T.C. Memo. 1996-25
UNITED STATES TAX COURT
ESTATE OF CYRIL I. MAGNIN, DECEASED,
DONALD ISAAC MAGNIN, EXECUTOR, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 24883-92. Filed January 24, 1996.
Donald L. Feurzeig, Derek T. Knudsen, and John M.
Youngquist, for petitioner.
Susan J. Adler and Rebecca T. Hill, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
RUWE, Judge: Respondent determined a deficiency of
$1,921,528 in petitioner's Federal estate tax. By amended
answer, respondent has asserted an increase in the deficiency in
petitioner's Federal estate tax in the amount of $157,685.
After concessions, the issues for decision are: (1) Whether
decedent's 1971 transfers in trust with retained life estates are
includable in decedent's gross estate, or whether they are
excluded from the estate because they were bona fide sales for
adequate and full consideration under section 2036(a);1 and (2)
whether the fair market value of certain real property owned by
decedent and subject to a lease is $170,000, as determined by
petitioner's appraiser, or is $228,000, as determined by
respondent in the notice of deficiency.2 For convenience, the
facts with respect to the second issue will be set forth with our
opinion on that issue.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts, the first, second, and third
supplemental stipulations of facts, and the attached exhibits are
incorporated herein by this reference.
Petitioner is the Estate of Cyril I. Magnin (Cyril). Cyril
was born in San Francisco, California, on July 6, 1899, and died
testate on June 8, 1988, in San Francisco. Donald Isaac Magnin,
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code as of the date of decedent's death, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
2
Petitioner also contends that it is entitled to claim
additional deductions under sec. 2053 and an increase in the
State death tax credit under sec. 2011. These issues shall be
resolved in accordance with the Court's opinion herein under Rule
155.
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decedent's oldest son, is the executor of his estate. Donald
Magnin filed a timely Federal estate tax return on behalf of
petitioner wherein he elected the alternate valuation date,
December 8, 1988. Donald Magnin resided in San Francisco,
California, at the time he filed the estate tax return.
Background
Cyril's father, Joseph Magnin (Joseph), was born in London,
England, on December 27, 1868. Joseph was the third child of
Isaac and Mary Ann Cohen Magnin (Mary Ann), who emigrated from
England to San Francisco in 1875. In 1877, Mary Ann established
I. Magnin, a fine clothing store for women.
Joseph started working for I. Magnin when he was a teenager.
In 1898, he married Charlotte Davis (Charlotte), the head
milliner at I. Magnin. This caused family tensions between
Joseph and his mother. Mary Ann ran I. Magnin with an iron hand
and had a strict rule against family members' fraternizing with
employees. Cyril was born the next year on July 6, 1899. During
the years 1893 to 1913, Joseph was being passed over by Mary Ann
for responsible management positions with I. Magnin in favor of
his younger brothers.
Joseph left I. Magnin in 1913 and invested in a store, which
was organized as a corporation by the name of "Newman, Magnin &
Co." (Newman-Magnin). Similar to I. Magnin, Newman-Magnin
specialized in the sale of women's clothing. In 1918, Joseph
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bought out the other owners, and in 1919, changed the name of the
corporation to "Joseph Magnin Co., Inc." (JM). JM has been in
continuous existence as a California corporation from 1919
through at least 1988. Starting a rival women's clothing store
using the Magnin name caused a rift between Joseph and the rest
of his family, which lasted for many years.
Joseph led JM to compete directly in I. Magnin's retail
market for the same customers and the same suppliers. Because I.
Magnin had all its finest suppliers tied up in exclusive
contracts, JM had a difficult time finding suppliers. In the
early years of JM, the store thrived on the strength of
Charlotte's millinery business, which had followed her from I.
Magnin to JM. Until the late 1930's, JM was known in the trade
as the second-rate I. Magnin.
Cyril began working for JM as a child, and at the time of
World War I, he was involved in management. In 1925, Cyril
married Anna Smithline (Anna), and they remained married until
Anna's death on July 12, 1948. Cyril and Anna had three
children: Donald Isaac Magnin (Donald), born November 17, 1926;
Ellen Lois Magnin (Ellen), born April 19, 1928; and Jerry Allen
Magnin (Jerry), born July 30, 1938. Cyril's children also began
working for JM at early ages.
Anna was a skilled designer and buyer of women's apparel
when she and Cyril married, and she became an important designer
and chief buyer of JM's women's apparel. Although everyone at JM
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worked as a team, Anna and Cyril's mother, Charlotte, were the
key persons in setting the merchandising pace of the store, and
Cyril was more or less the key idea man.
JM did not do well financially during the Great Depression.
Joseph started a factoring business, Donner Factors, which
advanced money to companies against their accounts receivable.
Donner Factors was a successful company and, for a long time,
made more money than JM.
Joseph, the president of JM, was very conservative. He and
Cyril had differing philosophies as to JM's approach to retailing
women's apparel. Joseph insisted on continuing to compete with
I. Magnin for upscale, older customers, whereas Cyril wanted to
tap the market of younger women. Cyril perceived in the late
1930's that the country was beginning to mobilize as a result of
the war and that military personnel were moving West along with
their spouses. The younger women moving West were increasingly
entering the business world, and they had money to spend and no
preconceived ideas of where to buy. These different philosophies
led to arguments between Joseph and Cyril. Finally, in 1937,
Joseph turned the operation of JM over to Cyril, predicting that
he would fail with his "crazy ideas". Joseph remained president
of JM but concentrated his efforts on Donner Factors.
In January 1940, Jean Blum, Joseph, and Cyril formed a
Nevada corporation by the name of "Specialty Shops, Inc."
(Specialty), for the purpose of operating a branch store under
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the Joseph Magnin name in Reno, Nevada. Mr. Blum, who was a
close friend of Joseph's (and eventually of Cyril's), provided
the funds to open Specialty's first store in Reno, because JM
lacked the capital to do so. Mr. Blum purchased 50 percent of
the stock initially issued and lent money to Joseph and Cyril to
purchase the remainder. Prior to the creation of Specialty and
the opening of its Reno store, JM had opened only one other
branch store in Palo Alto, California, in 1928.
In July 1948, Anna died unexpectedly. Joseph and Anna had
been very close. She had long been a mediator in the disputes
between Cyril and Joseph. Cyril briefly thought of selling JM to
I. Magnin, which upset Ellen. Ellen left school at age 20, moved
back home, and took over Anna's position as buyer for JM.
In October 1950, Ellen married Walter S. Newman (Walter).
Shortly after the wedding, Walter went to work for JM as a
financial troubleshooter and was subsequently put in charge of
store operations (i.e., all store activities except
merchandising). Ellen reduced her day-to-day activities at JM
immediately after the wedding.
Donald and Jerry were also active in operating JM. Donald
began working full time for JM after his graduation from Stanford
in 1949, first as a merchandise bookkeeper and then as a hosiery
buyer. Donald entered the Navy during the Korean War in 1952.
He returned to JM in about September of 1953. Jerry began
working full time for JM after he left the Air Force in 1961.
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In 1949, Cyril began dating Lillian Helwig (Lillian), who
was the manager of one of the JM stores. Joseph strongly
disliked Lillian, as did Cyril's children. They were not pleased
when Cyril married Lillian on June 19, 1952.
1951 Agreement Between Joseph and Cyril
In 1951, Joseph and Cyril were concerned about the future of
the business. Cyril had begun dating women after Anna's death,
and Joseph wanted to ensure that the business would remain in the
family and that Cyril's shares of stock would not go to one of
these women. Cyril, on the other hand, was concerned about
control of the business upon Joseph's death. Control of the
business was very important to Cyril; he saw control of the
business as a means to enhance his social, political, and
business position in the community. Cyril also feared that if he
had to share control with his children, he might someday be fired
by them.
On October 31, 1951, Joseph and Cyril executed a written
document, which they labeled an "Agreement", concerning their JM
and Specialty stock (the Agreement or the 1951 Agreement). As of
October 31, 1951, JM had issued and outstanding 255,174 shares of
stock, consisting of 72,717 shares of preferred stock and 182,457
shares of common stock, all of which had voting rights.3 The
3
The articles of incorporation of Newman, Magnin & Co.
(continued...)
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shareholdings of Joseph and Cyril in JM were as follows:
Joseph Cyril
Common stock 50,648 75,044
Preferred stock 21,464 11,035
Total 72,112 86,079
Thus, Joseph held 28.26 percent of the voting power of JM, and
Cyril held 33.73 percent of the voting power; together their
shares represented 61.99 percent of the voting power.
As of October 31, 1951, Specialty had issued and outstanding
101,000 shares of stock, consisting of 1,000 shares of voting
common stock and 100,000 shares of nonvoting preferred stock.
The ownership of Specialty stock as of that date is unclear, but
it appears that Mr. Blum owned 500 shares of the common stock and
50,000 shares of the preferred stock, and Cyril and Joseph
together owned the remaining 500 shares of common stock and
50,000 shares of preferred stock.
On October 31, 1951, Cyril also held certain options to
acquire JM stock. On October 31, 1945, Joseph had granted to
Cyril and Anna (as joint tenants with the right of survivorship)
3
(...continued)
(subsequently JM) were silent as to the voting rights of the
preferred stock until a 1968 amendment, which expressly provided
that the preferred stock was entitled to voting rights equal to
those of the common stock. However, it appears that prior to the
1968 amendment, the preferred stock was considered to be voting
by the corporation and that the holders of the preferred stock
actually did exercise voting rights.
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an option to purchase 18,158 shares of Joseph's common stock in
JM at $1 per share. The option could be exercised only within 90
days after Joseph's death. Cyril also held various options to
purchase 7,185 shares of JM common and 11,850 shares of JM
preferred stock owned by Edward R. and Mae C. Nichols, which were
granted by four agreements dated between April 4, 1941, and May
6, 1943 (the Nichols options).4 Joseph was a party to the May 6
agreement, which had granted the option to purchase most of the
Nicholses' JM stock (i.e., 7,185 shares of common and 10,000
shares of preferred stock).
The preamble to the 1951 Agreement set forth the following
premises:
WHEREAS the parties hereto are the owners of the
majority of the issued and outstanding stock of JOSEPH
MAGNIN COMPANY, INC., a California Corporation, and
SPECIALTY SHOPS, INC., a Nevada Corporation,
hereinafter called "said corporations"; and
WHEREAS the parties hereto have over many years
last past mutually controlled the operation and
management of said corporations in the best interests
of said corporations and the stockholders thereof; and
WHEREAS Cyril Magnin desires that upon the death
of Joseph Magnin, the control of said corporations
shall be vested in Cyril Magnin for the term of his
life; and
WHEREAS Joseph Magnin is willing under and subject
to the terms and conditions hereinafter set forth, to
4
In May 1960, Cyril assigned his rights in the Nichols
options to the testamentary trust established by Joseph's will of
which he was the trustee. On June 3, 1960, Cyril exercised the
options on behalf of the trust.
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provide in his Last Will and Testament that all of his
stock, both common and preferred, of said corporations
shall be bequeathed to Cyril Magnin, as trustee for the
benefit of Cyril Magnin, Ellen Magnin Newman, Donald
Magnin and Jerry Magnin, and that Cyril Magnin, as said
trustee, shall have the sole right to vote said stock
for the term of his life as provided in said Last Will
and Testament[.]
Consistent with these premises, the terms of the Agreement
provided that Joseph agreed to bequeath his JM and Specialty
stock to Cyril as sole trustee for Cyril's life as already
provided in his will, which provision he agreed not to revoke.
Cyril agreed to will in trust all his JM and Specialty stock "now
owned or hereafter acquired" to a bank trustee for the benefit of
his three children.
The Agreement also provided that the terms and conditions on
the part of Cyril were to be secured by a deposit in pledge with
Bank of California, N.A. (the Bank), as pledgeholder of the stock
belonging to Cyril; that as long as Cyril performed the terms and
conditions of the Agreement, the voting rights would vest in him,
but in the event of default, the voting rights would vest in the
pledgeholder. Cyril agreed not to transfer, assign, or encumber
any of his stock in the corporations, except that he could give
stock to his children. The Agreement provided that at no time
should the issued and outstanding stock of the corporations
belonging to persons other than Joseph, Cyril, or his three
children exceed 49 percent, except in the event of a sale of the
entire capital stock of the corporations. Moreover, any other
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stock, securities, cash, or other property received by Cyril upon
the sale or exchange of his stock in either corporation, or in
the event of a merger, consolidation, spinoff, splitoff, or
splitup, would be subject to the terms and conditions of the
Agreement.
The Agreement further provided that in the event of the sale
of all or any part of the stock of the corporations, or in the
event of a dissolution of either corporation, Cyril would create
a trust of the proceeds received, under the terms of which the
income of said trust would belong to Cyril for his life, and the
principal would be distributed upon his death to his three
children. The terms of the Agreement were subject to
modification by the unanimous consent of Cyril on the one hand
and of Donald, Ellen, and Jerry (after he has reached his
majority) on the other hand.
By letter dated October 31, 1951, and signed by Joseph,
Cyril, Donald, and Ellen, the Bank was instructed to hold certain
stock certificates "solely for safekeeping" in accordance with
the Agreement between Joseph and Cyril. By the terms of the
letter, the Bank was given no responsibility with respect to the
performance of the Agreement, but the stock certificates were
subject to redelivery to Cyril upon authorization executed by
Cyril and Joseph, or by Cyril, Donald, and Ellen (after Joseph's
death and if Donald were available). A schedule attached to the
letter identified the certificates and the number of JM shares
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delivered.5 There is no evidence that Joseph and Cyril delivered
any Specialty stock to the Bank.
On May 15, 1952, Joseph and Cyril entered into a
supplementary agreement. The supplementary agreement referred to
the option that Joseph had granted to Cyril and Anna on October
31, 1945, to purchase 18,158 shares of Joseph's common stock in
JM at $1 per share. Pursuant to the terms of the option, the
certificates representing the 18,158 shares had been deposited
with Joseph's attorney, Nat Schmulowitz.6 The supplementary
agreement between Joseph and Cyril provided that the 1945 option
would remain in effect, except that if Cyril exercised the
option, the shares delivered to Cyril upon such exercise were to
be pledged to the Bank and subject to the terms of the 1951
Agreement. In the event that Cyril did not exercise the option,
then Mr. Schmulowitz would deliver the shares in his possession
to the Bank to be held subject to the 1951 Agreement.
On November 16, 1952, Joseph and Cyril entered into a second
5
There is some discrepancy between the number of shares
delivered to the Bank and the number of shares owned by Joseph
and Cyril as of Oct. 31, 1951. The schedule indicates that
51,648 shares of JM common stock were delivered by Joseph, but
Joseph owned only 50,648 shares of JM common stock as of Oct. 31,
1951. Similarly, the schedule reflects that 11,135 shares of JM
preferred stock were delivered to the Bank by Cyril, but Cyril
owned only 11,035 shares of JM preferred stock as of Oct. 31,
1951.
6
The share certificates that were delivered to Mr.
Schmulowitz in 1945 were not delivered to the Bank pursuant to
the Agreement between Joseph and Cyril in 1951.
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supplementary agreement. This second supplementary agreement set
forth the parties' understanding that nothing in the 1951
Agreement prohibited Cyril from selling all his stock of, or from
dissolving, JM or Specialty in the event that either corporation
received a fair purchase offer. In such event, Cyril agreed to
create a trust of the stock proceeds under the terms of which the
income would belong to Cyril for his life, and the principal
would be distributed to his children upon his death. Cyril also
agreed under this second supplementary agreement to vote his
shares (as an individual and as trustee for Joseph's testamentary
trust) so that his children would constitute two of the five
members of the board of directors of each corporation.7
Performance of October 31, 1951, Agreement
Joseph died on April 29, 1953. Cyril was the executor of
Joseph's estate. Joseph's Last Will and Testament bequeathed all
his stock in JM and Specialty to Cyril in trust and provided that
Cyril was to divide the stock into four separate trusts. One-
half of the stock was to be placed in the Cyril Magnin Trust for
the benefit of Cyril. One-sixth of the stock was to be placed in
each of the three remaining trusts, one trust for the benefit of
7
It appears that this provision of the second supplemental
agreement was drafted in error. Although Cyril promised to vote
his shares so that his children would constitute two of the five
directors, JM had seven and Specialty had three authorized
directors as of November 1952.
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each of Joseph's three grandchildren. As the trustee of the four
trusts, Cyril had the power to vote the stock. These provisions
were as promised by Joseph to Cyril under the October 31, 1951,
agreement. Additionally, Cyril received a life interest in the
income from the Cyril Magnin Trust.
Joseph's estate tax return included the value of JM and
Specialty stock as follows:
Stock Per-Share Value
18,158 shares JM subject to option
at $1 per share $1.00
33,490 shares JM, common 1.50
21,464 shares JM, preferred .90
112-1/2 shares Specialty, common 150.00
25,000 shares Specialty, preferred .90
The IRS estate tax examiner proposed certain adjustments to
Joseph's taxable estate, including an increase in the per-share
value of JM common and preferred stock to $2.25 and $1,
respectively. The estate agreed to these changes.
On February 4, 1955, Cyril executed a Last Will and
Testament in which he bequeathed all JM and Specialty stock in
trust for the benefit of each of his three children. The will
expressly acknowledged that such provision was in performance of
the October 31, 1951, agreement between Cyril and Joseph.
Subsequently, on November 30, 1965, Cyril executed a new will
superseding his 1955 will, which also provided for the creation
of a trust of JM and Specialty stock for the benefit of his
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children in performance of his October 31, 1951,8 agreement with
Joseph.
On May 25, 1971, Cyril created three trusts, one for each of
his three children. He transferred, inter alia, the proceeds of
the JM stock that had been sold in a 1969 buyout of all JM stock
by Amfac, Inc. Under the terms of each trust, Cyril retained an
income interest for his life, and upon Cyril's death, the trust
was to terminate, and the principal and undistributed income were
to be distributed to the beneficiary.
For the calendar quarter ending June 30, 1971, Cyril filed a
gift tax return. In an attachment entitled "Statement Describing
Incomplete Gifts", Cyril reported the creation of the three
trusts, stating that they were created "pursuant to pre-existing
agreements between * * * [himself] and his father" and explaining
that the transfers were not completed gifts. The IRS accepted
the gift tax return as filed.
Facts Related to Value of JM and Specialty
JM originally operated one location in downtown San
Francisco. In 1928, a second store was opened in Palo Alto,
California, and three other stores were opened between 1943 and
1950--one in San Mateo and two in Sacramento, California. JM did
8
We note that the actual language in both Cyril's 1955 and
1965 wills referred to an Oct. 5, 1951, agreement. However,
respondent conceded, and we agree, that Cyril meant to refer to
the Oct. 31, 1951, agreement.
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not begin to expand considerably until the mid-1950's, eventually
operating 32 stores by the end of 1969.
In January 1940, Cyril, Joseph, and Mr. Blum formed
Specialty for the purpose of operating a branch store in Reno,
Nevada. At that time, JM lacked the capital to open a new store.
Specialty opened a second store in Oakland, California, in 1948,
and a third store in Lake Tahoe, Nevada, in 1950. All
Specialty's stores were operated under the JM name and by JM
management, and they had merchandise and customers similar
to JM's.
Whenever possible, JM and Specialty elected to lease rather
than own their store locations. The companies did not have a
great deal of available capital, and leasing store locations
permitted them to expand.
Relevant financial data from the financial statements of JM
for the fiscal years ending January 31, 1949 through 1952, are as
follows:
Fiscal Year Ending January 31
(In Thousands)
1949 1950 1951 1952
Assets $1,778 $1,886 $1,983 $2,161
Earned surplus 645 749 757 782
Sales 4,994 4,856 5,239 5,591
Net income 117 58 41 38
Similarly, relevant data from the financial statements of
Specialty for the fiscal years ending January 31, 1949 through
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1952, are as follows:
Fiscal Year Ending January 31
(In Thousands)
1949 1950 1951 1952
Assets $452 $405 $385 $432
Earned surplus 120 103 127 148
Sales 742 644 593 677
Net income 35 6 24 21
OPINION
The Internal Revenue Code imposes a Federal estate tax on
the transfer of the taxable estate of a decedent who is a citizen
or resident of the United States. Secs. 2001 and 2002. The
value of the gross estate includes the value of all property to
the extent of the decedent's interest therein on the date of
death.9 Sec. 2033.
Section 2036(a) provides that a decedent's gross estate also
includes the value of all property interests transferred by a
decedent during his life in which the decedent has retained for
life the right to the possession, enjoyment, or income from the
property. However, section 2036(a) does not apply when the
property interest of the decedent was transferred pursuant to a
"bona fide sale for an adequate and full consideration in money
9
The executor, however, may elect to value a decedent's
property as of an alternate valuation date; i.e., 6 months after
death. Sec. 2032.
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or money's worth". Sec. 2036(a).10
The parties do not dispute that the 1971 transfer in trust
of the proceeds of Cyril's shares in JM was one in which he
retained a life interest within the meaning of section 2036(a).
Instead, petitioner contends that the transfer of the remainder
interest to Cyril's children was made pursuant to the terms of
the 1951 Agreement in exchange for Cyril's receipt of lifetime
voting control of JM and a 50-percent lifetime income interest in
Joseph's shares. Thus, petitioner argues that in 1951 Cyril
received adequate and full consideration in money or money's
worth when he obligated himself to transfer the remainder
interest in his JM shares pursuant to the 1951 Agreement.
We must determine whether the agreement entered into between
Cyril and Joseph in 1951 constituted a bona fide sale supported
by adequate and full consideration in money or money's worth. As
a preliminary matter, however, we must determine which party
bears the burden of proof on this issue.
Generally, the burden of proof is on the taxpayer. Rule
10
Sec. 2036(a) provides:
General Rule.--The value of the gross estate shall
include the value of all property to the extent of any
interest therein 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 * * *
(1) the possession or enjoyment of, or the
right to the income from, the property * * *
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142(a); Welch v. Helvering, 290 U.S. 111 (1933). The
Commissioner bears the burden of proof, however, with respect to
"any new matter, increases in deficiency, and affirmative
defenses, pleaded in the answer". Rule 142(a). An assertion in
an amended answer is treated as a new matter when it either
alters the original deficiency or requires the presentation of
different evidence. Wayne Bolt & Nut Co. v. Commissioner, 93
T.C. 500, 507 (1989); Achiro v. Commissioner, 77 T.C. 881, 890
(1981). The assertion of a new theory that merely clarifies or
develops the original determination is not a new matter in
respect of which the Commissioner bears the burden of proof.
Wayne Bolt & Nut Co. v. Commissioner, supra; Achiro v.
Commissioner, supra; Estate of Jayne v. Commissioner, 61 T.C.
744, 748-749 (1974).
In her notice of deficiency, respondent determined a
deficiency in petitioner's estate tax of $1,921,528. The
deficiency was based in large part on respondent's determination
that the value of the three trusts created in 1971, in which
decedent retained a life interest, was includable in the gross
estate. In the notice, respondent determined that the value
includable in the gross estate was $3,789,849, which was
calculated by taking the value of the three trusts at the
appropriate valuation date ($3,833,727), less the value of
consideration received by decedent in connection with the 1951
Agreement ($43,878). As more fully discussed below, section 2043
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reduces the amount that is includable under section 2036 by the
value of any consideration received by the decedent.
On November 22, 1993, respondent filed a Motion for Leave to
File an Amended Answer, which this Court granted. In her amended
answer, respondent asserted a deficiency in petitioner's estate
tax of $2,079,213 based in part on respondent's revised
determination that decedent received no consideration for the
transfer and that the entire value of the three trusts was
includable in the gross estate.
Respondent's assertion in the amended answer that there was
no consideration clearly increased the original deficiency.
Accordingly, we find that the issues of whether there was any
consideration and whether the consideration was less than $43,878
are new matters, in respect of which the burden of proof falls on
respondent. However, the burden of proof with respect to the
other issues remains on petitioner. Rule 142(a).
The requirement that there must be "adequate and full
consideration" in order to trigger the exception in section 2036
is to prevent the depletion of the decedent's estate. Estate of
Frothingham v. Commissioner, 60 T.C. 211, 215-216 (1973); see
also Commissioner v. Wemyss, 324 U.S. 303, 307 (1945);
Commissioner v. Bristol, 121 F.2d 129, 134 (1st Cir. 1941), revg.
42 B.T.A. 263 (1940). The type of consideration contemplated by
this exception is not the same as common law contractual
consideration. Commissioner v. Wemyss, supra at 306; Estate of
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Gregory v. Commissioner, 39 T.C. 1012, 1016 (1963). Rather, the
exception contemplates
the kind of consideration which in an arm's length
business transaction provides the transferor of
property with the full value thereof, in exchange; and
that if the consideration is not paid in money,
property, or services, but is represented by some
benefit, then the benefit must be of the equivalent
money value in order to constitute the required
"adequate and full consideration." * * * [Estate of
Goetchius v. Commissioner, 17 T.C. 495, 503 (1951).]
We note that transactions among family members are subject to
particular scrutiny to determine whether they represent a true
arm's-length bargain or merely a cooperative attempt to make a
testamentary disposition. Estate of Huntington v. Commissioner,
16 F.3d 462, 466-467 (1st Cir. 1994), affg. 100 T.C. 313 (1993);
Bank of New York v. United States, 526 F.2d 1012, 1016-1017 (3d
Cir. 1975); Estate of Morse v. Commissioner, 69 T.C. 408, 418
(1977), affd. 625 F.2d 133 (6th Cir. 1980). This is not to say,
however, that transactions between family members can never be
for consideration in money or money's worth. Estate of
Huntington v. Commissioner, supra; Leopold v. United States, 510
F.2d 617, 623 (9th Cir. 1975); Estate of Morse v. Commissioner,
supra at 419. "Even a family agreement, although achieved
without apparent bitterness, has been regarded as bargained for
when members of the family had interests contrary to those of
other members of the family." Bank of New York v. United States,
supra at 1017 (fn. ref. omitted).
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In the present case, although Cyril and Joseph were father
and son, the circumstances surrounding the 1951 Agreement
indicate that the parties had divergent interests. Cyril and
Joseph were concerned with the future of the family business.
Cyril wanted to gain control of JM following Joseph's death.
Cyril feared that if he had to share control with his children,
he might be fired by them. In exchange for obtaining lifetime
control, Cyril agreed to will his own stock in trust for the
benefit of his children. Under the terms of the 1951 Agreement,
Cyril not only relinquished his freedom to transfer his stock to
whomever he wished but also tied up the proceeds of the stock in
the event he sold it. Joseph, on the other hand, wanted to
ensure that Cyril's stock would not end up in the hands of one of
the women Cyril was dating. In exchange for Cyril's promise not
to give his stock to anyone but his children, Joseph promised not
to revoke the provision in his will bequeathing his stock to
Cyril as sole trustee with voting rights (and thus control) for
Cyril's life. Because a will is an ambulatory instrument that
has no effect until the death of the testator, without the 1951
Agreement, Joseph could have revoked or revised his will any time
prior to his death. Dodd v. United States, 345 F.2d 715, 719 (3d
Cir. 1965); Wasserman v. Commissioner, 24 T.C. 1141, 1144 (1955).
Cyril and Joseph put their promises in writing, and the
Agreement represented a give-and-take on each side. Both
parties, in fact, performed as promised under the Agreement.
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Based on this record, we find that there was an element of
bargained-for consideration present.
The fact that there was some bargained-for consideration
does not mean that there was adequate and full consideration
within the meaning of section 2036(a). In order to constitute
adequate and full consideration, the value of what the decedent
received must be measured against the total value of property
that the decedent transferred. United States v. Past, 347 F.2d
7, 12 (9th Cir. 1965); Estate of D'Ambrosio v. Commissioner, 105
T.C. 252 (1995).
Petitioner does not contest that the value of the stock
Cyril agreed to transfer pursuant to the 1951 Agreement exceeded
the value of the interest in Joseph's stock that Cyril
received.11 Rather, petitioner contends that because the value
of what Cyril received exceeded the value of the remainder
interest that Cyril transferred to his children, he received
adequate and full consideration.
We recently addressed this issue in Estate of D'Ambrosio v.
Commissioner, supra. In that case, we held that when a decedent
receives consideration for making a transfer of property to a
11
In its brief, petitioner assigns a value of $83,600 to
Cyril's entire stock interest ($42,000 of which is allocated to
Cyril's remainder interest) and assigns a value of only $58,146
to the interest in Joseph's stock received by Cyril.
Petitioner's values are based on the opinion of its expert
witness, using a valuation date of Oct. 31, 1951. Respondent's
expert assigned a value of $244,000 to Cyril's stock as of that
date.
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trust in which the decedent retains only a life interest, the
adequacy of the consideration must be determined by comparing the
value of the consideration received with the total value of the
property the decedent transferred to the trust rather than with
just the remainder interest. Id. at 259-260. Indeed,
petitioner's argument is no different from contending that the
value of the retained life estate should be regarded as part of
the consideration received for the transfer, an argument this
Court has specifically rejected. Estate of Glen v. Commissioner,
45 T.C. 323, 343 (1966).
The same issue was presented in United States v. Past,
supra, where the decedent and her husband transferred their
community property to a trust in which the decedent received an
income interest for life. The transfer was pursuant to a divorce
settlement. Citing this Court's opinion in Estate of Gregory v.
Commissioner, supra, the Court of Appeals for the Ninth Circuit
rejected the argument that the decedent's transfer to the trust
was excepted from section 2036(a) as a bona fide sale for
adequate and full consideration. The court held that the
consideration received by the decedent had to be measured against
the total value of the property that she contributed to the
trust, rather than the value of the remainder interest in the
property that she contributed. Given that the decedent
transferred $243,989 in property to the trust in return for a
life estate worth approximately $143,346, the Court of Appeals
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for the Ninth Circuit held that the decedent did not receive
adequate and full consideration under section 2036(a). United
States v. Past, supra at 12-14.
Whether the consideration received by Cyril under the 1951
Agreement was "adequate and full" within the meaning of section
2036(a) must be determined by comparing the value of what Cyril
received on October 31, 1951, with the October 31, 1951, value of
the stock that Cyril owned and agreed to transfer to his children
at his death; i.e., the value that otherwise would have been
included in his gross estate by virtue of the retained life
estate. Id. at 12; United States v. Allen, 293 F.2d 916, 918
(10th Cir. 1961); Estate of D'Ambrosio v. Commissioner, supra at
260; Estate of Gregory v. Commissioner, 39 T.C. at 1016; Gradow
v. United States, 11 Cl. Ct. 808 (1987), affd. 897 F.2d 516 (Fed.
Cir. 1990). Such measurement is consistent with the purpose
behind the "adequate and full consideration" exception--to
prevent the depletion of the decedent's estate. Commissioner v.
Wemyss, 324 U.S. at 307; Commissioner v. Bristol, 121 F.2d at
134; Estate of Frothingham v. Commissioner, 60 T.C. at 215-216.
Accordingly, we hold that the consideration received by Cyril
under the 1951 Agreement was not "adequate and full" within the
meaning of section 2036(a), and, therefore, the value of the
trusts that Cyril created in 1971 must be included in his gross
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estate.12
Where a transfer of property fails to meet the requirements
of this exception to section 2036(a) because it was for
insufficient consideration, section 2043(a) provides some relief
from potential double taxation. Estate of Frothingham v.
Commissioner, supra at 216. Section 2043(a) provides in
pertinent part:
(a) In General.--If any one of the transfers * * *
described in sections 2035 to 2038, inclusive, and
section 2041 is made * * * for a consideration in money
or money's worth, but is not a bona fide sale for an
adequate and full consideration in money or money's
worth, there shall be included in the gross estate only
the excess of the fair market value at the time of
death of the property otherwise to be included on
account of such transaction, over the value of the
consideration received therefor by the decedent.
Thus, under section 2043(a), the consideration received is to be
valued at the time of receipt by the decedent (i.e., at the time
12
Even if we were to hold that sec. 2036(a) requires receipt
of adequate and full consideration for only the remainder
interest, we would find that petitioner has not met its burden of
proving that the value of the interest in Joseph's stock that
Cyril received equaled the value of the remainder interest
transferred. We conclude, infra, that the value of the interest
received by Cyril is $43,878. The value of the remainder
interest transferred by Cyril is $42,000 according to petitioner
and $122,997.64 under respondent's calculations. These values
were determined after the parties made certain posttrial
adjustments to their expert reports. Although we need not
determine the precise value of the remainder interest transferred
by Cyril, we conclude that it was more than $43,878. This
conclusion is based on the evidence, including the expert
witnesses' opinions and the values placed on JM and Specialty
stock in gift and estate tax returns filed by Cyril and Joseph
between 1948 and 1953.
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of the 1951 Agreement between Cyril and Joseph) and then credited
against the date-of-death value (or, as in this case, the value
as of the alternate valuation date) of the property subject to
section 2036(a). The net amount is to be included in the gross
estate. United States v. Righter, 400 F.2d 344, 348 (8th Cir.
1968); United States v. Past, 347 F.2d at 14; Estate of Vardell
v. Commissioner, 307 F.2d 688, 693 (5th Cir. 1962), revg. 35 T.C.
50 (1960); Estate of Davis v. Commissioner, 51 T.C. 269, 280-281
(1968), revd. and remanded 440 F.2d 896 (3d Cir. 1971); Estate of
Gregory v. Commissioner, 39 T.C. at 1021.
Petitioner argues that in valuing the consideration received
by Cyril, this Court should apply a proportional rule and reduce
the includable value of the trusts by the proportion of the value
of the corpus at death that is attributable to the consideration
received by Cyril under the 1951 Agreement. However, it is well
settled that the consideration received is to be valued at the
time of the transfer (i.e., at the time of the 1951 Agreement)
and then credited against the date-of-death value of the property
subject to section 2036(a). United States v. Righter, supra at
348; United States v. Past, supra at 14; Estate of Vardell v.
Commissioner, supra at 693; Estate of Davis v. Commissioner,
supra at 280-281; Estate of Gregory v. Commissioner, supra at
1021.
The parties do not dispute that Cyril received a life income
interest in 50 percent of Joseph's JM and Specialty stock, as
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well as the voting rights (as trustee) with respect to all of
Joseph's stock. The parties do, however, dispute the value of
the interests that Cyril received. In her notice of deficiency,
respondent permitted an offset for the value of consideration
received by Cyril in the amount of $43,878. However, as
previously mentioned, respondent amended her answer to disallow
any such offset. On brief, respondent argues that in the event
that this Court finds that there was consideration, the amount of
the offset pursuant to section 2043(a) is limited to $30,752,
based on the report and testimony of her expert appraiser,
Stephen A. Stewart. Petitioner contends that the value of what
Cyril received on October 31, 1951, is $58,146, based on the
report and testimony of its expert appraiser, Bryan H.
Browning.13
Both experts determined the overall value of JM and
Specialty using a combination of a discounted future cash-flow
analysis and a market comparable analysis. The experts differ in
their application of premiums or discounts in arriving at the
value of the consideration received by Cyril. Mr. Browning,
petitioner's expert, applied a control premium of 40 percent to
the proportional equity value of JM, because after execution of
the 1951 Agreement, Cyril would hold 62 percent of the total
13
The difference between the values assigned by each party
to the consideration received, $27,394, is not significant when
one considers the value of the trusts includable in the gross
estate, which is equal to $3,833,727.
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voting rights of JM. No similar premium was applied to the
Specialty stock. Mr. Stewart, on the other hand, applied a 35-
percent discount for lack of marketability and a 20-percent
minority discount,14 because the interest that Joseph transferred
to Cyril amounted to less than 50 percent of the stock in each
company.15
The term "value" means fair market value, which is "the
price at which the property would change hands between a willing
buyer and a willing seller, neither being under any compulsion to
buy or to sell and both having reasonable knowledge of relevant
facts." Sec. 20.2031-1(b), Estate Tax Regs. The standard is
objective, using a purely hypothetical willing buyer and seller.
Propstra v. United States, 680 F.2d 1248, 1251-1252 (9th Cir.
1982); Estate of Newhouse v. Commissioner, 94 T.C. 193, 218
(1990); Estate of Mueller v. Commissioner, T.C. Memo. 1992-284.
However, "the hypothetical sale should not be constructed in a
vacuum isolated from the actual facts that affect the value of
14
Mr. Stewart applied the minority discount only under the
discounted future cash-flow approach, because, in his opinion,
the market comparison approach already produces a per-share value
for a minority interest.
15
While expert opinions can assist the Court in evaluating a
claim, we are not bound by the opinion of any expert witness and
may reach a decision based on our own analysis of all the
evidence in the record. Helvering v. National Grocery Co., 304
U.S. 282, 295 (1938); Silverman v. Commissioner, 538 F.2d 927,
933 (2d Cir. 1976), affg. T.C. Memo. 1974-285; Estate of Newhouse
v. Commissioner, 94 T.C. 193, 217 (1990).
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the stock". Estate of Andrews v. Commissioner, 79 T.C. 938, 956
(1982).
Petitioner must prove that respondent's determination of
value set forth in her notice of deficiency is incorrect. Rule
142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933); Estate of
Gilford v. Commissioner, 88 T.C. 38, 51 (1987). Respondent bears
the burden of proving the increases in the deficiency asserted in
her amended answer. Rule 142(a); Estate of Bowers v.
Commissioner, 94 T.C. 582, 595 (1990). Valuation is a question
of fact, and the trier of fact must weigh all relevant evidence
to draw the appropriate inferences. Hamm v. Commissioner, 325
F.2d 934, 938 (8th Cir. 1963), affg. T.C. Memo. 1961-347; Estate
of Newhouse v. Commissioner, supra at 217.
After considering the reports and testimony of both experts
and all the other evidence in the record, we think that neither
party has shown that the value of the interest received by Cyril
should be greater or less than the $43,878 determined by
respondent in her notice of deficiency. Accordingly, we hold
that petitioner is entitled to reduce the includable value of the
trusts by $43,878 pursuant to section 2043(a).
The final issue for decision concerns the fair market value
of a retail shoe store located in Louisville, Kentucky, as of
December 8, 1988, the alternate valuation date. Petitioner
valued the property at $150,980 on its estate tax return. In the
notice of deficiency, respondent valued the property at
- 31 -
$228,000.16 At trial and on brief, petitioner argued that the
value of the property was $170,000. The fair market value of
property is a question of fact. The value determination in the
notice of deficiency is presumed correct, and petitioner bears
the burden of proving otherwise. Rule 142(a); Welch v.
Helvering, supra.
The subject property, a retail shoe store, is located in an
older, inner-city neighborhood, west of the downtown area of
Louisville. The area is depressed, and property values have
steadily declined in the area since the 1960's. The site is
zoned for commercial use. The property was purchased by Cyril
for $207,721, and the deed was recorded in July 1983. The
property was subject to a lease, which commenced on April 26,
1983, and was for an initial term of 20 years. At the end of the
initial lease period, the tenant had the right to extend the term
for two additional consecutive periods of 5 years each. The
terms of the lease provided for minimum annual payments of
$22,514, plus 5 percent of the gross sales less the minimum rent.
The tenant was responsible for all expenses directly related to
the property, including taxes, insurance, and interior and
exterior maintenance.
Petitioner introduced a report and testimony of its expert
16
Respondent's valuation in the notice of deficiency of
$228,000 was based upon the income stream provided for in the
lease capitalized at a rate of 10 percent.
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appraiser, J. Michael Jones. Mr. Jones valued the property as of
June 8, 1988. Although petitioner elected to use the alternate
valuation date of December 8, 1988, Mr. Jones testified that he
did not think his appraisal would have changed had it been made
as of 6 months later. Mr. Jones used the cost approach, the
sales comparison approach, and the income capitalization approach
to value the property, giving the most weight to the latter
method. Pursuant to the income capitalization approach, Mr.
Jones began with the income stream provided for in the lease and
subtracted out a relatively small allowance for vacancy and
collection loss (due to the long-term lease), as well as an
amount for management expenses. Mr. Jones determined a
capitalization rate of 12.2 percent using the mortgage-equity
technique, and he applied this rate to the operating income
stream.
We find petitioner's expert to be a credible witness. He
utilized acceptable appraisal methods, and his underlying
assumptions were reasonable. We, therefore, find that petitioner
has met its burden of proving that the value of the property was
$170,000.
Decision will be entered
under Rule 155.