at 262.
We begin by
finding that the private annuity agreement was not bona fide, but
The estate argues that an unpublished Fifth Circuit case,
Estate of McLendon v. Commissioner, 77 F.3d 477, (5th Cir. 1995),
revg. T.C. Memo. 1993-459, stands for the proposition that the
bona fides of a private-annuity transaction are irrelevant to its
validity.
Estate of McLendon stands for no such thing--the
opinion even quotes the section imposing the requirement of bona
fides--but it decides the case on other grounds.
- 53
was instead "a disguised gift o
(citing Wheeler v. Únited States
1997).) .
a
ham transaction.
1 6 F.3d '749,
There are two key pieces o
767
Id. 'at 263
(5th Cir.
evidence
The agreement that Garza drafted transferred Thelma s
interest only to Michael ahd. Miáhelle.
Thelma intended to limit
David''St control ov'er the property sl e has giving to her. children,
but wet specifically find that she di
him.
not intënd to .disinherit
A more artful attórney might havè written a ýriväte' annuity
that made David's 'rights and obligations clear withoutigiving him
the ability to -deplete the· FLPs' assets.
Garza assumed 041,
however,
that Michael and>Michellerwould ignore what he hadedrafted and
they had signed, and -instead ca^rry o t ( s they ultimately did)
Thelma' s true intentions
sham
That÷rendëred the private annuity a
nòthing more than a .substitute for a will leaving Thèlma s
. estate in equal.shares to her childrën
See, e.gr; Estate of
Rector v.+ Commissioner, T. C. Memo. 2 07 367 (similar reasoning in
a failed. FLP case)
.
The ,second key piece of evidenc
is in wliat she. transferred
In April. 2000, she transferred all of her interest in each FLP to
two of her children, «including all tl e marketable securities and
If . the problem with the pri ate annuity was merely one
of inadequate donsideration, we would inclåde only the' excess of
what was transferred over what Thelma received in her estate..
Sec.. 2043.
Í3ut because4we .are fir2ing that? the FLPs were4in
effect not transferred, and Thelma retained an interest in them
until death, we include the entire value of tlie property
transferred.for the private annuity in her estate.
- 54 -
cash in HI-1.
Then in May -she received her first payment--
.
.
$40,000 of the cash and $40,000 of the securities that she'd just
transferred to Michael and Michelle.
In every subsequent month,
she received back another $80, 000 of cash and securities that she
had transferred.
Thelma's children dïd not. use their own assets,
let alone the income from the assets in the FLPs, to make these
payments .
They couldn' t have .
Even collectively they could not
afford to pay Thelma $80,000 a month.
What. Thelma's children did
instead was to hold the assets in the exact same form that they
were in before the private annuity and then slowly transfer bits
and pieces of them back to her,^ planning to divide what was left
over (including a share for, David), after she died.
Again, this
makes the private annuity look much more like a testamentary
substitute than a bona fide sale .
To be bona fide, a transaction need not be between
strangers.
Estate of Bongard,
124 T.C. at 123.
But there must
be some objective proof that the transaction wouldn' t materially
differ ·if the parties involved were negotiating at arms' length.
Id .
Any such f inding would be insupportable here .
Thelma's transfer of her interest in Gary's estate to the
children as part of the private annuity looks even· less like a
bona fide sale.
According to Garza, Thelma transferred her
interest, in Gary's estate to the FLPs by first transferring the
Marital and Family Trusts to herself, disregarding their
- 55
formalities.
He described the transaction at trial:
she's transferring, .in the capacity of trustee,
capacity of recipient.
"Well',
to herself in the
It would beilike me doing a document to
transfer money from one pocket to another pocket."
+Garza went on.
to clarify that she completed this transaction simultaneously
with the transfer to herschildren without putting anything in
writing.
We're skeptical.
The account statements reveal that the
Marital and Family Trust assets, along with ~assets in an account
in the name of Gary's estate, were all transferred into the HI-l
partnership.
These accounts remained separately titled during
the private-annuity transaction andlthen until Thelma's death,
even though Garza testified that Thelma distributed the Family
and Marital Trust assets to hers.elf and sold them to her
children..
(That's the estate's explanation for how Thelma
obtained a 96.25-percent interest in the FLPs prior to the
private-annuity transaction.")
We next turn to whether Thelma ireceived adequate and full
consideration when she transferred hbr assets for the private
annuity.
The key is whether what Thelma received is roughly
equivalent to what she gave up.
"
depletes the transferor's estate is
[Ü]nless a transfer that
oined with a transfer that
" Using the Family and Marital Trust assets in this way may
have independent estate-tax consequences,.and we address these
issues later.
augments the estate by a commensurate (monetary) amount, there is .
no "adequate and full consideration"'."
Kimbell, 371 F.3d at 262
(quoting Wheeler v-. United States, 116 F.3d at 762).
It is on
.
this point that the private annuity is most vulnerable._
We have already found that Garza conjured the partnership
discounts out of the air.
But even if those discounts were
correct, Garza undervalued each FLP interest sold in the private
annuity.
On April 1, 2000, the balances of the accounts that
eventually were transferred to HI-1 were:
.
Account*
4/1/00 Balance
THIMA
$4,263,636
MT
$
547,192
FT
$
713,813
Total
$5,524,641
.
*Note that these are not even HI-1 accounts.
Chase did not begin
transferring the assets out of these accounts into HI-1 accounts
until after the private annuity was completed. Given the many
.
problems with these transactions, we are going to call this.one
administrative delay and move on.
Garza, in his April 4 letter, valued HI-l's assets at $3,250,334
--the value from Gary's estate tax return.
Garza put the same lack of effort into valuing HI-2.
A
Chase employee got a revised estimate of the value of the Hunt
Oil phantom stock by giving Massman a call in February 2000.
At
that time Massman valued the phantom stock at $6.4 million, which
- 57
is almost $1 million more than the
5 5 million value Garza took
from Gary's estate tax return
There is .no record evidence of a boomsor à bust in the Texas
farm-and-ranch property market from Apri«l.'1999\to April 2000, but
we are certain that na careful fattorriey would have .had, the
properties in HI-3 reappraised before iricluding them in the
private annuity.V ^To meet section 2036(a)'s requirement that the
transfer was "for adequate. and full consideration in money or
money' s wort-h, " Garza shoulde have
etermined the f air market
value of the properties at .the time of transfer so that the . value
of the annuity received would be roughly equal to that of the
property sold.
Wheeler : 116 F.3d at 759
("adequate and ful-1
consideration under the exceptiön»to section 2036(a) .requires
only that the sale .not
eplete the g oss estate")
Recall that
Garza just took the values off Gary's estate. tax return--va:lues
which included properties: not even h ld by HI-3
We there f ore: hold on . the bas is öf , these f indings that the
.
transfer?of Thelma's FLP interests för the private annuity must
be ignored, and the válue ðf the FLPN must be added to her estate
unless she retained neither possessi¼n, nornenjoyment of, nor the
right to incomesfrom the transferred property, nor the right to designate the persons who would possess or enjoy that property.
For a definition of. fair mar et value for jurposes of the
estate and gift transfer taxes, see sec. 20.2031-1(b), Estate Tax
Regs . , sec . 25 . 2512 -1, .Gi f t Tax Regs .
- 58 -
b.
Did Thelma Retain a Prohibited.Interest in
the Property She Transferred to Her
Children through the Private Annuity?
Because we find Thelma didn't receive adequate consideration
in a bona fide sale for the transfer of her property for the
annuity, her estate needs to show under section 2036(a) (1) that
she did not keep possession or "enjoyment" of that property after
the private annuity agreement.
"[A]
transferor retains the
enjoyment of property if there is an express or implied agreement
at the time of the transfer that the transferor will retain the
present economic benefits of the property, even if the retained
right is not legally enforceable."
Commissioner, 114 T.C.
Estate Tax Regs.
144, 151
Estate of Reichardt v.
(2000); see sec. 20.2036-1(a),
For example, "the existence of formal legal
structures which prevent de jure retention of benefits of the
transferred property does not preclude an implicit retention of
such benefits."
Estate of Bongard, 124 T.C. at 129 (citing
Estate of Thompson v. Commissioner, 382 F.3d 367,
2004).
Cir.
375
(3d Cir.
-Estate of McNichol v. Commissioner, 265 F.2d 667, 671 (3d
1959), affg. 29 T.C.
1179
(1958)).
Now it is true that Thelma's relationship to the assets
changed after the private annuity.
She. didn't need to regularly
dip into the FLPs once she began receiving $80,000 a month under
the annuity.
But as previously discussed, her children paid her
with the very assets she supposedly sold to them.
Her monthly
- 59 -
payments came directly from HI-1 TH MA, which was an FLP account,
meaning that she retained a present economic benefit from her
assets after she "sold" them.
. Admit ting thàt Michaël and
Michelle couldn't àfford to pay $80,000 per month to their
mother, Garza testified that the pl n all along was for the
children to "pay the payments from the assets in the private
annuity that they purchased."
See supra pp. 35, Tbl. 7.
She
also continued to make deposits into the various FLP,accounts,
shifted assets between accounts, lånd otherwise treated them as if
they were her own rather than àctually transferred to Michael and
Michelle.
See, e.g., sùpra p. 20, Tb1
1.
After the.private
annuity àgreement, Thelma nefer resigned ,as president of the LLCs
and remained .a party to the.ifarm lleases.
She also had ongoing
signature äuthority over assetsiin HI-l's Cha'se accounts, which
she exércised after the annuîty agreemerit
At trial, Michelle
testified tliat her mother withcírew m ney from HI--1 to pay her
income taxes after she sold'theapa t ership interests to her
children.
Q
A
All right . Do you recall on or around April 14 of
2000 that your mother needed $65, 000?
.
Yes.
Q
Okay.
And she needed that to pay taxes .
Correct?
A
To pay estimated taxes, yes.
Q
Okay. And this money; this $65, OOO--she took
this money out= öf a f amily liiñitèd- partnership
account . Correct?
A
This money was taken out of the family limited
partnership shortly after the time we,did the
private annuity transaction, because my mother's
private annuity payments were not to kick in until
the first week of May.
She needed the money to
pay the taxes, and so this is what happened.
The
biggest concern was getting the taxes paid.
Q
So there was a transfer taken out of a family
limited partnership account to cover that then?
A
Yes .
Thelma also made it clear to Michael and Michelle, even
after the private annuity was signed, that. they were to make sure
that David got one-third of the property in the FLPs.
Garza ·
testified that there was "no design to not include David;
[Thelma]
just didn't want him to have managerial signature
rights . "
And Michelle said at trial that although the private
annuity didn't include David on paper, he was equally included
with his two siblings.
The Hurfords therefore treated David as a
coowner in the FLPs after the annuity was in place.
plainly stated,
agreement.
Michelle
"IDavid] was a part of the private annuity
He's a one-third owner."
Michael and Michelle
followed their mother's directions for the disposition of her
property, even af ter she supposedly gave up any interest in it .
Under section 2036 (a) (2) , we f ind this to be an exercise by
Thelma of a "right, either alone or in conjunction with any other
person, to designate the persons who shall possess or enjoy the
property."
We also find that it is the exercise of a power by
Thelma altering or amending the tra11sfer of the property going to
pay for the private annuity of the
2038 (a) (1) .
541ort
described in section
The consequence is, agãin, to pull the F'LPs back -
into her gross estate.
.
1
We therefore . find that; under sections 2036 and 2038,, Thelma
retained an impermissible. interest in the assets she had tried to
transfer to her childrennthrough the private annuity.
All the
assets "sold" to Michael and Michelle in the private annuity
transaction must be included- iri Thelma' s -estate.1' , And that means
we need to address the validity of the FLPs themselves and
whether or not- the estat e may take discounts resulting from that
form of ownership.
2.
Were the FLPs Valid?
a.
Was the Creation of the FLPs .Bona Fide and
for Adequate ..and Full.. Consideration?
As with the exchange of FLPs fo
the private annuity,
Thelma's exchange of property for interests in the FLPs must be
bona fide and for adequate and full consideration if .it is to be
effective at removing property from her taxable estate.
Compared
to private annuities, however, caselaw.on the subject of FLPs is
a rich source of analogous fact patterns and helps us figure out
" Because we' re includinc i Tfielma e estate the assets
that went to pay for the private anifuity
e hold against the
Commissioner on his alternate assertion of a gift tax and
associated negligence penalty in docket- number 23954-04.
- 62 -
where on the spectrum of legitimate tax planning Thelma's estate lies.
Let-'s start with the FLPs' bona fides.
We focus on Thelma's
motivation for moving her property into the FLPs.
obvious.
One motive is
Neither the Hurfords nor Garza are shÿ about admitting
that they created the FLPs for the valuation discounts.
At
trial, Garza said he and the family "discussed discounts * * *
more than a dozen times."
But they are equally insistent that
the FLPs had other purposes.
Garza listed ten reasons on each of
the FLPs' partnership agreements (numbering as in the ·original)
1.
provide resolution of any disputes which may
arise among the Partners in order to preserve
Partnership harmony and avoid the expense and
problems of.litigation;
2.
maintain and centralize control of Partnership
Assets;
3.
consolidate fractional interests in Partnership
Assets to achieve cost savings and to allow those
Assets to be managed in an orderly manner;
4.
increase Partnership wealth;
5.
continue the ownership of Partnership Assets and
restrict the right of non-Partners to acquire
interests in Partnership assets;
6.
provide protection to Partnership Assets from
claims of future creditors against Partnership
members;
8.
prevent the transfer of a Partnership member's
interest in the Partnership as a result of a
failed marriage,
9.
provide flexibility in business planning not
available through trusts, corporations, or other
busines.s entities;
.
- 63 4
10."
facilitate the administration and redúce the òost
associated with the disability or probate of the
estate of· Partnership members; and
.
11.
promote the Partnership' s knowledge of and
communication about the management,
responsibilities, and benèfits of Partnership
Assets.
We do not just look at a list of reasons, though.
Thelma's
nontax reason has to be a significarit factor motivating creation
of the partnerships and not merely a theóretical justification,
and we've observed before that taxpayers often disguise tax-
avoidance motives with a rote recitation of nontax purposes.
See
Estate of Bongard, l'24 T. C. at 118.
As the Third Circuit said in
Estate of Thompson, 382 F.3d at 383
(quoting Gregory v.
Helvering,
"Even when all the
293 U. S. 465,
469
(1935) )
'i' s are
dotted and t's are crossed, ' a transaction motivated solely by
tax planning and with 'no business or corporate purpose * * * is
nothing more than a contrivance.'"
s we have seen, Garza cZid
not .make a rigorous effort to correc ly form the FLPs.
many of the i's undotted and t's unci-ossed.
He left
But we won't
disregard Thelma's transfers .to the FLPs because of his
sloppiness.
Instead we'll examine the evidence to see whether
any of these nontax reasons was a significant factor in founding
the FLPs.
Estate of. Bongard, 124 T.Ò. at 118; Estate of. Harper
v. Commissioner, T.C. Memo. 2002-121
Of the ten listed nontax purposes, the Hurfords rely mainly
on asset protectiori and asset management.
They claim that the
- 64 -
assets needed protection from the liabilities associated with the
farm and ranch properties and from creditors.
As for asset
management, they.claim that the FLPs would consolidate the
management of the cash and securities held by Thelma, the Marital
Trust, and the Family Trust.
We have found in other cases that similar claims about asset
protection, without supporting evidence, were insufficient proof
of a significant nontax purpose.
See Estate of Bongard, 124 T.C.
at 128 (FLP's credit-protection function already served by
existing trusts); Estate of Korby v. Commissioner, T.C. Memo.
2005-102,
(failure to show FLP would protect assets from
creditors)
affd. 471 F.3d 848
(8th Cir.
Commissioner, T.C. Memo. 2005-103,
2006); Estate of Korby v.
(FLP no greater protection
than previous form of ownership) affd. 471 F.3d 848
(8th Cir.
2006); Estate of Rosen v. Commissioner, T.C. Memo.
2006-115 .
And we find that placing the assets in FLPs provided'no greater
protection than they had while held by the Family or Marital
Trusts, or in Thelma's own name.
Nor have the Hurfords convinced
us that giving each child a small ownership interest reduced the
risk of a creditor's reaching the assets.
And we cannot find in
this case any advantage in consolidated management that Thelma or
the two trusts gained from the transfer, particularly because the
partners' relationship to the assets didn't change after
formation.
Estate of Reichardt v. Commissioner, 114 T.C. at 152.
While we have found that consolidated asset management can be a
significant nontax purpose, 3Estate of Schutt v. Commissioner,
T.C. Memo. 2005-126, .we have also d nied that such a purpose is
significant where a FLP is "just a
ehicle for-changing the form
of the investment in the assets, a mere casset container."
of Erickson v. .Commissioner, T.C. Memo. 2007-1.07.
Estate
We find that
asset management and asset protection were not significant non-
tax purposes in this case.
What was.the purpose of the
LPs then?
We've already
mentioned the ,Hurfords' desire _to discount the value of Thelma'.s
property.
But that finding's not enpugh.by itself;·. we have .
developed in our, caselaw a longer list of, factors that, if
present, will cincline _us to find that the. transfer of property to
a FLP was not motivated by a legitimate and significant nontax
reason.
These factors include
The taxpayer's financial ;dependence on
distributions from. the partnership, Estate of
Thompson v. Commissioner, T. C. Memo. 2002-246;
Estate of Harper v. Commissioner, T. C. Memo.
2002-121;
042 whether , the taxpayer comminglèd her ownt funds
with partnership funds, Esi-ate of Reichardt,
.114 T.·C.
at 152
042 the taxpayer's delay or failure to transfer
the property to the partnetship, Estate of
Hillgren v. Commissionert T.C. vMemo. 2004-46;
Estate of Rosen v. Commissioner, T. C. Memo.
2006-115;
042 the taxpayer' s old age or j>oor health when
the FLP was formed, Estate of Rosen, T. C. Memo.
2006-115; Estate of Korby> v. Commissioner,
T.C. Memo. 2005-103, Estate of Korby v.
Commissioner, T.C. Memo. 2005-102, affd.
471 F.3d 848 (8th Cir. 2006); and
042 whether the FLP functioned as a business
enterprise or otherwise engaged in any
meaningful economic activity, Estate of
Bongard, 124 T.C. at 126.
Adherénce to partnership formalities is a theme underlying
many of these factors.
121.
See Estate of Harper, T.C. Memo. 2002-
And the Hurfords' disregard for partnership formalities
began early.. Thelma asked Chase just a few weeks after creating
the FLPs to distribute $65,000 from HI-1 so she could make an
estimated income tax payment, because she had transferred nearly.
all of her liquid'assets to HI-1--strong evidence that she was
financially dependent on distributions from the partnership.
The
HI-1 partnership made another mistake when it reported on
Thelma's K-1 that she.received no disbursements in 2000, which is
evidence that everyone was still treating HI-l's assets as
Thelma's own.
Thelma also commingled her own funds with the partnerships'
until shortly before she died on February 19, 2001--and long
after the Hurfords supposedly traded the FLPs for the private
annuity.
Chase transferred the proceeds from the sale of the
Tyler house into the HI-1 THIMA account.
.Thelma herself '
transferred the proceeds from her IRA to the HI-1 THIMA account
in Decembèr .200û.
See supra §.^22, Tbl 5.
house nor the IRA were meant to "l$e
The Hurfords also disregardeci
But neither the·Tyler
>artnership property
artne ship; formalities by
significantly dëlàying the transfer of the assets from Thelmà and
the trusts to the FLPs .
Mäny of ?HI l'-s assets remained in 1
Thelmai's and' the trusts' accounts «for seVeral months =after the
FLPs were formed.(
HI-2 had similar problems.
even acknowledge thàt HI-2 owned th
2001.
Húnt Oil did not
phantom stock untiluJanuary
While the. estate árgues that the official tránsfer date
was March 22, 2000, it hasinot explained why it took so long to
complete the. paperwork.
Thë transfer of thë Dallas/Ellis County
property tòr÷HI 3 was put- off3för two years, and we've already
.
recouñted hòw'disordered the other deeds were.
The other underlying theme in our cäselaw is that a FLP
needs to be a functioning business ör at lea'st have some
meaningful economic. activity.* Estate of Bongard,
126.
124 T.C. at
It's easy-enough to show thiá if Ja working business is
contributed to.a FLP
.
See Kimbell, 371 F.3d at 267 (working
interest in oil and gas0pi-operties) .
We've also found that a FLP
may have'meaningful economle activitý where the partnership
furthers family investment goalsior wliere the#partners work
together to jointly manäge familycinvestmënts.
Estate of
Mirowski, T . C. Memö. 200 8 -74 ; ~ Estate3 of . Schutt v. Commis sioner,
T. C. Memo. 20054126.
But where none 040of
the pärtners was involved
in conducting the partnerships' business, it's unlikely that the
transfer has a legitimate and significant nontax reason.
Estate of Thompson,
See
382 F.3d at 379.
Look at the FLPs in.this case.
securities and cash.
.HI-l just held marketable .
The Hurfords did not have even a minimal
involvement in deciding which securities HI-l should own, or even
whether it should buy or sell.
Cf.
(Estate of Schutt, T.C. Memo.
2005-126, where we said that while the mere holding of securities
in an untraded portfolio is a negative factor, the record in that
case reflected a significant nontax reason for creating the
FLPs).
All investment decisions were left to Chase,, and the same
people at Chase made the decisions before and after the assets
were moved to HI-1.
HI-1.
HI-2 required even less of the Hurfords than
The only choice they could make concerning the Hunt Oil
phantom stock was to hold it.or to cash out.
The HI-3
partnership did hold real estate, but again, the partnership was
not actively managing any of the farms or ranches.
The three
leases of those properties were all in place when HI-3 was formed
and the Hurfords did nothing more than collect rent.
There is. no
evidence that the partners met to discuss family business or
investment strategy, or even discuss the partnerships' profits or
losses.
This would have been difficult given the partnerships'
mayfly-like life span:
they were hatched and dispatched to the
private-annuity transaction in a few weeks' time, and afterward
served primarily asi a holding pen t o fund Thelma' s mánthly
annuity payments.
See supra p. 35, Tbl. 7.
This leaves only t±he Hurfords
reason for creating the FLPs.
And
drive for a di»scount f as a
e do find that their purpose
was nothing more than allowing the Hurfords to claim a discount
when Thelma transferred her interes&'in them to her children for
the private annuity; there was no nontax business or economic
reason for them to exist. " Michelle s notes -fróm one of the
initial meetings with Garza confirm tthis.
She wrotè,
",have kids
own .1 percent of everything to maxiniize discount advantages " i We
thus find that Thelma's transfers to the FLPs were not" bona'fide
sales.
Even if the transfers were bona fideFwe would find thãt
they were not for adequate and full consideration. ' The ge½eral
test for deciding whether. trahsfefs to a partnership.are made for
adequate and full consideration is to measure the value' received
in the form-of a partnership* interest to see if it',i
approximately equal to . the-property given up.
124 T.C. at 118; Kimbell, 371 F.3d at 262.
Estate of Bóngard,
But Kïmbell also
teaches more specifically that we should focus on three things:
(1) whether the interests credited tÄ each of
the partners was proportionate to the faik
market value of the assets .each partner
cont-ributed . to the partnership,
(2) whether t he assets cohtrïbÚted by e ch
partner to t'he partnership were properly
.
- 70 -
credited to the respective capital accounts
of the partners, and
(3) whether on termination or dissolution of
the partnership .the partners were entitled to
distributions from the partnership in amounts
equal to their respective capital accounts.
Id. at 266.
We phrase our own test a bit differently:
We look to see if
"All partners in each partnership received interests proport-ion-
ate to the fair market value of the assets they each transferred,
and partnership legal formalities were respected."
Bongard,
Estate of.
-
124 . T . C . at 117 .
It is obvious that the.value of Thelma's interest in each
FLP was worth less than the assets she contributed.
For all
three FLPs, Thelma' s and Gary' s estates20 each received a 48-
-
percent interest and the three children and the LLC each received
a 1-percent interest gratis.
But for HI-2 and HI-3, Thelma and
Gary' s estate contributed 50 percent of the assets .
What Thelma
contributed to HI-1 was.even more disproportionately large
compared to the interest she received.
Thelma transferred almost
$4 million of assets to HI-1 in April 2000.
The Family and
20 Recall that the "Gary T. Hurford Trust" was given a 48percent interest in the partnerships, but that no such trust
actually existed.
Instead, the Family and Marital Trusts created
under Gary' s will, together with an account holding other assets
from Gary's estate, were all contributed to the HI-l partnership,
and eventually consolidated in the HI-1 THIMA account long after
the private annuity transaction was completed. . See supra pp. 2023.
- 71 Marital Trusts contributed a littleainder $1.2 million combined.
Even assuming the Gary T. Hurford Trust existéd as a-Valid
partner, these numbers shòw .that eaãh partner's interest in each
of the FLPs did not refl'ect his or her or its coritribution.
It is equally obvións 'that thefe was no pòoling of assets in
the interest. of áreating true joint nownership or starting a new
enterprise--Thelmavand Gary' s estate contributed everything.
There was nö contribution from any öf the Hurford children either
in money, property, or serva:ces, nor were their partnership
interests reported as. gifts to them.
And we've already found
that the crediting ,of the partners' capital accounts was entirely
fictional
See. supra p. 39.
Thelma's unilateral contribution
supports an inference that. Only a desire-for tax sâvings.
motivated the FLPs' formation.
. .
See Estate of Harper, T.C. Memo.
2002-121; cf . Estate of Harrison
T. C. Memo. 1987-8
(where óther
partners made significant contributions at formation, the
.
partnership served as a vehicle for a genuine pooling of
interests) .
For a FLP to 'work, the minority interest holders must at a
minimum receive their interests either by gift or by. contributing
their òwn assets or services .
Section 1. 704 -1 (e ) (1) (iii) , Income
Tax Regs . , provides that
A donee or purchaser of a capital interest in
a partnership is not recogñized as a partner
* * * unless such interest:is acquired in a
bona fide transaction, not; a mere sham for
- 72 -
tax avoidance or evasion purposes, and the
donee or purchaser is the real owner of such
interest. * * *
This didn't happen here--the. Hurford children neither contributed
their own property nor did Thelma report gifts to ·them of
partnership interests.
We have found no legal authority for
Garza's position that partners can have a partnership interest
with nothing more than a shuffle of paper.
We therefore cannot
recognize the Hurford children as true partners of the FLPs.
We find that the only purpose the FLPs served in Garza's
scheme was to allow the Hurfords to take a discount when Thelma
transferred her assets for the private annuity a short time after
the partnerships were formed.
Therefore, we find that Thelma's
transfers to the FLPs were not bona fide sales for adequate and
full consideration.
b.
Did Thelma Retain the Possession or Enjoyment
of, or the Right to the Income From, .the
Property She Transferred to the FLPs in
Violation of Section 2036(a)(1)?
One question remains:
Must we discount the value of those
assets now included in Thelma's estate for lack of control and
lack of marketability because they consist of interests in FLPs?
The answer depends on whether we would've looked past the FLP to
include the underlying assets in those FLPs in Thelma's estate
absent the private annuity transaction.
We return to the same
analysis under section-.2036(a) (1) to find the answer.
The key is whether there- was. an express or implied agreement
at the "time of the itransfer to th'e FLPs that "Í'helma would keep
the present economic benefits of the property, even if the
retained right were not legally enfórceåble.
Estate of
Reichardt, 114 T.C. at 151 (citing references omitted).
found 'implied agreements when
042
.
the decedent transferred nearly all of his
assets to the FLP, e.g., Estate of Reichardt,
114 T. C.
042
042
The decedent used FLP ass ts to pay his
personal expenses, e.g., Estate of Rosen,
T.C. Memo. 2006-115;
042
We have
144
(2000) ; and
the decedent's relationshipst-o the assets
remained the same before and after the transfer,
e.ý., Estate of Reichardt, 114 T.C. 144
Estate of Rosen, T. C. Memo. 2006-115.
(2000);
Garza' s plan plunges this case right into these precedents .
The key proof of an implied agreement that Thelma would continue
to be able to enjoy her property after she gave nearly all of it
to the FLPs lies in evidence of what happened after the FLPs were
formed--they were shuttled righti into the private annuity just
weeks after they were created and beforë they were fully- funded
with Thelmá' s assets .
And Thelma received her very own assets
back from her children as payments under the private-annuity
agreement.
Yet even though Thelma supposedly held^ an interest in
the FLPs for only a few weeks, we've already recounted· how she
impermissibly took distributions for her living expenses directly
from the FLP accounts.
And like many of the other cases where we
- 74 -
have found a retained interest, she needed that money because she
had transferred nearly everything she owned into the FLPs.
Her
relationship to her assets didn't change after she transferred
them to the FLP accounts--and remained the same even after the
private.annuity sale.
We therefore find that, after transferring the assets into.
the FLPs, Thelma retained. an interest in them in violation of
section 2036(a) (1).
Well, almost.
Because she transferred the
FLP interests to her children through the private annuity--albeit
in a transfer we have found problematic under section 2036(a) (1)
itself--it is possible that she severed her ties to the FLP
interests and didn't hold the impermissible retained interest at
death.
This i's where section 2035(a) comes into play.
2035(a)
says:
Section
SEC. 2035(a).
Inclusion of Certain Property in
Gross Estate.--If-.
(1) the decedent made a transfer (by
trust or otherwise) of an interest in any
property, or relinquished a power with
respect to any property, during the 3-year
period ending on the date of the decedent's
death, and
(2).the value of such property (or an
interest therein) would have.been included in
the decedent's gross estate under section
2036, 2037, 2038, or 2042 if such transferred
interest or relinquished power had been
retained by the decedent on the date of his
death, the value of the gross estate shall
include the value of any property (or
042
- 75
interest therein) which would àhave been so included.
Section 2035 (a) , together with u section 2036 (a) (1) ; thus also
requires the estate; to include the .value''of assets Thelma.
transferred to the FLPs, assuming she severed her connebtion to
the FLPs wi'th the- sale. of her interests to the private annuity
Of course, those assets are already included'because'of the
problems with the private annuity.
We hold, therefore, that the
Hurfords cwere'not entitled to any discounts because of the FLPs
when they calculated the amount of the monthly annuity payments,
and so no discounts apply when detërmining the amount now
includable in the estate .
C.
The Family and Marital .Trusts
We have already described how tjhe Marital and Family Trust
account statements show that Thelma moved those accounts. into the
HI-1 partnership and then tried to shuttle them)to her children
t hrough the private ànnuity.
At trial, Garza described what
happened to the two trusts as follows:
Well, the accounts were transferred by the
bank to the limited partnerships, so those
, ' trusts became assets--the assets in the- trusts
were transferred to.the limited partnerships.
The limited partnership iriterests were sold to
the private annuity. See, in effect, you had
a distribution to Thelma, then a conveyance to
The Commissioner also argues that section 2036 (a) (2) or
section 2038 (a) (1) regulres incltision in the estate .of thes assets
transferred into the FLPs
We need not address this argument,
because we've found section 2036(a) (1), in conjunction with
section 2035 (a) , suf f ices .
-
76
-
the partnership, then a sale of the
partnership interest to the kids, using the
private annuity..
Later, when asked whether Thelma had an interest in the Marital
and Family Trusts at death, Garza responded:
"Well, the assets
had been blown out to limited partnerships which had been sold,
so I think there were trusts, but I don't think they--I think
they were pretty hollow at that point."
On this narrow point, we agree with Garza.
The Family Trust
was an-entirely legitimate part of Gary's estate plan, intended
to use his unified credit of $650,000.
Bisignano had carefully
ensured that the terms of the Family Trust imposed an
ascertainable standard on withdrawals--Thelma was limited to
taking distributions for her. "health, education, support, or
maintenance."· -Without this limitation, the Code would treat
Thelma as if she had general power of appointment,22 and section
2041(a) (2) would include property subject to that power in
Thelma's gross estate.
But the Hurfords cannot qualify for the ,
exception merely by stating it in the will and avoiding it in
practice.
Thelma exercised.a general power by "distributing" all
of the Family Trust to herself and "selling" those assets in the
22 A general power of appointment is one that is "exercisable in favor of the decedent, [her] estate, [her] creditors, or
the creditors of [her] estate."
Sec. 2041(b) (1). Any control
limited by the ascertainable standard (as was provided by Gary's
Family Trust), however, "shall not be deemed a general power.of
appointment."
Sec. 2041(b) (1) (A).
.
private-annuity agreement,sand so they became subject. to her full
control, andaindividual ownership.
Since Thelma used all the
. Family Trust'=s assets as her own in the private annuity
we
disregard the: fact that. they .at:one time could have been
sheltered from any estate tax under the ,plan designed by
Bisignano.
There are many other-problems with the Marital Trust s
assets independent of the FLP and private-annuity transactions.
For example, though Gary's will passed all of the sproperty in his
estate--except for the Family Trust's assets, his home, and his
personal effects-4ìnto-the! Marital Trust,e only a small. portion of
it.ended up inithe Marital Trust account with Chase or was
otherwise titled,in. the Trust' s name :
And Gary' s estate . took .a
QTIP election- for approximately $6,500,000..
Were we to try to
construct an alternate holding- for this part of Thelma's .estate,
as the Commissioner urges, we- woulci quickly run into tricky
questions of whether Thelma' s handling of - that property was a
conversion and disposition. of the QTIP property under, sections
2511 and 2519.24
We'll leave those .questions for another.case,
.
Seò. 203 (a) bfoadly provi es t hat the gross estate includes ."all property, real or personal, tangible or intangible,
whe ever situated."
24 For example, does a transfer of QTIP^into a FLP terminate the clualified incomé interest that the Code requires Thelma
to have from the·time she receives the interest.until death?
Sec.
2044;
sec.
25..2519-1(f), .Gift Tax Regs.
.
and hold instead that all the property that Garza moved from
Thelma and the Trusts into the FLPs and the private annuity is
included without discount in her gross estate under section
2031(a)'s broad language including in an estate "all property,
real or personal, tangible or intangible, wherever situated."
D.
Gifts Thelma Made in February 2000
Thelma gave away $675,000 in taxable gifts in February 2000
and reported them on her gift tax return for that year (Form
709).
The Code requires a taxpayer to include adjusted taxable
gifts made during life in the computation of the tentative estate
tax.
Sec. 2001(b) (1).
The Code then reduces that amount by the
hypothetical tax on a taxpayer's post-1976 taxable gifts.
2001(b) (2).
Sec.
The effect is~ that the estate uses a higher marginal
rate on the graduated rate schedule when computing the estate
tax.
The Commissioner argues that because Thelma's estate failed
to report post-1976 adjusted taxable gifts on her estate tax
return, the estate miscalculated the estate tax due.
RNe agree
with the Commissioner.
II.
Attorney's Fees
The Commissioner challenges the estate's deduction of
$45,000 for attorney's fees it claims it paid.Garza to administer
Thelma's estate.
Section 2053(a) (2) allows a deduction for.
administration expenses, including attorney's fees.
See sec.
-
20.2053-3(a), Estate Tax Regs.
79
2
It is the estate's burden to.
substantiate the deduction. . See.Rule 142.
The Commissioner agrees with the Hurfords that they paid
Garza over $300,000, so we find it à bit hard to believe that
they cannot show any of these fees were paid to administer
Thelma's estate.
Garza never complained that the-Hurfords failed
to pay a bill.and we are quite sure that his work on Thelma's
estate was not done pro bono.
Still, the record is- thin.
At trial., the Commissioner
cross-examined the Hurfords and Garza, trying to figure out how
much of Garza's fees were paid by the estate itself'.
But Garza's
bills were.as sloppy as his other paperwork, and no one was able
to decipher them.
The Commissioner asked Michelle'how much the
estate's administration fee was:
.Q.
Do you know what the total fees, estate=tax fees,
were paid to Garza Staples?
A.
Well, $45,000 were paid on behalf of my mother's
estate.
Q. ·
Were there«fees paid after the estäte tax return
for your father's estate was filed that were paid
to Garza Staples?
A.
Yes.
Q.
And. is that amount claimed on the 706?
There. was $15,000 paid in the year 2000.
Section 7491 sh'ifts the burden of proof to the Commissioner when the taxpayer has produced.credible evidence.
However, the Hurfords' lawyers withdrew their section 7491 motion,
so Rule 142 applies.
- 80 A.
No.
We find Michelle credible and, by a·bare preponderance of the
evidence, find that the estate has proved its $45,000 deduction
for attorney's fees.
III.
Negligence
The estate contests the Commissioner's assertion of a
negligence penalty under section 6662..
Before determining the
estate's liability, we first have to decide whose negligence
matters--Thelma's or her executor's.
On this point, both parties
agree that it is Michael's actions that we need to consider,
because the estate- is the taxpayer and Michael acted as the
estate's fiduciary in his capacity as executor.
We agree that
this makes his conduct the focus of our analysis of whether a
negligence penalty under section 6662 is justïfied.
See Estate
of Holland v. Commiss.ioner, T.C..Memo. 1997-302; see also, e.g.,
Bank of the West v. Commissioner,
93 T.C. 462,
472
(1989)
(imposing on estate's fiduciary a negligence-based penalty for
failure to timely file); Thomas v. Commissioner, T.C. Memo. 2001225
(same).
Since the facts of this case span a long period, we also
need.to determine when to scrutinize Michael's conduct.
On this,
the Code and regulations direct us to use the time period
encompassing the preparation of the return at issue, because the
"term 'negligence'
includes any failure to make a reasonable
.
81
attempt to comply with the proVisions of the .internal revenue
laws or to exercise ordinary and réa'sonable care 'in the
preparation of a tax return."
Regs. . (emphasis added) .
Sec
1.6662-3(b) (1),
Income Tax
We will thefefore corisider the tim
during which Garza and Turner & Stone prepared9 Thelma's estate's
tax returns .
Both Garza and Turner & Stone represented the
estate during this' time arid prepared *thë estate· táx~return that
Michael signed .
We cönsider Michael' s· knowledge sand observations
of his attorney's and accountants' actions to decide whether the
estate is liable
The pènalty irl tlîïs case is triggered by a failure to "make
a reasonable attémpt to comply" with internal revenué laws or to
"exercise ordinary and reasonable care in»the prèparatiön of a
tax re turn . "
Sec . 1 6662 -3 (b) (1) , Incäme ' Tax Regs .
Negligence
also includes "failure by the taxþayer- tò keep adequate books and
records. or to subst antiate items properly."
Id.
.Négligence is
"strongly indicated"a where the taxpayep "fails to make a
reasonable attempt to ascertain thé correctness of a deduction,
credit, or exclusion ón a réturn which would seem to a reasonable
and,prudent person td be Mtoo góód to be true' under the
circumstances."
Id.
If Michael had prepared the estate tax return himself, there
is little doubt that we could fihd negligencé or art intentional
.
- 82 -
disregard of the tax rules.
the returns.
But Michael himself didn't prepare
Instead, he hired Garza and Turner & Stone.
The negligence penalty can be rebutted by a showing of
reasonable cause and.good.faith.
Sec. 6664 (c).
And Michael
points to his reliance on-professional advice for proof.
We
begin with the regulation, which somewhat unhelpfully states that
reliance on professional advice is "reasonable cause and good
faith if, under all the circumstances, such reliance was
reasonable and the taxpayer acted in good faith."
4 (b) (1), Income Tax Regs.
Sec. 1.6664-
The caselaw more helpfully points to
three factors to test whether the taxpayer--and remember that in
this case, that means Michael--properly relied on professional
advice.
43,
99
Neonatology Associates, P.A. v. Commissioner, 115 T.C.
(2000), affd. 299 F.3d 221
(3d Cir.
2002).
042- First, was the adviser.a competent
professional who had sufficient expertise
to justify reliance?
042 Second, did the taxpayer provide necessary
and accurate information to the adviser?
042 Third, did the taxpayer actually rely in
good faith on the adviser's judgment? Id.
Both Garza and Turner & Stone were professionally licensed
and would have appeared competent to a layman at the time they
prepared the estate tax return.
Reliance on even these
professionals appears more rational in light of Bisignano's prlor
recommendations.
Although nowhere nearly as aggressive, and
- 83
certainly more competently drafted, Bisignäno's advice contained
strategies simïlar in name and purpose to Gárza s .
Garza was
thus not the first to ïntroduce~Midhael to the"concept of family
limited partnerships, and "we do^not- find Ivlichael to have
unreasonably relied on Garzá when pursuing tax-reduction
strategies on¼behalf of his mother's estate.
Commissioner, T.C. Memo. 2006-25.
See Melnik v.
We find it more likely than
not that .Michael was reasbnäble in nòt 4khowing that Garza's
particular method of estatè.plänning was so far off the mark that
it would lead him and his family into t-lieir present morass of
litigation.
We find little indicätion that Michael kriew or
reasonably could have known>that- Garza' s schemes were not within
the realm of legitimate estate =plarifiing: practices·'or 'that Gärza
or Turner & Stone lacked sufficie;nt competence in estate tax law.
Sec .
1. 6664 -4 (c) ,
Income Tax Regs .
On the .second point, we find thát Michael provided both
Garza and Turner & Stone> withk all the relëvant financial data
needed to assess the correct level of×estate tax
4 (c) (1) (i) ,
Set. 1.6664-
Income Tax Regs .
It's the third point--did Michael reasonably and in good
faith rely on Garza and Tui-ner & Stone s professional advïce-that's the hardest t o address.
Sec. 6664 (c).
The regulations
direct us to consider "all facts and circumstances" to decide
whether Michael's i-eliance was reasonable ànd in good faith.
Sec .
1. 6664-4 (c) (1) ,
Income Tax Regs .
Michael is a child
psychiatrist of considerable education and experience in his
field, but we find that he is not sophisticated in tax and
.
business matters.
See Malone v. Commissioner, T.C. Memo. 2005-
69; cf. Estate of Holland, T.C. Memo..
1997-302
(imposing a
negligence penalty on executor who was estate-planning and tax
attorney) .
Our review of Michelle's notes of meetings and calls with
her brother, Garza, and the accountants consistently show a
family that wanted to do all it could to reduce or eliminate the
tax bill they faced, but also show constant questioning of their
advisors about what was going on and whether it would work. = This
makes µs fall back on United .States v. Boyle, 469 U.S. 241
(1985) , ÷where the Court noted:
Most taxpayers are not competent to discern
error in the substantive advice of an
accountant or attorney. . To require·the
taxpayer to challenge the attorney, to seek a
"second opinion," or to try to monitor counsel
on the provisions of the Code himself would
nullify the very purpose of seeking the advice
of a presumed expert in the first place. * * *
"Ordinary business .care and prudence" do not
demand such actions.
Id. at 251; see also Chamberlain v. Commissioner, 66 F.3d 729,
733
(5th Cir. 1995),
(quoting Boyle) affg. in part, revg. in
L
part, T.C. Memo. 1994-228; Stanford v. Commissioner, 152 F.3d
450, 461-62 (5th Cir. 1998),
(discussïng the need for even an
- 85 -
intelligent person to obtain expert advice) affg. in part and
vacating in part,
108 T. C. 344
(1997) .
We consider it well established that a taxpayer has the
right to minimize his tax _liability, and it was reasonable for
Michael to have. relied on professionals in the arcane and complex
field of estate-tax law.
That his and his family's choice of
advisers proved so unsuitable has led them to their present
situation--unable to.enjoy fully2the estate built up by old Mr.
Hurford, and seeking relief at court instead.
But we do find
that Michael' s reliance on the professionals he chose, .however
unsuitable they turned out to be, was nevertheless under the
circumstances done reasonably and in.good faith.
We therefore
impose no penalty for negligence or disregard of the Code.
Decisions' will be entered
under Rule 155.
%
en
. .m S-
.t¯
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.