T.C. Memo. 2006-263
UNITED STATES TAX COURT
ESTATE OF RONALD G. KEETON, DECEASED, KIMBERLY KEETON SPENCE,
PERSONAL REPRESENTATIVE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 20067-03. Filed December 13, 2006.
Douglas A. Wright, for petitioner.
Lauren B. Epstein, for respondent.
MEMORANDUM OPINION
GOEKE, Judge: Respondent issued a notice of deficiency in
the Federal estate tax of the Estate of Ronald G. Keeton (the
estate) of $46,690. After concessions,1 the sole issue for
1
The parties have stipulated that they have resolved all
other issues raised by the notice of deficiency and petition.
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decision is whether the estate is entitled to the family-owned
business deduction under section 2057.2 In response to an
argument respondent made in his opening brief, the estate has
conceded that it cannot prevail under the statute because it
fails to meet one of the substantive requirements necessary to
obtain the deduction. However, the estate contends that (1) the
argument raised in respondent’s brief contradicts the stipulation
of facts, and (2) respondent prejudiced the estate by raising a
new issue on brief. We hold that respondent did not raise a new
issue and that the estate may not rely on the stipulation of
facts to preclude respondent’s argument.
Background
The parties submitted this case fully stipulated under Rule
122. The stipulations of facts and the attached exhibits are
incorporated herein by this reference. Ronald G. Keeton
(decedent), died on July 19, 1999. Decedent was a citizen and
resident of the United States at the time of his death. The
record does not reflect where in the United States decedent lived
at the time of his death. The parties have stipulated that the
legal address of decedent’s personal representative is in Panama
City, Florida.
2
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the date of decedent’s
death, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
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On the date of his death, and at all times since
incorporation, decedent owned 100 percent of the stock of Keeton
Corrections, Inc. (Keeton Corrections), a subchapter C
corporation, and 100 percent of the stock of Non-Secure Programs,
Inc. (NSP), an S corporation. Decedent materially participated
in the operation of both companies. Both companies operate
corrections facilities. Keeton Corrections, a Kentucky
corporation authorized to do business in Florida, was
incorporated in 1985 and has operated continuously since that
time. Keeton Corrections initially contracted with the United
States, the Commonwealth of Kentucky, and the State of Florida to
provide corrections facilities and services as part of the
Federal and State penal systems. NSP, a Florida corporation, was
incorporated on March 22, 1995. NSP is not a subsidiary of
Keeton Corrections. After the incorporation of NSP, Keeton
Corrections and the State of Florida assigned the Florida State
contracts to NSP. Keeton Corrections continued to operate
corrections facilities under Federal contract in Florida and
various other States. Upon his death, decedent passed his
interests in both Keeton Corrections and NSP to his daughter,
Kimberly Spence. Ms. Spence continues to operate these
companies.
The estate timely filed a Form 706, United States Estate
(and Generation Skipping Transfer) Tax Return, on October 24,
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2000 (the estate tax return). On Schedule T of the estate tax
return, the estate claimed a deduction under section 2057 of
$675,000. The estate reported qualified family-owned business
interests (QFOBIs) valued at $2,870,933, consisting of decedent’s
interest in Keeton Corrections valued at $1,285,531 and his
interest in NSP valued at $1,585,402. Pursuant to section
2057(b)(1)(B), the executor elected the application of section
2057 and filed the agreement referred to in section 2057(h).
Respondent issued his notice of deficiency on August 26,
2003. In his notice of deficiency, respondent, among other
adjustments, disallowed the family-owned business deduction in
its entirety.
Discussion
I. Section 2057
Section 2057(a) provides an estate tax deduction for QFOBIs
effective for estates of decedents dying after December 31, 1997.
Taxpayer Relief Act of 1997, Pub. L. 105-34, sec. 502(c), 111
Stat. 852. A QFOBI includes an interest as a proprietor in a
business carried on as a proprietorship or an interest in an
entity carrying on a business if at least 50 percent of the
entity is owned, directly or indirectly, by the decedent or a
member of the decedent's family. Sec. 2057(e)(1). If an estate
qualifies for and elects to take the deduction, up to $675,000 of
the adjusted value of QFOBIs may be deducted from the value of a
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decedent’s gross estate. Sec. 2057(a)(2). Several requirements
must be met either before death or at the time of death for
interests in a business to be eligible for the section 2057
deduction. Section 2057(b)(1) sets forth requirements necessary
to obtain the deduction:
SEC. 2057(b). Estates to Which Section Applies.--
(1) In general.--This section shall apply to an
estate if--
(A) the decedent was (at the date of the
decedent's death) a citizen or resident of
the United States,
(B) the executor elects the application
of this section and files the agreement
referred to in subsection (h),
(C) the sum of–
(i) the adjusted value of the
qualified family-owned business
interests described in paragraph
(2), plus
(ii) the amount of the gifts
of such interests determined under
paragraph (3),
exceeds 50 percent of the adjusted gross estate, and
(D) during the 8-year period ending on
the date of the decedent's death there have
been periods aggregating 5 years or more
during which–
(i) such interests were owned
by the decedent or a member of the
decedent's family, and
(ii) there was material
participation (within the meaning
of section 2032A(e)(6)) by the
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decedent or a member of the
decedent’s family in the operation
of the business to which such
interests relate.
The parties have stipulated that the estate has satisfied
the requirements listed in section 2057(b)(1)(A) and (B). The
parties have also stipulated that the only dispute is whether the
stipulated facts demonstrate that the estate has satisfied the
requirements of section 2057(b)(1)(C) and (D).
II. Evolution of the Parties’ Current Positions
In his notice of deficiency, respondent gave the following
explanation for denying the deduction:
It is determined that the deduction claimed under
Section 2057 of the Internal Revenue Code of 1986 is
not allowed because during the eight year period ending
on the date of the Decedent’s death there were not
periods aggregating five years or more during which
such interests were owned by the Decedent or a member
of the Decedent’s family. Therefore the sum of the
adjusted value of the family-owned business interests
plus the amount of gifts of such interests does not
exceed 50% of the adjusted gross estate.
In its petition and opening brief, the estate argued that
there were periods aggregating 5 years or more during which
decedent owned both Keeton Corrections and NSP. The estate
asserted that the language of section 2057(b)(1)(D) refers to
“such interests” and does not require that each individual
interest in a corporation meet the 5-year requirement. The
estate asserted that the two corporations should be viewed as one
collective business because the incorporation of NSP, which
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occurred fewer than 5 years before decedent’s death, was a
continuation of the business of Keeton Corrections that provided
the same services to the same customers and under the same
contracts. Therefore, the estate concluded that it satisfied the
50-percent test under section 2057(b)(1)(C) because it would be
able to include the values of both corporations. The estate also
argued that even if NSP did not satisfy section 2057(b)(1)(D),
the estate could still include the value of NSP in the 50-percent
test calculation under section 2057(b)(1)(C) because NSP was an
“Includible qualified family-owned business interest” under
section 2057(b)(2), which section 2057(b)(1)(C) cross-
references.3
In his opening brief, respondent asserted that even if the
estate were allowed to combine the interests in NSP and Keeton
Corrections for purposes of section 2057(b)(1)(C), the adjusted
value of those combined interests would still not exceed 50
percent of the adjusted gross estate. Since the estate would not
be able to satisfy section 2057(b)(1)(C), even if able to
aggregate the values of both corporations, respondent concluded
that the estate would not be able to qualify for the deduction.
3
Sec. 2057(b)(2) provides that “includible qualified family-
owned business interests” are interests that are included in
determining the value of the decedent’s gross estate and that
have passed to a qualified heir from the decedent.
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The estate concedes that the adjusted value of the combined
interests in NSP and Keeton Corrections does not exceed 50
percent of the adjusted gross estate.
III. The Current Dispute Between the Parties
Since the estate concedes that it does not pass the 50-
percent test under section 2057(b)(1)(C), it is unnecessary for
us to decide whether NSP meets the requirement under section
2057(b)(1)(D) for purposes of the 50-percent test in section
2057(b)(1)(C). The estate’s concession obviates any further
analysis under the statute because if both corporations combined
do not satisfy the 50-percent test of section 2057(b)(1)(C), the
estate will not be entitled to the deduction.
The estate has raised two additional procedural arguments
that require resolution by this Court. First, the estate argues
that the parties have stipulated that the combined value of
Keeton Industries and NSP satisfies section 2057(b)(1)(C), and
that the stipulation is binding on the parties and this Court.
Rule 91(e); Stamos v. Commissioner, 87 T.C. 1451, 1454 (1986).
In the alternative, the estate argues that we must refuse to
consider respondent’s argument that both interests combined could
not meet the requirement under section 2057(b)(1)(C) because he
prejudiced the estate by not raising it until his opening brief.
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For the reasons discussed below, we disagree with the estate on
both points.
IV. The Stipulation of Facts Does Not Preclude Respondent From
Arguing That the Estate Will Fail To Meet the Requirements
of Section 2057(b)(1)(C) Even If the Two Corporations Are
Aggregated.
The estate claims that respondent’s argument is contrary to
the stipulation of facts entered into by the parties. In
particular, the estate cites paragraph 15 of the parties’
stipulation of facts, which states:
15. The value of the combined interest in Keeton
Corrections, Inc. and Non-Secure Programs Inc. exceeds
50% of the decedent’s adjusted gross estate.
The estate claims that respondent’s argument is an “attempt to
mislead this Court.” We disagree. The estate may not rely on
the above stipulation. The stipulation as worded does not
contradict what respondent is arguing. The stipulation says that
the combined value of the interests in Keeton Corrections and NSP
is greater than 50 percent of the adjusted gross estate.
However, that is not what the statute requires. In order to
obtain the deduction, section 2057(b)(1)(C) requires that the
combined adjusted values of the qualified family-owned business
interests exceed 50 percent of the adjusted gross estate. These
are not just semantics--section 2057 devotes two entire
subsections to defining and providing formulas for the terms
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“adjusted value” and “adjusted gross estate”.4
By stipulating that the “combined value” of Keeton
Corrections and NSP exceeds 50 percent of the adjusted gross
estate, the parties have left out a crucial part of the
calculation by not including the word “adjusted” in front of
value. The parties did not, however, omit the word “adjusted”
from “adjusted gross estate”. The estate is not alleging that
4
Sec. 2057(c) and (d) defines the “adjusted gross estate”
and the “adjusted value” of the QFOBIs. The adjusted value of
the QFOBIs enters into the numerator, and the adjusted gross
estate is the denominator for purposes of the 50-percent test
under sec. 2057(b)(1)(C). The adjusted value of the QFOBIs is
determined by aggregating the value of all qualified family-owned
business interests that are includable in the decedent’s gross
estate and are passed from the decedent to a qualified heir.
This amount is then reduced by the value of claims and mortgages
under sec. 2053(a)(3), and (4), less the following: (1)
Indebtedness on a qualified residence of the decedent (determined
in accordance with the requirements for deductibility of mortgage
interest set forth in sec. 163(h)(3)); (2) indebtedness incurred
to pay the educational or medical expenses of the decedent, the
decedent’s spouse, or the decedent’s dependents; and (3) other
indebtedness of up to $10,000. H. Conf. Rept. 105-220, at 397-
398 (1997), 1997-4 C.B. (Vol. 2) 1457, 1867-1868. The value of
the adjusted gross estate is equal to the decedent’s gross
estate, reduced by any claims against the estate and mortgages on
estate assets, and increased by the amount of the following
transfers, to the extent not already included in the decedent’s
gross estate: (1) Any lifetime transfers of qualified business
interests that were made by the decedent to members of the
decedent’s family provided such interests have been continuously
held by members of the decedent’s family (other than the
decedent’s spouse), plus (2) any other transfers from the
decedent to the decedent’s spouse that were made within 10 years
of the date of the decedent’s death, plus (3) any other gifts
made by the decedent within 3 years of the decedent’s death,
except nontaxable transfers made to members of the decedent’s
family covered by the annual per donee exclusion of sec. 2503(b).
Id.
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there was a mutual mistake made in the stipulation process. See,
e.g., Graham v. Commissioner, T.C. Memo. 2005-68. We cannot read
the stipulation the estate cites as saying that the adjusted
values of NSP and Keeton Corrections together exceed 50 percent
of the adjusted gross estate because that is simply not what the
stipulation says. Even on brief, the estate continued to argue
that it satisfied the 50-percent test because “the combined value
of Keeton Industries and NSF exceeds 50 percent of the adjusted
gross estate.” Both the estate’s reliance on the stipulation and
its articulation of the 50-percent test in its briefs reflect a
misreading of the statute. Therefore, respondent did not concede
anything in the stipulation that contradicts what respondent is
arguing now--that the adjusted value of the interests does not
exceed 50 percent of the adjusted gross estate. The stipulation
of settled issues reflects that the parties agreed that the
estate was entitled to deduct a total of $732,000 for claims
against the estate which were not reported on the return but were
allowed in the notice of deficiency. These amounts significantly
reduced the adjusted value of the corporations and caused the
adjusted value of the corporations to fall below 50 percent. See
sec. 2057(d)(1).
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V. Respondent Has Not Unfairly Prejudiced the Estate by Arguing
on Brief That the Adjusted Value of the Combined Interests
of the Corporations Does Not Exceed 50 Percent of the
Adjusted Gross Estate.
The estate argues that this Court should refuse to consider
respondent’s argument concerning the 50-percent test because
according to the estate, respondent raised it as a new issue in
his opening brief. In support of its position, the estate cites
cases where this Court has declined to consider arguments raised
for the first time by a party in its pretrial memorandum or brief
where our consideration of such argument would surprise or
prejudice the opposing party. Harrison v. Commissioner, T.C.
Memo. 1994-268 (citing Gordon v. Commissioner, 85 T.C. 309, 331
n.16 (1985); Fox Chevrolet, Inc. v. Commissioner, 76 T.C. 708,
733-736 (1981)).
The estate’s argument that it has been prejudiced revisits
the argument it made that respondent’s position contradicts the
stipulation of facts. The estate’s position is that it is
prejudiced because it agreed to forgo trial based upon the
premise that the only issue in dispute was whether the estate
could combine the values of the two corporations to pass the 50-
percent test. Based upon the estate’s reading of the stipulation
regarding the combined values of the corporations, the estate
assumed that whether the two corporations combined passed the 50-
percent test was no longer at issue. We have already concluded
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that the estate is misreading the stipulation. We cannot think
of any other reason why the estate would be prejudiced. The 50-
percent test under section 2057(b)(1)(C) is an arithmetical
calculation based on the definitions of adjusted value and
adjusted gross estate in section 2057(c) and (d). The values
used to compute the adjusted gross estate and the adjusted value
are no longer in dispute. Respondent has not caused the estate
to “face a belated confrontation which precludes or limits that
party’s opportunity to present pertinent evidence”. Ware v.
Commissioner, 92 T.C. 1267, 1268 (1989), affd. 906 F.2d 62 (2d
Cir. 1990). All of the evidence needed to apply the legal
standard is already in the record. Neither party has suggested
that the record contains insufficient facts to permit us to
dispose of the case on the grounds of respondent’s argument. See
Smalley v. Commissioner, 116 T.C. 450, 457 (2001). The estate is
not arguing that any information needed to determine the values
in section 2057(c) and (d) is missing or that respondent’s
calculations are incorrect.
Further, the estate has no reason to be surprised by
respondent’s argument. Respondent’s argument does not raise a
new issue but appeals to the correct application of the law,
based upon the record presented and in support of a claim of
which the estate was well aware. See Zapara v. Commissioner, 126
T.C. 215, 219 (2006). It is based on the correct application of
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section 2057(b)--the same section upon which the parties have
focused their dispute from the beginning of this controversy.
See Smalley v. Commissioner, supra at 457. At its core, the
notice of deficiency denied the estate the deduction because it
failed the 50-percent test under section 2057(b)(1)(C). The
parties have been arguing about whether the estate’s corporations
pass the 50-percent test from the outset. Respondent’s argument
does not raise any new issue that should have surprised the
estate in any way. We conclude that respondent’s argument
applying section 2057(b)(1)(C) does not prejudice or surprise the
estate.
VI. Conclusion
The estate has conceded respondent’s argument that the
estate cannot meet the requirements of section 2057(b)(1)(C) even
if the adjusted values of the two corporations are aggregated
and therefore does not qualify for the qualified family-owned
business deduction under section 2057. The actual stipulation
that the parties entered into did not establish that the estate
satisfied section 2057(b)(1)(C). Therefore, the stipulation
contradicts neither respondent’s argument nor the estate’s
concession of his argument. Finally, the fact that respondent
raised his argument for the first time on brief does not prevent
us from considering it because it simply applies the correct law
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to the facts based upon a legal dispute framed by the notice of
deficiency. Accordingly, the estate is not entitled to any
deduction under section 2057.
To reflect the foregoing, and concessions,
Decision will be entered
under Rule 155.