Estate of Schuler v. Commissioner

T.C. Memo. 2000-392

UNITED STATES TAX COURT

ESTATE OF ROBERT V. SCHULER, DECEASED, JAY SCHULER & THOMAS
SCHULER, CO-PERSONAL REPRESENTATIVES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 14002-99. Filed December 28, 2000.

Richard E.T. Smith, Jon J. Jensen, and Garry A. Pearson, for

petitioner.

Tracy Anagnost Martinez and Melissa J. Hedtke, for

respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

PARR, Judge: Respondent determined a deficiency of $215,758

in the Federal estate tax due from the estate of Robert V.

Schuler (decedent).
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After concessions,1 the sole issue for decision is whether

decedent's transfers of stock in 1994 and 1995 to members of his

brother's family were, in substance, indirect gifts of stock to

members of his own family. We hold they were.

FINDINGS OF FACT

Some of the facts have been stipulated and are so found,

unless otherwise noted. The stipulation of facts and the

accompanying exhibits are incorporated herein by this reference.

Decedent died testate on October 4, 1995, in Wahpeton, North

Dakota (Wahpeton). At the time the petition in this case was

filed, the personal representatives of the estate, Jay Schuler

and Thomas Schuler, resided in Wahpeton.

All section references are to the Internal Revenue Code in

effect for the date of decedent's death, and all Rule references

1
In the notice of deficiency, respondent determined values
for certain real properties and a limited partnership interest
owned by decedent at the time of his death that decreased the
value of the gross estate. Respondent determined that the value
of the taxable estate should be increased for the amount claimed
as a charitable deduction which was in excess of the value of the
properties contributed to qualified charities, for the unreported
value of decedent's brokerage account, and for interest accrued
on certain indebtedness owed to decedent. The estate concedes
these adjustments.
The estate attached Schedule J to Form 706, United States
Estate (and Generation-Skipping Transfer) Tax Return, to claim
deductions for $35,000 of attorney's fees, $7,500 of accountant's
fees, and $4,400 of miscellaneous expenses. The parties have
stipulated that the estate will incur additional administrative
expenses which will further decrease the value of the taxable
estate.
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are to the Tax Court Rules of Practice and Procedure, unless

otherwise indicated.

The Schuler Family Businesses

Minn-Kota Ag Products, Inc.

At sometime during the late 1930's or early 1940's, the

parents of decedent and decedent's brother, George M. Schuler,

Jr. (decedent's brother or George), established Schuler Grain

Co., a grain elevator business located in the Red River Valley

region of west central Minnesota. Decedent and his brother

expanded the grain elevator business into a full-service

agricultural center by selling farmers seed and fertilizer in the

spring and by buying grain from them at harvest time. When

chemical supplements became available for agricultural use,

decedent and his brother sold the farmers the chemicals. Upon

the demise of their parents, decedent and his brother became the

owners of the business.

In 1986, Schuler Grain Co. reorganized into a corporation

called Minn-Kota Ag Products, Inc. (Minn-Kota). Minn-Kota issued

class A voting common stock, all of which was owned by an

unrelated employee, and nonvoting noncumulative preferred stock.

In 1989, all of the Minn-Kota voting common stock was acquired by

George's son, George M. Schuler III (Jody), and the preferred

stock converted into restricted class B common stock, which was

owned by decedent, decedent's son, Jay Schuler (Jay), George, and
 - 4 -

Jody.

Sigco Sunplant, Inc.

In 1970, decedent, George, and their mother, Dorothy, formed

Sigco Sunplant, Inc. (Sigco). Sigco is engaged in the sunflower

seed business. Upon Dorothy's demise, Sigco was owned equally by

decedent and his brother.

The Plan and the Stock Transfers

Decedent had heart disease, had undergone heart bypass

surgery, and had suffered seven heart attacks, most of them

before the transfers at issue. Decedent had seven children, his

brother has six children, and many of both men's children have

children. In discussions with their insurance agent, Dave

Middaugh (Mr. Middaugh), decedent and his brother made it clear

that they wanted their families to succeed them in the

businesses, and that they wanted decedent's family to control

Sigco and George's family to control Minn-Kota.

After many discussions, decedent, his brother, and Mr.

Middaugh devised a three-step plan to transfer divided ownership

of Sigma and Minn-Kota to each other's family and to use section

2503(b) to save estate taxes.

The first step to transfer the Sigco stock was for decedent

and his wife to make joint gifts of Sigco stock equal to $20,000

of value to their children and grandchildren during December 1994

and January 1995. The second step was for George and his wife to
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duplicate the first step; that is, to make joint transfers of

Sigco stock equal in value to $20,000 to each of decedent's

children and grandchildren. The third step in their scheme was

for certain of decedent's children to transfer the shares that

they had received to four of their siblings, including to Jay and

his children.2

The first step to transfer the Minn-Kota stock was for

George and his wife to make joint gifts of Minn-Kota stock valued

at $20,000 to each of their children and grandchildren in

December 1994 and January 1995. The second step was for decedent

and his wife to duplicate the first step; that is, to transfer in

each year $20,000 of Minn-Kota stock to George and his wife and

their children. The third step was for certain of George's

children and their spouses to transfer the stock in amounts equal

in value to $10,000 to Jody and his wife, Holly, and to their

children, George M. Schuler IV (George IV) and William.3

1994 Transfers of Sigco Stock

On December 28, 1994, in addition to transferring shares of

2
Mr. Middaugh's notes with respect to this plan stated that
the "IRS could claim Step 3 is a step transaction - would be
highly likely if 1) there was a written agreement to do so, and
2) if it was done at the same time. Suggest it be voluntary and
at the end of 1995 at earliest." The third step had not been
executed at the time of trial.
3
Mr. Middaugh made a note similar to the one in supra note 2
with respect to this step of the scheme. At the time of trial,
"Step 3" had not been executed.
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Sigco stock to his children and their spouses and children,

decedent transferred4 shares to his brother's son and his family,

as follows:

Relationship of Number Value
Transferee Transferee to Decedent of Shares of Shares

Jody Nephew 2.22 $19,980
Holly Schuler (Holly) Niece by marriage 2.22 19,980
George IV Grandnephew 1.81 16,290
Total 56,250

On that same day, in addition to transferring shares of

Sigco stock to Jody and his wife and their children, George

transferred shares to decedent's children and their spouses, as

follows:

Relationship of Number Value
Transferee Transferee to Decedent of Shares of Shares

Jay Son 2.22 $19,980
Thomas Son 2.22 19,980
Jennifer Daughter-in-law 2.22 19,980
Cynthia Deal Daughter 2.16 19,440
Mike Deal Son-in-law 2.16 19,440
Constance Waibel Daughter 2.22 19,980
Christine Haire Daughter 2.22 19,980
Kathleen Deal Daughter 2.22 19,980
Karen Steinborn Daughter 2.16 19,440
Kyle Steinborn Son-in-law 2.16 19,440
Total 197,640

1994 Transfers of Minn-Kota Stock

On December 28, 1994, decedent transferred shares of Minn-

4
Decedent's wife consented to have the transfers (including
generation-skipping transfers) made by decedent during 1994
considered as made one-half by each. See sec. 2513(a).
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Kota stock to his brother and his brother's family, as follows:

Relationship of Number Value
Transferee Transferee to Decedent of Shares of Shares

George Brother 542 $19,999.80
Barbara Sister-in-law 542 19,999.80
James Nephew 542 19,999.80
Jerome Nephew 542 19,999.80
Kim Nephew 542 19,999.80
Jan McCann Niece 542 19,999.80
Francine Cook Niece 542 19,999.80
George IV Grandnephew 325 11,992.50
William Grandnephew 325 11,992.50
Total 163,983.60

Although George transferred shares of Minn-Kota to his

children and to his children's families on this same day, George

did not transfer any shares of Minn-Kota to any members of

decedent's family.

1995 Transfers of Sigco Stock

On January 3, 1995, in addition to transferring shares of

Sigco to members of his own family, decedent made the following

transfers5 to members of his brother's family:

Relationship of Number Value
Transferee Transferee to Decedent of Shares of Shares

Jody Nephew 2.22 $19,980
Holly Niece by marriage 2.22 19,980
William Grandnephew 1.81 16,290
Total 56,250

On the same day, George made the following transfers of

5
Decedent's wife consented to have the transfers (including
generation-skipping transfers) made by decedent during 1995
considered as made one-half by each. See sec. 2513(a).
 - 8 -

Sigco stock to decedent's family:

Relationship of Number Value
Transferee Transferee to Decedent of Shares of Shares

Jay Son 2.22 $19,980
Thomas Son 2.22 19,980
Jennifer Daughter 2.22 19,980
Cynthia Deal Daughter 2.00 18,000
Mike Deal Son-in-law 2.00 18,000
Karen Steinborn Daughter 1.89 17,010
Kyle Steinborn Son-in-law 1.89 17,010
Constance Waibel Daughter 2.06 18,540
Christine Haire Daughter 2.00 18,000
Kathleen Deal Daughter 2.00 18,000
Total 184,500

1995 Transfers of Minn-Kota Stock

On January 3, 1995, decedent made transfers of Minn-Kota to

his brother's family, as follows:

Relationship of Number Value
Transferee Transferee to Decedent of Shares of Shares

George Brother 542 $19,999.80
Barbara Sister-in-law 542 19.999.80
James Nephew 542 19.999.80
Jerome Nephew 542 19.999.80
Kim Nephew 542 19.999.80
Francine Cook Niece 542 19.999.80
Jan McCann Niece 542 19.999.80
George IV Grandnephew 325 11,992.50
William Grandnephew 325 11,992.50
Total 163,983.60

On the same day, George made transfers of Minn-Kota stock to

his own family; however, he transferred no shares of Minn-Kota to

decedent's family.

Before making the December 28, 1994, and January 3, 1995,

transfers at issue, decedent and his son owned 75 percent of the

Sigco shares outstanding (decedent owned 25 percent and Jay owned
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50 percent) and George owned the other 25 percent. Additionally,

decedent and his family collectively owned 50 percent of the

Minn-Kota class B common shares (decedent owned 49.6 percent and

his family owned 0.4 percent), and George and his family owned

the other 50 percent. Jody owned 100 percent of the Minn-Kota

class A voting common stock.

After the transfers, decedent's family owned almost 80

percent of Sigco, and George's family owned almost 68 percent of

Minn-Kota. Jody continued to own all of the Minn-Kota voting

common stock.

Before making these transfers, in which decedent transferred

stock valued at $440,467.20 to his brother's family and George

transferred stock valued at $382,140 to decedent's family,

neither brother had ever transferred any Sigco or Minn-Kota stock

to the other's family. George transferred 540 shares of Minn-

Kota stock to decedent's son, Jay, on December 18, 1996, January

2, 1997, and January 2, 1998.6 The value of the stock in each of

these transfers was $19,926. George made no transfers of stock

to any other members of decedent's family during this time.

6
The parties stipulated that George made no transfers of
stock to decedent's children after 1995. However, the parties
agree that stipulation is incorrect and that George made these
transfers to Jay at these times.
 - 10 -

OPINION

Respondent determined that decedent's transfers of Sigco and

Minn-Kota stock during 1994 and 1995 to his brother's family were

reciprocated or "crossed" and, in substance, gifts to decedent's

own children and their families. Accordingly, respondent

disallowed the annual exclusions for gifts of a present interest

for decedent's transfers of stock to his brother's family and

increased the amount of taxable gifts reported on decedent's

estate tax return.

The estate contends that respondent's determination is

erroneous because the transfers at issue were made for a business

purpose, and decedent's intent in making the transfers was

donative.

Section 2001(a) provides that a tax is imposed on the

transfer of the taxable estate of every decedent who is a citizen

or resident of the United States. The tax imposed is equal to

the excess of a tentative tax computed on the sum of the taxable

estate and the adjusted taxable gifts over the aggregate amount

of tax that would have been payable with respect to gifts made by

the decedent after December 31, 1976, using the unified rate

schedule in effect at the date of death. See sec. 2001(b). The

term "adjusted taxable gifts" means the total amount of the

taxable gifts (within the meaning of section 2503) made by the

decedent after December 31, 1976, other than gifts which are
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includable in the gross estate. See id.

In general, a tax is imposed for each calendar year on the

transfer of property by gift by any individual, whether the gift

is made directly or indirectly. See secs. 2501(a), 2511(a). The

term "taxable gifts" means the total amount of gifts made during

the calendar year, less certain deductions. See sec. 2503(a).

However, the first $10,000 of gifts of a present interest in

property made by a donor to any person in a calendar year are

excluded from taxable gifts. See sec. 2503(b).

As a general rule, we respect the form of a transaction. We

do not apply the substance over form principles unless the

circumstances so warrant. See Gregory v. Helvering, 293 U.S. 465

(1935); Estate of Jalkut v. Commissioner, 96 T.C. 675, 686

(1991).

The reciprocal trust doctrine, an application of substance

over form, has been used in the estate and gift tax area to

determine who is the transferor of property for the purposes of

inclusion in the gross estate. See United States v. Estate of

Grace, 395 U.S. 316, 321 (1969). Recently, in Sather v.

Commissioner, T.C. Memo. 1999-309, this Court applied the

reciprocal trust doctrine to reduce the number of present

interest annual exclusions for gift tax purposes.

In United States v. Estate of Grace, supra, Joseph P. Grace

created a trust for the benefit of his wife and, 2 weeks later,
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his wife created a substantially identical trust for his benefit.

In holding that for Federal estate tax purposes each settlor will

be considered the creator of the trust that is in form created by

the other, the Supreme Court stated:

It is undisputed that the two trusts are interrelated.
They are substantially identical in terms and were
created at approximately the same time. Indeed, they
were part of a single transaction designed and carried
out by decedent. It is also clear that the transfers
in trust left each party, to the extent of mutual
value, in the same objective position as before.
Indeed, it appears, as would be expected in transfers
between husband and wife, that the effective position
of each party vis-a-vis the property did not change at
all. It is no answer that the transferred properties
were different in character. For purposes of the
estate tax, we think that economic value is the only
workable criterion. [Id. at 325.]

In the instant case, the transfers were not made in trust;

however, that is a distinction without a difference. "The law

searches out the reality and is not concerned with the form."

Lehman v. Commissioner, 109 F.2d 99, 100 (2d Cir. 1940), affg. 39

B.T.A. 17 (1939); see also United States v. Estate of Grace,

supra at 321. Thus, the same principle and much of the same

factors of the reciprocal trust doctrine are considered in the

reciprocal transaction doctrine, which applies to reciprocal

indirect transfers of a present interest.

For instance, in Furst v. Commissioner, T.C. Memo. 1962-221,

this Court found that where six donors each made transfers of

shares of stock to members of his or her immediate family, and

transfers of the same stock in the same amounts to members of
 - 13 -

each other donor's immediate family, the transfers, in reality,

gave the members of a donor's family all of the stock that donor

transferred. Therefore, we held that the number of annual

exclusions would be determined by the number of recipients in

each donor's immediate family.

Moreover, in Schultz v. United States, 493 F.2d 1225, 1226

(4th Cir. 1974), the taxpayer transferred stock in a closely held

corporation to each of his three children and to each of the

three children of his brother. On that same day, the taxpayer's

brother transferred the same number of shares to each of his

three children and to each child of the taxpayer. The court

held, without deciding whether United States v. Estate of Grace,

supra, would apply with equal force to indirect gifts, that a

reasonable jury could have concluded that the taxpayer intended

to benefit his children by the transfers, rather than those of

his brother. Accordingly, the court sustained the Commissioner's

disallowance of the annual exclusion for gifts the taxpayer

claimed for the transfers to his brother's children.

The facts of the instant case prove conclusively that the

transfers at issue were reciprocal; that is, decedent's transfers

to his brother's family were made in exchange for George's

transfers to decedent's family members.

The parties stipulated that the brothers' motivations in

making the transfers included the desire to separate ownership of
 - 14 -

Sigco and Minn-Kota between the two families and to minimize

estate taxes. Clearly, as both decedent and his brother owned

stock of both corporations, separation of ownership by exchanging

the stock through transfers to each other's family members at

least implies reciprocity. The estate asserts, however, that the

business purpose for exchanging the stock excepts these

transactions from the reciprocal transaction doctrine. We

disagree.

The estate contends that the business purpose was to divide

the companies and place Jay in control of Sigco and Jody in

control of Minn-Kota. Separation of the families' ownership of

Sigco and Minn-Kota, insofar as it was accomplished, was not the

main purpose of the transfers. Before the transfers, decedent's

family owned 75 percent of Sigco; after the transfers, it owned

almost 80 percent. Thus, the transfers resulted in little of the

Sigco ownership shifting from George's family to decedent's

family. Moreover, the estate's contention is proved false by the

facts that decedent transferred shares of Sigco in 1994 and 1995

to George's son Jody, and other members of George's family, and

George transferred more than 1,600 Minn-Kota shares to decedent's

son, Jay, after decedent's death.

Finally, before the transfers at issue, decedent owned 25

percent of the Sigco shares outstanding and Jay owned 50 percent;

collectively, a 75-percent majority. Therefore, the transfers at
 - 15 -

issue were not necessary for Jay to acquire control of Sigco.

Both before and after the transfers, Jody owned 100 percent of

the Minn-Kota voting stock and, therefore, controlled Minn-Kota;

acquiring control of Minn-Kota for Jody was not the purpose of

the transfers.

A business purpose, if any, was not the primary motivation

for making the reciprocal transfers at issue. It is an

inescapable conclusion that decedent and his brother made the

circuitous transfers for the primary purpose of increasing the

number of exclusions under section 2503(b) that otherwise would

have been available to them.

In United States v. Estate of Grace, supra, the Supreme

Court held that application of the reciprocal trust doctrine

requires only that the trusts be interrelated, and requires that

the arrangement, to the extent of mutual value, leave the

settlors in approximately the same economic position as they

would have been in had they created the trusts naming themselves

as life beneficiaries. In concluding application of the

reciprocal trust doctrine does not depend upon a finding that

each trust was created as a quid pro quo for the other, the

Supreme Court stated:

We do not mean to say that the existence of
"consideration," in the traditional legal sense of a
bargained-for exchange, can [n]ever be relevant. In
certain cases, inquiries into a settlor's reasons for
creating the trusts may be helpful in establishing the
requisite link between the two trusts. We only hold
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that a finding of a bargained-for consideration is not
necessary to establish reciprocity. [United States v.
Estate of Grace, 395 U.S. at 325 n.10.]

In this case, the transfers were interrelated. We have no

doubt that decedent's transfers of stock to his brother's family

were quid pro quo for George's transfers of stock to decedent's

family; the exchanged stock was the bargained-for consideration.

Furthermore, the brothers' plan to exchange the stock via

transfers to each other's families on the same days in 1994 and

1995 establishes that the transfers were reciprocal. See Lehman

v. Commissioner, supra at 100-101 ("Here the transfer by the

decedent's brother, having been paid for and brought about by the

decedent, was in substance a 'transfer' by the decedent".).

The estate contends that decedent was not left in the same

economic position after the transfers as his net worth was

"severely depleted". The estate misconstrues the reciprocal

transaction doctrine. The relevant inquiry in reciprocal

indirect transfer cases is whether the transferees are in

approximately the same economic position as they would be if the

donor transferred the property directly to them. See Schultz v.

United States, supra; Furst v. Commissioner, supra. Here, in

simultaneous, circuitous transfers, decedent conveyed stock with

a total value of $440,467.20 to his brother's family, and George

conveyed stock with a total value of $382,140 to decedent's

family. The difference in these amounts, $58,327.20, was
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eliminated by George's transfer of stock with a total value of

$59,778 to decedent's son, Jay, in the 3 years following

decedent's death. Thus, it is clear that decedent's family

members received stock of approximately the same economic value

via the circuitous route devised by decedent, his brother, and

their insurance agent as they would have by direct transfers from

decedent.

Finally, the estate asserts that the reciprocal transaction

doctrine does not apply to this case because decedent would have

made the transfers to his brother's family even if George had

made no reciprocal transfers to decedent's family. We disagree.

We find implausible the estate's assertion that decedent

would have transferred gratuitously assets sufficient to severely

deplete his net worth. Moreover, it well settled that the

Federal estate tax does not hinge upon the subjective intent of

the decedent. See United States v. Estate of Grace, supra at

323. Relevant to the decision in this case is that the objective

facts prove conclusively that decedent and his brother executed a

plan to make simultaneous, reciprocal transfers of property of

approximately equal economic value to each other's family

members, and that decedent's immediate family members received

property of approximately the same economic value as they would
 - 18 -

have received if decedent had transferred the property directly

to them.

The estate's position has no basis in either fact or law.

Accordingly, respondent is sustained on this issue.

To reflect the foregoing,

Decision will be entered

under Rule 155.