Estate of Duane B. Farnam, Mark D. Farnam, Personal Representative, and Estate of Lois L. Farnam, Mark D. Farnam, Personal Representative v. Commissioner

130 T.C. No. 2

UNITED STATES TAX COURT

ESTATE OF DUANE B. FARNAM, DECEASED, MARK D. FARNAM, PERSONAL
REPRESENTATIVE, AND ESTATE OF LOIS L. FARNAM, DECEASED, MARK D.
FARNAM, PERSONAL REPRESENTATIVE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 3575-06. Filed February 4, 2008.

Held: For purposes of the liquidity test of sec.
2057(b)(1)(C), I.R.C. (relating to estate tax
deductions under sec. 2057(a), I.R.C., for certain
qualified family-owned business interests), decedents’
loans to their family-owned corporation are not treated
as “interests” in the corporation.

Sue Ann Nelson and Robert J. Stuart, for petitioners.

Blaine Holiday, for respondent.
 - 2 -
OPINION

SWIFT, Judge: Respondent determined deficiencies of

$763,131 and $1,491,616 in the Federal estate tax of the estates

of decedents Duane B. Farnam (DBF Estate) and Lois L. Farnam (LLF

Estate), respectively.

The issue for decision is whether, for purposes of the

liquidity test of section 2057(b)(1)(C), decedents’ loans to

their family-owned corporation are to be treated as “interests”

in the corporation.

Unless otherwise indicated, all section references are to

the Internal Revenue Code (Code) as in effect for the dates of

decedents’ deaths, and all Rule references are to the Tax Court

Rules of Practice and Procedure.1

Background

The facts of this case have been submitted fully stipulated

under Rule 122 and are so found.

At the times of their deaths, decedents Duane B. Farnam and

Lois L. Farnam were residents of Otter Tail County, Minnesota.

At the time of filing the petition, decedents’ estates’ personal

representative resided in Fargo, North Dakota.

1
Although decedents died in different years--2001 and
2003--the relevant Code provisions for both years are in all
material respects the same.
 - 3 -
For many years, decedents owned and (with other members of

the Farnam family) managed Farnam Genuine Parts, Inc. (FGP), a

Minnesota corporation. Prior to its incorporation in 1981,

decedent Duane B. Farnam owned and operated the business as a

sole proprietorship.

Throughout its existence, FGP operated retail and wholesale

stores in Minnesota, North Dakota, and South Dakota that sold

automobile parts, retail and wholesale, to individuals, farms,

tire stores, automobile repair shops, gasoline service stations,

and construction and industrial companies.

Starting in 1981 and every year thereafter, members of the

Farnam family, including decedents, and entities owned by members

of the Farnam family lent funds to FGP. FGP used the borrowed

funds in its business operations. Over the years, to

substantiate and to document the loans, FGP issued promissory

notes (FGP notes) in favor of the Farnam family members and

related entities from whom the borrowed funds were received.

The FGP notes were unsecured and subordinate to claims of

FGP’s outside creditors. Initially, FGP paid principal but not

interest on the borrowed funds, but from 1984, in response to new

tax laws, FGP made annual payments of principal and interest on

the FGP notes. The parties stipulate that the FGP notes are to

be treated as legitimate and enforceable FGP debt obligations.
 - 4 -
In 1995, decedents formed the Duane B. Farnam Limited

Partnership (Duane LP) and the Lois L. Farnam Limited Partnership

(Lois LP). Decedents were each partners of Duane LP and Lois LP,

and decedents contributed to these two partnerships their

ownership interests in 10 buildings and in several of the FGP

notes. The primary business of each of the partnerships was to

own, maintain, and lease buildings to FGP for use as automobile

parts stores.

On formation, decedents Duane and Lois Farnam owned 99

percent and 1 percent, respectively, of Duane LP, contributing

property with values of $2,259,328 and $22,822, respectively, to

the capital of Duane LP.

On formation, decedents Duane and Lois Farnam owned 1

percent and 99 percent, respectively, of Lois LP, contributing

property with values of $30,622 and $3,031,528, respectively, to

the capital of Lois LP.

On September 6, 2001, decedent Duane Farnam passed away. On

June 23, 2003, decedent Lois Farnam passed away.

At the time of decedent Duane Farnam’s death in 2001,

decedents each individually owned 50 percent of the 1,000

outstanding shares of FGP voting common stock, and Mark Farnam,

decedents’ only son and personal representative, owned all of the

99,000 outstanding shares of FGP nonvoting common stock. In

addition, decedent Duane Farnam owned a 99-percent capital
 - 5 -
interest, and Mark Farnam owned a 1-percent capital interest in

Duane LP.

At the time of her death in 2003, decedent Lois Farnam and

Mark Farnam each owned 50 percent of the 1,000 outstanding shares

of FGP voting common stock, and Mark Farnam continued to own all

of the 99,000 outstanding shares of FGP nonvoting common stock.

In addition, decedent Lois Farnam owned a 92.72-percent capital

interest in Lois LP, and Mark Farnam and his wife and two

children owned the remaining 7.28-percent capital interest in

Lois LP.

On behalf of the DBF and LLF Estates, there were timely

filed Federal estate tax returns on which were claimed qualified

family-owned business interest (QFOBI) deductions under section

2057 of $625,000 and $675,000, respectively. On the Federal

estate tax returns, the common stock in FGP and the FGP notes

decedents owned at the times of their deaths (directly and

through their controlled partnerships) were included in the

respective decedents’ gross estates and in the calculation of the

QFOBI 50-percent liquidity test of section 2057(b)(1)(C). The

parties have stipulated the values of decedents’ stock interests

in FGP and the values of decedents’ FGP notes.

On or about November 29, 2005, respondent issued statutory

notices of deficiency determining the above Federal estate tax

deficiencies and disallowing the claimed QFOBI deductions.
 - 6 -
The parties have stipulated that if the FGP notes are to be

treated as QFOBIs, the adjusted values of the QFOBIs decedents

owned will constitute approximately 80 percent and 56 percent,

respectively, of the adjusted gross estates of decedents Duane B.

Farnam and Lois L. Farnam, the 50-percent liquidity test of

section 2057(b)(1)(C) therefore will be satisfied, and

petitioners will be entitled to the claimed $625,000 and $675,000

QFOBI deductions. If the FGP notes are not to be treated as

QFOBIs owned by decedents, the adjusted values of the QFOBIs will

constitute approximately 44 percent and 24 percent, respectively,

of decedents’ adjusted gross estates, the 50-percent liquidity

test of section 2057(b)(1)(C) therefore will not be satisfied,

and petitioners will not be entitled to the claimed $625,000 and

$675,000 QFOBI deductions.

Discussion

The issue before us presents a difficult question of

statutory interpretation. Petitioners and respondent each

scrutinize carefully the language of section 2057, the

legislative history, and the use of similar language elsewhere in

the Code.

The question of statutory interpretation at issue focuses

particularly on language from section 2057(e)(1)(B)-–namely, “an

interest in an entity” carrying on a trade or business.
 - 7 -
Petitioners contend that (as long as the family ownership

test of section 2057(e)(1)(B)(i) and (ii) is met), for purposes

of meeting the 50-percent liquidity test of section

2057(b)(1)(C), an “interest” in a family corporation or

partnership may include not only equity ownership interests but

also loan interests.

Respondent contends that, for purposes of meeting the 50-

percent liquidity test of section 2057(b)(1)(C), an “interest” in

a family corporation or partnership does not include a loan

interest in the family corporation.2

We begin our analysis with the language and structure of the

statute itself. Kaiser Aluminum & Chem. Corp. v. Bonjorno, 494

U.S. 827, 835 (1990); United States v. S.A., 129 F.3d 995, 998

(8th Cir. 1997); Allen v. Commissioner, 118 T.C. 1, 7 (2002).

In interpreting a statute, our purpose is to give effect to

Congress’s intent. Chevron U.S.A., Inc. v. Natural Res. Def.

Council, Inc., 467 U.S. 837, 842-843 (1984); Iowa 80 Group, Inc.

v. IRS, 406 F.3d 950, 952 (8th Cir. 2005); Fernandez v.

Commissioner, 114 T.C. 324, 329 (2000). If the language of a

statute is plain and unambiguous, the function of the Court is to

apply the statute according to its terms. See United States v.

Ron Pair Enters., Inc., 489 U.S. 235, 240-241 (1989). If the

2
Respondent’s position is also stated in Tech. Adv. Mem.
200410002 (Nov. 6, 2003).
 - 8 -
statute is ambiguous, as section 2057 clearly is, we look to the

statute’s legislative history and other authorities for

assistance in determining legislative intent. Burlington N. R.R.

v. Okla. Tax Commn., 481 U.S. 454, 461 (1987); Fernandez v.

Commissioner, supra at 329-330.

Section 2057(a) allows an estate tax deduction from the

value of a gross estate of up to $675,000 for the value of QFOBIs

a decedent owned at the time of death.3

Section 2057(a) provides in part as follows:

SEC. 2057. FAMILY-OWNED BUSINESS INTERESTS.

(a) General Rule.--

(1) Allowance of deduction.--For purposes of
the tax imposed by section 2001, in the case of an
estate of a decedent to which this section
applies, the value of the taxable estate shall be
determined by deducting from the value of the
gross estate the adjusted value of the qualified
family-owned business interests of the decedent
which are described in subsection (b)(2).

3
The qualified family-owned business interest (QFOBI)
allowance was first enacted in the Taxpayer Relief Act of 1997,
Pub. L. 105-34, sec. 502, 111 Stat. 847, as a tax exclusion under
sec. 2033A. In 1998, the QFOBI provision was moved to sec. 2057
and was converted from a tax exclusion to a tax deduction.
Internal Revenue Service Restructuring and Reform Act of 1998,
Pub. L. 105-206, sec. 6007(b), 112 Stat. 807. Notwithstanding
this conversion from an exclusion to a deduction, sec. 2057 is
substantially the same as former sec. 2033A. The Economic Growth
and Tax Relief Reconciliation Act of 2001, Pub. L. 107-16, sec.
521(d), 115 Stat. 72, repealed sec. 2057 for estates of decedents
dying after Dec. 31, 2003. In the absence of intervening estate
tax legislation, sec. 2057 is scheduled to be reinstated for
estates of decedents dying after Dec. 31, 2010. Id. sec. 901(a)
and (b), 115 Stat. 150.
 - 9 -
(2) Maximum deduction.--The deduction allowed
by this section shall not exceed $675,000.

Generally, under section 2057(b)(1)(C), for an estate to

qualify for a QFOBI deduction, the value of the QFOBIs owned by a

decedent at the time of death must exceed 50 percent of the total

value of the decedent’s adjusted gross estate--the so-called 50-

percent liquidity test. Section 2057(b)(1)(C) provides as

follows:

SEC. 2057. FAMILY-OWNED BUSINESS INTERESTS.

(b) Estates to Which Section Applies.--

(1) In general.--This section shall apply to
an estate if--

* * * * * * *

(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 * * *

Under section 2057(e)(1), definitional provisions are

provided, and it is expressly stated in subparagraph (A) that a

QFOBI with regard to a sole proprietorship means only an equity
 - 10 -
interest therein (i.e., only an interest “as a proprietor”).

Section 2057(e)(1)(A) provides as follows:

SEC. 2057. FAMILY-OWNED BUSINESS INTERESTS.

(e) Qualified Family-Owned Business Interest.--

(1) In general.--For purposes of this
section, the term “qualified family-owned business
interest” means --

(A) an interest as a proprietor in a
trade or business carried on as a
proprietorship, * * * [Emphasis added.]

Under section 2057(e)(1)(B) relating to family-owned

corporations and partnerships, no such express equity limitation

on the definition of an interest in a family-owned entity is

stated, and reference is made, in the flush language, only to “an

interest in” a family-owned entity. However, clauses (i) and

(ii) of section 2057(e)(1)(B) immediately go on to require

alternative 50-, 70-, and 90- percent family “ownership” in the

entity–-the so-called family ownership test.

Section 2057(e)(1)(B) provides as follows:

SEC. 2057. FAMILY-OWNED BUSINESS INTERESTS.

(e) Qualified Family-Owned Business Interest.--

(1) In general.--For purposes of this
section, the term “qualified family-owned business
interest” means--

* * * * * * *
 - 11 -
(B) an interest in an entity carrying on
a trade or business, if

(i) at least--

(I) 50 percent of such entity
is owned (directly or indirectly)
by the decedent and members of the
decedent’s family,

(II) 70 percent of such entity
is so owned by members of 2
families, or

(III) 90 percent of such
entity is so owned by members of 3
families, and

(ii) for purposes of subclause (II)
or (III) of clause (i), at least 30
percent of such entity is so owned by
the decedent and members of the
decedent’s family.

Section 2057(e)(3)(A) goes on to provide specific rules for

calculating the family-ownership test under section

2057(e)(1)(B)(i) and (ii), on the basis of the holding by family

members of “stock” or partnership “capital” interests in the

entity. Section 2057(e)(3)(A) provides in part as follows:

SEC. 2057. FAMILY-OWNED BUSINESS INTERESTS.

(e) Qualified Family-Owned Business Interest.--

* * * * * * *

(3) Rules regarding ownership.--

(A) Ownership of entities.–-For purposes
of paragraph (1)(B)--
 - 12 -
(i) Corporations.–-Ownership of a
corporation shall be determined by the
holding of stock * * *

(ii) Partnerships.–-Ownership of a
partnership shall be determined by the
owning of the appropriate percentage of
the capital interest in such
partnership.

If an estate claims and qualifies for a QFOBI deduction

under section 2057(a), but if, within 10 years after the

decedent’s death, a qualified heir of the decedent disposes of

any portion of a QFOBI, a recapture tax relating to the QFOBI

deduction the estate claimed on its Federal estate tax return is

triggered. Sec. 2057(f)(1)(B).

As noted, throughout section 2057 words expressly denoting

equity ownership are used. Immediately preceding section

2057(e)(1)(B) is the express limitation on a sole proprietor’s

interest that (for purposes of the liquidity test of section

2057(b)(1)(C)) will be taken into account to that of “a

proprietor”. See sec. 2057(e)(1)(A). In addition, in section

2057(e)(3)(A) and (B) express references to “equity” interests

are made by use of the words “stock”, “capital”, and “ownership

interest in”.

Petitioners argue that the absence in the language of

section 2057(e)(1)(B) of an express limitation on the word

“interest” (e.g., to a “capital” interest or to an “equity”

interest) that (for purposes of the liquidity test of section
 - 13 -
2057(b)(1)(C)) will be taken into account indicates that no such

limitation was intended and therefore that “loan” interests

should be taken into account. Petitioners cite the proposition

that “where a statute, with reference to one subject contains a

given provision, the omission of such provision from a similar

statute concerning a related subject is significant to show that

a different intention existed”. 2B Singer, Sutherland Statutory

Construction, sec. 51.02, at 199-201 (6th ed. 2000); see also

United States v. Lamere, 980 F.2d 506, 513 (8th Cir. 1992)

(“Where language is included in one section of a statute but

omitted in another section of the same statute, it is generally

presumed that the disparate inclusion and exclusion * * * [were]

done intentionally and purposely.”); Flahertys Arden Bowl, Inc.

v. Commissioner, 115 T.C. 269, 274 (2000), affd. 271 F.3d 763

(8th Cir. 2001) (per curiam).

Petitioners also note that section 2057 contains a number of

references to “any” interest in a qualified family-owned

business, suggesting to petitioners that the reference in section

2057(e)(1)(B) to “an” interest is not to be limited to just an

“equity” interest. See sec. 2057(e)(2)(A) (“any” interest in a

trade or business); id. subpar. (B) (“any” interest in an

entity); id. subpar. (C) (“any” interest in a trade or business).

We note that no regulations have been promulgated under

section 2057.
 - 14 -
The legislative history of section 2057 is not of particular

help in resolving the issue before us. Petitioners point to a

House-Senate conference committee report which contains a broad

reference to “any” interest in a family-owned business, as

follows:

a qualified family-owned business interest is defined
as any interest in a trade or business (regardless of
the form in which it is held) with a principal place of
business in the United states if ownership of the trade
or business is held at least 50 percent by one family
* * * [H. Conf. Rept. 105-220, at 396 (1997), 1997-4
C.B. (Vol. 2) 1457, 1866.]

Petitioners also argue that the general purposes of section

2057 stated in the legislative history support a broad reading of

an interest which may qualify as a QFOBI. Those purposes were:

(1) To reduce estate taxes for qualified family-owned businesses,

(2) to protect and preserve family farms and other family-owned

enterprises, and (3) to minimize the liquidation of such

enterprises in order to pay estate taxes. S. Rept. 105-33, at 40

(1997), 1997-4 C.B. (Vol. 2) 1067, 1120; see also Staff of Joint

Comm. on Taxation, General Explanation of Tax Legislation Enacted

in 1997, at 65 (J. Comm. Print 1997). Petitioners contend that

these legislative purposes would be frustrated if estates owning

family businesses funded with equity qualified for the QFOBI

deduction but estates owning similar family businesses funded in

part with shareholder loans did not.
 - 15 -
Respondent responds that estates holding loan interests

would not have the same difficulties paying estate taxes as would

estates holding only equity interests in family businesses

because loan interests can be sold to unrelated investors to

obtain cash without affecting the ownership structure of the

family-owned business.

The parties refer to section 6166, an estate tax provision

somewhat related to section 2057, and petitioners argue that the

language thereof illustrates how Congress could have limited

section 2057 had it intended to do so. Section 6166 provides for

a deferral of the payment of Federal estate taxes where the

decedent’s interest in a closely held business exceeds 35 percent

of the adjusted gross estate. For purposes of section

6166(b)(1), the statute expressly limits “interest in” a closely

held business to an equity or ownership interest by using the

terms “interest as a proprietor”, “interest as a partner”, and

“stock”. The relevant language of section 6166(b)(1) provides as

follows:

SEC. 6166. EXTENSION OF TIME FOR PAYMENT OF ESTATE TAX
WHERE ESTATE CONSISTS LARGELY OF INTEREST IN
CLOSELY HELD BUSINESS.

(b) Definitions and Special Rules.--

(1) Interests in closely held business.--For
purposes of this section, the term “interest in a
closely held business” means--
 - 16 -
(A) an interest as a proprietor in a
trade or business carried on as a
proprietorship;

(B) an interest as a partner in a
partnership carrying on a trade or business
* * *

* * * * * * *

(C) stock in a corporation carrying on a
trade or business * * *. [Emphasis added.]

Respondent acknowledges the relationship between section

6166 and section 2057, but respondent argues that the limitations

in section 6166 to equity ownership interests support

respondent’s position that section 2057(e)(1)(B) should be

construed in a parallel manner to limit the QFOBI to an equity

ownership interest.

Our holding herein is based largely on the close proximity

of the language “interest in an entity” in section 2057(e)(1)(B)

to the explicit equity ownership language of section

2057(e)(1)(B)(i) and (ii). We find it illogical to divorce the

equity ownership requirements of section 2057(e)(1)(B)(i) and

(ii) from the immediately preceding language. As we read the

statute, the “interest in an entity” language of section

2057(e)(1)(B) encompasses, or embraces, or is limited to, only

the type of interests (i.e., to equity ownership interests) that

is described in the rest of the very same sentence (i.e., in the

immediately following clauses of section 2057(e)(1)(B)).
 - 17 -
Also, as previously noted, language connoting equity

ownership is used pervasively in section 2057, and we conclude

that the section 2057(e)(1)(B) definition of an “interest in an

entity”, for purposes of the qualified family-owned business

interest deduction, is limited to equity ownership interests.

For the reasons stated, we conclude that the FGP loan

interests held by decedents (directly and indirectly through

their controlled partnerships) are not to be treated as QFOBIs

for purposes of section 2057 and thus that the QFOBI deductions

petitioners claimed are not allowable.

Other arguments made by the parties and not discussed herein

we have considered and rejected as without merit.

To reflect the foregoing,

Decision will be entered

under Rule 155.