T.C. Memo. 1999-15
UNITED STATES TAX COURT
ESTATE OF ETHEL S. NOWELL, DECEASED,
DAVID A. PRECHEL, PERSONAL REPRESENTATIVE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 19056-96. Filed January 26, 1999.
Alfred J. Olsen, James J. Rossie, Jr., Stephen E. Silver,
Brad S. Ostroff, and Martha C. Patrick, for petitioner.
Rick V. Hosler, for respondent.
MEMORANDUM OPINION
COHEN, Chief Judge: This case is before the Court on cross-
motions for partial summary judgment under Rule 121. Respondent
determined a deficiency of $342,688 in the Federal estate tax of
the estate of Ethel S. Nowell (decedent). The issues for
decision are: (1) Whether certain partnership interests
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includable in the gross estate pursuant to section 2044 should be
merged or aggregated with the partnership interests includable in
the gross estate pursuant to section 2038, for valuation
purposes; and (2) whether the interests in two partnerships
passing at death should be valued for Federal estate tax purposes
as "assignee" interests or as partnership interests.
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect as of the date of decedent's
death, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
Background
Decedent died on December 22, 1992, a resident of Arizona.
She was survived by Nancy Prechel, decedent's only child from a
prior marriage, and by David A. Prechel (Mr. Prechel) and Diane
D. Prechel (Ms. Prechel), decedent's only grandchildren.
Mr. Prechel, a resident of Arizona, was decedent's personal
representative when the petition in this case was filed.
Prior to January 18, 1991, decedent's assets consisted of
her undivided one-half community property interest in certain
publicly traded securities and real property. These assets were
held in the Ethel S. Nowell Trust (the revocable trust) that was
established on April 20, 1990. Mr. Prechel and Ms. Prechel were
named as cotrustees of this trust.
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Ansell L. Nowell (Mr. Nowell), decedent's predeceased
husband, had established the A.L. Nowell Trust on April 20, 1990,
contributing his one-half community property interest in the
publicly traded securities and real estate to the trust and
naming himself and Mr. Prechel as cotrustees. Upon Mr. Nowell's
death on April 26, 1990, the A.L. Nowell Trust estate was
distributed into three trusts: The Decedent's Trust, the
A.L. Nowell Qualified Interest Trust-exempt (QTIP trust-exempt),
and the A.L. Nowell Qualified Interest Trust-nonexempt (QTIP
trust-nonexempt). The QTIP trust-exempt and the QTIP trust-
nonexempt are referred to collectively herein as the QTIP trusts.
Decedent and Mr. Prechel were cotrustees of each trust at
decedent's death.
The property in the QTIP trusts was to be held for the
benefit of decedent during her lifetime, with the remaining
property interests to be distributed to Mr. Prechel and
Ms. Prechel (in trust) at decedent's death. In Mr. Nowell's
estate, the property that was held by the QTIP trusts was treated
as qualified terminable interest property (QTIP property)
pursuant to section 2056(b)(7). Accordingly, Mr. Nowell's
executor made the appropriate election, and his estate claimed a
marital deduction in the amount of $808,046 attributable to the
QTIP property. The deduction was not disallowed for Federal
estate tax purposes.
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On January 18, 1991, decedent and Mr. Prechel formed the
Prechel Farms Limited Partnership (PFLP). The general
partnership interests were held by Mr. Prechel and the QTIP
trust-nonexempt, while the limited partnership interests were
held by the Decedent's Trust, the QTIP trust-exempt, and the
revocable trust. The property that was contributed to the PFLP
consisted of certain assets that were held by the trusts and a
$500 contribution from Mr. Prechel. The following chart
indicates the partnership status of each partner, the value of
contributed property, and each partner's respective profits and
loss percentage.
Contributed Profit & Loss General or
Partners Property* Percentage Limited
Revocable trust $1,386,500 60.41% Limited
Decedent's Trust 300,000 13.07% Limited
QTIP trust-nonexempt 408,000 17.78% General
QTIP trust-exempt 200,000 8.72% Limited
Mr. Prechel 500 0.02% General
*Represents the value of property contributed.
The ESN Group Limited Partnership (ESNGLP) was also formed by
decedent and Mr. Prechel on January 18, 1991. The following
chart indicates the partners, their partnership status, the value
of contributed property, and each partner's respective profits
and loss percentage.
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Contributed Profit & Loss General or
Partners Property* Percentage Limited
Revocable trust $75,000 13.04% Limited
Decedent's Trust 300,000 52.17% General
QTIP trust-exempt 200,000 34.79% Limited
* Represents the value of property contributed.
Both partnerships were duly organized and validly existing
partnerships under the laws of the State of Arizona at decedent's
death.
Each partnership's Articles and Certificate of Limited
Partnership provided in pertinent part:
7.05 Rights of Unadmitted Assignee. A Person who
acquires one or more Units but who is not admitted as a
Substituted Limited Partner pursuant to Section 7.06
hereof (1) shall be entitled only to allocations and
distributions with respect to such Units in accordance
with these Articles, (2) shall have no right to any
information or accounting of the affairs of the
Partnership, (3) shall not be entitled to inspect the
books or records of the Partnership, (4) shall not have
any of the rights of a General Partner or a Limited
Partner under the Act or these Articles, but (5) shall
be subject to the obligations of a Unit Holder under
these Articles, including but not limited to those
provisions of Articles Seven, Ten and Eleven, to the
same extent and in the same manner as any Unit Holder
making a Prohibited Transfer.
7.06 Admission of Unit Holders as Partners.
Subject to the other provisions of this Article Seven,
a transferee of Units may be admitted to the
Partnership as a Substituted Limited Partner only upon
satisfaction of the conditions set forth below:
(1) All General Partners consent to such admission;
* * * * * * *
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8.01 Termination of General Partners.
* * * * * * *
(C) Permitted Transfers by General Partners
* * * * * * *
(2) A transferee of Units from a
General Partner hereunder shall be
admitted as a General Partner with
respect to such Units if, but only if,
(a) at the time of such Transfer, such
transferee is otherwise a General
Partner, or (b) there is one or more
General Partners and the admission of
such transferee as a General Partner is
approved by a majority of the Partners.
[Emphasis added.]
Upon decedent's death, all partnership interests in PFLP were
distributed to Mr. Prechel, and all partnership interests in
ESNGLP were retained by the respective trusts for Ms. Prechel's
benefit.
On September 22, 1993, Mr. Prechel, as decedent's personal
representative, filed a United States Estate (Generation-Skipping
Transfer) Tax Return, Form 706, for decedent's estate. The
return included the partnership interests that were held by the
revocable trust pursuant to section 2038 and the partnership
interests that were held by the QTIP trusts pursuant to section
2044. The partnership interests were discounted based on lack of
marketability, lack of control, and other disabilities. The
discounts ranged from 50 percent to 65 percent of the net asset
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value of the partnerships. The following chart sets forth the
Federal estate tax values of the partnership interests as
represented in the United States Estate Tax Return.
Ownership Estate Tax
Partnership Interest Units Value Discount
PFLP in Revocable trust 1,386,500 $298,100 65%
ESNGLP in Revocable trust 75,000 31,900 50%
PFLP in QTIP trust-nonexempt 408,000 125,300 50%
PFLP in QTIP trust-exempt 200,000 43,000 65%
ESNGLP in QTIP trust-exempt 200,000 85,000 50%
On examination, respondent determined that the partnership
interests that were held by the revocable trust and the QTIP
trusts should be merged for valuation purposes. Accordingly,
respondent determined that the value of the partnership interests
in the revocable trust should be increased by $577,300 and that
the value of the partnership interests in the QTIP trusts should
be increased by $272,404. Respondent also added $2,500 to
decedent's gross estate for a 1992 Federal income tax refund.
The resulting deficiency in Federal estate tax was determined to
be $342,688.
Discussion
Partial summary judgment is appropriate when the record
shows that there is no genuine issue of material fact and that a
decision may be rendered as a matter of law. Rule 121(b);
Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), affd.
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17 F.3d 965 (7th Cir. 1994). The facts in this case have been
stipulated for purposes of the cross-motions for summary
judgment. Decedent's gross estate includes partnership interests
pursuant to sections 2038 and 2044 valued with fractional
interest discounts based on lack of marketability and other
disabilities. The first issue is whether the partnership
interests that were held by the estate should be valued
independently of each other. The second issue is whether the
partnership interests that passed at decedent's death were
partnership interests or "assignee" interests. Both issues
present legal questions and are, therefore, appropriate for
partial summary judgment.
Issue 1
Section 2031 includes in the decedent's gross estate the
value of property described in sections 2033 through 2044. Under
section 2038, a decedent's gross estate includes the value of all
property interests transferred by a decedent during the
decedent's lifetime, unless for full consideration, if at the
decedent's death the enjoyment of such property is subject to any
change through a retained power to revoke. Section 2044 includes
in the gross estate the value of all property in which the
decedent had a qualified income interest for life and for which a
deduction was allowed under section 2056(b)(7) in computing the
value of the decedent's predeceased spouse's estate. Property
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included in the decedent's gross estate pursuant to sections 2031
through 2044 is generally included at its fair market value, 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 sell, and both having reasonable knowledge of the relevant
facts. Sec. 2031; United States v. Cartwright, 411 U.S. 546, 551
(1973); sec. 20.2031-1(b), Estate Tax Regs.
The partnership interests that were held by the revocable
trust are included in decedent's gross estate pursuant to section
2038, and the partnership interests that were held by the QTIP
trusts are included in decedent's gross estate pursuant to
section 2044. Respondent argues that, in valuing the partnership
interest for Federal estate tax purposes, the decedent should be
treated as the owner of property included in the estate pursuant
to section 2044 and that the respective partnership interests
held by the trusts should merge or be aggregated. Accordingly,
respondent concludes that decedent's estate should be taxed on an
84.1-percent limited partnership interest in PFLP, a 99.9-percent
general partnership interest in PFLP, and a 100-percent limited
partnership interest in ESNGLP, rather than on the separate
partnership interests owned by each trust.
We rejected respondent's aggregation argument in Estate of
Mellinger v. Commissioner, 112 T.C. 26 (1999), filed this date,
and we find no reason to reach a different conclusion in this
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case. In Estate of Mellinger, the decedent died owning 2,460,580
shares of stock that were held in her revocable trust. The stock
was included in her estate pursuant to section 2033. Also
included in her taxable estate, pursuant to section 2044, were
2,460,580 shares of the same stock held in a QTIP trust
established by the decedent's predeceased spouse. Respondent
argued that the shares should be aggregated and valued as a
control block rather than as two separate minority interests. We
rejected that argument stating:
Respondent has identified nothing in the statute that
indicates that Congress intended that result or that
QTIP assets should be aggregated with other property in
the estate for valuation purposes. Cf. secs. 267, 318,
544 (indicating aggregation of interests in terms of
ownership). Furthermore, at no time did decedent
possess, control, or have any power of disposition over
the FOH shares in the QTIP trust. Cf. secs. 2035,
2036, 2041 (requiring inclusion in the gross estate
where decedent had control over the assets at some time
during her life). [Id. at __ (slip op. at 17).]
Respondent, in Estate of Mellinger, also argued that the
decedent should be treated as the owner of QTIP property for
valuation purposes. We held that "Neither section 2044 nor the
legislative history indicates that decedent should be treated as
the owner of QTIP property for this purpose." Id. at __ (slip
op. at 18). Accordingly, the shares of stock in the trusts were
valued as two separate minority interests. Id. at __ (slip op.
at 18); see also Estate of Bonner v. United States, 84 F.3d 196
(5th Cir. 1996).
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These principles are equally applicable to the case before
us. Analysis of section 2044 and the accompanying regulations
thereunder does not indicate that Congress intended that property
interests includable under section 2044 should be merged or
aggregated with interests in the same property included in the
estate pursuant to section 2038 for purposes of determining
Federal estate tax value. Section 2044 provides only that the
value of property in the gross estate shall include property in
which the decedent had a qualifying income interest for life and
that the inclusion of such property shall be at its fair market
value. Sec. 20.2044-1(d), Estate Tax Regs. Section 2044(c)
treats QTIP property as "passing from the decedent" but does not
indicate that the decedent should be treated as the owner of such
property for purposes of aggregation. Thus, the partnership
interests included pursuant to section 2038 and section 2044
should be valued separately.
Issue 2
The second issue for decision is whether the interests in
the two partnerships passing at death should be valued for
Federal estate tax purposes as "assignee" interests or as
partnership interests.
The Federal estate tax is a tax on the privilege of
transferring property upon one's death. United States v.
Manufacturers Natl. Bank of Detroit, 363 U.S. 194, 198 (1960).
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"[T]he property to be valued for estate tax purposes is that
which the decedent actually transfers at his death rather than
the interest held by the decedent before death, or that held by
the legatee after death." Propstra v. United States, 680 F.2d
1248, 1250 (9th Cir. 1982); see also Ahmanson Found. v. United
States, 674 F.2d 761, 769 (9th Cir. 1981).
For purposes of determining value, the standard is an
objective test using hypothetical buyers and sellers in the
marketplace and is not a personalized one that envisions a
particular buyer and seller. Estate of Andrews v. Commissioner,
79 T.C. 938, 956 (1982); Kolom v. Commissioner, 71 T.C. 235, 244
(1978), affd. 644 F.2d 1282 (9th Cir. 1981). Respondent argues,
however, that, although the valuation standard utilizes a
hypothetical buyer, who could not, under the terms of the
partnership agreement, purchase a partnership interest, it does
not transform the nature of the interest that actually passed at
death from partnership interests to assignee interests.
Respondent's argument rests on the notion that the partnership
interests that were transferred to Mr. Prechel remained
partnership interests because he was "automatically" admitted as
a general partner by virtue of his already being a partner in
both partnerships. In addition, respondent argues that, because
the trusts continued to hold some of the partnership interests
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after decedent's death, only substituting Ms. Prechel as the
beneficiary, the interests remained partnership interests.
In determining the value of an asset for Federal estate tax
purposes, State law first determines precisely what property is
transferred. Morgan v. Commissioner, 309 U.S. 78, 80 (1940);
Estate of Bright v. United States, 658 F.2d 999, 1001 (5th Cir.
1981). After that determination is made, the Federal tax law
takes over to determine how such rights and interests will be
taxed. United States v. Bess, 357 U.S. 51, 55 (1958). Thus,
State law must be consulted to determine what property interests
were transferred at a decedent's death.
Under the Arizona Limited Partnership Act, "An assignment
entitles the assignee to receive, to the extent assigned, only
the distribution to which the assignor would be entitled." Ariz.
Rev. Stat. sec. 29-340 (1991). A partner in an Arizona limited
partnership cannot, however, confer to an assignee the rights to
exercise the powers of a partner, unless provided otherwise in
the partnership agreement. Id. The PFLP and ESNGLP partnership
agreements specify that the assignee of limited partnership
interests in either partnership will become an assignee and not a
substitute limited partner unless, among other things, the
general partners consent to the assignee's admission as a limited
partner. Accordingly, limited partner status in PFLP and ESNGLP
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is conferred on Mr. Prechel and Ms. Prechel only if the general
partners consent.
Under the partnership agreements, the assignee of a general
partnership interest is a general partner with respect to such
assignment if "at the time of such * * * [assignment, the
assignee] is otherwise a General Partner". If the assignee of a
general partnership interest is not a general partner, the
assignee will become a substitute general partner only if
approved by a majority of the partners. Because Mr. Prechel was
already a general partner in PFLP, the 408,000 general
partnership units in PFLP assigned to him continued to be a
general partnership interest.
Applying the Federal estate tax valuation principles to the
interests described above, the limited partnership interests must
be valued as "assignee" interests, and the general partnership
interest in PFLP distributed to Mr. Prechel must be valued as a
general partnership interest. Determination of whether
Mr. Prechel and Ms. Prechel will be treated as limited partners
of the respective partnerships can be made only by taking into
consideration whether the remaining general partners will consent
to their admission as limited partners, subjective factors that
cannot be taken into consideration under the objective standard
of the hypothetical seller/buyer analysis. See Propstra v.
United States, supra at 1252; Estate of Andrews v. Commissioner,
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supra at 956; Kolom v. Commissioner, supra at 244. Thus, the
limited partnership interests received by Mr. Prechel and
Ms. Prechel must be valued as assignee interests.
There are, however, no subjective factors to consider when
determining whether Mr. Prechel will be a general partner with
respect to the general partnership interest assigned to him. The
partnership agreement automatically treats him as a general
partner. Accordingly, the general partnership interest received
by Mr. Prechel should be valued as a general partnership
interest. No general partnership interests passed to
Ms. Prechel.
Petitioner's motion for partial summary judgment will be
granted in part and denied in part, and respondent's motion for
partial summary judgment will be granted in part and denied in
part.
To reflect the foregoing,
An appropriate order will
be issued.