Estate of Samuel P. Black, Jr., Samuel P. Black, III v. Commissioner

133 T.C. No. 15

UNITED STATES TAX COURT

ESTATE OF SAMUEL P. BLACK, JR., DECEASED, SAMUEL P. BLACK, III,
EXECUTOR, ET AL.,1 Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 23188-05, 23191-05, Filed December 14, 2009.
23516-06.

From 1927 until 1993, Mr. B was an employee,
officer, or director of E (an insurance company) and
was a major contributor to E’s success. In 1993, he,
his son, P, and trusts for P’s two sons contributed
their unencumbered E stock to BLP, a family limited
partnership, in exchange for partnership interests
proportionate to the fair market value of the E stock
each contributed. Mr. B’s advisers had explained the
estate tax advantages of placing his E stock in BLP,
but the transaction was initiated to implement Mr. B’s
buy-and-hold philosophy with respect to the family’s E
stock. Specifically, that transaction was a solution
to his concerns that (1) P’s wife and her parents (she
in connection with a possible divorce from P, they
because of their continual financial problems) would
require P to sell or pledge some of his E stock to

1
The following cases are consolidated herewith for trial,
briefing, and opinion: Estate of Irene M. Black, Deceased,
Samuel P. Black, III, Executor, docket Nos. 23191-05 and 23516-
06.
 - 2 -

satisfy their monetary needs (P previously had pledged
125,000 E shares as collateral for a loan), and (2) his
grandsons would sell all or some of the E stock that
they would receive upon the termination of their
trusts. In 1993, P and the two trusts owned
approximately $12 million (of the B family’s
approximately $80 million) worth of E stock.

Mr. B’s estate plan established a pecuniary
marital trust for Mrs. B and a $20 million bequest to a
university endowment. Mr. B died in December 2001, and
Mrs. B, 5 months later, before there was time to fund
the marital trust, which P, as executor of both
estates, had intended to fund with a portion of Mr. B’s
estate’s interest in BLP. On Mrs. B’s estate’s Federal
estate tax return, P deemed the marital trust to be
funded as of the date of her death.

Because Mrs. B’s estate lacked sufficient liquid
assets to discharge its tax and other liabilities, P,
BLP’s managing partner, and E agreed to have BLP sell
some of its E stock in a secondary offering. That sale
raised $98 million, of which E lent to Mrs. B’s estate
$71 million. The interest on the loan was payable in a
lump sum on the purported due date, more than 4 years
from the date of the loan, and was deducted in full on
Mrs. B’s estate’s tax return under sec. 20.2053-
1(b)(3), Estate Tax Regs. Mrs. B’s estate used the
funds to discharge its Federal and State tax
liabilities, pay the $20 million bequest to the
university endowment, reimburse E’s costs, totaling
$980,625, in connection with the secondary offering,
and pay $1,155,000 each to P, as executor fees, and to
a law firm, as legal fees.

R determined that (1) the value of the E stock
apportionable to Mr. B’s partnership interest in BLP at his
death is includable in his gross estate under either sec.
2035(a) or 2036(a)(1) or (2), I.R.C., (2) the marital
deduction to which Mr. B’s estate is entitled under sec.
2056, I.R.C., is limited to the value of the partnership
interest in BLP that actually passed to the marital trust,
(3) the deemed funding date of the marital trust and, hence,
the size of the BLP interest includable in Mrs. B’s estate
under sec. 2044, I.R.C., is determined by reference to the
value of BLP on the date of Mr. B’s death, not on the date
of Mrs. B’s death when the value of BLP was higher and it
would require a smaller interest in BLP to fund the trust,
(4) the interest payable on the BLP loan to Mrs. B’s estate
is not a deductible administration expense under sec.
2053(a)(2), I.R.C., and (5) Mrs. B’s estate is not entitled
to deduct the $980,625 reimbursement of E’s secondary
 - 3 -

offering costs and is entitled to deduct only $500,000 of
P’s executor fee and $500,000 of the legal fees.

1. Held: Because Mr. B’s transfer of E stock to BLP
in exchange for a partnership interest therein constituted
“a bona fide sale for an adequate and full consideration in
money or money’s worth” within the meaning of sec. 2036(a),
I.R.C., the value of Mr. B’s gross estate does not include
the value of the transferred E stock apportionable to his
date-of-death interest in BLP.

2. Held, further, holding No. 1 renders R’s
second determination moot.

3. Held, further, the deemed funding date of the
marital trust is the date of Mrs. B’s death.

4. Held, further, the loan from BLP to Mrs. B’s
estate was not “necessarily incurred” within the
meaning of sec. 20.2053-3(a), Estate Tax Regs., and,
therefore, the interest thereon is not a deductible
administration expense under sec. 2053(a)(2), I.R.C.

5. Held, further, Mrs. B’s estate is entitled to
deduct $481,000 of its reimbursement of E’s secondary
offering costs, $577,500 for P’s executor fee, and
$577,500 for legal fees because only those amounts
correspond to expenditures or effort on behalf of Mrs.
B’s estate.

John W. Porter, J. Graham Kenney, Stephanie Loomis-Price,

and Jason S. Zarin, for petitioner.

Gerald A. Thorpe and Andrew M. Stroot, for respondent.

HALPERN, Judge: Respondent has issued four notices of

deficiency (the notices) to Samuel P. Black III (petitioner).

Two were issued to him in his capacity as executor of the estate

of Samuel P. Black, Jr. (Mr. Black’s estate and Mr. Black,

respectively), and two were issued to him in his capacity as

executor of the estate of Irene M. Black (Mrs. Black’s estate and

Mrs. Black, respectively). Two notices were with respect to
 - 4 -

Federal gift tax (one with respect to Mr. Black and one with

respect to Mrs. Black), each determining a deficiency in tax of

$147,623 for 2001 for gifts by Mr. Black that were treated for

Federal gift tax purposes as made one-half by each spouse. The

other two notices were with respect to Federal estate tax, one

determining a deficiency in tax of $129,166,964 for Mr. Black’s

estate, and the other determining a deficiency in tax of

$82,224,024 for Mrs. Black’s estate. Petitioner is the son of

Mr. and Mrs. Black.

After concessions (all of which relate to valuation issues

and issues resolved by the settlement of the valuation issues)

the issues for decision are (1) whether the fair market value of

stock that Mr. Black contributed to the Black Interests Limited

Partnership (Black LP) is includable in his gross estate pursuant

to section 20362 (the section 2036 issue); (2) if we decide that

the fair market value of the stock Mr. Black contributed to Black

LP, rather than the fair market value of Mr. Black’s interest in

Black LP, is includable in his gross estate under section 2036,

whether the marital deduction to which Mr. Black’s estate is

entitled under section 2056 should be computed according to the

value of the partnership interest that actually passed to Mrs.

Black or according to the value of the underlying stock

apportionable to that interest (the marital deduction issue); (3)

2
Unless otherwise stated, all section references are to the
Internal Revenue Code as amended and in effect for the dates of
decedents’ deaths, and all Rule references are to the Tax Court
Rules of Practice and Procedure. We round all dollar amounts to
the nearest dollar.
 - 5 -

for purposes of determining the value of the marital trust

property includable in Mrs. Black’s gross estate under section

2044, whether the marital trust that Mr. Black established for

Mrs. Black’s benefit should be deemed funded on the date of his

death or on the date of her death (the date of funding issue);

(4) whether Mrs. Black’s estate may deduct, as an administrative

expense under section 2053(a)(2), $20,296,274 in interest on an

alleged loan from Black LP (the interest deductibility issue);

(5) whether Mrs. Black’s estate may deduct, as administrative

expenses under section 2053, the following fees or expense

reimbursements: (a) a $1,150,000 fee paid to petitioner for

services as the executor of Mrs. Black’s estate and trustee of

the marital trust, (b) a $1,150,000 fee paid to the law firm of

MacDonald, Illig, Jones & Britton LLP (MacDonald Illig), and (c)

$980,625 paid to Black LP as reimbursement for expenses incurred

in connection with a secondary offering of stock Black LP held

(together, the fee deductibility issues); (6) whether under

section 7491(a) respondent bears the burden of proof with respect

to all factual issues (the burden of proof issue). The notices

also contain certain other adjustments that are purely

computational. Their resolution depends on our resolution of the

issues in dispute.

FINDINGS OF FACT

Some facts are stipulated and are so found. The stipulation

of facts, with accompanying exhibits, is incorporated herein by

this reference.
 - 6 -

At the time the petitions were filed, petitioner resided in

Pennsylvania.

The Black Family

Mr. Black was born on April 2, 1902, and died, at the age of

99, on December 12, 2001. Mrs. Black was born on December 18,

1906, and died shortly after Mr. Black, on May 25, 2002. Mr. and

Mrs. Black were married in 1932 and remained married until Mr.

Black’s death. The Blacks were survived by their son

(petitioner) and grandsons (petitioner’s children), Samuel P.

Black IV (Samuel), and Christopher Black (Christopher), who were

33 and 31 years old, respectively, when Mrs. Black died.

Mr. Black’s History With Erie Indemnity Company

Mr. Black was born into poverty in Mercer County,

Pennsylvania. At age 11, he was selling bread on the street

corner and peddling newspapers door-to-door. At age 19, he began

work as an insurance adjuster at the Philadelphia Indemnity

Exchange, where he worked with H.O. Hirt and O.G. Crawford.

In 1925, H.O. Hirt and O.G. Crawford founded Erie Indemnity

Co. (Erie) and, in 1927, hired Mr. Black as Erie’s first full-

time claims manager. In 1925, Erie was a Pennsylvania automobile

insurance company; by the early 1990s, Erie had become a

multiline insurance company offering auto, home, commercial, and

life insurance in 11 States and the District of Columbia through

a network of independent insurance agents. Erie also managed the

Erie Insurance Exchange, a reciprocal insurer.
 - 7 -

Mr. Black was a large part of Erie’s success. Upon joining

Erie, Mr. Black installed an extension of the “home office”

telephone in his room at the YMCA across the street from Erie’s

office, making Erie one of the first insurance companies to offer

around-the-clock claims service. Mr. Black established Erie’s

underwriting department, where he drafted policies and

endorsements and filed documents to conform to State and Federal

laws. Mr. Black also recruited agents and managed sales

territories for Erie.

In 1930, Mr. Black became a member of the board of directors

of Erie. In 1962, when he was 60 years old, Mr. Black retired

from his position as senior vice president. After his retirement

from Erie, Mr. Black continued to serve on Erie’s board of

directors. In 1997, when he retired from the board of directors

(at the age of 95), Mr. Black had not missed a single board

meeting in 67 years. According to William F. Hirt, son of

founder H.O. Hirt, Mr. Black was “a major, major contributor to

the success of Erie.” In 1997, petitioner was elected to succeed

Mr. Black as a member of Erie’s board of directors.

Through the years, Mr. Black acquired in Erie both class B

voting stock and class A nonvoting stock. Mr. Black was very

bullish about the growth prospects for Erie stock, and he bought

it at every opportunity. By the 1960s, Mr. Black had become the

second largest Erie shareholder. Mr. Black was a conservative

investor who subscribed to the “buy and hold” investment

philosophy, particularly with regard to Erie stock.
 - 8 -

Upon his retirement from Erie, Mr. Black received permission

from Erie to form his own insurance agency, Samuel P. Black &

Associates, Inc., which became one of Erie’s independent

insurance agents. Although by 1992 petitioner had taken over

management of Samuel P. Black & Associates, Inc., Mr. Black was

actively involved in its operation until shortly before his death

in 2001.

Mr. Black’s Gifts of Erie Stock

On October 6, 1988, Mr. Black, as settlor, and petitioner,

as trustee, created two trusts, one for each of Mr. Black’s

grandsons, Samuel and Christopher (together, the grandson

trusts). Each grandson trust was funded with 10 shares of Erie

class A nonvoting stock.

In October 1988, December 1989, and December 1990, Mr. Black

gave 600 shares, 1,120 shares, and 804 shares, respectively, of

Erie class A nonvoting stock to petitioner. Also, in December

1989, December 1990, December 1992, and January 1993, Mr. Black

gave a total of 2,829 shares of Erie class A nonvoting stock,

through petitioner, to each of the grandson trusts.

Before 1988, Mr. Black had made other gifts of both Erie

class A nonvoting stock and Erie class B voting stock to

petitioner. Before 1993, petitioner had acquired Erie stock only

by gift from Mr. Black or through stock splits.

As of October 11, 1993, Mr. Black owned 2,425,752 shares of

Erie class A nonvoting stock and 400 shares of Erie class B

voting stock.
 - 9 -

Formation of Black Interests Limited Partnership

Between 1988 and 1993, when Mr. Black transferred Erie stock

to petitioner and created trusts that held Erie stock for his

grandsons, the stock split several times and substantially

increased in value. Mr. Black became concerned that his

grandsons (each of whom would be able to withdraw the trust

principal, one-half at age 25 and the balance at age 30, at which

point the grandson trusts would terminate) and petitioner would

either need to or want to sell some or all of their Erie stock.

His concern increased as the value of that stock increased.

Mr. Black’s fear that petitioner might dispose of some or

all of his Erie stock arose out of his concern (1) that

petitioner might default on a personal loan from PNC Bank for

which he had previously pledged 125,000 Erie shares as

collateral, and that he might need to satisfy his obligation with

that pledged stock, (2) over the status of petitioner’s marriage

to Karen Black, to whom he had been married since 1965, which Mr.

Black thought would not last much longer and which, if it ended

in divorce (as it did in 2004), might result in the transfer of

some of petitioner’s Erie stock to her,3 and (3) about Karen

Black’s father’s business and personal bankruptcies, which

resulted in her parents’ continuing need to obtain money from her

and petitioner, a need that could conceivably require the sale of

some of petitioner’s Erie stock.

3
Karen Black did, in fact, receive the 125,000 pledged Erie
shares in the divorce, by which time that stock had been released
from its pledge to PNC Bank.
 - 10 -

Mr. Black’s fear that his grandsons might dispose of some or

all of the Erie stock that they would receive upon termination of

their trusts arose out of his concern (1) that, as of 1993,

although both Samuel and Christopher were over 20 years old,

neither held a job or was even looking for one, (2) that, in Mr.

Black’s view, both grandsons were too close to their mother, whom

Mr. Black considered to be lazy, and (3) that they were both

inexperienced financially and, therefore, might fall prey to

people anxious to have them invest their money.

Mr. Black was also concerned about a brewing split between

the two children of H.O. Hirt, William F. Hirt (Mr. Hirt) and

Susan Hirt Hagen (Ms. Hagen), each of whom was a trustee of one

of two trusts (created by H.O. Hirt) that, as of October 12,

1993, controlled 76.2 percent of Erie’s voting stock. The two

trusts shared a common institutional cotrustee. Under the terms

of the trusts, the voting stock both trusts held was to be voted

as a unit as directed by a majority of the three trustees.

In 1990, Ms. Hagen’s husband, Thomas B. Hagen (Mr. Hagen),

became Erie’s chief executive officer. By 1993, however, an

inappropriate relationship between Mr. Hagen and another senior

officer was disrupting business decisions and causing valuable

employees to resign. Ultimately, at a board meeting in September

1993, a majority of Erie’s directors voted to terminate Mr.

Hagen’s employment. Mr. Black disapproved of Mr. Hagen’s conduct

and of his management of Erie, and he approved of Mr. Hagen’s

dismissal. He foresaw the possibility that the growing
 - 11 -

antagonism between Mr. Hirt and Ms. Hagen might result in a split

of the H.O. Hirt trusts and that the Black family stock, which,

by 1993, represented 13 to 14 percent of the total voting and

nonvoting Erie stock, might represent the swing vote in favor of

the Hirt camp against the Hagen camp. That was another reason he

wanted to consolidate and retain the family’s Erie stock.

Mr. Black’s gifts of Erie stock to petitioner and to the

trusts for his grandsons were in some measure influenced by two

of his regular advisers: James D. Cullen (Mr. Cullen) of

MacDonald Illig, Mr. Black’s business and estate planning lawyer;

and Robert L. Wagner (Mr. Wagner), a certified public accountant

with Ernst & Young (E&Y), Mr. Black’s tax and financial adviser.

Beginning in 1988, Messrs. Cullen and Wagner regularly met with

Mr. Black and advised him to take advantage of his lifetime gift

tax exclusion by making gifts of Erie stock to family members

which, as described supra, he did. By the early 1990s, however,

Mr. Black was expressing to those two advisers his concerns over

the potential disposal of Erie stock by his grandsons and

petitioner. During a meeting with Messrs. Cullen and Wagner, the

latter offered to consult with one of his partners, Andy Painter

(Mr. Painter). In August 1992, Mr. Painter gave Mr. Wagner a

memorandum suggesting--and later himself met with Mr. Black to

suggest--a number of alternative, essentially tax planning,

vehicles for Mr. Black to consider, including a family limited

partnership, grantor retained interest trusts, and, to satisfy

Mr. Black’s desires with respect to charitable giving, an income
 - 12 -

or remainder charitable trust, or private foundation. Mr.

Painter’s memorandum refers to an article written by Stacy

Eastland (Mr. Eastland), at that time an attorney with the law

firm of Baker & Botts LLP, who specialized in estate planning.

Mr. Cullen spoke with Mr. Black about the article, which outlines

a number of nontax reasons for forming a family limited

partnership, including keeping family assets in the family,

reducing costs by consolidating family assets, protecting family

assets from future creditors, and protecting family assets from

divorce proceedings.

Ultimately, Mr. Black’s advisers recommended the formation

of a family limited partnership to satisfy his goals of (1)

consolidating and protecting the family’s Erie stock and (2)

minimizing the estate taxes that would be payable upon his death

and Mrs. Black’s death. Mr. Black followed their recommendation.

To that end, in October 1992 he retained Mr. Eastland to draft a

family limited partnership agreement.

On March 2, 1993, Mr. Eastland sent to Mr. Black a draft

partnership agreement for the creation of Black LP, and, on

October 12, 1993, Black LP was created as a Texas limited

partnership pursuant to the “Agreement and Articles of

Partnership of Black Interests Limited Partnership” (the

partnership agreement) executed on that date by the partners, Mr.

Black and petitioner, the latter both in his individual capacity

and as trustee of the grandson trusts. On October 12, 1993, a
 - 13 -

certificate of limited partnership for Black LP was filed with

the Texas secretary of state.

At the time of the formation of Black LP, Mr. Black, at age

91, was in good health. He was not suffering from any life-

threatening illness, and he maintained an active lifestyle. He

participated in the daily operations of Samuel P. Black &

Associates, Inc., was an active member of the Erie board of

directors, maintained a lively social schedule, remained an avid

golfer, and traveled to Florida several times a year.

Upon the formation of Black LP, Mr. Black contributed to it

all his Erie class A nonvoting stock (2,425,752 shares) and 390

of his 400 shares of Erie class B voting stock in exchange for

all the class A limited partnership interests, an 83.985-percent

class B limited partnership interest, and a 1-percent class B

general partnership interest; petitioner contributed to Black LP

444,446 shares of Erie class A nonvoting stock in exchange for a

0.5-percent class B general partnership interest and a 13.317-

percent class B limited partnership interest. In his capacity as

trustee of the grandson trusts, petitioner contributed 19,276

shares of Erie class A nonvoting stock on behalf of each trust in

exchange for two 0.599-percent class B limited partnership

interests. The only Black family Erie stock held out of Black LP

were the 125,000 shares that petitioner had pledged to PNC Bank

and 20 class B voting shares, of which Mr. Black and petitioner

each held 10 shares.
 - 14 -

Upon the formation of Black LP, each partner therein (Mr.

Black, petitioner, and the two trusts) received an interest in

the partnership proportionate to the fair market value of the

assets contributed.

Section 2.06 of the partnership agreement sets forth the

purposes of Black LP as follows:

Section 2.06. Purposes. The purposes of the
Partnership are the following:

(a) To consolidate the management of certain
properties owned directly and indirectly by the family
of Samuel P. Black, Jr.; to promote efficient and
economical management of the properties by holding them
in a single entity; to avoid the division of certain of
the properties of the family of Samuel P. Black, Jr. in
order to promote the greater sales potential of the
properties; to avoid potential expensive litigation and
disputes over certain of the properties of the family
of Samuel P. Black, Jr. by providing mechanisms which
will provide for management and procedures in Article
VIII and Section 11.01 to resolve disputes; to provide
mechanisms which will eliminate the potential in the
future of any member of the family transferring his or
her interest in the Partnership without first offering
that interest to the other family members;

(b) To engage generally in the insurance business,
to acquire, own, hold, develop and operate insurance
enterprises, either as operator, managing agent,
principal, agent, partner, stockholder, syndicate
member, associate, joint venturer, participant or
otherwise; to invest funds in, and to raise funds to be
invested in such business; to purchase, construct or
otherwise acquire and own, develop, operate, lease,
mortgage, pledge and to sell or otherwise dispose of
insurance enterprises, and other properties and any
interest therein; or to do any and all things necessary
or incident thereto;

(c) To acquire, invest, hold, own, develop,
operate mortgage, pledge, sell or otherwise dispose of
the stock of Erie Indemnity Company; to do any and all
things necessary or incident thereto;

(d) To manage and control investments in other
partnerships, businesses and entities, whether debt,
 - 15 -

equity, or otherwise; to hold, buy, sell, lease,
pledge, mortgage, and otherwise deal in or dispose of
those investments or similar interests;

(e) To invest in stocks, bonds, securities, and
other similar interests, including, without limitation,
purchasing, selling, and dealing in stocks, bonds,
notes, and evidences of indebtedness of any person,
firm, enterprise, corporation or association, domestic
or foreign and bonds and any other obligations of any
government, state or municipality, school district or
any political subdivision thereof, domestic or foreign,
and bills of exchange and commercial paper, and any and
all other securities of any kind, nature, or
description whatsoever, to invest in gold, silver,
grain, cotton and other commodities and provisions
usually dealt in or on exchanges, or upon the over-the-
counter-market; to form, organize, capitalize and
invest in, alone or jointly with others, and to sell or
otherwise dispose of the same to others, and to form
corporations, partnerships, joint ventures, limited
liability companies and other business entities, and in
general, without limitation of the foregoing, to
conduct such activities as are usual and customary in
connection with, stocks, bonds and securities and other
investments in corporations, partnerships, joint
ventures, limited liability companies and other
business entities;

(f) To transact or engage in any other business
that may be conducted in partnership form * * *

Management of Black LP was vested in the managing partner.

Mr. Black was the managing partner from formation until October

16, 1998, when he ceded to petitioner his 1-percent general

partnership interest and his responsibilities as a managing

partner.

The partnership agreement generally prohibits a general or

limited partner or the partner’s spouse (including a divorced

spouse) from transferring an interest in the partnership to

persons or entities unrelated to any of the partners without “the

written consent of the Partnership and all other Partners”. The
 - 16 -

partnership agreement grants to the partnership or the partners a

right of first refusal to purchase any partnership interest with

respect to any lifetime disposition, including involuntary

dispositions and dispositions incident to the divorce of a

partner, and any testamentary disposition upon the death of a

partner or the spouse of a partner.

The partnership agreement requires that the net cashflow of

the partnership (defined as the yearend excess of cash over

reasonable reserves for working capital and other cash

requirements) be distributed, at least annually, to each class B

and general partner, pro rata. It provides that, in any event,

there be distributed to the partners sufficient amounts to enable

the partners to discharge their income tax liabilities

attributable to their interests in the partnership. Except for

those distributions and distributions in liquidation, the

partnership agreement permits no distributions to partners until

termination and liquidation of the partnership. The partnership

agreement also generally provides for the pro rata allocation of

profits and losses to the class B general and limited partners.

The partnership agreement provides that, when Mr. Black is

not serving as managing partner, the managing partner is

prohibited, unless he obtains the prior written consent of a

majority of the limited partnership interests, from (1) making

any single investment or series of related investments during a

calendar year requiring a total capital commitment greater than

the lesser of 5 percent of the book value of the partnership
 - 17 -

assets or $2,500,000, (2) acquiring debt of any kind that would

result in the partnership’s having outstanding aggregate debt

equal to or greater than 10 percent of the book value of the

partnership assets, (3) agreeing or consenting to the sale,

lease, transfer, or other disposition (whether in one transaction

or a series of related transactions) of any partnership asset or

assets the value of which is equal to or greater than 5 percent

of the book value of the partnership assets, (4) disposing of all

or any portion of any partnership asset to a permitted assignee

(as the partnership agreement defines that term) where the value

of the asset, or the portion proposed to be disposed of, has a

book value in excess of $100,000.

The partnership agreement provides that no general or

limited partner shall have the right to withdraw from the

partnership before it dissolves and liquidates.

Lastly, the partnership agreement provides that it “may be

modified, terminated or waived only by a writing signed by the

party to be charged with such modification, termination or

waiver.”

Activities of the Partnership

According to Mr. Black’s wishes, Black LP retained all its

Erie stock from formation (in 1993) until after Mr. Black died

(in 2001). Indeed, upon becoming Black LP’s sole managing

partner in 1998, petitioner followed Mr. Black’s wishes despite

misgivings over Black LP’s continued retention of Erie stock.

Those misgivings arose out of his concern regarding the ongoing
 - 18 -

feud between the Hirts and the Hagens and the adverse effect that

feud might have on the company and the price of its stock.4

Nonetheless, between 1993 and 2001, the net asset value of Black

LP, consisting mostly of Erie stock, rose from approximately $80

million to more than $318 million.

During 1995 and 1996, Black LP purchased for $830,000

commercial condominium units in Erie, Pennsylvania, which it

leased in part to Samuel P. Black & Associates, Inc., and in part

to an independent insurance agency of which petitioner owned 65

percent and was president and treasurer. One or more of those

condominium units was later leased to Erie after Samuel P. Black

& Associates, Inc., moved out. In 1996, Black LP spent more than

$37,000 making leasehold improvements to those units. In 2001,

before Mr. Black’s death, Black LP paid $89,900 for another

commercial property in Erie, Pennsylvania, which, in 2002, it

leased to Samuel P. Black & Associates, Inc.

In February, April, and October 2000, Black LP paid $924,000

to purchase 4,400 shares (approximately 80 percent of the

outstanding stock) of Samuel P. Black & Associates, Inc.

Black LP’s cumulative income, from 1994 through 2001,

consisted of $27,835,476 attributable to Erie dividends and

$100,561 attributable to other income, consisting almost entirely

4
Because of his concerns regarding the management of Erie,
petitioner ultimately caused Black LP to sell the remaining two-
thirds of its Erie stock in 2005 and 2006, at which time Erie
stock was publicly traded. The partnership had sold the first
roughly one-third of the stock in a secondary offering after Mrs.
Black’s death in 2002. See infra.
 - 19 -

of property rentals, and it made total distributions to partners

of $25,659,526, over $20 million (or approximately 80 percent) of

which was distributed to Mr. Black. That is, during that time,

Black LP distributed an amount equal to approximately 92 percent

of the Erie dividends it received.

Mr. Black’s Assignments of Partnership Interests

On October 16, 1998, Mr. Black assigned his 1-percent

general partnership interest in Black LP to petitioner.

Between 1993 and 2001, Mr. Black also made numerous gifts of

his class A and class B limited partnership interests in Black LP

to the Erie Community Foundation (which received his entire class

A limited partnership interest), petitioner, the grandson trusts,

his grandchildren individually (after their trusts terminated),

and five separate charitable trusts Mr. Black created.

Cumulatively, Mr. Black’s gifts of class B limited partnership

interests to family members (including the grandson trusts) and

private charities constituted 6.8974 percent of the total class B

limited partnership interest and reduced his initial 83.985-

percent class B limited partnership interest to a 77.0876-percent

interest.

On October 4, 1995, Mr. Black, as both settlor and trustee,

established the Samuel P. Black, Jr. Revocable Trust (the

original trust), whose terms he amended on March 20, 1998 (the

amended trust) (together, the revocable trust), and to which, on

August 27, 2001, he transferred his 77.0876-percent class B

limited partnership interest in Black LP. The transfer was made
 - 20 -

specifically subject to the partnership agreement “with respect

to the class B Limited Partnership Interest assigned hereby, and

the restrictions on transferability therein contained.”

The Revocable Trust

The original trust document provided for the payment of the

net income from the trust principal to Mr. Black (or for his

benefit) for his life, and for the distribution of the trust

estate, upon Mr. Black’s death, as he “shall appoint and direct *

* * in his last will and testament”, or, failing to so “appoint

and direct” (which, in fact, was the case), in the manner set

forth in the original trust. The original trust document also

provided for the creation of a marital trust for Mrs. Black as

follows:

If the Settlor’s wife, IRENE M. BLACK, survives
the Settlor, the Trustee shall hold IN TRUST, as the
Marital Trust under Section C below, a legacy equal to
the smallest amount, if any, needed to reduce the
federal estate tax liability of the Settlor’s estate to
zero or to the lowest possible figure. In calculating
this amount, the Trustee shall first take into account
the amount of all other property, which, for federal
estate tax purposes, is includable in the Settlor’s
gross estate and which passes or has passed in any
manner (other than by the terms of this paragraph) to
the Settlor’s wife in a form which qualifies for the
marital deduction. The Trustee shall also take into
account all other deductions and all credits against
the federal estate tax finally allowed to the Settlor’s
estate for federal estate tax purposes.

In making the computation necessary to determine
such amount the final determination in the federal
estate tax proceeding of the Settlor’s estate shall
control. This amount shall be satisfied only out of
assets that qualify for the marital deduction under the
provisions of the Internal Revenue Code applicable at
the time of the Settlor’s death or out of the proceeds
of such assets. Assets distributed in kind in
satisfaction of this amount shall be distributed at
 - 21 -

their market value on the date or dates of
distribution.

The residual trust property, not held in the marital trust or

otherwise distributed, was to go to petitioner, as was the after-

tax principal of the marital trust upon Mrs. Black’s death.

The amended trust document did not include the language in

the original trust providing for the disposition of marital trust

property to petitioner and instead substituted the following two

provisions:

If the Settlor’s wife, IRENE M. BLACK, survives
the Settlor, then the Trustee shall distribute to the
Settlor’s son, SAMUEL P. BLACK III, the sum of Twenty
Million Dollars ($20,000,000). Any part or portion of
this gift which the Settlor’s son, SAMUEL P. BLACK III,
disclaims shall be added to the “Samuel and Irene Black
Endowment” established by the Settlor with The
Pennsylvania State University for the purpose of
enhancing Penn State Erie, The Behrend College.

During his lifetime, the Settlor established an
endowment known as the “Samuel and Irene Black
Endowment” with the Pennsylvania State University for
the purpose of enhancing Penn State Erie, The Behrend
College. Following the death of the Settlor’s wife,
Irene M. Black, the Trustee shall distribute from the
principal of the Marital Trust that amount, if any,
which is needed to bring the funding level of the
Endowment to Twenty Million dollars ($20,000,000). In
determining the amount to be paid to the Endowment from
the Marital Trust, the Trustee shall subtract all
contributions made after 1995 by or on behalf of the
Settlor during his lifetime, the Settlor’s son, Samuel
P. Black III, and from the Settlor’s estate following
his death, including contributions from The Black
Family Foundation and contributions from The Samuel P.
Black Fund at the Erie Community Foundation. The
remaining principal of the Marital Trust shall be
distributed to the Settlor’s son, SAMUEL P. BLACK III,
if living, otherwise in accordance with Section D of
this Article I.
 - 22 -

The effect of those two provisions was to provide a maximum

bequest of $20 million to Penn State Erie, The Behrend College

(Penn State Erie).5

Mr. and Mrs. Black’s Nonpartnership Assets and Income
In 1993, at the time of the formation of Black LP, Mr. and

Mrs. Black owned assets, other than Mr. Black’s Erie stock, worth

more than $4 million. Beginning in 1994 (the first full taxable

year for Black LP) and for all years through 2001 (the year of

Mr. Black’s death), the Blacks received cumulative income from

sources other than Black LP of approximately $5,610,000, ranging

from a low of approximately $303,000 (in 1994) to a high of

approximately $2,228,000 (in 2001).6 Thus, both before and after

the formation of Black LP, the Blacks received annual income from

sources other than the Erie stock Mr. Black transferred to Black

LP that was more than sufficient to cover their personal living

expenses.

5
Both at the creation of the $20 million bequest to Penn
State Erie in 1998 and when it was time to fund that bequest
after Mr. Black’s death in 2001, Penn State Erie expressed a
preference for cash, to which Mr. Black acquiesced. As a result
of petitioner’s disclaimer of the $20 million bequest to him,
pursuant to the terms of the amended trust, Penn State Erie
received a $20 million cash bequest.
6
During that same period, the Blacks received cumulative
income of approximately $22,544,000 from Black LP, which
represented approximately 80 percent of their total income for
the period.
 - 23 -

Administration of the Estates

Implementation of the Wills and the Revocable Trust

Both Mr. and Mrs. Black appointed petitioner executor of

their respective estates. In that capacity, he filed a Form 706,

United States Estate (and Generation-Skipping Transfer) Tax

Return, on behalf of each estate (Mr. Black’s Federal estate tax

return and Mrs. Black’s Federal estate tax return, respectively).

Mr. Black’s Federal estate tax return was filed on September 12,

2002, and Mrs. Black’s, on August 25, 2003.

Pursuant to Mr. Black’s will, his residuary estate

(everything other than his tangible personal property) was to be

distributed according to the terms of the revocable trust. Mrs.

Black bequeathed her residuary estate to petitioner. The

foregoing provisions resulted in petitioner’s receipt of (1) all

Mr. Black’s residuary estate not held in the marital trust and

(2) the principal of the marital trust that remained after

payment of the amount Mrs. Black’s estate owed because of “any

increase in taxes payable by her estate because of the inclusion

in her gross estate of all or any portion of * * * [the] Marital

Trust.” Petitioner did, however, disclaim the $20 million

specific bequest to him in the revocable trust. As a result,

that bequest, by its terms, went to Penn State Erie and rendered

inoperative the alternative method of providing $20 million to

Penn State Erie through the marital trust.

The short period between Mr. Black’s death, on December 12,

2001, and Mrs. Black’s death, on May 25, 2002, did not provide
 - 24 -

sufficient time to compute Mr. Black’s pecuniary bequest to the

marital trust provided for under the terms of the revocable

trust, and the marital trust was not funded as of the date of

Mrs. Black’s death. Moreover, because, pursuant to the terms of

the revocable trust, the marital trust terminated upon Mrs.

Black’s death, it was never funded. In his capacity as the

executor of Mrs. Black’s estate, petitioner deemed the marital

trust to be funded on the date of her death. In that same

capacity, petitioner also made an election on Mr. Black’s estate

tax return, under section 2056(b)(7), to treat the property

funding the marital trust as qualified terminable interest

property.7 He filed a statement with Mr. Black’s estate tax

return explaining that he, as (successor) trustee of the

revocable trust, intended to fund the marital trust with a

portion of the 77.0876-percent class B limited partnership

interest in Black LP that Mr. Black had assigned to the revocable

trust during his lifetime.

7
Sec. 2056(a) permits a deduction from the decedent’s gross
estate for “an amount equal to the value of any interest in
property which passes * * * from the decedent to his surviving
spouse”. Pursuant to sec. 2056(b)(1), however, a marital
deduction is not ordinarily available for property passing to a
surviving spouse where the interest of the surviving spouse may
terminate or fail, e.g., as in this case, upon the surviving
spouse’s death. Sec. 2056(b)(7), however, allows a marital
deduction for qualified terminable interest property (QTIP),
which is defined, in sec. 2056(b)(7)(B)(i), as property passing
from a decedent in which the spouse has a qualified income
interest for life, and to which a QTIP election applies.
Respondent does not dispute that petitioner made a timely QTIP
election.
 - 25 -

The parties have stipulated (and we so find) that (1) the

fair market value of a 77.0876-percent class B limited

partnership interest in Black LP was $165,476,495 on December 12,

2001 (the date of Mr. Black’s death), and (2) the fair market

value of a 1-percent class B limited partnership interest in

Black LP was $2,469,728 on May 25, 2002 (the date of Mrs. Black’s

death), and $2,281,124 on November 25, 2002 (the alternate

valuation date elected by Mrs. Black’s estate).

The Secondary Offering

Mr. Black’s estate reported a Federal estate tax liability

of approximately $1.7 million, which, on or about September 12,

2002, it paid with its cash assets. Mrs. Black’s estate lacked

sufficient liquid assets to pay what were anticipated to be

substantial Federal and State tax liabilities attributable to the

Black LP class B limited partnership interest that was to

constitute the principal of the marital trust.

In an attempt to borrow money to pay both tax liabilities

and administration expenses on behalf of Mrs. Black’s estate,

petitioner, as executor of the estate, first approached

commercial lending institutions, including PNC Bank, National

City Bank, Wachovia Bank, Credit Suisse, First Boston, Goldman

Sachs, and several local banks. None of those institutions would

accept the pledge of a partnership interest in Black LP as

security for a loan. Instead, each wanted Black LP to pledge its

Erie stock as security. In addition, they required “collaring”,

an agreement that the Erie shares would be sold if their value
 - 26 -

fell below a certain price. Petitioner found those terms

unacceptable. He was particularly concerned that the Erie shares

would drop in price because of the discord among Erie’s board of

directors and that the “collaring” requirement might result in

the forced sale of the thinly traded Erie shares, which would

further depress their price.

Petitioner next turned to Erie for a loan, but Erie was not

interested in lending money to either the trust or the estate.

On July 29, 2002, Mr. Cullen sent a letter to Erie’s president

and chief executive officer describing Mrs. Black’s estate’s need

for cash and suggesting as one “liquidity solution” Erie’s

participation in a secondary offering of some of Black LP’s Erie

stock. Erie felt that a secondary offering would enhance Erie

shareholder value, and it agreed with Messrs. Cullen and Black to

participate in a secondary offering of about one-third of Black

LP’s Erie stock.

On January 29, 2003, Black LP sold 3 million shares of Erie

class A nonvoting stock in a secondary offering at $34.50 per

share.8 As a condition of Erie’s participation in the secondary

offering, Black LP agreed to pay Erie’s expenses incurred in

connection therewith, which included an underwriting discount of

$1.81 per share resulting in net proceeds to Black LP, before

8
At the time, Black LP owned 8,726,250 shares of Erie class
A common stock so that the 3 million shares sold in the secondary
offering represented slightly more than one-third of Black LP’s
Erie stock.
 - 27 -

other expenses, of $32.69 per share, for a total of approximately

$98 million.

The Transfer of Funds From Black LP to Mrs. Black’s Estate
and The Revocable Trust

On October 11, 2002, in preparation for the secondary

offering and on behalf of Mrs. Black’s estate and the revocable

trust, petitioner entered into a “Loan Commitment Agreement” with

Black LP (the loan agreement) whereby Black LP (as “Lender”),

upon receipt of the proceeds from the secondary offering, agreed

to lend $71 million to Mrs. Black’s estate and the revocable

trust (as “Borrowers”) “with all interest and principal due in

full not earlier than November 30, 2007.” The borrowers agreed

to “reimburse the Lender” for all expenses it incurred in

connection with the secondary offering.

On February 25, 2003, Black LP transferred $71 million to

Mrs. Black’s estate and the revocable trust in exchange for a

promissory note for that amount executed by petitioner on behalf

of both. The note provided for 6 percent simple interest with

all principal and interest “due and payable not earlier than

November 30, 2007.”9 The note provided that the borrowers “shall

have no right to prepay principal or interest at any time.” The

note further provided for a “late charge” equal to 5 percent of

9
At trial, the parties stipulated that the accumulated
interest would, in fact, be paid on Nov. 30, 2007 (which was the
next day), but Mr. Cullen testified that the $71 million
principal amount would be refinanced, perhaps by means of
installment payments, because Mrs. Black’s estate did not have
sufficient liquidity to repay it.
 - 28 -

any payment “not received by the Lender within TEN (10) days

after the due date” (referred to as an “overdue payment”).

Also, on February 25, 2003, the parties to the loan

agreement executed a “Pledge Agreement” and an “Assignment of

Partnership Interest” whereby, as security for the $71 million

loan, Mrs. Black’s estate and the revocable trust pledged and

assigned their class B limited partnership interest in Black LP

to the lender, Black LP.

The interest due on November 30, 2007, was computed to be

$20,296,274 and was deducted, in full, on Schedule J, Funeral

Expenses and Expenses Incurred in Administering Property Subject

to Claims, of Mrs. Black’s estate tax return.

Mrs. Black’s Estate’s Use of the Funds Received From Black LP

Mrs. Black’s estate dispersed the $71 million it received

from Black LP (and an additional $309,946) as follows:

U.S. Treasury--Federal
estate tax payment $54,000,000

U.S. Treasury--Federal
estate tax refund (22,263,473) $31,736,527

Pennsylvania Department
of Revenue--inheritance
& estate taxes 15,700,000

Erie Insurance Co.
reimburse costs 982,070

Petitioner--executor fees 1,155,000

MacDonald Illig--legal fees 1,155,000

Gift to Penn State Erie 20,000,000

U.S. Treasury--fiduciary
income taxes 515,973
 - 29 -

Pennsylvania Department of
Revenue--fiduciary
income taxes 65,376
Total 71,309,946

The $982,070 payment was to reimburse Black LP for its

reimbursement of Erie for Erie’s expenses in conjunction with the

secondary offering, including legal fees, the cost of filings

with the Securities and Exchange Commission, and some of the

costs incurred for meetings with investment firms. Mrs. Black’s

estate deducted that expenditure, in addition to the $1,155,000

payment to MacDonald Illig for legal services and the $1,155,000

paid to petitioner as executor and/or trustee fees, as

administration expenses.10

OPINION

I. The Burden of Proof Issue

If a taxpayer introduces credible evidence with respect to

any factual issue relevant to ascertaining the taxpayer’s tax

liability and the taxpayer complies with all substantiation

requirements, maintains all required records, and cooperates with

the Commissioner’s reasonable requests for witnesses, section

7491 places the burden of proof on the Commissioner with respect

to that issue. Sec. 7491(a)(1) and (2); Rule 142(a)(2).

Petitioner alleges that he has satisfied all the prerequisites to

the application of section 7491 and that, therefore, “Respondent

bears the burden of proof under § 7491(a) with regard to each of

the factual issues in this case”. Respondent alleges that

10
Mr. Black’s estate did not claim any deduction for
administration expenses.
 - 30 -

petitioner has “not introduced credible evidence with respect to

the material factual issues in this case as required by §

7491(a).”

We need not decide whether section 7491(a) applies to the

material factual issues in these consolidated cases because we

find that a preponderance of the evidence supports our resolution

of each of those issues. Therefore, resolution of those issues

does not depend on which party bears the burden of proof. See,

e.g., Estate of Bongard v. Commissioner, 124 T.C. 95, 111 (2005).

II. The Section 2036 Issue

A. General Principles

Section 2001(a) imposes a tax “on the transfer of the

taxable estate of every decedent who is a citizen or resident of

the United States.” Section 2051 defines the taxable estate as

“the value of the gross estate” less applicable deductions.

Section 2031(a) specifies that the gross estate comprises “all

property, real or personal, tangible or intangible, wherever

situated”, to the extent provided in sections 2033 through 2046.

Section 2033 broadly provides: “The value of the gross

estate shall include the value of all property to the extent of

the interest therein of the decedent at the time of his death.”

Sections 2034 through 2046 then explicitly mandate the inclusion

of several more narrowly defined classes of assets. Among those

specific sections is section 2036, which provides, in pertinent

part, as follows:
 - 31 -

SEC. 2036. TRANSFERS WITH RETAINED LIFE ESTATE.

(a) 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 or for any period not
ascertainable without reference to his death or for any
period which does not in fact end before his death--

(1) the possession or enjoyment of, or the
right to the income from, the property, or

(2) the right, either alone or in conjunction
with any person, to designate the persons who
shall possess or enjoy the property or the income
therefrom.

Section 20.2036-1(c)(1)(i), Estate Tax Regs., further

explains: “An interest or right is treated as having been

retained or reserved if at the time of the transfer there was an

understanding, express or implied, that the interest or right

would later be conferred.”11

“The general purpose of * * * [section 2036] is ‘to include

in a decedent’s gross estate transfers that are essentially

testamentary’ in nature.” Ray v. United States, 762 F.2d 1361,

1362 (9th Cir. 1985) (quoting United States v. Estate of Grace,

395 U.S. 316, 320 (1969)). Accordingly, courts have emphasized

that the statute “describes a broad scheme of inclusion in the

gross estate, not limited by the form of the transaction, but

11
During the audit years, the identical language was
contained in sec. 20.2036-1(a), Estate Tax Regs. The language
was moved to sec. 20.2036-1(c)(1)(i), Estate Tax Regs., by T.D.
9414, 2008-35 I.R.B. 454, 458, and that provision is applicable
to estates of decedents dying after Aug. 16, 1954. See sec.
20.2036-1(c)(3), Estate Tax Regs.
 - 32 -

concerned with all inter vivos transfers where outright

disposition of the property is delayed until the transferor’s

death.” Guynn v. United States, 437 F.2d 1148, 1150 (4th Cir.

1971).

Section 20.2036-1(a), Estate Tax Regs., refers to the

section 20.2043-1, Estate Tax Regs., definition of “a bona fide

sale for an adequate and full consideration in money or money’s

worth” (the parenthetical exception). In pertinent part, section

20.2043-1(a), Estate Tax Regs., provides: “To constitute a bona

fide sale for an adequate and full consideration in money or

money’s worth, the transfer must have been made in good faith,

and the price must have been an adequate and full equivalent

reducible to a money value.”

We must decide whether the Erie stock that Mr. Black

contributed to Black LP, rather than his partnership interest

therein, is includable in his gross estate under section 2036(a)

because (1) his transfer of that stock to Black LP did not

constitute a bona fide sale for an adequate and full

consideration and (2) he retained an interest in the transferred

stock within the meaning of section 2036(a)(1) or (2). We begin

by considering whether Mr. Black’s transfer of Erie stock to

Black LP was a bona fide sale for adequate and full

consideration. We find that it was.
 - 33 -

B. Mr. Black’s Transfer of Erie Stock to Black LP as a Bona
Fide Sale for Adequate and Full Consideration

1. Introduction

To avail himself of the parenthetical exception, petitioner

must show that the transfer was both (1) a bona fide sale and

(2) for adequate and full consideration. We consider each

requirement in turn.

2. Mr. Black’s Transfer of Erie Stock to Black LP as a
Bona Fide Sale of That Stock

a. General Principles

The Court of Appeals for the Third Circuit, to which an

appeal of these cases would lie, barring stipulation to the

contrary, see sec. 7482(b), has stated that, whereas a “bona fide

sale” does not necessarily require an “arm’s length transaction”,

the sale (which we understand to include an exchange) still must

be “made in good faith”, Estate of Thompson v. Commissioner, 382

F.3d 367, 383 (3d Cir. 2004) (citing section 20.2043-1(a), Estate

Tax Regs.), affg. T.C. Memo. 2002-246 (2002). The Court of

Appeals further stated that “A ‘good faith’ transfer to a family

limited partnership must provide the transferor some potential

for benefit other than the potential estate tax advantages that

might result from holding assets in the partnership form.” Id.
The Court of Appeals was “mindful of the mischief that may arise

in the family estate planning context” but concluded that “such

mischief can be adequately monitored by heightened scrutiny of

intra-family transfers, and does not require a uniform
 - 34 -

prohibition on transfers to family limited partnerships.” Id. at

382.

The requirement that the transfer be in good faith--that is,

provide the transferor some potential for benefit other than

estate tax savings--is consistent with this Court’s requirement,

“[i]n the context of family limited partnerships”, that the

transferor have “a legitimate and significant nontax reason for

creating the family limited partnership”. See Estate of Bongard

v. Commissioner, 124 T.C. at 118. We further required that “The

objective evidence must indicate that the nontax reason was a

significant factor that motivated the partnership’s creation * *

*. A significant purpose must be an actual motivation, not a

theoretical justification.” Id. A finding that the transferor

sought to save estate taxes does not preclude a finding of a bona

fide sale so long as saving estate taxes is not the predominant

motive. Accord Estate of Mirowski v. Commissioner, T.C. Memo.

2008-74; see Estate of Schutt v. Commissioner, T.C. Memo. 2005-

126 (“Thus, the proffered evidence is insufficient to establish

that estate tax savings were decedent’s predominant reason for

forming Schutt I and II and to contradict the estate’s contention

that a true and significant motive for decedent’s creation of the

entities was to perpetuate his buy and hold investment

philosophy.”).

b. Arguments of the Parties
Petitioner argues that the “undisputed facts” show that the

formation of Black LP was motivated by “‘significant and
 - 35 -

legitimate’ non-tax reasons.” He notes that Mr. Black’s primary

reasons for wanting to form Black LP were to provide centralized

long-term management and protection of the Black family’s

holdings in Erie stock, to preserve Mr. Black’s buy-and-hold

investment philosophy with respect to that stock, to pool the

family’s stock so that it could be voted as a block (thereby

giving the family the swing vote in the not unlikely event of a

split between the two H.O. Hirt trust shareholders), and to

protect the Erie stock from creditors and divorce. Petitioner

further argues that Black LP accomplished those goals as follows:

! Adherence to Mr. Black’s buy-and-hold investment

philosophy resulted in the growth of Black LP’s net

asset value from $80 million when the partnership

was formed in 1993 to over $315 million when Mr.

Black died in 2001;

! the partnership prevented petitioner from selling

or encumbering the $11 million of Erie stock he

contributed to the partnership;

! the Erie stock the grandson trusts contributed to

the partnership was not available for distribution

to Mr. Black’s grandsons when their trusts

terminated in 1995 and 2000;

! the Black family’s consolidated position allowed it

to maintain a seat on the Erie board of directors

through 2004, when, because he had lost confidence
 - 36 -

in Erie, petitioner resigned from the board and

decided to sell all the partnership’s Erie stock;

! the partnership protected petitioner’s Erie stock

from equitable division in his divorce and reduced

the value of the marital estate that his wife was

entitled to receive.

Petitioner relies on the similarity of the facts here to the

facts in Estate of Schutt v. Commissioner, supra, in which we

found that the use of a family partnership to perpetuate the

decedent’s buy-and-hold investment strategy with respect to

publicly traded Dupont and Exxon stock, in the “unique

circumstances” of that case, constituted “a legitimate and

significant non-tax purpose” for the formation of the

partnership. Petitioner also cites other opinions for the

proposition that consolidating family assets and providing for

long-term centralized management of those assets are valid nontax

purposes for forming a family limited partnership. E.g., Kimbell

v. United States, 371 F.3d 257 (5th Cir. 2004); Estate of

Mirowski v. Commissioner, supra; Estate of Stone v. Commissioner,

T.C. Memo. 2003-309; Estate of Harrison v. Commissioner, T.C.
Memo. 1987-8. Morever, petitioner argues that all the nontax

reasons for forming Black LP were based on Mr. Black’s actual, as

opposed to theoretical, concerns.

Respondent rejects petitioner’s arguments. Respondent

acknowledges that Mr. Black subscribed to a buy-and-hold

investment philosophy, particularly with respect to Erie stock,
 - 37 -

and that Black LP was formed to hold the Erie stock that he,

petitioner, and the grandson trusts previously held so that the

family would continue to control that stock. Respondent

disagrees, however, that the transfers of Erie stock to Black LP

were necessary to achieve that goal or that Mr. Black’s alleged

concerns over the potential disposition of Erie stock by

petitioner and the grandson trusts were significant factors in

his decision to form Black LP. In reaching those conclusions,

respondent purports to distinguish the caselaw on which

petitioner relies.12

12
With respect to the bona fide sale issue, the parties take
opposing views on the similarity of these cases to Estate of
Schutt v. Commissioner, T.C. Memo. 2005-126. Whether we reach
the same result here that we reached in Estate of Schutt will
depend on our answers to two questions: (1) Whether Mr. Black’s
buy-and-hold philosophy with respect to the family’s Erie stock
was a legitimate and significant nontax purpose for the formation
of, and contribution of Erie stock to, Black LP, and (2) if so,
whether, to ensure the implementation of that philosophy and the
anticipated nontax benefits attendant thereupon, Mr. Black and
petitioner (individually and as trustee of the grandson trusts)
needed to transfer their Erie stock to Black LP.

Certain of respondent’s arguments in support of his position
that Mr. Black did not make a bona fide sale of Erie stock to
Black LP, e.g., that Black LP did not have a functioning business
operation, that Black LP held only passive assets, and that
petitioner was not substantially involved in the formation of
Black LP, allege the absence of factors that were also absent in
Estate of Schutt, and, for that reason, are not persuasive in
distinguishing that case. Other of respondent’s arguments, e.g.,
that Mr. Black allegedly failed to retain sufficient assets
either to pay the estate and inheritance taxes that would be
incurred by his and Mrs. Black’s estates or to fund the $20
million endowment that he had established for Penn State
University, relate to the issue of whether Mr. Black retained an
interest in the Erie stock at the time of his death for purposes
of sec. 2036(a)(1). Therefore, they are inapposite to the bona
fide sale question.
 - 38 -

In the recent case of Estate of Jorgensen v. Commissioner,

T.C. Memo. 2009-66, we rejected the taxpayer’s argument that the

decedent’s “investment philosophy premised on buying and holding

individual stocks with an eye toward long-term growth and capital

preservation” was “a legitimate or significant nontax reason for

transferring the bulk of one’s assets to a partnership.” In

reaching that decision, we distinguished Estate of Schutt v.

Commissioner, T.C. Memo. 2005-126, on the ground that in that

case “[t]he decedent’s wife was the daughter of Eugene E. duPont,

and the decedent hoped to maintain ownership of the stock

traditionally held by the family including stock held by certain

trusts created for the benefit of his children and grandchildren

in the event those trusts terminated.” Estate of Jorgensen v.

Commissioner, supra n.10.

In Estate of Schutt we acknowledged that the Court of

Appeals for the Third Circuit, in Estate of Thompson v.

Commissioner, 382 F.3d at 380, “suggested that the mere holding

of an untraded portfolio of marketable securities weighs

negatively in the assessment of potential nontax benefits

available as a result of a transfer to a family entity.” We

stated that we agreed with that premise, “particularly in cases

where the securities are contributed almost exclusively by one

person”, citing Estate of Strangi v. Commissioner, T.C. Memo.
2003-145, and Estate of Harper v. Commissioner, T.C. Memo. 2002-

121. Nonetheless, we determined that the entities in question
 - 39 -

had been formed for a legitimate and significant nontax purpose,

reasoning as follows:

In the unique circumstances of this case, however, a
key difference exists in that decedent’s primary
concern was in perpetuating his philosophy vis-a-vis
the stock of the * * * [trusts for his children and
grandchildren] in the event of a termination of one of
those trusts. Here, by contributing stock in the
Revocable Trust, decedent was able to achieve that aim
with respect to securities of the * * * trusts even
exceeding the value of his own contributions. In this
unusual scenario, we cannot blindly apply the same
analysis appropriate in cases implicating nothing more
than traditional investment management considerations.

To summarize, the record reflects that decedent’s
desire to prevent sale of core holdings in the * * *
trusts in the event of a distribution to beneficiaries
was real, was a significant factor in motivating the
creation of * * * [the entities at issue], was
appreciably advanced by formation of * * * [those
entities], and was unrelated to tax ramifications.
* * *

Respondent attempts to distinguish these cases from Estate

of Schutt v. Commissioner, supra, by arguing that, unlike the

decedent’s concerns in that case regarding the potential

dissipation of the family’s DuPont and Exxon stock, Mr. Black’s

concerns regarding the potential dissipation of the Erie stock

held by petitioner and the grandson trusts were either ill

founded (in the case of petitioner’s stock) or insignificant (in

the case of the grandson trusts’ stock).

c. Analysis
(1) Introduction

Between 1927, when Erie hired him to be its first claims

manager, and 1997, when petitioner succeeded him as a member of

the board of directors (a period covering almost his entire adult
 - 40 -

life), Mr. Black was an employee, officer, and/or director of

Erie. His ties to Erie and his belief in its financial prospects

were easily the equal of the decedent’s ties to and belief in

DuPont and Exxon in Estate of Schutt v. Commissioner, supra.

Respondent does not disagree that Mr. Black desired to

perpetuate the family’s Erie stock holdings and, given Mr.

Black’s longstanding relationship with Erie and his strong belief

in its favorable earnings prospects, that that was a legitimate

and significant desire on Mr. Black’s part. Respondent does

disagree, however, that that desire was either a significant or

legitimate motivation for the formation of Black LP.

Petitioner argues that Mr. Black formed Black LP as the best

means of implementing his buy-and-hold philosophy to protect his

family’s Erie stock. Protecting his family’s Erie stock was Mr.

Black’s principal nontax motivation, and that motivation arose

out of his concerns regarding the potential dissipation of (1)

petitioner’s unpledged Erie stock and (2) the grandson trusts’

Erie stock. Together, those two blocks of Erie stock were the

only Black-owned Erie stock that Mr. Black did not himself

control. We will address the legitimacy and significance of each

of those concerns.

(2) Petitioner’s Erie Stock

Respondent argues that there was no evidence in 1993, when

Black LP was formed, that petitioner intended to sell any of his

Erie stock. He further argues that, although Mr. Black may have

been unhappy with petitioner’s decision to pledge some of his
 - 41 -

Erie stock as collateral for a loan, the record does not support

a finding that Mr. Black “lacked confidence in petitioner’s

ability to manage the family’s assets.” Respondent concludes

that, had Mr. Black harbored any significant concerns about

petitioner’s commitment to perpetuate his buy-and-hold investment

philosophy regarding the continued retention of the family’s Erie

stock, he would not have transferred his managing partner

interest to petitioner in 1998 or arranged for petitioner to

succeed to his and the marital trust’s limited partnership

interests when both he and Mrs. Black had died. Respondent’s

arguments overlook petitioner’s main point, which is that,

although Mr. Black may have been satisfied that petitioner shared

his goal of retaining the family’s existing investment in Erie

stock, he feared that petitioner’s relationship with his wife and

in-laws might require him, against his better judgment or, even,

against his will, to dispose of or, alternatively, to pledge as

collateral for a new loan additional Erie stock. In particular,

Mr. Black worried that petitioner’s marriage would end in a

contentious divorce and about his father-in-law’s present and

continuing need for financial support.

Petitioner’s position is supported by the undisputed

testimony of Mr. Cullen, Mr. Black’s business and estate planning

lawyer. Respondent argues that any doubts Mr. Black may have had

concerning the status of petitioner’s marriage were speculative

or theoretical and not based on fact. As respondent states, at

the time of the formation of Black LP in 1993, petitioner had
 - 42 -

been married for 28 years, and Mr. Black did not learn of

petitioner’s marriage difficulties and impending divorce until

1998. As respondent suggests, Mr. Black’s concerns were likely

based on his negative opinion of both Karen Black and her

parents. Respondent does not suggest, however, that the facts on

which that negative opinion was based were not true. And

respondent does not cast significant doubt on Mr. Cullen’s

testimony that Mr. Black did, in fact, harbor concerns that

petitioner might be pressured into selling or pledging additional

Erie stock to raise money for Karen Black or her parents.

Moreover, respondent argues that petitioner shared his father’s

buy-and-hold philosophy with respect to the family’s Erie stock.

Yet that suggests that the previous borrowing secured by 125,000

Erie shares was at the request of Karen Black and her parents,

which lends credence to Mr. Black’s concerns. We also note that

Mr. Black’s fears that petitioner’s marriage would not last

proved to be prophetic as divorce proceedings began 7 years later

and concluded with a divorce 4 years after that.

Respondent also argues that, even if Mr. Black was, in fact,

concerned about protecting petitioner’s Erie stock in the event

of divorce, putting the stock in Black LP did not enhance the

protections already available under State law, citing 23 Pa.

Cons. Stat. sec. 3501(a)(3) (1990). Pursuant to that provision,

“[p]roperty acquired by gift, except between spouses, bequest,

devise or descent” does not constitute “marital property” subject

to equitable division between divorcing spouses except to the
 - 43 -

extent of the increase in the value of such property “prior to

the date of final separation”. Respondent argues that that

provision afforded the same protection against Karen Black’s

potential acquisition of the Erie stock that Mr. Black

transferred by gift to petitioner (which includes all

petitioner’s Erie stock) as did the transfer of that stock to

Black LP. Respondent makes the same argument with respect to the

Erie stock that petitioner stood to inherit upon Mrs. Black’s

death.

Respondent’s argument overlooks the fact that, even though

petitioner’s Erie stock was nonmarital property exempt (except to

the extent of some marital period appreciation) from equitable

division under Pennsylvania law, that stock might nonetheless

constitute the only significant asset available, as a practical

matter, to fund whatever award might have been made to Karen

Black under a divorce decree or marital settlement agreement.

That point was acknowledged by respondent’s counsel during his

cross-examination of Mr. Cullen:

Q (by respondent’s counsel): Okay. I guess what
I’m saying is does it matter? If the Erie stock is
inherited, it’s not marital property. The spouse can’t
reach it. If it’s partnership units that are
inherited, that’s also nonmarital property, so maybe
we’re talking about the same thing, the advantage
supposedly of the partnership interest is a valuation
question of discounted appreciation, if you will,
versus the full value of the appreciation?

A: But I’m afraid that your question might assume
that once you calculate the marital estate, and you
look at the Erie stock, that she only gets the
appreciation. One of the things that could be awarded
to her as part of her number is the Erie stock. Do you
follow me?
 - 44 -

Q: I don’t because if it’s nonmarital property,
how can it be awarded to her?

THE COURT: She’s due a sum of money,
and they can fund it with anything they
choose?

MR. THORPE: Yes.

THE WITNESS: Yes, sir.

MR. THORPE: That’s my point, too.

THE WITNESS: But the partnership
prevented it from being funded with Erie
stock.

The point is also illustrated by the 2005 Marital Settlement

Agreement between petitioner and Karen Black, pursuant to which

she was awarded the 125,000 Erie shares that, previously, had

been pledged as security for a loan. Conversely, Karen Black did

not receive any portion of petitioner’s interest in Black LP,

which lends credence to Mr. Black’s belief that the transfer of

petitioner’s unpledged Erie stock to a family partnership would

help to protect it from Karen Black’s property claims incident to

any divorce. Therefore, we conclude that Mr. Black reasonably

believed that the transfer of Erie stock to Black LP would

protect it from the claims of potential creditors, including

Karen Black. See Kimbell v. United States, 371 F.3d 257, 268

(5th Cir. 2004); Keller v. United States, __ F. Supp. 2d __, 104

AFTR 2d 2009-615, 2009-2 USTC par. 60,579 (S.D. Tex. 2009).

(3) The Grandson Trusts’ Erie Stock

Respondent argues that the potential dissipation of the Erie

stock that Mr. Black transferred to the grandson trusts between

October 1988 and January 1993 could not have been a significant
 - 45 -

factor in Mr. Black’s decision to form Black LP because (1) those

transfers began less than 4 years before the decision to form

Black LP and continued to occur even after that decision,

suggesting Mr. Black’s lack of concern that his grandsons might

dispose of the stock upon vesting, and (2) the Erie stock in

those trusts represented an “insignificant portion”

(approximately 1.2 percent) of the family’s holdings.

The fact that Mr. Black transferred Erie stock to the

grandson trusts shortly before and even after the decision to

form Black LP is not necessarily inconsistent with the undisputed

testimony of Mr. Cullen and petitioner that Mr. Black was

concerned that his grandsons would dispose of or borrow against

the security of their Erie stock upon the termination of the

trusts. In October 1988, when Mr. Black began funding the trusts

with Erie stock, that stock was worth a fraction of its worth in

1992 and 1993, when Mr. Black made the decision to form Black LP.

Also, at that time his grandsons were both less than 20 years

old. Those facts suggest that the earlier transfers, between

October 1988 and December 1990, did not concern Mr. Black because

the value of the Erie stock transferred to the grandson trusts

was relatively low, the number of Erie shares was small, and his

grandsons had not reached an age at which their lack of ambition

was important. Two years later, when the Erie stock had

appreciated substantially and his grandsons’ lack of ambition and

financial responsibility persisted, Mr. Black transferred the

trusts’ Erie stock to a family partnership to keep it from his
 - 46 -

grandsons. That decision seems reasonable. Moreover, Mr.

Black’s additional transfers to the grandson trusts in December

1992 and January 1993 were not inconsistent with his concerns

regarding his grandsons because, we presume, he and petitioner

had already decided to transfer the corpus of each of those

trusts to the soon-to-be-formed family partnership.

In Estate of Schutt v. Commissioner, T.C. Memo. 2005-126, we

found that the decedent’s desire to prevent his grandchildren

from selling DuPont and Exxon stock was a legitimate and

significant nontax purpose for the creation of the entities at

issue in that case. Respondent argues that Estate of Schutt is

distinguishable in that the children’s trusts in that case

controlled DuPont and Exxon stock worth approximately $50 million

(which exceeded the value of DuPont and Exxon stock that Mr.

Schutt himself contributed to the entities at issue), an amount

representing “a substantial portion of the Schutt family’s

wealth.” Respondent notes that, in contrast, “the stock held by

Mr. Black’s grandsons’ trusts was, at the time of the

Partnership’s formation, relatively insignificant both in terms

of its value ($963,800) and as a percentage (approximately 1%) of

the Black family wealth.” Respondent further notes that, in

Estate of Schutt, there was a history of stock sales by
grandchildren that is absent in these cases, which is to say, Mr.

Black’s concerns, unlike Mr. Schutt’s, were purely speculative.

We do not agree that Mr. Black’s concerns regarding his

grandsons were speculative or, in the language of this Court in
 - 47 -

Estate of Bongard v. Commissioner, 124 T.C. at 118, a

“theoretical justification” rather than an “actual motivation”.

We find that Mr. Black’s concerns regarding his grandsons’

potential dissipation of all or some the Erie stock they would

receive upon the partial and full termination of their trusts was

reasonable given their unwillingness to seek employment and their

financial inexperience, and that those concerns motivated Mr.

Black to transfer the Erie stock in those trusts to Black LP.

We agree that the Erie class A nonvoting stock in the

grandson trusts, by itself, was, as respondent argues,

“relatively insignificant” as a percentage of the value of the

family’s Erie stock. But to focus on that stock in isolation is

improper. Mr. Black was concerned about the potential

dissipation of both that stock and petitioner’s stock, which,

together, represented more than 16.6 percent of the family’s Erie

class A nonvoting stock and, in 1993, had a value of more than

$12 million. Although the value of that Erie stock is not nearly

as great as the value of the grandchildren trust stock in Estate

of Schutt v. Commissioner, supra, it is nonetheless substantial,

and we find that Mr. Black’s concern regarding the potential

dissipation of all or some of that stock was significant as well

as legitimate.

Therefore, we agree with petitioner that these cases, like

Estate of Schutt, present a set of unique circumstances that, on
balance, require a finding that Black LP was formed for a
 - 48 -

legitimate and significant nontax purpose; i.e., to perpetuate

the holding of Erie stock by the Black family.13

d. Conclusion
Mr. Black’s transfer of Erie stock to Black LP constituted a

bona fide sale of that stock.

3. Mr. Black’s Sale of Erie Stock to Black LP as a
Sale for Adequate and Full Consideration in Money
or Money’s Worth

a. Analysis

In Estate of Bongard v. Commissioner, 124 T.C. at 118, we

held that the second prong of the two-part test for finding a

bona fide sale for adequate and full consideration is met if “the

transferors received partnership interests proportionate to the

value of the property transferred.” The parties have stipulated

(and we have found) that each partner in Black LP “received an

interest in the Partnership proportionate to the fair market

value of the assets contributed.” Relying on that stipulation,

petitioner concludes: “Thus, the ‘adequate and full

consideration’ prong has been satisfied.”

After noting petitioner’s suggestion that “the test for the

‘bona fide sale exception’ adopted by this Court in * * * [Estate
of Bongard v. Commissioner, 124 T.C. 95 (2005),] is the same as

13
Assuming Mr. Black's desire to perpetuate the holding of
Erie stock by the Black family constituted a legitimate and
significant nontax purpose for the formation of Black LP,
respondent does not argue, in the alternative, that Mr. Black's
transfer of less than all of his Erie stock in exchange for a
controlling general partnership interest in Black LP would have
sufficed to accomplish that purpose. Therefore, we do not
address that alternative argument.
 - 49 -

the test set forth by the Third Circuit in Estate of Thompson v.

Commissioner, 382 F.3d 367 (3d Cir. 2004)”, respondent states:

“Petitioners misapprehend the Estate of Bongard test.”

Respondent then argues that, under Estate of Bongard, “in the

absence of a tax-independent purpose, the receipt of

proportionate partnership interests does not constitute the

receipt of any consideration, but is, rather, a mere recycling of

value.” Respondent then quotes Estate of Thompson v.

Commissioner, 382 F.3d at 381:

Where, as here, the transferee partnership does not
operate a legitimate business, and the record
demonstrates the valuation discount provides the sole
benefit for converting liquid, marketable assets into
illiquid partnership interests, there is no transfer
for consideration within the meaning of § 2036(a).

Respondent concludes as follows:

Each of these courts is saying essentially the
same thing, that the receipt of a proportionate
interest in an entity that is imbued with a tax-
independent purpose does not deplete the gross estate.
Stated another way, receipt of a proportionate interest
is necessary, but not sufficient, to constitute
adequate consideration. In the absence of a tax-
independent purpose, the interest constitutes no
consideration. Indeed, that is exactly what the
Bongard court found with regard to the partnership
interests received in exchange for the LLC interests.
124 T.C. at 129.

Here, * * * the record establishes that the
Partnership did not operate a legitimate business and
that the sole purpose for converting Mr. Black’s liquid
interest in his Erie stock into an illiquid interest in
the Partnership was to obtain valuation discounts for
gift and estate tax purposes. Consequently,
petitioners have not established that the transfer
satisfies the “adequate and full consideration” prong
of the “bona fide sale exception.”
 - 50 -

Thus, respondent argues that the adequate and full

consideration prong depends on the legitimate and significant

nontax purpose prong. Of perhaps greater significance to these

cases, which, as noted supra, if appealed, are likely to be

appealed to the Court of Appeals for the Third Circuit, is

respondent’s argument that his analysis reflects the position of

both that court, as set forth in Estate of Thompson v.

Commissioner, supra, and this Court, as set forth in Estate of

Bongard v. Commissioner, supra.

We have determined that Mr. Black had a legitimate and

significant nontax purpose for his transfer of Erie stock to

Black LP. Because respondent stipulated that the Black LP

partners received partnership interests proportionate to the

value of the Erie stock they transferred, he has, in effect,

conceded that Mr. Black satisfied the adequate and full

consideration prong, and we so find.

Our determination herein is consistent with our decision in

Estate of Schutt v. Commissioner, T.C. Memo. 2005-126, which was

also appealable to the Court of Appeals for the Third Circuit.

In that case, we observed that, in Estate of Bongard v.
Commissioner, 124 T.C. at 124, the presence of the following four

factors supported a finding that the adequate and full

consideration requirement had been satisfied: (1) The

participants in the entity at issue received interests

proportionate to the value of the property each contributed to

the entity; (2) the respective contributed assets were properly
 - 51 -

credited to the transferors’ capital accounts; (3) distributions

required negative adjustments to distributee capital accounts;

and (4) there was a legitimate and significant nontax reason for

formation of the entity.

In these cases, respondent has conceded that the first

factor is present, and we have determined that the fourth factor

is present. The Black LP partnership returns filed for 1994 and

subsequent years demonstrate that the second and third factors

are present, too.

In Estate of Schutt v. Commissioner, supra, like respondent

in this case, we viewed the position of the Court of Appeals for

the Third Circuit in Estate of Thompson v. Commissioner, 382 F.3d

367 (3d Cir. 2004), as being consistent with our position in

Estate of Bongard v. Commissioner, 124 T.C. 95 (2005), commenting

as follows:

The Court of Appeals for the Third Circuit has
likewise opined that while the dissipated value
resulting from a transfer to a closely held entity does
not automatically constitute inadequate consideration
for section 2036(a) purposes, heightened scrutiny is
triggered. Estate of Thompson v. Commissioner, 382
F.3d at 381. To wit, and consistent with the focus of
the Court of Appeals in the bona fide sale context,
where “the transferee partnership does not operate a
legitimate business, and the record demonstrates the
valuation discount provides the sole benefit for
converting liquid, marketable assets into illiquid
partnership interests, there is no transfer for
consideration within the meaning of § 2036(a).” Id.
The family limited partnership in Estate of Bongard, like

Black LP, did not conduct an active trade or business. In Estate

of Bongard, the legitimate and significant nontax purpose for the

transfer of operating company stock to the partnership was “to
 - 52 -

facilitate a corporate liquidity event” for the operating

company. Therefore, we conclude that, by treating Estate of

Bongard and Estate of Thompson as consistent with respect to

their application of the parenthetical exception, respondent

concedes, and, as demonstrated by our opinion in Estate of

Schutt, this Court agrees, that a family limited partnership that

does not conduct an active trade or business may nonetheless be

formed for a legitimate and significant nontax reason.14 In

Estate of Thompson v. Commissioner, 382 F.3d at 383, the Court of

Appeals stated:15

14
That respondent does not require the legitimate and
significant nontax purpose to be the partnership’s operation of a
business is also made clear both by his failure to make that
argument on brief and by the following colloquy between
respondent’s counsel and the Court at the end of trial:

THE COURT: But this wasn’t a business that was
put into the --

MR. THORPE: Yes. Right. Well, let me rephrase
our position. I don’t think our position is so
restricted to say that under the * * * [Bongard] test,
it has to be strictly a business purpose. I mean,
certainly I think * * * [Bongard] would indicate that
it could be some significant, legitimate, nontax
purpose. That’s pretty broad.

THE COURT: Okay. So would avoiding a family
dispute suffice for the first prong of the * * *
[Bongard] test?
MR. THORPE: Yes. If it’s significant and
legitimate * * *
15
Judge Greenberg, concurring in Estate of Thompson v.
Commissioner, 382 F.3d 367, 383 (3d Cir. 2004), joins the
majority opinion “without reservation” but appears to read that
opinion as suggesting that, for a discounted, proportionate
interest in a family limited partnership to constitute full and
adequate consideration, the partnership hold a “legitimate”
(continued...)
 - 53 -

After a thorough review of the record, we agree
with the Tax Court that decedent’s inter vivos
transfers do not qualify for the § 2036(a) exception
because neither the Thompson Partnership nor Turner
Partnership conducted any legitimate business
operations, nor provided decedent with any potential
non-tax benefit from the transfers. [Estate of
Thompson v. Commissioner, 382 F.3d at 383; emphasis
supplied.]

b. Conclusion

Mr. Black’s transfer of Erie stock to Black LP was made for

adequate and full consideration.

C. Application of Section 2036(1) and (2)

Because we have concluded that Mr. Black’s transfer of Erie

stock to Black LP constituted a bona fide sale for adequate and

full consideration for purposes of section 2036(a), the fair

market value of that stock is not includable in Mr. Black’s gross

15
(...continued)
business. Judge Greenberg’s point is that the Court’s refusal to
apply the sec. 2036(a) parenthetical exception in the case
“should not discourage transfers in ordinary commercial
transactions, even within families”. In that context, Judge
Greenberg states:

This * * * point is important because courts
should not apply section 2036(a) in a way that will
impede the socially important goal of encouraging
accumulation of capital for commercial enterprises.
Therefore in an ordinary commercial context there
should not be a recapture under section 2036(a) and
thus the value of the estate’s interest in the entity,
though less than the value of a pro rata portion of the
entity’s assets, will be determinative for estate tax
purposes. * * * [Id. at 386; emphasis supplied.]

The third judge on the panel joined Judge Greenberg’s
concurring opinion. In the absence of respondent’s reliance on
(or even discussion of) the concurring opinion in Estate of
Thompson, we do not opine as to its impact, if any, on these
cases.
 - 54 -

estate under either section 2036(a)(1) or (2), and we need not

further consider the application of either of those provisions.

D. Conclusion

The fair market value of Mr. Black’s partnership interest in

Black LP, rather than the fair market value of the Erie stock

that he contributed thereto, is includable in his gross estate.

III. The Marital Deduction Issue

Because we have decided that the fair market value of Mr.

Black’s partnership interest in Black LP, rather than the fair

market value of the Erie stock that he contributed thereto, is

includable in his gross estate, the marital deduction to which

Mr. Black’s estate is entitled under section 2056 must be

computed according to the value of the partnership interest that

actually passed to Mrs. Black, not according to the underlying

Erie stock apportionable to that interest. Therefore, the

marital deduction issue is moot.

IV. The Date of Funding Issue

A. The Arguments of the Parties

As found supra, petitioner, in his capacity as trustee of

the revocable trust, decided to fund the marital trust with a

portion of the 77.0876-percent class B limited partnership

interest in Black LP that Mr. Black had assigned to the revocable

trust. Pursuant to the terms of the revocable trust, assets

distributed in kind to fund the marital trust were required to be

distributed “at their market value on the date or dates of

distribution.” Mrs. Black died before the amount of the
 - 55 -

pecuniary bequest could be determined and the marital trust

funded, and, because the trust was to terminate upon Mrs. Black’s

death, it was never actually funded. To deem the trust to have

been funded was necessary, however, to determine the amount

includable in Mrs. Black’s gross estate under section

2044(b)(1)(A). That section requires that her gross estate

include the value of all property with respect to which Mr.

Black’s estate was entitled to a marital deduction under section

2056(b)(7).16 Petitioner selected the date of her death as the

deemed date of funding.

The parties have stipulated that the fair market value of a

1-percent class B limited partnership interest in Black LP was

$2,146,603, on December 12, 2001 (the date of Mr. Black’s death),

and $2,469,728 on May 25, 2002 (the date of Mrs. Black’s death).

If the marital trust is deemed to have been funded on the date of

Mr. Black’s death, the number of class B limited partnership

units needed to fund the pecuniary bequest to that trust will be

greater than the number of such units needed to fund that bequest

on the date of Mrs. Black’s death. In that event, the fair

market value of the marital trust on the date of Mrs. Black’s

death and, therefore, the amount includable in her gross estate

under section 2044(b)(1)(A) will be greater than if the marital

trust is deemed to have been funded with the lesser number of

class B limited partnership units determined by the value of

those units on the date of her death.

16
See supra note 7.
 - 56 -

Citing the requirement in the revocable trust that the

marital trust terminate at Mrs. Black’s death, petitioner argues

that “logic dictates that the Marital Trust must be deemed to be

funded as of that date.” In support of his position, petitioner

cites section 20.2044-1(e), Example (8), Estate Tax Regs.

Respondent counters that, under the terms of the revocable trust,

Mrs. Black’s “legacy passed to her upon Sam Black’s death”, and,

“[a]ccordingly, the amount comprising Irene Black’s legacy is

determined as of the date of Sam Black’s death, reflecting any

adjustments to the value of Sam Black’s gross estate as finally

determined.” Respondent argues that section 20.2044-1(e),

Example (8), Estate Tax Regs., “sheds no light on the issue of

when a QTIP trust should be deemed funded when the surviving

spouse dies before it is actually funded.”

B. Analysis

In general, the amount includable in the decedent’s gross

estate under section 2044 “is the value of the entire interest in

which the decedent had a qualifying income interest for life,

determined as of the date of the decedent’s death (or the

alternate valuation date, if applicable).” Sec. 20.2044-1(d)(1),

Estate Tax Regs. That general rule is illustrated by section

20.2044-1(e), Example (1), Estate Tax Regs., as follows:
Inclusion of trust subject to election. Under D’s
will, assets valued at $800,000 in D’s gross estate
(net of debts, expenses and other charges, including
death taxes, payable from the property) passed in trust
with income payable to S for life. Upon S’s death, the
trust principal is to be distributed to D’s children.
D’s executor elected under section 2056(b)(7) to treat
the entire trust property as qualified terminable
 - 57 -

interest property and claimed a marital deduction of
$800,000. S made no disposition of the income interest
during S’s lifetime under section 2519. On the date of
S’s death, the fair market value of the trust property
was $740,000. S’s executor did not elect the alternate
valuation date. The amount included in S’s gross
estate pursuant to section 2044 is $740,000.

Section 20.2044-1(e), Example (8), Estate Tax Regs., on

which petitioner relies, provides as follows:

Inclusion of trust property when surviving spouse dies
before first decedent’s estate tax return is filed. D
dies on July 1, 1997. Under the terms of D’s will, a
trust is established for the benefit of D’s spouse, S.
The will provides that S is entitled to receive the
income from that portion of the trust that the executor
elects to treat as qualified terminable interest
property. The remaining portion of the trust passes as
of D’s date of death to a trust for the benefit of C,
D’s child. The trust terms otherwise provide S with a
qualifying income interest for life under section
2056(b)(7)(B)(ii). S dies on February 10, 1998. On
April 1, 1998, D’s executor files D’s estate tax return
on which an election is made to treat a portion of the
trust as qualified terminable interest property under
section 2056(b)(7). S’s estate tax return is filed on
November 10, 1998. The value on the date of S’s death
of the portion of the trust for which D’s executor made
a QTIP election is includible in S’s gross estate under
section 2044.

Thus, Example (8) confirms that the general rule applies to

the valuation of the property in a QTIP marital deduction trust

(i.e., that it be valued as of the date of the grantee spouse’s

death) when (as in these cases) the grantee spouse dies before

the estate tax return for the grantor spouse is filed. The

foregoing regulation and the above-quoted examples illustrating

its application necessarily presuppose that the marital trust is

funded before the beneficiary spouse dies. As respondent notes,

however, neither the regulation nor Example (8) addresses the
 - 58 -

actual date upon which the marital trust is considered to have

been established (funded).

Although respondent successfully rebuts petitioner’s

reliance on the above-cited regulations, he does not mount a

successful defense of his own position. To begin with,

respondent misstates the terms of the revocable trust. They do

not support respondent’s argument that Mrs. Black’s legacy passed

to her upon Mr. Black’s death. The pertinent language of the

revocable trust states: “If * * * [Mrs. Black] survives * * *

[Mr. Black], the Trustee shall hold IN TRUST, as the Marital

Trust * * * a legacy equal to * * * [the pecuniary bequest].”

The amount of the pecuniary bequest was not ascertainable until

Mr. Black’s Federal estate tax liability was known, and, because

of the need to appraise the date-of-death value of the principal

asset in Mr. Black’s estate (his 77.0876-percent class B limited

partnership interest in Black LP) to compute that liability, that

amount was not known on the date of Mr. Black’s death.

Mr. Black’s Federal estate tax return was filed on September

12, 2002, more than 3 months after Mrs. Black’s death on May 25,

2002. Moreover, the outside appraisal of the value (on the date

of his death) of Mr. Black’s 77.0876-percent class B limited

partnership interest in Black LP was dated September 11, 2002, 1

day before his Federal estate tax return was filed. Although the

result of that appraisal must have been known before September

11, 2002, Mr. Cullen testified credibly that it was not known

until after Mrs. Black’s death.
 - 59 -

Had Mrs. Black lived long enough to allow for the funding of

her marital trust, then, as required by the terms of the

revocable trust, that funding would have been accomplished with a

class B limited partnership interest in Black LP the size of

which would have been determined with reference to its fair

market value on the date of distribution from the revocable trust

to the marital trust. There is no reason to apply a different

rule to a deemed distribution of that interest to the marital

trust. The issue is what date, after Mr. Black’s death, to

choose. Because the marital trust was to terminate upon Mrs.

Black’s death, that is the last possible date on which it could

have been funded. We agree with petitioner that to pick that

date, which is the date closest to what would have been the

actual date of the distribution to the marital trust had Mrs.

Black survived, as the deemed date of funding is logical and

reasonable.

Lastly, under the terms of the revocable trust, petitioner

had the option of funding the marital trust with cash. Had Mrs.

Black survived long enough to enable petitioner to fund the

marital trust with cash before her death, and had he been able

(and inclined) to sell a portion of the revocable trust’s

77.0876-percent class B limited partnership interest in Black LP

to raise that cash, he would have sold that interest for its

current fair market value. He would not have sold a greater

interest determined with reference to the fair market value of

Black LP class B limited partnership units as of December 12,
 - 60 -

2001, the date of Mr. Black’s death. We see no reason to reach

an inconsistent result where the marital trust is funded (or

deemed to have been funded) in kind with a class B limited

partnership interest in Black LP.

C. Conclusion
For purposes of determining the value of the marital trust

property includable in Mrs. Black’s gross estate under section

2044, the marital trust that Mr. Black established for Mrs.

Black’s benefit should be deemed funded and the fair market value

of the property that was to constitute the trust corpus should be

determined as of May 25, 2002, the date of her death, not as of

December 12, 2001, the date of his death.

V. The Interest Deductibility Issue

A. General Principles

Section 2053(a)(2) provides that “the value of the taxable

estate shall be determined by deducting from the value of the

gross estate such amounts * * * for administration expenses * * *

as are allowable by the laws of the jurisdiction * * * under

which the estate is being administered.”17 Section 20.2053-3(a),

Estate Tax Regs., provides, in pertinent part: “The amounts

17
Neither party suggests that Pennsylvania law bars the
executor of an estate from claiming an interest expense as an
administration expense with respect to the estate. Therefore,
for purposes of these cases, we find that the interest expense
for which petitioner claims a deduction was properly incurred
under Pennsylvania law, despite the absence of evidence that it
was specifically approved by a Pennsylvania court. See sec.
20.2053-1(b)(2), Estate Tax Regs. (A “deduction * * * of a
reasonable expense of administration will not be denied because
no court decree has been entered if the amount would be allowable
under local law.”).
 - 61 -

deductible from * * * [the] gross estate as ‘administration

expenses’ * * * are limited to such expenses as are actually and

necessarily, incurred in the administration of the decedent’s

estate”. See also Estate of Todd v. Commissioner, 57 T.C. 288,

296 (1971). Section 20.2053-1(b)(3), Estate Tax Regs., provides

that an item may be deducted on the estate tax return “though its

exact amount is not then known, provided it is ascertainable with

reasonable certainty, and will be paid. No deduction may be

taken upon the basis of a vague or uncertain estimate.”

In Estate of Graegin v. Commissioner, T.C. Memo. 1988-477,

we held that the obligation to make a balloon payment of interest

upon the maturity of a 15-year promissory note for repayment of

an amount borrowed from the decedent’s closely held corporation

to pay his estate’s Federal estate tax liability entitled the

estate to an immediate deduction for the interest as an

administration expense under section 2053(a)(2). Both principal

and interest were due in a single payment on the 15th anniversary

due date, and prepayment of both was prohibited. In sustaining

the deduction, we noted that the amount of interest was capable

of precise calculation. Although we were “disturbed” by the

single payment of principal and interest, we found it “not

unreasonable” in the light of the anticipated availability of the

assets of decedent’s spouse’s trust to repay partially both

principal and interest upon maturity of the note, the term of

which had been set according to decedent’s spouse’s life

expectancy.
 - 62 -

We have generally held that when, to pay the debts of an

estate, an executor borrows money instead of selling illiquid

assets, interest on the loan is deductible. See, e.g., Estate of

Bahr v. Commissioner, 68 T.C. 74 (1977); Estate of Todd v.

Commissioner, supra; Estate of Graegin v. Commissioner, supra.

Moreover, we have so held when the loan was made by a company

stock of which was included in the value of the gross estate and

which (1) was owned by the decedent’s family and (2) “was neither

able nor required to redeem enough * * * [company] shares to

provide funds to pay * * * [all debts of the estate] when due”.

McKee v. Commissioner, T.C. Memo. 1996-362. In that case, the

executors (who were also directors of the company lender)

anticipated that the company stock would increase in value, and

we concluded that “borrowing funds, rather than selling stock,

allowed decedent’s estate to more easily meet its burdens by

taking advantage of the increasing value of the stock.”

B. Arguments of the Parties

Petitioner argues that the loan from Black LP was necessary

“to solve Mrs. Black’s Estate’s liquidity dilemma”; i.e., to

provide the funds needed to pay estate taxes and administration

expenses. He stresses that the amount of the loan was reasonable

and that, because prepayment of principal and interest was

prohibited, the amount of interest on the loan was fixed and

capable of calculation when the promissory note was executed, not

“vague or uncertain” within the meaning of section 20.2053-

1(b)(3), Estate Tax Regs. Petitioner concludes that, under the
 - 63 -

foregoing authorities, the interest on the note to maturity was

deductible in full on the Form 706 filed by Mrs. Black’s estate.

In reaching that conclusion, petitioner argues that, under such

cases as Estate of Todd v. Commissioner, supra, petitioner, as

executor of Mrs. Black’s estate, “exercised reasonable business

judgment” when he borrowed the necessary funds rather than cause

Black LP either to distribute those funds to the estate or to

redeem a portion of the estate’s interest (through the marital

trust) in Black LP. Petitioner further notes that, pursuant to

the partnership agreement, Black LP was not required to make a

distribution to or redeem an interest from Mrs. Black’s estate to

fund the estate’s tax liabilities. Petitioner also argues that,

although petitioner acted on behalf of both the borrowers and the

lender, he “did not stand alone or unrestricted on either side of

the transaction” because he had fiduciary responsibilities to

both, particularly to the other partners in Black LP. Lastly,

petitioner argues that, under both the objective test and the

“economic reality” test set forth in Geftman v. Commissioner, 154

F.3d 61, 70, 75 (3d Cir. 1998), revg. in part and vacating in

part T.C. Memo. 1996-447, the loan to Mrs. Black’s estate was

bona fide because (1) there was a note, security, interest

charges, a repayment schedule, actual repayment of the loan, and

other factors that indicate an unconditional obligation to repay,

and (2) the economic realities surrounding the relationship

between the borrowers and the lender demonstrate that there was a

reasonable expectation or enforceable obligation of repayment.
 - 64 -

Respondent counters that the loan (and, hence, the payment

of interest) was neither necessary nor bona fide. In arguing

that the loan was unnecessary, respondent states that “there was

no liquidity problem that would justify the loan.” In support of

that position, respondent stresses that petitioner, as executor

of both Mr. and Mrs. Black’s estates and as managing and majority

partner in Black LP, was in a position to distribute Erie stock

held by Black LP to Mrs. Black’s estate by way of either a

partial, pro rata distribution to the partners of Black LP or a

partial redemption of the estate’s interest, neither of which

would have adversely affected the interests of the charitable

trust partners. In support of his argument that the transfer of

funds was not a bona fide loan, respondent states that the

transaction had no economic effect other than to generate an

estate tax deduction for the interest on the loan. According to

respondent, that is because the only way the borrowers can repay

the alleged loan is to have Black LP make an actual or deemed

distribution of Erie stock (or proceeds from the sale thereof) to

them (whether or not in partial redemption of their partnership

interest) followed by an actual or deemed repayment of the stock

(or proceeds) to Black LP in discharge of the note, which would

result in a circular flow of either the Erie stock or the

proceeds from its sale by Black LP. Respondent concludes:

“Other than the favorable tax treatment resulting from the

transaction (a sec. 2053 deduction for interest expense that the

parties are essentially paying to themselves), it is difficult to
 - 65 -

see what benefit was derived from this circular transfer of

funds.” Lastly, respondent argues that, contrary to petitioner’s

argument, the transaction did not satisfy the prerequisites for

bona fide loan status as set forth in Geftman v. Commissioner,

supra, and in Estate of Rosen v. Commissioner, T.C. Memo. 2006-

115. In particular, respondent argues that by providing for

payment “no earlier than November 30, 2007”, the note lacked a

fixed maturity date, and that Mr. Cullen’s “vague testimony that

an installment arrangement will be worked out in the future

[because of the borrowers’ inability to repay the entire

principal on November 30, 2007]18 hardly confirms an intent that

the loan be repaid.”

C. Analysis

We find that the $71 million loan from Black LP to Mrs.

Black’s estate and the revocable trust, and the borrowers’

payment of interest thereon, was unnecessary. Therefore the

interest is not deductible. See sec. 20.2053-3(a), Estate Tax

Regs.

The only significant asset in Mrs. Black’s estate was the

Black LP partnership interest to be transferred from the

revocable trust to the marital trust. Between 1994 and 2001,

Black LP’s total income was less than $28 million, and its total

distributions to partners were less than $26 million. Even

assuming equivalent income and distributions to partners between

February 25, 2003, the date of the loan, and November 30, 2007,

18
See supra note 9.
 - 66 -

the purported due date for repayment of the loan, timely

repayment by the borrowers of the $71 million loan principal out

of partnership distributions (derived almost entirely from

dividends on Black LP’s Erie stock) was, on the date of the loan,

inconceivable. Thus, the borrowers knew (or should have known)

that, on the loan date, payment of the promissory note, according

to its terms, could not occur without resort to Black LP’s Erie

stock attributable to the borrowers’ class B limited partnership

interests in Black LP.19

Petitioner argues that the borrowers had no right under the

partnership agreement to require a distribution to them of assets

(i.e., Erie stock) either as part of a pro rata distribution to

partners or in partial redemption of their partnership interests.

But the partnership agreement provided for the modification

thereof, and a modification permitting either a pro rata

distribution of Erie stock to the partners or a partial

redemption of the borrowers’ partnership interests would not have

violated petitioner’s fiduciary duties, as managing partner, to

any of the partners.

Assuming additional sales or pro rata distributions of Erie

stock would have been considered undesirable, the only feasible

19
Our conclusion that repayment of the note necessarily
would require a sale of the Erie stock attributable to the
borrowers’ partnership interests in Black LP is premised on the
assumption that, on the date they executed the promissory note,
the borrowers intended to repay the loan in full on Nov. 30,
2007. Petitioner does not argue to the contrary. He argues only
that the eventual decision to refinance the loan does not alter
its status as a bona fide loan.
 - 67 -

means of repaying the loan by the purported due date of November

30, 2007, would have been for Black LP to make an actual or

deemed distribution of Erie stock to the borrowers in partial

redemption of their interests in the partnership and for the

borrowers to make an actual or deemed return of the stock to

Black LP in discharge of the promissory note. That transaction,

had it, in fact, occurred, would have demonstrated that the loan

was unnecessary because the parties thereto would have been in

exactly the same position as they would have been had Black LP

used Erie stock to redeem part of the partnership interests of

the estate and revocable trust, and, in 2003, to pay the debts of

the estate, had they sold that Erie stock (e.g., by means of a

secondary offering identical, except for the identity of the

seller, to the one that actually occurred).20 The only

distinction between the loan scenario and the partial redemption

scenario is that the former gave rise to an immediate estate tax

deduction for interest in excess of $20 million, offset by a

substantially smaller income tax expense (because of the

passthrough of interest income) to the Black LP partners. That

the loan scenario, like the partial redemption scenario, required

a sale of Erie stock to discharge the debts of Mrs. Black’s

estate, i.e., that Erie stock was available and actually used for

20
Alternatively, the partial redemption scenario could have
been structured as a sale of Erie stock by Black LP pursuant to
the secondary offering that actually occurred followed by a
distribution of $71 million in cash to the estate and the
revocable trust in redemption of their partnership interests in
Black LP.
 - 68 -

that purpose, negates petitioner’s contention that the loan was

needed to solve a “liquidity dilemma”. The loan structure, in

effect, constituted an indirect use of Erie stock to pay the

debts of Mrs. Black’s estate and accomplished nothing more than a

direct use of that stock for the same purpose would have

accomplished, except for the substantial estate tax savings.

Those circumstances distinguish these cases from the cases on

which petitioner relies in which loans from a related, family-

owned corporation to the estate were found to be necessary to

avoid a forced sale of illiquid assets, see Estate of Todd v.

Commissioner, 57 T.C. 288 (1971); Estate of Graegin v.

Commissioner, T.C. Memo. 1988-477, or to enable the estate to

retain the lender’s stock for future appreciation, McKee v.

Commissioner, T.C. Memo. 1996-362. In none of those cases was

there a sale of either the stock or assets of the lender to pay

debts of the estate borrower, as occurred in these cases.

Moreover, as respondent points out, the principal beneficiary of

the estate, petitioner, was also the majority partner in Black

LP. Thus, he was on both sides of the transaction, in effect

paying interest to himself. As a result, those payments effected

no change in his net worth, except for the net tax savings.

Having found that the interest on the purported loan from

Black LP to Mrs. Black’s estate and the revocable trust was not

“necessarily incurred in the administration of the decedent’s

estate”, as required by section 20.2053-3(a), Estate Tax Regs.,
 - 69 -

we do not address the issue of whether the transaction resulted

in a bona fide loan.

D. Conclusion

The $20,296,274 interest expense incurred by Mrs. Black’s

estate did not constitute a deductible administration expense

under section 2053(a)(2).21

VI. The Fee Deductibility Issues

A. Background

Respondent seeks to deny to Mrs. Black’s estate a deduction

for (1) any portion of the $980,625 the estate paid to Black LP

as reimbursement for the latter’s reimbursement of Erie for costs

incurred in connection with the secondary offering of Black LP’s

Erie stock,22 (2) any portion of the $1,155,000 executor fee paid

to petitioner in excess of $500,000, and (3) any portion of the

$1,155,000 in legal fees paid to MacDonald Illig in excess of

$500,000. Mrs. Black’s estate deducted each of the foregoing

payments on Schedule L, Net Losses During Administration and

21
Because we deny the entire deduction for interest on the
ground that the $71 million loan (or, indeed, any loan) from
Black LP was unnecessary to enable Mrs. Black’s estate to
discharge its debts, we have not addressed respondent’s
alternative argument that the loan was larger than what was
needed to discharge the debts of Mrs. Black’s estate, and that
interest attributable to the loan proceeds used to fund the $20
million bequest to Penn State Erie (an obligation of Mr. Black’s
estate) should be treated as nondeductible.
22
Although Mrs. Black’s estate and the revocable trust, as
coborrowers under the loan agreement, both agreed to reimburse
Black LP for its expenses related to the secondary offering, and
although petitioner signed that agreement in his dual capacity as
executor for the estate and trustee of the trust, respondent does
not dispute that the estate made the payment at issue; he
disputes only its deductibility by the estate.
 - 70 -

Expenses Incurred in Administering Property Not Subject to

Claims, as expenses incurred in administering nonprobate

property. Petitioner argues that Mrs. Black’s estate is entitled

to deduct each of those expenditures in its entirety.

B. General Principles

Section 2053(b), entitled “Other administrative expenses”,

generally provides a deduction for expenses incurred in

administering nonprobate property, to the same extent as they

would be deductible under section 2053(a); i.e., if incurred in

administering probate property.23 Thus, such expenses must be

“actually and necessarily incurred in the administration of the

decedent’s estate; that is, in the collection of assets, payment

of debts, and distribution of property to the persons entitled to

it.”24 Sec. 20.2053-3(a), Estate Tax Regs.

23
Because such expenses relate to nonprobate property, they
are not subject to the requirement, in sec. 2053(a), that they be
“allowable by the laws of the jurisdiction * * * under which the
estate is being administered.”
24
The evidence indicates that some portion of each of the
fees in question relates to activities that necessarily involve
the administration of both probate and nonprobate property.
Because the principles governing deductibility are identical for
both types of expenditures, the distinction is without
consequence herein. Moreover, as in the case of the interest
expense incurred by Mrs. Black’s estate, to the extent the fees
in question relate to probate property, respondent does not argue
that Pennsylvania law bars petitioner from claiming the fees as
proper administration expenses. See supra note 16.
 - 71 -

C. Analysis and Conclusions

1. Reimbursement of Costs Incurred in Connection
With the Secondary Offering: $982,070

Petitioner argues that the secondary offering of Black LP’s

Erie stock followed by a loan of a portion of the proceeds was a

legitimate means of paying the estate tax liability and the

obligations under the revocable trust of Mrs. Black’s estate, and

that its reimbursement of Erie’s expenses related to the

secondary offering was a “reasonable and necessary” and,

therefore, deductible cost of Mrs. Black’s estate. Respondent

argues that the reimbursement was not “necessary” within the

meaning of section 20.2053-3(a), Estate Tax Regs., because the

Erie stock belonged to Black LP, not Mrs. Black’s estate, and

that Black LP sold the stock.

To the extent the secondary offering of Erie stock generated

funds needed and used to discharge debts of Mrs. Black’s estate,

Black LP’s obligation to reimburse Erie for costs associated with

that offering was related to and occasioned by Mrs. Black’s

death, and, for that reason, the reimbursement might be

deductible by her estate under section 2053. Accord sec.

20.2053-8(d) Example (1), Estate Tax Regs.; see Burrow Trust v.

Commissioner, 39 T.C. 1080, 1089 (1963) (holding that, where a

revocable inter vivos trust paid its own trustee’s fees, the

settlor’s estate could nonetheless deduct those fees under

section 2053 because the trustees’ services “were primarily

occasioned by the death of the decedent”), affd. 333 F.2d 66

(10th Cir. 1964). Moreover, the payment at issue is the estate’s
 - 72 -

reimbursement of Black LP pursuant to the loan agreement, not

Black LP’s reimbursement of Erie. Therefore, the payment may

qualify as an expense related to a sale “necessary in order to

pay the decedent’s debts, expenses of administration, or taxes”

within the meaning of section 20.2053-3(d)(2), Estate Tax Regs.,

despite the fact that the property sold was, technically,

property owned by Black LP rather than by the estate. We find

that the estate’s indirect ownership, through its interest in

Black LP, of the Erie stock is sufficient to bring the sale of

that stock within the cited regulation, which concerns the

deductibility of expenses of selling “property of the estate”.

The flaw in petitioner’s argument is that only a portion of

the funds the secondary offering generated was used on behalf of

Mrs. Black’s estate. Of the $98 million realized from Black LP’s

sale of Erie stock, only $71 million was made available to the

estate, and of that $71 million, $20 million was used to fulfill

Mr. Black’s bequest, through the revocable trust, to Penn State

Erie. That bequest was an obligation of Mr. Black’s estate.

After subtracting the approximately $3.3 million of fees at issue

herein, it appears that approximately $48 million ($31,736,527

for Federal estate taxes,25 $15,700,000 for Pennsylvania

25
Petitioner argues, in connection with the interest
deductibility issue, that the entire $71 million loan was needed
to pay the tax liabilities and administrative expenses estimated
to be payable by Mrs. Black’s estate as of the February 2003 loan
date. Petitioner includes in that computation the $54 million
Federal estate tax payment that accompanied the February 2003
Form 4768, Application For Extension of Time to File a Return
and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes.
(continued...)
 - 73 -

inheritance and estate taxes, and $581,349 for Federal and

Pennsylvania fiduciary income taxes resulting from capital gain

on the sale of Black LP’s Erie stock in connection with the

secondary offering) or approximately 49 percent of the $98

million the secondary offering raised was actually used to

discharge debts of Mrs. Black’s estate. Therefore, we find that

Mrs. Black’s estate is entitled to deduct $481,000 of its

$982,070 reimbursement of costs related to the secondary

offering.

2. Executor’s Fee Paid to Petitioner: $1,155,000
Petitioner claims that the executor’s fee constituted

payment for his services related to raising funds to pay the

estate tax, responding to audit requests, marshaling assets of

Mrs. Black’s estate, and gathering materials and information

necessary to prepare the estate tax return for Mrs. Black’s

estate, including materials and information necessary to enable

the appraiser to determine the value of the assets in Mrs.

Black’s estate. Much of that effort consisted of gathering

information and materials for the appraisal of the class B

25
(...continued)
There is no explanation in the record for the more than $22
million overpayment (which was refunded to the estate) of Federal
estate taxes, but Mr. Cullen’s July 29, 2002, letter to Erie
soliciting Erie’s assistance in raising cash for the estate makes
clear that, among the items for which a cash infusion was said to
be necessary, was “$50 million to fulfill Mr. and Mrs. Black’s
charitable bequests”, the only such bequest being Mr. Black’s $20
million bequest to Penn State Erie via the revocable trust.
Therefore, we reject petitioner’s attempt to allocate $54 million
of the loan proceeds to Federal estate taxes and nothing to the
$20 million bequest to Penn State Erie.
 - 74 -

limited partnership interest that was to constitute the corpus to

the marital trust, and effort associated with the secondary

offering. Petitioner argues that all his efforts related to

nonprobate property included in Mrs. Black’s gross estate and

that, therefore, his fee was deductible by the estate under

section 2053(b). Respondent argues that $650,000 of petitioner’s

fee related to services performed for Mr. Black’s estate, the

revocable trust, and Black LP “for which no deduction is

permitted to Mrs. Black’s estate.”

We find that petitioner’s fee, insofar as it related to his

efforts in connection with the secondary offering of Erie stock,

is deductible to the same extent as is the estate’s reimbursement

of Erie’s costs related to that sale; i.e., to the extent that

the funds raised thereby were used to discharge debts of Mrs.

Black’s estate. Thus, approximately 49 percent of that portion

of the fee is deductible.

We find that petitioner’s gathering of information for

appraisers represented effort on behalf of both Mr. and Mrs.

Black’s estates. A lengthy appraisal of the date-of-death value

of the Black LP interest included in the gross estate of each

decedent was attached to the Federal estate tax return filed on

behalf of each estate. The two appraisals were conducted by the

same appraisal company, appraised the same type of interest (an

interest in Black LP), used the identical appraisal methodology,

were approximately the same length, and, to a great extent,

contained identical language. Therefore, to assume that whatever
 - 75 -

information petitioner supplied to the appraiser pertained more

or less equally to each appraisal is reasonable. For that

reason, we find that the portion of the executor’s fee

attributable to petitioner’s services related to the appraisals

should be divided equally between the two estates so that Mrs.

Black’s estate may deduct only one-half of that amount.

We also find that whatever portion of petitioner’s fee that

may be said to have compensated him for his services related to

the marital trust (services that, allegedly, consumed 90 percent

of his time) must be divided equally between the estates.

Petitioner’s argument for full deductibility of the fee is that

“the marital trust has a direct nexus to Mrs. Black’s Estate

because the estate tax liability for the inclusion of the Marital

Trust’s assets in the gross estate is borne by Mrs. Black’s

Estate. See I.R.C. § 2044.” But the fee has an equally direct

nexus to Mr. Black’s estate because his estate may deduct under

section 2056 the value on the date of his death of the marital

trust’s assets. That deduction exactly mirrors the inclusion, by

Mrs. Black’s estate, of the value of those assets on the date of

her death and is of equal significance.

The same is true of whatever portion of the executor’s fee

may be said to have compensated petitioner for his efforts in

responding to respondent’s audit requests. Both estates were

under audit so that a 50-50 split between the estates also

appears to be appropriate in connection with that effort.
 - 76 -

Lastly, we agree with respondent that no more than a de

minimis portion (e.g., 1 percent) of the executor fee should be

allocated to petitioner’s marshaling of assets on behalf of Mrs.

Black’s estate. As respondent states, the estate consisted of

assets worth only $39,709 in addition to the Erie stock in the

marital trust, which was valued by the estate’s own appraiser at

over $100 million.

According to the foregoing we find that one-half of the

$1,155,000 executor’s fee paid to petitioner was attributable to

his efforts on behalf of Mrs. Black’s estate. Therefore, that

estate is entitled to a deduction of $577,500 for the executor’s

fee.

3. Legal Fees Paid to MacDonald Illig: $1,155,000

Mr. Cullen testified that the legal fees related to

“[e]verything in connection with the death of Mrs. Black,

including the administration of her estate, the [marital] trust,

preparation of [estate and fiduciary] tax returns, participation

in the secondary [offering], everything.” The “everything” also

included services (assisting petitioner) in connection with the

estate tax audit. Mr. Cullen further testified that 80 percent

of his firm’s time was spent on matters relating to the marital

trust, which included services related to the secondary offering,

and 20 percent on matters relating to Mrs. Black’s estate,

including estate and fiduciary return preparation and payment of

the taxes owed.
 - 77 -

Respondent argues that Mrs. Black’s estate “should be

allowed to deduct fees only in the amount of $500,000, and that

$650,000 should be disallowed as being related to services

rendered to entities other than the marital trust.” Thus,

respondent does not challenge the overall reasonableness of the

fee charged for legal services on behalf of the two estates and

the marital trust. He challenges only petitioner’s treatment of

the entire fee as a charge to Mrs. Black’s estate.

For the reasons stated supra, in connection with our

consideration of the deductibility of petitioner’s fee, we find

that Mrs. Black’s estate may deduct 49 percent of whatever

portion of the legal fees is attributable to services related to

the secondary offering and one-half of the portion attributable

to services related to the marital trust and the Federal estate

tax audit. Similarly, because each estate filed a Federal gift

tax and a Federal estate tax return, we find that a 50-50 split

of the portion of the legal fees attributable to MacDonald

Illig’s services in preparing those returns is appropriate.

Only Mrs. Black’s estate filed fiduciary income tax returns.

Therefore, her estate may deduct the portion of the legal fees

attributable to the preparation and filing of those returns. The

record does not contain copies of those returns. If, as Mr.

Cullen testified, those returns reflected only the capital gain

passed through to Mrs. Black’s estate on Black LP’s sale of Erie

stock in connection with the secondary offering, the returns

could not have been particularly complex. Thus, the fee
 - 78 -

attributable to the preparation of those returns should be

relatively small.26

As in the case of petitioner’s fee, we find that one-half of

the $1,155,000 in legal fees was attributable to services

rendered to Mrs. Black’s estate. Therefore, that estate is

entitled to a deduction of $577,500 for legal fees.27

To reflect the foregoing,

Decisions will be entered
under Rule 155.

26
The record does not contain a copy of the MacDonald Illig
bill for services rendered to Mrs. Black’s estate. Therefore, we
do not know how that firm apportioned its fee to the various
services rendered.
27
No petition filed in these consolidated cases alleges that
all or any portion of the executor’s fee and/or legal fees
disallowed as deductions to Mrs. Black’s estate should be allowed
as deductions to Mr. Black’s estate. Moreover, petitioner has
neither amended the pleadings under either Rule 41(a) or (b) nor
filed supplemental pleadings under Rule 41(c) to so allege.
Therefore, we do not consider the deductibility by Mr. Black’s
estate of all or any portion of the disallowed amounts.