UNITED STATES TAX COURT

T.C. Memo.

1994-234

UNITED STATES TAX COURT

ROBERTA SCHREIBER ULMER, ET AL., Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos.

12602-91, 14026-91.,

14348-91, 14349-91.

Filed May 26, 1994.

R determined that the Estate of C (EC) was liable

for gift and estate taxes that arose from alleged gifts

made by C to C's children, petitioner R (PR) and

petitioner M (PM), during the taxable period ending

June 30, 1979. Sec. 2501, I.R.C. Specifically, R

asserts that C entered into an enforceable contract to

make gifts to PR. PR denies that C was obligated to

transfer property under New York law. R also asserts

that C sold an interest in the family business to PM

for less than adequate consideration. PM argues that

adequate consideration was provided for the transfer of

the business interest. R has also asserted that PR and

PM are liable as transferees for gift taxes owed due to

taxable transfers during that period. Sec. 6324(b),

I.R.C. R also asserts that EC is liable for a fraud

penalty pursuant to sec. 6653(b), I.R.C.

Cases of the following petitioners are consolidated

herewith: Roberta Schreiber Ulmer, docket No. 12602-91; Marvin

Rosenblatt, docket No. 14026-91; Estate of Cecil Rosenblatt,

Deceased, Roberta Schreiber Ulmer, Hannah Goldstein, and Iris

Gruenebaum, Administratrices, C.T.A., c/o Matthew F. Sarnell,

Esq., docket Nos. 14348-91 and 14349-91.

SERVED MAY 2 61994

1. Held: EC is not liable for gift tax owed for

a transfer of property from C to PM during the period

in issue. No gift tax liability arose because the

promised transfer did not occur during that period.

2. Held, further, EC iS not liable for gift tax

owed for gifts made by C to 040R

during the period in

issue. No gift tax liability arose because C was not

obligated under New York lawito make transfers to PR

during that period.

3. Held, further, PR is not liable as a

transferee under sec. 6324(b), I.R.C.

4. Held, further, PM is not liable as a

transferee under sec. 6324(b), I.R.C.

5. Held, further, EC is not liable for a fraud

penalty pursuant to sec. 6653!(b), I.R.C., because R has

not carried her burden of prqving liability.

Ru.le 142(b), Tax Court Rules of Practice and Procedure.

Matthew F. Sarnell, Stanley L. Kantor, Gregory A. Robinson,

and Melvin Paradise, for petitioners.

Frances Ferrito Regan and Pamela L. Cohen, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

HALPERN, Judcre:

Respondent has determined deficiencies in

both estate tax and gift taxes, and additions to tax in

connection with the gift taxes, against petitioner Estate of

Cecil Rosenblatt, Deceased, Roberta Schreiber Ulmer, Hannah

Goldstein, and Iris Gruenebaum, Administratrices, C.T.A. (the

Estate).

Respondent has also determined that petitioners Roberta

Schreiber Ulmer (Roberta) and Marvin Rosenblatt (Marvin) are

liable as transferees of the property of Cecil Rosenblatt (Cecil)

- 3 for a deficiency in gift tax, and for an addition to tax, for the

calendar quarter ended June 30, 1979.

Because these cases

involve common questions of fact, they have been consolidated for

trial, briefing, and opinion.

The deficiency in estate tax determined by respondent

against the Estate in docket No. 14349-91 is $187,490.73.

The deficiencies in gift tax and additions to tax determined

by respondent against the Estate in docket No. 14348-91 are as

follows:

Period Ending

Gift Tax

June 30, 1979

December 31, 1979

June 30, 1980

September 30, 1980

December 31, 1980

March 31, 1981

June 30, 1981

December 31, 1981

December 31, 1982

December 31, 1984

$1,751,979.70

3,393.00

18,217.50

17,360.71

1,332.50

41,650.00

45,488.95

84,706.04

87,633.85

31,375.30

2,083,137.55

Total

Additions to Tax

6653(b)2

$875,989.85

1,696.50

9,108.75

8,680.36

666.25

20,825.00

22,744.48

42,353.02

43,816.93

15,687.65

1,041,568.79

The liability as a transferee determined by respondent

against Roberta in docket No. 12602-91 is $600,000.

2

I.R.C., sec. 6653(b) was amended by the Tax Equity and

Fiscal Responsibility Act of 1982 (TEFRA), Pub. L. 97-248,

sec. 325(a), 96 Stat. 324, 616. The TEFRA version of sec.

6653(b) modified the calculation of the fraud addition. The

statutory notices with respect to the periods ending Dec. 31,

1982, and Dec. 31, 1984 (after the effective date of TEFRA), do

not expressly indicate whether respondent used the post-TEFRA

formulation. Since the parties have settled the issues regarding

those years, we assume that the parties have taken into account

any relevant changes in the law. All citations to sec. 6653 are

intended to refer to that section as effective during the

relevant period(s) in issue.

.

- 4 The liability as a transfere

determined by respondent

against Marvin in docket No. 14026-91 is $1,800,000.

The parties have settled numerous issues and have left for

our decision only the ramificatio s of certain events occurring

during June 1979.

Unless otherwise noted, all section references are to the

Internal Revenue Code in effect for the taxable period in issue,

and all Rule references are to the Tax Court Rules of Practice

and Procedure .

FINDINGS OF FACT

Some facts have been stipulated and are so found.

The

stipulation of facts filed by the parties and accompanying

exhibits are incorporated herein by this reference.

Residences

At the time the petitions in

hese cases were filed, the

residence of Marvin was in New Yor , New York, and the residence

of Roberta was in Baltimore, Maryland.

The Family

Cecil was the wife of William Rosenblatt, deceased

(William).

Their children were Marvin, Roberta, Hannah Goldstein

(Hannah), and Iris Gruenebaum (Iris) (collectively, the

children).

Cecil died on May 12, 1986.

William's Death

William predeceased Cecil, dying on January 31, 1977.

At

the time of William's death, he owned a 90-percent interest in

the William Rosenblatt partnership (WR), and Marvin owned the

- 5 remaining 10-percent interest.

The business of WR was to

purchase and sell unmounted diamonds and to create diamond

jewelry for sale to various jewelry dealers and retailers.

William died testate.

Pursuant to his last will and

testament (the will), William made the following bequests:

bequeathed $10,000 to each of the children.

He

He also bequeathed

$60,000 in trust for the benefit of each of Roberta, Hannah, and

Iris (but not Marvin).3

He bequeathed a portion of the residue

of his estate outright to Cecil.

He bequeathed the remaining

portion in trust (the residuary trust) for the benefit of Cecil

and the children.

Cecil had a life interest in the residuary trust.

She also

had a particular power to appoint trust assets to the children.

The children were to share in the remainder of the residuary

trust on the death of Cecil.

Renunciations

Following William's death, in April 1977, each of the

children renounced his or her interest in the residuary trust and

Roberta, Iris, and Hannah each renounced her interest in the

$60,000 bequeathed in trust for her benefit.

The residuary trust

was neither established nor funded, and the entire residue of

William's estate passed outright to Cecil.

William's partnership

The will explains William's failure to make such a bequest

to Marvin by stating that Marvin had been assisted in

establishing himself in his own business and was a partner with

his father in the William Rosenblatt partnership, from which he

would draw a salary until the assets of that business were

liquidated.

- 6 interest in WR was included in thè residue.

That interest was

valued on the estate tax return for William's estate at $632,607.

That amount was accepted after audit of the return by the

Internal Revenue Service.

In consideration of Marvin's renunciation of his interest in

the residuary trust, he received an additional 11.25-percent

interest in WR, which increased his interest to 21.25 percent.

Successor Partnership

In January 1978, Cecil and Marvin formed a partnership under

the name of William Rosenblatt (WR2) to continue the business of

WR.

The initial capital of WR2 consisted of the net worth of WR.

That capital was shown in the WR2 partnership agreement (the

partnership agreement) as having béen contributed 78.75 percent

by Cecil and 21.25 percent by Marvin.

The partnership agreement

provided that, initially, Cecil was to have a 90-percent interest

in the profits and losses of WR2 and Marvin was to have a

10-percent interest.

The partnership agreement further provided

that, beginning in the second year of the partnership, and

concluding in the fifth year of the partnership, Cecil's interest

in profits and losses was to be decreased (in 10-percent

increments, annually), and Marvin's increased (similarly), until

each was to receive 50 percent of profits and losses.

In June 1978, Marvin's interest in the capital of WR2 was

increased from 21.25 percent to 28.37 percent in consideration of

his contributing certain pieces of jewelry to the partnership.

- 7 The June 1979 Agreement and the Supplemental Agreement

On June 30, 1979, Cecil and Marvin entered into two

agreements, one an untitled three-page agreement (the June 1979

agreement) and the second a supplement thereto (the supplemental

agreement).

By way of the June 1979 agreement, Cecil and Marvin

agreed that (1) in consideration of receiving $270,000 from

Marvin, Cecil would sell to him a 46.63-percent interest in WR2

(increasing his capital interest therein from 28.37 percent to

75 percent) and (2) the partnership agreement would be modified,

as set forth.

In part the June 1979 agreement provides:

W I T N E S S E T H:

WHEREAS, the parties hereto did form a partnership

under the firm name WILLIAM ROSENBLATT * * *; and

*

*

*

*

*

*

*

WHEREAS, CECIL ROSENBLATT has agreed to sell to

MARVIN ROSENBLATT so much of her interest in the

partnership as shown on the books of the partnership as

of this date to enlarge MARVIN ROSENBLATT'S partnership

capital interest to 75% and reduce her capital interest

in the partnership to 25%, for $270,000

NOW, THEREFORE, in consideration of the mutual

covenants hereinafter set forth, it is agreed as

follows:

1.

CECIL ROSENBLATT agrees to accept, concurrent

with the signing hereof, the sum of $270,000.00 from

MARVIN ROSENBLATT for the sale by her to MARVIN

ROSENBLATT of a 46.63% interest in the partnership

doing business under the name WILLIAM ROSENBLATT, it

being agreed:

(a) That effective June 1, 1980, after

payment of the first promissory note provided

for in Subparagraph (d) of this paragraph,

the partnership interests of the parties

hereto and the division of net profits and

losses of the partnership shall be:

MARVIN ROSENBLATT

CECIL ROSENBLATT

75%

25%

(b) That after June 1, 1980, the net profits

and losses of the partnership shall be

divided * * * in accordance with the capital

interests as set forth in Subparagraph (a) of

this paragraph.

*

*

*

*

*

*

*

(d) The $270,000.00 purchase price shall be

evidenced by a series of five promissory

notes * * * The first four of said notes '

shall be in the sum of $50,000 each, payable

June 1, 1980, June 1, 1981, June 1,1982, and

June 1, 1983; the fifth note shall be in the

sum of $70,000, payable June 1, 1984.

The supplemental agreement provides:

SUPPLEMENTAL AGREEMENT TO AGREEMENT DATED

JUNE 30, 1979, BY AND BE 040WEEN

CECIL

ROSENBLATT AND MARVIN ROSENBLATT

With respect to the intetests of the parties over and

above their partnership interest in the firm conducted under

the partnership name of WILLIAM ROSENBLATT * * * the parties

agree as follows:

1.

With respect to the three daughters of

CECIL ROSENBLATT, to wit: ROBERTA, IRIS and HANNAH, it

is agreed that they will be paid out the balance due

them pursuant to the understanding made at the time of

the death of WILLIAM ROSENBLA T, by June 30,

1980, and

that after they are paid out the full amount which was

promised to them as aforesaid, no funds of the

partnership conducted under the name of WILLIAM

ROSENBLATT will be paid to any of the said daughters of

CECIL ROSENBLATT, except by m tual consent of the

parties hereto. If, after they have been paid out the

full amount promised to them, business funds of the

partnership conducted under the name of WILLIAM

ROSENBLATT are paid to any of the said girls without

the consent of MARVIN ROSENBLATT, such advances shall

be charged against the capital account of CECIL

ROSENBLATT in the said partnership.

2. MARVIN ROSENBLATT agrpes and does hereby renounce

any and all right he may have to contest the Last Will and

Testament of CECIL ROSENBLATT, his mother, it being agreed

- 9 and understood that CECIL ROSENBLATT shall have the right to

dispose of her Estate as she sees fit, without interference

or claims on the part of MARVIN ROSENBLATT.

Dated:

June 30, 1979

|sf

CECIL ROSENBLATT

|sf

MARVIN ROSENBLATT

The December 1979 Agreement

In December 1979, Cecil and Marvin entered into another

untitled agreement, whereby Cecil agreed to sell to Marvin her

remaining 25-percent interest in WR2 for $109,601.

The sale was

to be effective January 1, 1980, and Marvin was to pay for the

transfer by delivering to Cecil a series of promissory notes.

Also, Cecil agreed to waive paragraph 1(a) and (b) of the

June 1979 agreement, so that, effective January 1, 1980, all

profits and losses of WR2 would belong to Marvin.

Marvin's Notes

Before negotiating the June 1979 agreement and the

supplemental agreement, Marvin prepared a list of issues to be

taken up with Cecil.

Among the items on the list are:

Payout the girls within 9 months, by Dec. 31, 1979,

amount agreed upon.

* No further business funds to girls - except if

mutually agreed and that it reduces your equity.

Raise my percent of business to 75%, by Dec. 31, 1979,

by signed amendment to partnership agreement (the

payout of the girls represents over 50% of original

value of business without consideration for taxes, fees

and expenses)

* Thereafter, I may use all business funds as I choose.

* As previously agreed, all 'other' funds are mine, now

and in the future

You retain 25% of business,

ith the same buy-out

provisions of our partnership agreement, except that I

have the option for a total buyout after X (to be

determined) number of years.1

* You receive approximately $270, 000 - in cash or

short-term promissory notes secured by the business, by

Dec. 31, 1979 (to raise my equity to 75% of an assumed

business value of $600,000 of recent accounting record.

I must pay the difference between 75% of $600,000, or

$450,000, and the approximat ly 30%, or $180,000, which

I now possess $450,000 - 180,000 = $270,000)

The Ledger Cards

At the time of Cecil's death in 1986, three sets of ledger

cards (the ledger cards) were found in a locked cabinet among her

papers at WR2's offices.

Each set of ledger cards is titled

Roberta, Hannah, or Iris, respectively.

The entries on the

ledger cards were handwritten by Cecil.

The information

contained on the ledger cards is a tached to this report as an

appendix.

When summed, the amount

shown on the ledgers titled

"Roberta", "Iris", and "Hannah" tot;al $571,117, $574,473, and

$602,214, respectively.

OPINION

I.

Introduction

Many of the issues presented

have been settled by the parties.

n these consolidated cases

The remaining issues all turn

on our analysis of certain events occurring during June 1979.

Respondent maintains that, by virtue of two agreements entered

into by Cecil and her son, Marvin, in June 1979 (the June 1979

agreement and the supplemental agreement), Cecil made taxable

- 11 gifts to Marvin in the amount of $1,800,000 and to each of his

sisters, Roberta, Hannah, and Iris, in the amount of $600,000

apiece.

Respondent also maintains that the underpayment in gift

tax for the calendar quarter ended June 30, 1979 (the June 30

quarter), resulting from Cecil's failure to report such gifts,

was due to fraud.

and deny any fraud.

Petitioners deny that any such gifts were made

Marvin and Roberta are petitioners only

because respondent has determined that each is liable as a

transferee of the property of Cecil for the gift tax liability

(and addition to tax) for the June 30 quarter.

II.

Respondent's Determinations

In respondent's notice of deficiency issued to the Estate

with respect to the gift tax, respondent states simply that she

has determined that, during the June 30 quarter, Cecil (1) made a

gift of 50 percent of a jewelry business with a fair market value

of $1,800,000 to her son Marvin and (2) made cash gifts of

$600,000 (taking into account certain settled issues) to each of

her daughters, Roberta, Hannah, and Iris (collectively, the

daughters or sisters, as appropriate).

In her answer, at trial,

and on brief, it has become clear that respondent's determination

of gift tax liability for the June 30 quarter, is not as

straightforward as her notice of deficiency would suggest.

Respondent's determination is based on her assumption that the

jewelry business in question (WR2, a partnership business) was,

at the time of the claimed gifts, worth in excess of $3,600,000,

and that, by virtue of the June 1979 agreement and the

- 12 supplemental agreement, Cecil (1

made a bargain sale of a

portion of her interest in WR2 to Marvin for $1,800,000 less than

that portion was worth and (2) o ligated herself to pay $600,000

to each of her daughters.

We willl address, in turn, respondent's

determinations of gifts made by Cecil to (1) Marvin and (2) his

sisters.

Our decisions on those issues make it unnecessary for

us to address the valuation issue raised by respondent's

determinations.

III.

Gift to Marvin

A.

Introduction

During 1979, the gift tax wa

imposed for each calendar

quarter on the transfer of propert y by gift during that quarter.

Sec. 2501.

gifts.

Section 2512 concerns itself with the valuation of

In pertinent part, section1 2512 provides:

(a) If the gift is made in property, the value

thereof at the date of the gift shall be considered the

amount of the gift.

(b) Where the property is transferred for less

than an adequate and full con ideration in money or

money's worth, then the amount by which the value of

the property exceeded the valùe of the consideration

shall be deemed a gift, and shall be included in

computing the amount of gifts made during the calendar

quarter.

Respondent's position is simple:

On June 30, 1979, pursuant

to the June 1979 agreement, Marvin purchased from Cecil a

46.63-percent interest in WR2, paying for that interest

$1,800,000 less than it was worth.

As explained more fully

below, in section IV, respondent has determined that the interest

was worth $1,800,000 more than Marv n paid for it because

- 13 respondent believes that Cecil contemporaneously made an equal

gift to her daughters.

simple:

Petitioners' principal position also is

Marvin paid full value for the partnership interest,

thus negating the possibility of a gift.

B.

Analysis

Respondent's focus is on June 30, 1979.

Respondent argues

that, on that date, by virtue of the June 1979 agreement, Marvin

received a 46.63-percent interest in WR2 from Cecil.

As a

result, respondent claims that, had WR2 been liquidated at the

close of business on June 30, 1979, Marvin would have been

entitled to receive 75 percent of the capital of WR2:

Cecil transferred complete dominion and control of a

46.23% [sic.] interest in the capital account of WR2 to

petitioner Marvin on June 30, 1979. * * * If Cecil

had died between June 30, 1979 and June 30, 1980, the

assets of the partnership, after payments of debts to

other creditors, would have been distributed to

petitioner Marvin pursuant to the capital account. See

N.Y. Partnership L. § 71(c) (McKinney 1988).

We do not quarrel with respondent's interpretation of New York

partnership law.

We disagree, however, that, on June 30 1979,

pursuant to the June 1979 agreement, Cecil made a contemporaneous

transfer of any percentage of her partnership interest to Marvin.

The June 1979 agreement states that Cecil has agreed to sell

to Marvin so much of her interest in WR2 as "to enlarge MARVIN

ROSENBLATT'S partnership capital interest to 75% and reduce her

capital interest in the partnership to 25%".

In consideration of

the transfer of a 46.63-percent interest in WR2 to Marvin (to

increase his partnership interest to 75 percent), Marvin is

- 14 -

obligated to pay to Cecil $270,000, by delivering to her five

notes in that total amount.

Mary n's partnership interest in WR2

is not to increase to 75 percent immediately, however.

The

pertinent provision of the June 1 79 agreement is as follows:

That effective June 1, 1980, after payment of the first

promissory note provided for in Subparagraph (d) of

this paragraph, the partnership interests of the

parties hereto and the divis on of net profits and

losses of the partnership sh 11 be:

MARVIN ROSENBLATT

CECIL ROSENBLATT

75% 042

25%

[Emphasis added.]

Respondent recognizes the difficulty that paragraph 1(a)

presents to her.

She insists, however, that, contrary to the

inference to be drawn from that paragraph, Marvin's interest in

WR2 immediately increased to 75 percent.

She argues that:

"According to the Forms K-1 that were filed with WR2's federal

partnership return for the taxable year ending December 31, 1979,

the partnership reported that petitioner Marvin had a 75 percent

interest in the partnership's capital account and that Cecil had

only retained a 25 percent interes ."

Petitioners argue that respon ent has failed to take account

of another agreement entered into

etween Cecil and Marvin

subsequent to the June 1979 agreement and before the Forms K-1 in

question were filed.

Pursuant to t at agreement, entered into on

December 31, 1979 (the December 1979 agreement), among other

things,

(1) Cecil agreed to sell to Marvin her remaining

25-percent interest in WR2 and (2) Cecil waived paragraph 1(a) of

the June 1979 agreement.

That lastlprovision of the

- 15 -

December 1979 agreement, argues petitioner, would account for the

75-percent capital interest shown for Marvin on the Forms K-1.

The provision of the December 1979 agreement in question reads as

follows:

CECIL ROSENBLATT hereby waives the provisions of

Paragraphs (1)(a),(b),(c) and (e) of the June 30, 1979

Agreement between the parties, it being understood and

agreed that all profits and losses effective January 1,

1980 of the business hereafter conducted under the name

WILLIAM ROSENBLATT shall belong to MARVIN ROSENBLATT.

[Emphasis added.]

Because Cecil's waiver was not effective until January 1,

1980, we do not agree with petitioners that the December 1979

agreement adequately explains the entries on the 1979 Forms K-1.

Nevertheless, and although the Forms K-1 are some evidence to the

contrary, we find that Marvin's partnership (capital) interest in

WR2 did not increase from 25 percent to 75 percent on June 30,

1979.

In making that finding, we rely primarily on the June 1979

agreement, which we believe contemplates that Marvin's

partnership interest would remain at 25 percent until June 1,

1980, or later, if he were to default on the first promissory

note.

Such a delayed effective date makes sense to us when we

consider Marvin's notes made in anticipation of negotiating with

Cecil, Marvin's testimony, and the supplemental agreement.

As

discussed more fully in section IV, below, Marvin understood

that, before June 30, 1980, Cecil was free to withdraw money from

WR2 to meet certain obligations of hers to her daughters.

It is

clear to us that Marvin acknowledged the existence of that

obligation, but wanted it satisfied out of partnership assets

- 16 that he did not view as his.

Again as explained more fully

below, we view the delayed effective date provision as a method

both to allow and to control Cecil's use of partnership funds to

satisfy her obligation to her daug ters.

To the extent that the

Forms K-1 indicate that Marvin's interest in the capital of WR2

increased to 75 percent before Jan ary 1, 1980, we believe that

they are in error.

Respondent has asserted no theory with regard to the claimed

gift by Cecil to Marvin other than that, on June 30, 1979, as a

result of the June 1979 agreement, Marvin received a gift from

Cecil because Marvin's capital intërest in WR2 increased by

46.63 percent on that date.

In particular, respondent has not

argued that a transfer by gift constituted a binding promise to

transfer a capital interest to Marvin in the future.

theory would give rise to difficul

Such a

questions of valuation,

based, in part, on Cecil's control of her capital interest during

the interim.

Clearly, respondent k ows how to argue that a

binding promise constitutes a transfer by gift.

That is

precisely the argument that respond nt makes with regard to the

daughters.

Because respondent has

ot argued a gift by promise,

and because of the valuation difficulties presented, we will not

go beyond respondent's theory that

arvin's capital interest in

WR2 increased by 46.63 percent on J ne 30, 1979.

Having found

that, as a result of the 1979 agreement, Marvin's capital

interest in WR2 did not increase during the June 30 quarter, we

hold that there was no transfer by gift from Cecil to Marvin

- 17 during that quarter on account of the sale by Cecil to Marvin of

a 46.63-percent interest in WR2.

IV.

Gifts to the Daughters

A.

Introduction

Respondent has determined transfers by gift, by Cecil, of

$600,000 to each of the daughters during the June 30 quarter,

although respondent states on brief that payment of such amounts

occurred between August 1979 and the end of 1983.

Respondent

explains that seeming discrepancy by arguing that, in June 1979,

Cecil made a binding promise to make a gift, which itself

constitutes a transfer by gift.

We agree that a binding promise

to make a gift can constitute a transfer by gift for purposes of

section 2501; we do not agree, however, that such a binding

promise was made here.

B.

Promises to Make a Gift

The rule with regard to a promise to make a gift has been

well stated by the Court of Appeals for the Second Circuit, in

Rosenthal v. Commissioner, 205 F.2d 505, 509 (1953), revg. and

remanding 17 T.C. 1047 (1951):

"a binding promise to make a gift

becomes subject to gift taxation in the year the obligation is

undertaken and not when the discharging payments are made."

That

was the view of the Tax Court in Rosenthal v. Commissioner,

17 T.C. 1047 (1951), which was revd. and remanded by the Court of

Appeals for the Second Circuit, 205 F.2d 505 (2d Cir. 1953), to

determine whether the binding promise in question was made in

consideration of the release of the taxpayer from an earlier

- 18 -

binding promise.

See also Estate of Copley v. Commissioner,

15 T.C. 17, 20 (1950) (payments made in 1936 and 1944, pursuant

to a binding contract (an antenuptial agreement) entered into in

1931, were not taxable as gifts in 1936 and 1944), affd. 194 F.2d

364 (7th Cir. 1952).

C.

The Supplemental Agreement

Respondent finds binding promises to make gifts to the

daughters in the supplemental agreement.

The supplemental

agreement was entered into in congection with the June 1979

agreement, whereby, among other things, Cecil agreed to sell to

Marvin a 46.63-percent interest in WR2.

The pertinent language

of the supplemental agreement is as follows:

1.

With respect to the three daughters of

CECIL ROSENBLATT, to wit:

ROBERTA,

IRIS and HANNAH, it

is agreed that they will be paid out the balance due

them pursuant to the understanding made at the time of

the death of WILLIAM ROSENBLATT, by June 30, 1980, and

that after they are paid out the full amount which was

promised to them as aforesaid, no funds of the

partnership conducted under the name of WILLIAM

ROSENBLATT will be paid to any of the said daughters of

CECIL ROSENBLATT, except by mutual consent of the

parties hereto.

* * *

Neither the supplemental agreement nor the June 1979 agreement

spells out either (1) the understanding made at the time of the

death of William Rosenblatt or (2) any balance due pursuant

thereto.

Respondent has proposed

finding that there was an

agreement between Cecil and the children that she would

distribute to them the assets left in her control after the death

of William.

Based on the ledger cards found among Cecil's papers

after her death, respondent theorizes that the agreement was to

pay to each daughter $600,000 (and to Marvin $1,800,000).

Reading the supplemental agreement together with the June 1979

agreement, respondent concludes that the daughters are third

party beneficiaries of an agreement between Cecil and Marvin,

with an enforceable right to receive $600,000 apiece.

D.

The Daughters' Position

The daughters' position is clear:

While all of The Daughters received some financial

support or gifts from Decedent at times, which gifts

are the subject of settled issues in this case, none of

them ever received a promise of payment of $600,000.00

each and none of them ever received property or money

with value anywhere near $600,000.00.

While the daughters' position leaves open the possibility that

they were promised, and received, some amount (still

substantial), but nowhere near $600,000, we need not explore that

possibility.

The daughters challenge directly respondent's

fundamental premise that the supplemental agreement constituted a

binding promise to make gifts to them:

"The Supplemental

Agreement created no enforceable promise to transfer money or

property by gift to The Daughters, as third party beneficiaries,

as the promise was too vague and ambiguous to be enforceable."

Fundamentally, we agree with the daughters.

E.

Analysis

1.

Third Party Beneficiaries

The Court of Appeals for the Second Circuit (to which an

appeal in this case might lie) has recently summarized pertinent

I

- 20 aspects of the law of New York ( he applicable law) concerning

third party beneficiaries:

An intended third party beneficiary will be found when

it is appropriate to recognize a right to performance

in the third party and the circumstances indicate that

the promisee intends to give the third party the

benefit of the promised performance. Restatement

(Second) of Contracts § 302 (1981).

New York has

adopted the Restatement approach in determining whether

a third party beneficiary exists. Septembertide

Publishing, B.V. v. Stein & Day, Inc., 884 F.2d 675,

679 (2d Cir 1989); Fourth Ocean Putnam Corp. v.

Interstate Wrecking Co., 66 N.Y.2d 38, 44-45, 495

N.Y.S.2d 1, 5, 485 N.E.2d 208, 212 (1985). In

determining third party beneficiary status it is

permissible for the court to look at the surrounding

circumstances as well as the agreement. Septembertide,

884 F.2d at 679; Fourth Ocean, 66 N.Y.2d at 45, 495

N.Y.S.2d at 5, 485 N.E.2d at 1212. Moreover, it is

well-settled that the obligation to perform to the

third party beneficiary need not be expressly stated in

the contract. Vista Co. v. Columbia Pictures Indus.r

Inc., 725 F.Supp. 1286, 1296 (S.D.N.Y. 1989); see also

Strauss v. Belle Realty Co., 98 A.D.2d 424, 426-27, 469

N.Y.S.2d 948, 950 (2d Dep't 1983) (to enforce promise

third party need not be identified in contract but need

only show intent of contracting parties to benefit

third party), aff'd 65 N.Y.2d,399, 492 N.Y.S.2d 555,

482 N.E.2d 34 (1985).

Trans-Orient Marine Corp. v. Star Trading & Marine, Inc.,

925 F.2d 566, 573 (2d Cir. 1991).

Restatement, Contracts 2d, sec. 302 (sec. 302),

I

distinguishes an "intended" beneficiary, who acquires a right by

virtue of a promise, from an "incidental" beneficiary, who does

not.

See Restatement, Contracts 2d, secs. 304, 315.

Sec. 302

provides:

Intended and Incidental Beneficiaries

(1) Unless otherwise agreed between promisor and

promisee, a beneficiary of a promise is an intended

beneficiary if recognition of a right to performance in

I

- 21 the beneficiary is appropriate to effectuate the

intention of the parties and either

(a) the performance of the promise will satisfy

an obligation of the promisee to pay money to the

beneficiary; or

(b) the circumstances indicate that the promisee

intends to give the beneficiary the benefit of the

promised performance;

(2) An incidental beneficiary is a beneficiary who is

not an intended beneficiary.

2.

Cecil's Promise; Marvin's Intent

Cecil was the promisor and Marvin was the promisee.

We must

determine whether the sisters were intended or incidental

beneficiaries of a promise by Cecil to Marvin to pay money to

them.

There is convincing evidence that (1) Marvin believed that

his mother was obligated to his sisters and (2) the supplemental

agreement manifested his intent for her to meet her obligations.4

Marvin testified that his "intention was to have her meet her

obligations * * * within a brief period of time."

Cecil signed

4

With regard to the supplemental agreement, Marvin was asked

on direct examination:

Q

And can you tell me, did you have an idea or some

comprehension of what was meant by the phrase "pursuant

to the understanding made at the time of the death of

William Rosenblatt"?

He answered:

A

I believe it meant that my mother had reached some

understanding with my sisters based on a promise that

she had made to them at that time [at the time of their

renunciations of bequests under William's will), and my

purpose in signing this and having it -- agreeing to it

was to require by mother to meet her obligations to my

sisters.

the supplemental agreement.

We thus have no trouble in

concluding that the first requirement of sec. 302 is met:

The

daughters could show that recognition of a right to performance

in them (to have Cecil discharge her obligation to them) "is

appropriate to effectuate the intpntion of the parties".

Sec. 302(1).

Nevertheless, we be ieve that the evidence

contradicts the second requirement of sec. 302:

Either (1) "the

performance of the promise will satisfy an obligation of the

promisee to pay money to the beneficiary" or (2) "the

circumstances indicate that the ptomisee intends to give the

beneficiary the benefit of the prómised performance".

Sec. 302(1)(a) and (b), respectiv ly.

Respondent has not argued (n r would we agree) that Marvin

had any obligation to his sisters.

Rather, respondent argues:

Petitioner Marvin's stated purpose in signing the

Supplemental Agreement was to require his mother to

meet her obligation to his sisters based on a promise

that she had made to them at the time of the death of

their father. Petitioner Marvin intended that his

sisters would benefit from this contract. The plain

meaning of the Supplemental Agreement is evidence of

petitioner Marvin's intent to make the contract

enforceable by the sisters.

We infer that respondent believes that the conditions of

sec. 302(1)(b) are satisfied.

We disagree.

We do not believe that Marvin intended to give his sisters

the benefit of the promised performance, except incidentally.

Indeed, Marvin testified that, aft r his father's death, "I

wasn't on very close terms with, particularly, two of my three

sisters."

We believe that Marvin intended to give himself the

- 23 benefit of the promised performance, by limiting what money his

mother could take out of WR2 to benefit his sisters, and by

providing a limited period during which she could do that.

cross examination, Marvin testified as follows:

Q

When you started negotiating with your mother to

obtain the controlling interest in William Rosenblatt

A

Yes.

Q

-- was it a concern of yours that your mother had

given support to your sisters in the past?

A

Yes.

-

Q

During these negotiations, were you concerned

that, if she continued to give considerable support,

she would be taking money from the business to do so?

A

Could you repeat the question?

Q

Were you concerned, during these negotiations,

that if she continued to give large amounts of money to

your sister[s] -- were you concerned that she would

take it out of the business if she retained an interest

in the business?

A

I was concerned that any money she took out of the

business was partially mine and she shouldn't do that

because -- without my approval, small or large sums.

*

Q

*

*

*

*

*

*

Was your purpose for entering into * * * [the

supplemental] agreement with your mother to assure that

you would limit her access to business funds to make

any payments to your * * * sisters?

A

No, not to make any. I think it states that, if I

accepted her withdrawals, that it would be okay, but it

would be debited to her account. I think that's

plainly stated.

Q

So when I say -- but -- but in other words, the

purpose of the agreement was to limit and control your

mother's withdrawal from the business to make payments

to your sister -- sisters. In other words --

On

- 24 A

I wanted to --

Q

-- they were controls ppt on your mother, this

agreement.

A

The purpose of this was basically to go public.

It's just to formalize somet ing, where it was said

specifically that she could not. Now, that didn't mean

that she pilfered the cookie jar. It just meant the I

wanted it recorded. I wante it said, written down.

*

*

*

*

*

*

*

Q

Did you enter into this agreement because you felt

it was necessary that the -- that some kind of controls

be put on your mother withdr wing funds?

A

I would term it necessa y. As I said, I wanted to

go public. I believed that, if I went totally public

in the sense that -- a document -- she would live up to

it.

We think that Marvin's intent is well summed up in the final

exchange between respondent's counsel and Marvin.

Marvin

intended to memorialize how and when his mother could take money

out of the business to benefit his sisters.

For a year, she was

free to do so without his assent, subject only to the implicit

limitation that, were she to take too much money out of WR2,

Marvin might refuse to honor his n tes given to her in

consideration for the 46.63-percent interest he was to receive

from her on June 1, 1980.

Thereafter, the supplemental agreement

required Marvin to consent if Ceci

wanted to pay out WR2 funds

to her daughters.

All of this, we believe, was principally for

Marvin's benefit.

Marvin testified that he did not know whether

his sisters were aware of the suppl mental agreement.

Roberta

and Iris testified that they did not have knowledge of the

supplemental agreement at any time before the death of Cecil in

- 25 -

1986.

That the daughters were not aware of the supplemental

agreement is consistent with Marvin not having their benefit as

his principal concern.

Moreover, in large part because Marvin

did not tell them about it, and based on the record as a whole,

we do not believe that he intended to vest in his sisters a right

to enforce the supplemental agreement, and we so find.

We find that Cecil's daughters were incidental beneficiaries

of the agreement between Cecil and Marvin, with that agreement

giving them no enforceable rights against Cecil.

Cf. Burke v.

North Huntingdon Twp. Municipal Authority, 390 Pa. 588, 136 A.2d

310, 315 (1957) (contract stating that third party's claims would

be paid out of the purchase price of property "simply purports to

set up an intra-party plan for the payment of the seller's

obligations").

Therefore, we hold that Cecil made no transfer by

gift to them during the June 30 quarter pursuant to the June 1979

agreement and supplemental agreement.

As previously stated, we

do not have before us those periods during which respondent

claims there were actual transfers of funds to the daughters

pursuant to the obligations that respondent claims arose from the

1979 agreement and supplemental agreement.5

V.

Transferee Liability and Fraud

Since we hold that no taxable gifts were made by Cecil to

petitioner Roberta or to petitioner Marvin during the period in

5

Nor need we consider whether those transfers were not

transfers by gift because supported by the consideration of the

daughters' previous renunciations of bequests under the will of

William Rosenblatt. See, e.g., Rosenthal v. Commissioner, 205

F.2d 505 (2d Cir. 1953), revg. and remanding 17 T.C. 1047 (1951).

- 26 issue, we must conclude that no transferee liability is imposed

on Marvin and Roberta under secti n 6324(b).

Furthermore,

respondent has not carried her bu den of proof with respect to

whether petitioner Estate of Cecil is liable for the fraud

penalty for fraudulent underpayment of gift tax during the period

in issue.

VI.

Sec. 6653(b); Rule 142(b).

Conclusion

Inasmuch as we have found th t petitioners have carried

their burden of proof that no tax ble gifts occurred during the

period in issue, it necessarily f llows that respondent's

transferee liability and fraud per alty determinations cannot be

sustained.

We do not uphold respondent's determinations in any

respect.

To reflect the foregoing and

ue to agreements between the

parties,

Decisions will be entered

under Rule 155.

- 27 Appendix

Entries on the ledger cards found among Cecil Rosenblatt's

papers after her death.

The ledger titled "Roberta" contains the following entries:

DATE

Aug/79

Oct 4/79

1/6/80

3/20/80

4/16/80

1/1/81

6/15/81

8/24

8/26

10/26

ITEM

Dep

Watch

Diam Choker

Gave Storager

for Paintings

10/26

CR Gave Ck to Hackett

Jan/82

Dep

1/15/82

CR check to Hackett

1/8/82

Lisa

3/5

Pearls

illegible illegible

1/10/83

Dep

6/16

Dep

AMOUNT

$360,000

5,000

25,000

15,000

15,000

30,000

30,000

250

6,000

4,720.80

4,268.50

10,000

4,509

500

486

383

30,000

30,000

- 28 The ledger titled "Iris" contains the following entri es:

DATE

Aug/79

9/5/79

2/7/80

3/24/80

5/7/80

5/27/80

5/27/80

6/13/80

6/13/80

ITEM

I

$360,000

Broach & Chain

Gold [illegible]

Ring & Brac.

Diam. Earclips

Cash

Gold Choker

8/4/80

8/28/80

9/15/80

Mary's Saph. Ring

Star Earclips

Watch

Cartier Gold Brac.

9/18/80

9/23/80

Cufflinks

Lapis Brac & Clips

Pr. Pearl Earclips

Diam. Bracelet

Silver Box & B¶ac.

9/23/80

10/2/80

AMOUNT

5,000

25,000

6,500

125

2,350

2,500

5,000

500

1,650

2,500

1,800

1,000

600

550

550

4,500

100

600

12/4

Cufflinks

140

12/5

Chains & Boxes

325

12/9/80 Cash

5,000

12/15/80 Repairing Diam &

285.65

Appraisal

1,135

1/1/81

Dep.

20,000

5/5/81

Ruby Rings

1,200

Cufflinks

100

5/12/81

15.20 Emer. Cut

30,000

6/9/81

Mtg. of 15.20 Em.Cut

2,072

6/11/81 Jossie Studs

400

8/26/81 Susan Earrings[ llegible]

400

9/3/81

Pearls

1,000

9/8/81

Watch A.P.

1,000

9/10/81 Red Watch

900

9/14/81 Rolex Watch

1,500

9/22/81

1 Ruby & 1 Saph. Earrings 1,200

11/20

Choker Diam

10,500

11/23

C.R. loaned I.G.

1,000

1/22/82 C.R. loaned I.G.

7,000

Cufflinks 2 Pr.

300

1/26

Gold Brac. lengthen

150

3/16

Pearl Earclips

65

3/31/82 3 Watches

3,900

4/8

Saph Ring

2,800

5/10

Earclips

1,075

1/83

M.R. Pd.

30,000

6/8/83

30,000

12/3

Cufflinks

200

10/28

Ruby Earrings( ary)

- 29 -

The ledger titled "Hannah" contains the following entries:

DATE

Aug/79

Oct 2/79

Dec 18/79

Jan 16/80

Jan 16/80

Feb 8/80

Feb 14/80

3/11/80

4/9/80

6/20/80

8/15/80

8/28/80

9/29/80

10/20/8

11/13/80

11/24/80

12/5/80

12/15/80

2/27/81

3/27/81

4/3/81

4/8/81

6/19/81

6/19/81

ITEM

Dep

loaned by CR to HG

loaned to HG by CR

by CR

by CR

by CR

by CR

by CR

Airline Ticket

Diam Studs

CK by CR

Studs

Ck by CR

2 Diam Hearts

CK by CR

Airline Tickets

Ck by CR

Ck by CR

Ck to HG

Ck to HG

AMOUNT

$360,000

20,000

5,000

25,000

5,000

2,500

2,500

1,500

15,000

7,000

5,000

1,500

1,000

5,000

868

600

2,500

600

2,053

750

1,500

1,044.90

2,000

25,000

4,000

1,000

8/25/81

Gave to HG

2,500

10/19/81

12/23/81

3/1/82

Ck to HG

Ck to HG

Ticket to Paris 2/16

Ticket to LA

CR [illegible]

5,000

5,000.90

685

84

25,000

3/4

Ticket to LA 2/9

84

5/29

12/7

Ticket to Geneva

Ticket to NY 3/1

Ck to HG

CR sent ck

1/83

5/3

6/6/83

MR pd

Airline

MR pd

260

392

5,000

5,000

3,500

21,500

292

30,000