Estate of True: gaming the valuation question with buy-sell agreementsDecember 6, 2004 - Phil HodgenNonresidents with US Activities
Estate tax is imposed on the value of what a person owns at the time of death. Where one of the assets is a family business, you have the task of computing value. But of course for a business, the value is a matter of opinion. If your opinion places a high value on the business, the family pays a lot of estate tax. On the other hand, if (in your opinion) the business is worth peanuts, then the estate tax is also peanuts. You see the incentives for the heirs — lowball the values.
Family businesses frequently have buy-sell agreements. These are contracts among the shareholders that control the sale of stock. The purpose is to keep ownership of the business in the family. Typically, if you want to sell out to a non-family member, you can’t. You have to sell to the current shareholders, or sell the stock back to the company. Buy-sell agreements usually have a provision that says that when a shareholder dies, his/her stock must be sold to other shareholders or back to the company.
Buy-sell agreements have a mechanism built in for determining the price of the sale. This might be by some formula based on a financial metric (gross sales, net profit, whatever). Or it might be as simple as “call in an outside appraiser and get an opinion as to value.”
So. Let’s see. If we can get a low value, we can get a low estate tax. And we have a contract that sets a value for mandatory sale at the time of death. “Teacher, teacher! Pick me! I know the answer! Let’s use this buy-sell agreement to set a reeediculously low value for the business so we don’t have any estate tax!”
But the IRS didn’t fall off the turnip truck yesterday. They’re hip to this stuff.
Here’s a recent case, Estate of H. A. True, et al (link to the opinion at Washburn University’s website). The Tenth Circuit Court of Appeals reviewed a Tax Court ruling and decided the taxpayers had overreached. In a nutshell, the buy-sell agreement’s method for setting values was way out of whack with reality.
The moral of the story? Cut through the tax technicalities. It’s the old adage, “Pigs get fat, hogs get slaughtered.”
Here’s the full opinion.
COMMISSIONER OF INTERNAL REVENUE,
Release Date: DECEMBER 02, 2004
UNITED STATES COURT OF APPEALS
Appeal from the United States Tax Court
(T.C. Nos. 10940-97, 3408-98, 3409-98)
Buford P. Berry (Mary A. McNulty and Katherine Quigley, Thompson & Knight L.L.P., and Ronald M. Morris, Casper, Wyoming, with him on the briefs), Thompson & Knight L.L.P., Dallas, Texas, for Petitioners-Appellants.
Joan I. Oppenheimer, Attorney, Tax Division, Department of Justice (Eileen J. O’Connor, Assistant Attorney General, and Jonathan S. Cohen, Attorney, Tax Division, Department of Justice, with her on the briefs), Washington, D.C., for Respondent-Appellee.
Before SEYMOUR, Circuit Judge, PORFILIO, Senior Circuit Judge, and MURPHY, Circuit Judge.
SEYMOUR, Circuit Judge.
This appeal arises out of the consolidation of three separate tax deficiency notices issued by the Commissioner of Internal Revenue (I.R.S.) against the estate of H. A. True, Jr., deceased, H. A. True III, personal representative, and Jean D. True (collectively, taxpayers), regarding the transfer of interests in six different family businesses subject to longstanding buy-sell agreements. Taxpayers filed timely petitions in tax court challenging the I.R.S.’s estate and gift tax deficiency determinations. After a week- long trial, the tax court issued an extensive 336 page Memorandum Findings of Fact and Opinion, see Estate of True v. C.I.R., 82 T.C.M. (CCH) 27 (2001), in which it rejected taxpayers’ contention that the formula price and other restrictive terms in the buy-sell agreements controlled the value of the transferred business interests for estate and gift tax purposes. The court also imposed penalties against taxpayers for undervaluing the interests on their tax returns. Taxpayers appeal, and we affirm.
H. A. True, Jr. (Dave True or Dave), was born on June 12, 1915, and married Jean Durland (Jean True or Jean) in 1938. They remained married until Dave’s death on June 4, 1994. During their marriage they had four children: Tamma True Hatten (Tamma), H. A. True III (Hank), Diemer D. True (Diemer), and David L. True (David).
Dave was a successful entrepreneur and established a number of companies involved in oil and gas exploration, marketing, and transportation. The companies relevant to this appeal include True Oil Company, Belle Fourche Pipeline Company, Eighty-Eight Oil Company, and Black Hills Trucking Company. These companies often worked in concert, providing services to one another and assisting in one another’s efforts. Companies which generated a substantial amount of revenue often provided the funds to support companies which were not as profitable. Dave also established ranching operations. These included the True Ranches, Inc., “a vertically integrated cattle operation, running herds of cows and their offspring from conception through finishing ready for slaughter,” Estate of True, 82 T.C.M. (CCH) at 36, and White Stallion Ranch, Inc., which operated as a guest ranch./1/
Due to an unsatisfactory work experience early in his career, Dave developed a business philosophy which was guided by four basic principles. He did not want to own a business with anyone but his own family members, every business owner or partner should be actively engaged in the business, buy-sell agreements were necessary to avoid conflicts among owners and to establish clear exit strategies, and outside debt would be incurred only as a last resort. Each True company was governed by buy-sell agreements which embodied these business principles. The agreements dictated that an owner or partner could not transfer or encumber his or her interests in the business, and each owner or his or her spouse had to work in the business. Failure to work in the business, any attempt to transfer an interest in the business, death, and disability were each treated as if the holder of the interest had notified the other owners of his or her intent to withdraw from ownership. Upon the occurrence of such an event, the other owners were required to purchase the departing owner’s interests at a formula price listed in the buy-sell agreement.
The formula prices in the buy-sell agreements were derived from a calculation of the tax book value for the various True companies. The companies characteristically kept their business records according to tax book values rather than following generally accepted accounting principles (GAAP). The companies used the tax book accounting method for a variety of reasons. Under this method, the companies could take greater advantage of certain tax deductions and accelerated rates of depreciation granted to the oil and ranching industries. Likewise, because the Trues intended to keep their businesses strictly within the family, they determined there was no need to have their financial records exhibit the value of their companies as if placed on the public market. By using a tax value accounting method, however, the book values for the True companies tended to be much lower than what would be calculated under GAAP and did not always represent the fair market value of the businesses had they been liquidated. Because of the varying tax incentives granted to the oil, gas, and ranching industries, which allow for increased rates of depreciation and deductions, the tax value accounting method occasionally even resulted in a negative book value figure for some of the True companies.
As Dave and Jean True established new businesses or gained full control over businesses in which they formerly shared interests with non-family members, they entered into buy-sell agreements with one another. Characteristically, Dave possessed a larger percentage of shares or interest in the businesses than did Jean. Dave and Jean also took steps to ensure their children’s involvement in the family businesses. As high school students, the True children participated in the businesses by attending the True companies’ annual supervisor meetings and semiannual family business meetings. Likewise, throughout junior high school, high school, and college, the True sons had jobs on the family’s ranches and in the oil businesses.
In 1971, each child acquired a one percent interest in Belle Fourche Pipeline, which they purchased from the corporation at tax book value. At this time, the children were between twenty-one and thirty-one years of age. Dave and Jean did not report the transfers on a gift tax return because the children’s acquisition of the Belle Fourche Pipeline stock had been structured as a sale rather than a gift. In 1973, Dave and Jean also gave each child an eight percent interest in True Oil and True Drilling./2/ Dave and Jean both reported the 1973 gifts to their children on their gift tax returns for that year, valuing the gifts in terms of their tax book values./3/
The I.R.S. determined gift tax deficiencies against Dave and Jean for both the 1971 and 1973 transfers, asserting that the transfers involved “unreported gifts equal to the difference between the fair market value of the transferred interests and the amount paid for the interests or the amount reported as gifts.” Aplt. br. at 9. The Trues paid the deficiencies and brought two refund suits in federal district court. See True v. United States, 547 F. Supp. 201 (D. Wyo. 1982) (1973 gift tax case); True v. United States, No. C79-131K (D. Wyo. Oct. 1, 1980) (1971 gift tax case). In both cases, the district court sustained the Trues’ argument that the fair market value of the transferred interests was the reported tax book value./4/
Dave and Jean also consistently made annual gifts to their children and their spouses. These gifts tended to consist of “cash or ownership interests in various True companies valued at the maximum allowable amount that would not trigger gift tax.” Estate of True, 82 T.C.M. (CCH) at 37. However, the gifts were never received as cash in hand. Rather, cash gifts were deposited into business bank accounts assigned to each recipient. The funds were then “invested in the True companies, either by purchasing ownership interests or by making interest-bearing loans, or both.” Id.
Over the years, the children acquired interests in other True companies, including Eighty-Eight Oil, Black Hills Trucking, True Ranches, and White Stallion Ranch. In obtaining these interests, the children became partners or shareholders in the companies, entered into buy-sell agreements for each, and fulfilled the terms of the agreements by active participation in the businesses. The True children, or their spouses, owned equal percentages of interest in the companies, regardless of the extent of their individual involvement in each. Hank eventually became responsible for managing Belle Fourche Pipeline, Eighty-Eight Oil, and the True family environmental cleanup company. Diemer managed Black Hills Trucking, as well as another True business. David became manager of True Ranches and True Drilling. Tamma briefly worked for the family businesses as a personnel coordinator, and her husband, Donald Hatten, also worked for the True businesses for about ten years.
In 1984, Tamma and her husband withdrew from the True companies to open a ranch operation wholly independent from the True businesses. In accordance with the buy-sell agreements, Tamma’s parents and brothers bought out her interests in the companies at tax book value. The combined purchase price Tamma accrued for these interests equaled over $ 8.5 million. This amount was offset, however, by two of the True companies’ negative book values amounting to nearly $ 1.7 million at the time of the sale. After the sale, the rest of the family amended their various buy-sell agreements to reflect that Tamma and her husband were no longer owners or participants in the family businesses. Likewise, Dave and Jean ceased making annual gifts to Tamma and amended both of their wills and other estate planning documents to delete any specific provisions for Tamma and her family./5/ They did so out of the belief that Tamma was financially secure as a result of the sale, and because Dave and Jean True wanted their estate to go to their sons so that family funds would be reinvested in the companies and the businesses would stay together. Rec., vol. II at 123; id., vol. III at 397. In one of his testamentary documents, Dave also stated that Tamma was not to receive any assets from his estate. He noted that she had “severed her financial ties with the True companies, and thus her potential inheritance” had been fully satisfied during his lifetime as a result of the sale of her interests. Rec., ex. 13-J at 4; Estate of True, 82 T.C.M. (CCH) at 42.
During the 1980s, the True family (except Tamma) purchased several pieces of property to add to the operations of the True Ranches. As discussed in detail in True v. United States, 190 F.3d 1165 (10th Cir. 1999), our decision concerning these purchases, the properties were not directly purchased by the True Ranches, but by another one of the True companies. Id. at 1168-69. Through a variety of step-transactions-subsequent acquisitions, transfers, and exchanges among the various True companies-the new ranch land finally became the property of the True Ranches. In the course of this process, the Trues were able to reduce the tax value of the acquired property to zero. The I.R.S. challenged the validity of these transactions and issued tax deficiencies against taxpayers, which they in turn challenged in district court. On appeal, we agreed with the I.R.S. that taxpayers could not reduce the tax value of the ranch lands by taking advantage of various tax depreciations which would normally accompany the series of transactions by which the True Ranches acquired the property. Id. at 1179. We held that the varying transactions were “nothing but the Trues’ prearranged, integrated plan to accomplish indirectly tax advantages they could not accomplish directly.” Id. Therefore, we treated the ranch land acquisitions as if they had been directly acquired by the True Ranches, and precluded the Trues from claiming a zero tax value for the new land. Id.
In January 1993 and in response to changes in the tax laws, Dave sold to his wife and sons, in accordance with the buy-sell agreements, a portion of his partnership interests in several True companies. Prior to the 1993 sales, Dave held a majority interest in a number of the True partnerships. Under the new tax laws, the transfer of his interests in the partnerships to his wife and sons upon his death in accordance with the buy-sell agreements would have resulted in a termination of the partnerships as well as possible termination of the buy-sell agreements. See I.R.C. section 2701. In order to avoid this result, Dave transferred some of his interests in each partnership to Jean and his sons at tax book value to reduce his overall holdings. Dave and Jean disclosed the transfers on their 1993 gift tax returns but treated them as sales, thereby not reporting any taxable gifts resulting from the transfers. In March 1997, the I.R.S. issued notices of deficiency for the 1993 transfers, contending the values of the transferred interests were higher than the tax book values reported on the tax returns.
On June 4, 1994, Dave died unexpectedly. In accordance with the buy-sell agreements, Dave’s remaining interests in the True family companies were transferred to his wife and sons at tax book value. The estate subsequently filed an estate tax return reporting the date-of-death value of Dave’s interest in the True family companies as equal to the proceeds the estate received under the buy-sell agreements. In January 1998, the I.R.S. issued a notice of deficiency against the estate, asserting that the values of the True companies listed in the return were higher than the tax book values at which they were sold.
After Dave died, Jean decided she wanted to retire from active participation in the True companies. In compliance with the buy-sell agreements, she sold most of her interests in the companies to her sons at tax book value in June and July 1994. She filed a timely gift tax return for 1994, disclosing the transactions but treating them as sales and reporting she owed no taxes. As with the two previous transactions, the I.R.S. issued a notice of deficiency, claiming that the values of the interests Jean sold were higher than their reported value.
According to the I.R.S., and as set out here in tabular form, the deficiencies for each of the transactions were as follows:
1993 gift transfer $ 15,201,984
1994 estate value $ 43,639,111
1994 gift transfer $ 17,094,788.
The I.R.S. also determined that taxpayers should be subject to a penalty for substantial underpayment on the estate and gift tax returns. See I.R.C. section 6662(a), (b)(5). These penalties were calculated as follows:
1993 gift transfer $ 6,080,794
1994 estate value $ 17,455,644
1994 gift transfer $ 6,791,715.
In total, the I.R.S. calculated the tax deficiencies at over $ 75 million and the penalties at over $ 30 million.
Taxpayers filed timely petitions with the tax court contesting the I.R.S.’s rulings. During the one week trial, taxpayers’ core argument was that the tax book value and other restrictive terms detailed in the buy-sell agreements established the value of the transferred interests for estate and gift tax purposes. The tax court rejected this argument and instead determined the value of the transferred interests based on evidence presented at trial, including appraisals presented by experts for taxpayers and evidence from an expert rebuttal witness presented by the I.R.S. Based on its own valuation of the interests at issue, the court concluded their values substantially exceeded the amounts asserted by taxpayers, resulting in tax deficiencies and associated penalties under I.R.C. section 6662(a), (b)(5).
The tax court determined the tax deficiencies as follows:
1993 gift transfer $ 2,660,800
1994 estate value $ 11,162,543
1994 gift transfer $ 4,446,600.
In affirming the I.R.S.’s application of penalties, the tax court rejected taxpayers’ argument that they showed reasonable cause and good faith in their understatement of tax values and were therefore not subject to penalties. See I.R.C. section 6664(c). The tax court calculated the penalties as follows:
1993 gift transfer $ 317,352
1994 estate value $ 1,888,032
1994 gift transfer $ 909,590.
In total, the court’s calculation amounted to approximately $ 18.2 million for tax deficiencies and $ 3.1 million for penalties./6/
In appealing the tax court’s decision, taxpayers assert the court erred in concluding the formula prices in the buy-sell agreements did not establish the value of the interests for estate and gift tax purposes. They also argue that even if the formula prices should be disregarded, the tax court erred in not considering the other restrictive terms in the buy-sell agreements when it determined the fair market value of the interests. Finally, taxpayers challenge the tax court’s conclusion that the imposition of penalties was appropriate.
We exercise jurisdiction over this case pursuant to I.R.C. section 7482(a)(1) and review the tax court’s decision “in the same manner and to the same extent as decisions of the district courts . . . tried without a jury.” Id. Therefore, we review legal questions de novo and factual questions for clear error. IHC Health Plans, Inc. v. C.I.R., 325 F.3d 1188, 1193 (10th Cir. 2003); Kurzet v. C.I.R., 222 F.3d 830, 833 (10th Cir. 2000). The primary issue we address is whether the price terms in the buy-sell agreements controlled for the purpose of valuing the interests in Dave True’s estate.
The estate of every decedent who is a United States citizen or resident is subject to tax. See I.R.C. section 2001(a). The value of a decedent’s gross estate is “determined by including . . . the value at the time of his death all property, real or personal, tangible or intangible, wherever situated.” I.R.C. section 2031(a). The value of such property is generally measured in terms of its fair market value, which is the price at which a willing buyer and willing seller with knowledge of all the relevant facts would agree to exchange the property or interest at issue. See United States v. Cartwright, 411 U.S. 546, 550-51 (1973); Heyen v. United States, 945 F.2d 359, 364 (10th Cir. 1991); Treas. Reg. section 20.2031-1(b). In determining the fair market value of partnership interests or stock in a closely held corporation where no public market exists, courts have looked at a variety of factors to calculate the worth of an interest included in an estate. See I.R.C. section 2031(b) (valuation of unlisted stock and securities). To determine the value of closely held stock, it is appropriate to consider
[t]he good will of the business; the economic outlook of the
particular industry; the company’s position in the industry and
its management; the degree of control of the business
represented by the block of stock to be valued; and the values
of securities of corporations engaged in the same or similar
lines of businesses which are listed on a stock exchange.
Treas. Reg. section 20.2031-2(f). Partnership interests can be valued by “[a] fair appraisal as of the applicable valuation date of all the assets of the business, tangible and intangible, including good will; [t]he demonstrated earning capacity of the business;” and other factors relating to the valuation of corporate stock. Treas. Reg. section 20.2031-3. Finally, and particularly relevant here, the price terms in buy-sell agreements can sometimes control the value of assets for estate tax purposes.
As developed in case law, and embodied in Treasury Regulation section 20.2031-2(h),/7/ the stated price in a buy-sell agreement will control for estate tax purposes where (1) the price is determinable from the agreement, (2) the terms of the agreement are binding throughout life and death, (3) the agreement is legally binding and enforceable, and (4) the agreement was entered into for bona fide business reasons and is not a testamentary substitute intended to pass on the decedent’s interests for less than full and adequate consideration. See, e.g., Estate of Gloeckner v. C.I.R., 152 F.3d 208, 212-14 (2d Cir. 1998); St. Louis County Bank v. United States, 674 F.2d 1207, 1210 (8th Cir. 1982); Estate of Godley v. C.I.R., 80 T.C.M. (CCH) 158, 164 (2000); Estate of Lauder v. C.I.R., T.C.M. (RIA) 92736, 3716, 3729-30 (1992) (Lauder II); Treas. Reg. section 20.2031-2(h); Rev. Rule 59-60, 1959-1 C.B. 237, section 8 (1959). For ease of reference, we will refer to this test as the “price term control test.”
The tax court found, and the parties generally agree, that the first three prongs of the test are not at issue./8/ We therefore limit our determination to whether the tax court correctly concluded that the price terms in the True company buy-sell agreements do not control for estate tax valuation purposes because the agreements failed to satisfy the fourth prong of the test. We review this question of fact for clear error. See Estate of Gloeckner, 152 F.3d at 212, 215-16; Treas. Reg. section 20-2031- 2(h) (“effect . . . given to the option or contract price . . . depends upon the circumstances of the particular case”) (emphasis added). We will not reverse the tax court’s decision on this question unless “we are ‘left with the definite conviction that a mistake has been committed.'” Wolf v. C.I.R., 4 F.3d 709, 712 (9th Cir. 1993) (quoting United States v. U.S. Gypsum Co., 333 U.S. 364, 395 (1948)).
As noted above, the fourth prong of the price term control test asks whether a buy-sell agreement is entered into for bona fide business purposes and does not represent a testamentary substitute intended to pass a decedent’s interests on to the natural objects of his bounty for less than full and adequate consideration. This prong of the price term control test is conjunctive in nature. The buy-sell agreement must be entered into for a legitimate business purpose, and it cannot be a testamentary device. Dorn v. United States, 828 F.2d 177, 182 (3d Cir. 1987); St. Louis County Bank, 674 F.2d at 1210; Estate of Godley, 80 T.C.M. (CCH) at 164; Cameron W. Bommer Revocable Trust v. C.I.R., T.C.M. (RIA) 97380, 2423 (1997); Lauder II, T.C.M. (RIA) 92736 at 3730-31. The tax court found here, and the I.R.S. does not contest, that the True buy- sell agreements were entered into for a variety of legitimate business reasons. Estate of True, 82 T.C.M. (CCH) at 58-59. See also St. Louis County Bank, 674 F.2d at 1210 (maintenance of family ownership and control over business is legitimate business purpose); Lauder II, T.C.M. (RIA) 92736 at 3731 (preserving family control and ownership over family business is bona fide purpose for buy-sell agreement); Estate of Bischoff v. C.I.R., 69 T.C. 32, 39-40 (1977) (keeping business in family is legitimate business purpose). Our analysis is thus further refined to examining whether the tax court erred when it determined the True buy-sell agreements nonetheless served as testamentary substitutes.
The tax court reached its conclusion that the True company buy- sell agreements were substitutes for testamentary dispositions by first examining a variety of factors permitting an inference that the agreements served a testamentary purpose. The court then determined taxpayers failed to prove the price terms in the agreements represented adequate consideration at the time the parties entered into the agreements. Consequently, the court found the price terms were not binding for estate tax valuation purposes.
Challenging the tax court’s decision, taxpayers contend the court erred by placing too great an emphasis on whether the buy-sell agreements had a testamentary purpose rather than on whether the agreements represented an exchange for full and adequate consideration. Taxpayers therefore devote little, if any, analysis to the question of testamentary purpose, instead focusing the majority of their argument on whether the buy-sell agreements were in fact supported by adequate consideration. They argue they satisfy this latter question primarily by virtue of this court’s ruling in Brodrick v. Gore, 224 F.2d 892 (10th Cir. 1955), and the alleged preclusive effect of the rulings in the 1971 and 1973 gift tax cases. Upon our review of the tax court’s extensive opinion, as well as our own close examination of the relevant case law and the record on appeal, we conclude taxpayers’ arguments cannot prevail.
From the outset, we note there is not a wealth of cases outlining the full process by which a court should examine whether a buy-sell agreement satisfies the fourth prong of the price term control test. When this portion of the test is at issue, however, courts generally begin their analysis by examining a variety of factors from which they may draw an inference that the agreement served as a testamentary substitute. See St. Louis County Bank, 674 F.2d at 1211; Slocum v. United States, 256 F. Supp. 753, 754-56 (S.D.N.Y. 1966); Cameron W. Bommer Revocable Trust, T.C.M. (RIA) 97380 at 2424-27; Lauder II, T.C.M. (RIA) 92736 at 3731-33. These factors include the health or age of the decedent when entering into the buy-sell agreement, Estate of Gloeckner, 152 F.3d at 216; St. Louis County Bank, 674 F.2d at 1210; Slocum, 256 F. Supp. at 755; the lack of regular enforcement of the agreement, St. Louis County Bank, 674 F.2d at 1211; the exclusion of significant assets from the agreement, Lauder II, T.C.M. (RIA) 92736 at 3732; the arbitrary manner in which the price term was selected, including the failure to obtain appraisals or seek professional advice, id.; Estate of Gloeckner, 152 F.3d at 216; Cameron W. Bommer Revocable Trust, T.C.M. (RIA) 97380 at 2425; the lack of negotiation between the parties in reaching the agreement terms, id.; Lauder II, T.C.M. (RIA) 92736 at 3732; whether the agreement allowed for adjustments or revaluation of its price terms, Estate of Godley, 80 T.C.M. (CCH) at 164; Cameron W. Bommer Revocable Trust, T.C.M. (RIA) 97380 at 2424, 2426; whether all the parties to the agreement were equally bound to its terms, Brodrick, 224 F.2d at 896; Lauder II, T.C.M. (RIA) 92736 at 3731; Estate of Bischoff, 69 T.C. at 41; Estate of Littick v. C.I.R., 31 T.C. 181, 187-88 (1958); and any other testimony or evidence highlighting that the agreement supported the decedent’s testamentary plan, Estate of Godley, 80 T.C.M. (CCH) at 161. Moreover, “intrafamily agreements restricting the transfer of stock in a closely held corporation are subject to greater scrutiny than that given to similar agreements between unrelated parties.” Cameron W. Bommer Revocable Trust, T.C.M. (RIA) 97380 at 2423. See also Lauder II, T.C.M. (RIA) 92736 at 3731 (same); cf. Estate of Gloeckner, 152 F.2d at 214-15 (where beneficiary of buy-sell agreement not natural object of decedent’s bounty, no testamentary device); Bensel, 36 B.T.A. at 252-53 (buy-sell agreement between father and son who were hostile and estranged from one another not testamentary device).
Throughout this analysis, and in light of the many factors listed above, courts often ask whether the terms of the agreement, and the manner in which those terms were established, reflect an agreement reached by parties operating at arm’s length. In Dorn, the court noted that
[o]ur interpretation of [20.2031-2(h)] is informed by the fact
that Congress’s overarching goal in this area was to limit
circumvention of the general rule of fair market value at the
date of death by transactions that are not at arm’s length.
See I.R.C. section 2036 (1954).
Although few cases have relied on Treasury Regulation
section 20.2031(h) for support, those which do discuss it
support the position that the option price affects the
value of the gross estate only if the option was granted at
Dorn, 828 F.2d at 181. See also Estate of Godley, 80 T.C.M. (CCH) at 164; Estate of Littick, 31 T.C. at 186; Bensel v. C.I.R., 36 B.T.A. 246, 252-53 (1937), affd. 100 F.2d 639 (3rd Cir. 1938)./9/ While the commentary to section 2703 does indicate that the arm’s length standard is a new statutory factor, taxpayers overlook the fact that long before the passage of section 2703, courts consistently considered the arm’s length nature of transactions when determining the validity of buy-sell agreements created before 1990. See, e.g., Dorn v. United States, 828 F.2d 177, 181 (3d Cir. 1987); Bensel v. C.I.R., 36 B.T.A. 246, 252-53 (1937), affd. 100 F.2d 639 (3rd Cir. 1938); Estate of Lauder v. C.I.R., T.C.M. (RIA) 92736, 3716, 3733-34 (1992) (Lauder II); Estate of Littick v. C.I.R., 31 T.C. 181, 186 (1958). Consequently, the tax court did not err by including within its testamentary purpose and adequacy of consideration analyses an examination of whether the parties engaged in arm’s length transactions when they entered into the buy- sell agreements.
The tax court engaged in an extensive review of all the facts and circumstances surrounding the creation and terms of the True company buy-sell agreements, and determined there was much about the agreements to support a conclusion they were testamentary substitutes. We agree./10/
As we have pointed out, where the price term in a buy-sell agreement is reached in an arbitrary manner, is not based on an appraisal of the subject interest, or is done without professional guidance or consultation, courts draw an inference that the buy-sell agreement is a testamentary substitute. See Cameron W. Bommer Revocable Trust, T.C.M. (RIA) 97380 at 2425 (inference of testamentary device where decedent failed to obtain professional appraisal for properties and did nothing more than consult attorney who came up with price term in one day for interests listed in buy- sell agreement); Lauder II, T.C.M. (RIA) 92736 at 3732 (price term reached after only informal consultation with close family financial advisor and without any formal appraisals of company); cf. Estate of Gloeckner, 152 F.3d at 216 (inference of testamentary intent diminished, in part, by fact that decedent hired independent accountant to value stock listed in buy-sell agreement). Here, Dave True sought only a limited amount of professional advice in determining to use the tax book value for the price terms in the buy-sell agreements, and he did not substantially rely on any independent appraisals in doing so.
Cloyd Harris, a long time friend and accountant of the True family and their companies, testified that Dave wanted to pick a value that “was easily determined, without having to hire appraisers and oil field engineers and so on to come up with a valuation.” Rec., vol. II at 233. In discussions with Dave about the manner in which he might bring his children into the family businesses, id. at 228, Mr. Harris said he did not object to the use of tax book value in the buy-sell agreements. Id. at 232. Nevertheless, he did express some concern that when valuing the different True companies as stand-alone operations, “it would be very hard to justify book value or income tax basis value as fair market value . . . . If [one] were looking at a liquidating situation, then it would not have been a true value, but [the True companies were] an ongoing operating situation.” Id. at 233-34. Mr. Harris believed “book value was not out of line,” id. at 234, as a method of pricing the interests in the buy-sell agreements.
Dave True did obtain one appraisal in connection with his 1973 gift of True Oil to his children. See Estate of True, 82 T.C.M. (CCH) at 40; rec., vol. II at 205-06. However, the record indicates that at most the appraisal of True Oil was obtained and reviewed for litigation purposes during the 1973 gift tax case, rec., vol. II at 206, and was not relied upon by the children when entering into the agreements with their father. Id. at 328. Nor do taxpayers present evidence of any other appraisals obtained in connection with the children’s subsequent entry into buy-sell agreements with their parents for the other True companies. Therefore, for the majority of interests at issue here, there were no outside evaluations of the value of the companies for the purpose of determining whether their fair market value was adequately represented by the price terms in the buy-sell agreements. In similar fashion to the courts in Cameron W. Bommer Revocable Trust and Lauder II, which expressed concern regarding experienced businessmen setting price terms in buy-sell agreements with only the most limited of professional advice, Cameron W. Bommer Revocable Trust, T.C.M. (RIA) 97380 at 2425; Lauder II, T.C.M. (RIA) 92736 at 3732, we agree with the tax court’s determination that the manner by which Dave True selected the price terms for the buy-sell agreements contributes to a finding that the agreements were testamentary substitutes.
The court in Lauder II also noted that where the price term in a buy-sell agreement excluded the value of intangible assets, a further inference could be drawn that the agreement in question served a testamentary purpose. Id. Here, the nature of tax book value accounting for True Oil allowed the company’s proven oil and gas reserves to be omitted “because the reserves were essentially purchased with earnings from the other True companies and their value likely would be dissipated in the unsuccessful search for replacement reserves.” Estate of True, 82 T.C.M. (CCH) at 69; see also id. at 63, 70-71; rec., vol. II at 234-43. Hence,
while we appreciate that an adjusted book value formula may
provide a simple and inexpensive means for evaluating shares in
a company, we cannot passively accept such a formula where, as
here, it appears to have been adopted in order to minimize or
mask the true value of the [interests] in question.
Lauder II, T.C.M. (RIA) 92736 at 3732.
Another factor considered by the tax court in making its testamentary purpose determination was that the buy-sell agreements did not contain within their provisions a mechanism by which to reevaluate the price terms listed therein. See, e.g., Cameron W. Bommer Revocable Trust, T.C.M. (RIA) 97380 at 2424, 2426 (lack of periodic revaluation of price term one factor contributing to conclusion that buy-sell agreement was testamentary substitute). The tax court concluded, and we agree, that unrelated parties negotiating at arm’s length would likely have required a periodic reevaluation of the use of tax book accounting to value the interests in the buy-sell agreements. As Mr. Harris testified, keeping True Oil’s books on a tax value accounting method and employing the accelerated depreciation methods permitted thereunder took into account the company’s practice of expending the value of proven oil and gas reserves to finance the costly search for new reserves. Rec., vol. II at 234-43. If the company were to cease operating in such a manner, however, the tax book value accounting method would not be the best manner by which to value the company because the values of its reserves would not be considered. One would thus expect arm’s length parties to require a regular reevaluation of True Oil’s pricing formula, especially to the extent it took into account or omitted the company’s proven reserves. Similarly, Eighty-Eight Oil, which was labeled as one of the True companies which generated “large sums of cash,” id. at 242, was nonetheless reported at a negative tax book value upon Tamma’s sale of her interests in that company to her brothers and parents. Rec., ex. 154-J, attachment D. Parties operating at arm’s length would have certainly required the buy-sell agreements to include within their terms a method by which to reevaluate the price terms of the company in light of such a disparity.
Additionally, when the True children entered into the buy-sell agreements, there was no negotiation between the children and their father as to the terms of the agreements. The parties discussed the agreements and the reasons for the restrictions contained therein, rec., vol. II at 81, 84, 97, 303, 321-22; id., vol. III at 432, but the children did not engage in any bargaining with their father about the terms, rec., vol. II at 303. They did not seek outside counsel to represent their interests when entering or exiting the agreements, id. at 102, 298, 299, 361-62, nor did they have any knowledge as to who drafted the agreements, id. at 362; id., vol. III at 471. Rather, they were presented with a business opportunity crafted by their father which they could accept or reject. Id. at 83-84, 132, 304; id., vol. III at 432. In Lauder II, the tax court expressed concern about a buy-sell agreement in which the family patriarch appeared to decide unilaterally the formula price for the exchanged interests. Lauder II, T.C.M. (RIA) 92736 at 3732. Similarly, in Cameron W. Bommer Revocable Trust, the tax court viewed with suspicion a buy-sell agreement that was not reached by bona fide negotiations with respect to the price terms, and in which all the parties to the agreement were represented by the same lawyer. Cameron W. Bommer Revocable Trust, T.C.M. (RIA) 97380 at 2425.
Finally, what we deem most telling are the facts surrounding Tamma’s departure from the True companies. Prior thereto, her father’s will generally provided that the residue of his estate would pass to Jean, with the remainder passing to his four children in equal shares upon Jean’s death. Rec., ex. 14-J at 1-2. After Tamma’s departure from the businesses, she was wholly excluded from any interest in her father’s estate. Tamma was removed from Dave’s will, id. at ex. 11-J, and was no longer listed as a beneficiary under his living trust agreement, id. at ex. 12-J, 13-J. In a document exercising a power of appointment in favor of his living trust, Dave specifically noted that Tamma’s potential inheritance had been fully satisfied when she severed her financial ties with the True companies. Id. at 13-J at 4. At trial, Diemer testified he was aware his father excluded Tamma from his will after she sold her interests in the companies. He stated he and his father talked about the issue and that Dave “was very committed to keeping the businesses together, and he felt, on his death, that the cash [from the estate] would be necessary to keep-to stay in the business. And so, it was a conscious decision, I believe, since he made that comment, to make that decision.” Rec., vol. II at 123.
Taxpayers also reported that at the time of his death, Dave’s total estate was worth just over $ 120 million, forty-four percent of which represented the reported value attributable to Dave’s interests in the True companies. Aplt. supp. br. at 2, 7./11/ If, as taxpayers contend, the buy-sell agreements were not testamentary substitutes, Tamma likely would have been excluded only from that percentage of her father’s estate relating to his interests in the True companies. Instead, she garnered no benefit from her father’s estate, not even from the portion not directly associated with the True companies.
Like the court deciding Estate of Godley, in which the decedent indicated in a deposition prior to his death that the transfer of certain interests to his son was a gift executed for the purpose of circumventing estate tax liability, Estate of Godley, 80 T.C.M. (CCH) at 161, we have trouble ignoring Dave’s own statement in exercising his power of appointment that Tamma’s inheritance had been satisfied by the sale of her interests in the True companies. Diemer’s testimony supporting the same position, as well as Tamma’s exclusion from the large percentage of her father’s reported estate values not associated with the True companies, clearly support an inference that the buy-sell agreements served as testamentary substitutes for Dave True.
Having determined the evidence supports the tax court’s inference that the True company buy-sell agreements were testamentary substitutes, we turn to whether the tax court erred in finding the agreements were not supported by adequate consideration.
Where shareholders are members of the same family and the
circumstances indicate that testamentary considerations
influenced the decision to enter into a restrictive stock
agreement, an assumption that the price stated in the agreement
is a fair one is unwarranted. It is then incumbent upon the
estate to demonstrate that the agreement establishes a fair
price for the subject stock.
Cameron W. Bommer Revocable Trust, T.C.M. (RIA) 97380 at 2427. See also Lauder II, T.C.M. (RIA) 92736 at 3733. Taxpayers devote the majority of their analysis to this issue. Courts addressing this question in the context of Treasury Regulation section 20.2031-2(h) have provided slightly varying definitions for adequacy of consideration. However, in concert with the question of whether the buy-sell agreements raise an inference of testamentary intent, courts tend to agree that the option price will be deemed adequate consideration where it represents the price a willing buyer and willing seller would have reached in the course of an arm’s length negotiation. Dorn, 828 F.2d at 181; Estate of Godley, 80 T.C.M. (CCH) at 164; Cameron W. Bommer Revocable Trust, T.C.M. (RIA) 97380 at 2427. In Lauder II, the court stated:
[adequate and full consideration] is best interpreted as
requiring a price that is not lower than that which would be
agreed upon by persons with adverse interests dealing at arm’s
length. Under this standard, the formula price generally must
bear a reasonable relationship to the unrestricted fair market
value of the stock in question.
Lauder II, T.C.M. (RIA) 92736 at 3733-34 (citation omitted). In the instant case, in addressing the question of adequacy of consideration, the tax court concluded “the formula price under the buy-sell agreement must be comparable to what would result from arm’s length dealings between adverse parties, and it must bear a reasonable relationship to the unrestricted fair market value of the interest in question.” Estate of True, 82 T.C.M. (CCH) at 53. The court then determined taxpayers failed to satisfy this test.
In contesting the tax court’s determination of the adequacy of consideration, taxpayers assert the court’s emphasis on the arm’s length standard is contrary to law, an argument we have already rejected. See note 8 supra. They also argue this circuit’s ruling in Brodrick is binding precedent that the price terms in the agreements are controlling. Finally, they contend the Wyoming district court’s decisions in the 1971 and 1973 gift tax cases collaterally estop the I.R.S. from disputing that the price terms in the buy-sell agreements here represented adequate consideration at the time the Trues entered into the agreements. Based on these primary arguments, taxpayers maintain the True company buy-sell agreements were all supported by adequate consideration when they were executed, and therefore the price terms in those agreements should control for estate tax purposes.
In challenging the tax court’s finding that the price terms in the buy-sell agreements are not binding, taxpayers assert the court erred by not following our ruling in Brodrick. They contend Brodrick controls in resolving this controversy and that “[t]he Tax Court cannot ignore precedent that is squarely on point in the circuit to which its decision will be appealed unless the Supreme Court has changed the manner in which the law is interpreted or the law itself has changed.” Aplt. br. at 21./12/ In light of taxpayers’ assertions, we have carefully reviewed Brodrick, the statutes and regulations under which Brodrick was decided, and the relevant statutes and regulations passed since Brodrick’s issuance. We have examined those cases which reference or rely on Brodrick in their own analysis of whether the price terms in a buy-sell agreement control for estate tax purposes. We have also surveyed those cases which independently address the question of when and to what extent buy- sell agreement price terms implicate estate tax values. Having undertaken this analysis, we note that since we decided Brodrick in 1955, the manner by which courts determine when terms in a buy-sell agreement control estate tax values has evolved beyond the approach applied by our court in Brodrick. After due consideration and in light of this development in the law, we hold that Brodrick no longer represents controlling authority for our circuit on the question of when the price terms in buy-sell agreements set estate tax values./13/ We therefore reject taxpayers’ argument that the tax court erred in not treating Brodrick as wholly binding precedent for this case.
In Brodrick, a father and his two sons entered into a partnership governed by a written agreement. 224 F.2d at 894. The agreement’s terms included a requirement that if any of the partners decided to withdraw from the partnership, or upon the death of any partner, the withdrawing partner or his estate was obliged to offer the remaining partners his shares at a set book value, and the remaining partners were required to buy those shares. By will, the father also bequeathed to his sons his interest in the partnership. Id. Upon his death in 1951, the sons brought an action in probate court “to compel themselves, as executors, to sell to themselves, as individuals, the decedent’s interest in the partnership for . . . the alleged book value of such interest at the time of the death of the decedent.” Id. The probate court appointed a special administrator to represent the estate and held an adversary hearing. Id. at 895. The probate court determined thereafter that the estate was required to sell the partnership interest to the copartners for the book value of $ 345,897.53. That sum was paid to the estate by the copartners and the partnership interest of the decedent was in turn conveyed to the sons as copartners. Id.
The sons, as executors of their father’s estate, then filed an estate tax return reporting the value of the partnership interest as the $ 345,897.53 received by the estate for that interest. Id. The I.R.S. challenged the reported value of the partnership interest, asserting that the interest’s fair market value was higher than the amount received and that the former should control for estate tax purposes. The district court granted summary judgment for the sons and the I.R.S. appealed. Relying on Supreme Court authority, we held in Brodrick that
in the absence of collusion, in the absence of other bad faith,
and in the absence of its entry in a nonadversary proceeding,
the order or judgment [of the probate court] must be given
effect as a judicial determination that the executors were
obligated to sell and convey to the surviving copartners the
interest of the decedent in the partnership property for a sum
equal to the book value thereof, and as a judicial determination
of such book value.
Id. at 896 (citing Freuler v. Helvering, 291 U.S. 35, 45 (1934)). While we acknowledged that the book value of the partnership interests was lower than the fair market value, we stated that
such interest was burdened and encumbered with a certain
restriction contained in the partnership agreement . . . . Upon
the death of the decedent, the executors under his will
were . . . effectively bound and obligated to sell such interest
to the surviving copartners for a sum equal to its book value at
the time of the death of the decedent. The surviving copartners
were effectively bound and obligated to purchase such interest
from the estate and to pay therefor its book value. And inasmuch
as the estate was thus bound and obligated, such interest had no
value to the estate in excess of its book value. In other words,
the interest of the estate in the property was by the contract
limited in respect to value, the limitation being the book value
thereof at the time of the death of the decedent. And where the
interest of an estate in property is burdened and encumbered in
that respect by such an effective contractual provision, the
estate tax should be based upon the book value rather than a
fair market value in excess of the book value.
Id. (citations omitted). Because the I.R.S. had failed to raise any challenge to the validity of the probate court proceeding, “and did not deny that in compliance with [the probate court] order the interest of the decedent in the partnership assets was conveyed to the surviving copartners at and for a sum equal to the book value thereof,” id. at 897, we held the I.R.S. essentially foreclosed its opportunity to assert that the price term in the buy-sell agreement should not control for estate tax purposes. In sum, we ruled that where a property interest was burdened by specific contractual provisions, and such provisions equally bound all parties to the contract at life and at death, the value of such property for estate tax purposes would be based on the terms in the contract, rather than the property’s fair market value. Id. at 896.
In questioning Brodrick’s precedential value to the case currently before us, we must remember that the instant controversy centers on determining whether the True buy-sell agreements satisfy the price term control test and, in particular, whether the agreements represent bona fide business arrangements and not testamentary substitutes intended to pass on Dave True’s interests for less than full and adequate consideration. In answering this question, we are governed by the applicable portions of the Internal Revenue Code of 1986, which is a re-designation of the Internal Revenue Code of 1954, along with Treasury Regulation section 20.2031- 2(h). See Tax Reform Act of 1986, Pub. L. 99-514, 100 Stat. 2095./14/
Brodrick examined portions of the Internal Revenue Code of 1939, in particular sections 811(a), (c), and (d)./15/ In reaching our decision in Brodrick, we did not include in our analysis any reference to the tax regulations promulgated under the 1939 Code. See generally Treas. Reg. section 81 et seq. (1944 cum. supp.). Likewise, in determining that book value rather than fair market value should control for estate tax purposes where the interest in the estate was burdened by an effective contractual provision, we relied on cases which focused their analysis on two core questions: was the agreement binding throughout life and death, and was it legally binding and enforceable? See May v. McGowan, 194 F.2d 396 (2d Cir. 1952); Lomb v. Sugden, 82 F.2d 166 (2d Cir. 1936); Wilson v. Bowers, 57 F.2d 682 (2d Cir. 1932). These cases devoted very little analysis, if any, to whether the agreement represented a testamentary substitute intended to pass on the decedent’s interests for less than full and adequate consideration. The agreements in those cases were either not solely between family members, thereby limiting concerns regarding testamentary purposes, see Lomb, 82 F.2d at 166-67; Wilson, 57 F.2d at 683; or, where the agreement was between family members, the district court had “found there was no purpose to evade taxes.” May, 194 F.2d at 397. Hence, when determining whether a buy-sell agreement should control for estate tax purposes, the focus of these earlier cases remained on the legal enforceability of the agreement and whether the agreement equally bound the parties at life and death.
It has also been noted that these early cases, including Brodrick, were decided principally
by the use of a syllogism: the then Revenue Act provided that
the estate tax value is the value of the decedent’s property at
the date of death; the value at the date of death is the amount
the estate will receive for the property under the buy-sell
agreement; therefore, the estate tax value is equal to the
amount payable under the buy-sell agreement.
Roger R. Fross, Estate Tax Valuation Based on Book Value Buy-Sell Agreements, 49 TAX LAW. 319, 327-28 (1996); see also Fiorito v. C.I.R., 33 T.C. 440, 444 (1959) (where agreement sets price to be paid for property and binds all parties equally during life and at death, price term controls for estate tax purposes); Estate of Littick, 31 T.C. at 185-87 (agreement which binds parties to set price at life and at death will control for valuing property in estate).
The 1939 Code was revised in 1954. See Act of Aug. 16, 1954, Pub. L. No. 591, 68A Stat. 3, 374, 380-83. With respect to the relevant estate tax laws in this case, the statutory changes between the 1939 and the 1954 Codes were minimal. See H.R. Rep. No. 1337 (1954), reprinted in 1954 U.S.C.C.A.N. 4017, 4456-57 (noting how I.R.C. section 2031(a) (1954) (general definition for gross estate) largely corresponds to introductory material in I.R.C. section 811 (1939) (same), and how I.R.C. section 2037 (1954) (transfers taking effect at death) represent a combination and revision of law found in sections 811(c)(1)(C), (c)(2) and (c)(3) of the 1939 Code)./16/ Congress also included within the Code’s 1954 revisions a general delegation to the Secretary of Treasury to “prescribe all needful rules and regulations for the enforcement of [the Code], including all rules and regulations as may be necessary by reason of any alteration of the law in relation to internal revenue.” I.R.C. section 7805(a).
Under the authority of section 7805(a), and after engaging in the process of notice and comment rulemaking, see 23 F.R. 4529 (June 24, 1958), the Secretary of the Treasury promulgated a series of regulations in 1958, including those addressing the implementation of the estate tax. The introduction states that the regulations pertain to taxes imposed on transfers of estates of decedents dying after August 16, 1954, “and supercede the regulations contained in Part 81, Subchapter B, Chapter I, Title 26, Code of Federal Regulations (1939) (Regulations 105, Estates Tax), as prescribed and made applicable to the Internal Revenue Code of 1954 by Treasury Decision 6091 . . . .” Treas. Reg. section 20.0-1(a)(1); see also 25 F.R. 14021 (Dec. 31, 1960) (noting “[r]regulations under the 1939 Code, as made applicable to corresponding provisions of the 1954 Code by Treasury Decision 6091 . . . have been systematically superseded by regulations under the 1954 Code.”). The new regulations constituted an effort to provide direction on how to determine the extent of taxes to be “imposed on the transfer of the taxable estate of every decedent who is a citizen or resident of the United States.” I.R.C. section 2001(a). As particularly relevant here, in order to provide guidance on how to calculate the value of a decedent’s gross estate, including property in the form of unlisted stock and securities, see I.R.C. section 2031(a), (b), the Secretary of the Treasury promulgated regulation section 20.2031- 2(h), detailing factors to be considered when determining the value of property interests contained in an estate subject to an option or contract to purchase. See Treas. Reg. section 20.2031- 2(h)./17/ No similar regulation existed under the 1939 Code. See generally Treas. Reg. section 81 et seq. (1944 cum. supp.). Unlike Broderick, which involved the estate of a person who died in 1951, we are faced here with the proper method of determining the value of an estate of an individual who died in 1994, and we must include in our analysis consideration of section 20.2031- 2(h), which is applicable to “the transfer of estates of decedents dying after August 16, 1954. . . .” Treas. Reg. section 20.01-1(a)(1).
With the promulgation of section 20.2031-2(h), and as evidenced by our general discussion of the regulation supra at 16-31, evaluation of buy-sell agreements for estate tax purposes evolved beyond merely examining the manner and extent to which the parties were bound to an agreement’s terms and the syllogism noted by Fross. Today courts are required to engage in a careful examination of whether the contested agreement was a testamentary substitute intended to pass a decedent’s interests to the natural objects of his or her bounty for less than full and adequate consideration. See, e.g., Estate of Gloeckner, 152 F.3d at 214-17; Dorn, 828 F.2d at 181-82; St. Louis County Bank, 674 F.2d at 1210-1211; Cameron W. Bommer Revocable Trust, T.C.M. (RIA) 97380 at 2424- 29; Lauder II, T.C.M. (RIA) 92736 at 3731-35; see also Gloeckner, 152 F.3d at 213 (“essentially four requirements have evolved for a redemption price to be considered binding for estate tax purposes.”); Lauder II, T.C.M. (RIA) 92736 at 3729-30 (noting evolution of test for determining whether price in buy-sell agreement should control for estate tax purposes); Fross, supra at 330-39 (noting current focus of courts is on whether buy-sell agreement is a testamentary device). In the almost fifty years since section 20.2031-2(h) was issued, neither its construction nor its validity has ever been adversely challenged in the courts. Rather, private parties, the I.R.S., and the courts consistently cite to and rely on the regulation without question. See, e.g., Cartwright, 411 U.S. at 554; Estate of Gloeckner, 152 F.3d at 212-13; Dorn, 828 F.2d at 178; St. Louis County Bank, 674 F.2d at 1210; Slocum, 256 F. Supp. at 754; Estate of Blount v. C.I.R., 87 T.C.M. (CCH) 1303, 1309 (2004); Cameron W. Bommer Revocable Trust, T.C.M. (RIA) 97380 at 2423; Lauder II, T.C.M. (RIA) 92736 at 3729-30; Estate of Hall v. C.I.R., 92 T.C. 312, 334 (1989); Cobb v. C.I.R., T.C.M. (P-H) 85208, 906, 915 (1985); Estate of Bischoff, 69 T.C. at 39.
With the rise of section 20.2031-2(h) and the law’s evolution in this area, Brodrick’s influence on the question of whether price terms in a buy-sell agreement control for estate and gift tax purposes has waned. Brodrick was once regularly cited in support of the proposition that when all parties to a buy-sell agreement were equally bound at life and death, the agreement controlled for estate tax purposes. See, e.g., Estate of Seltzer v. C.I.R., 50 T.C.M. (CCH) 1250, 1253 (1985) (construing a 1950 agreement and holding “an enforceable agreement, which fixes the price to be paid, may limit the value of property for estate tax purposes”); Estate of Reynolds v. C.I.R., 55 T.C. 172, 189 n. 9 (1970) (construing restrictive price terms in 1946 agreement and holding “where the estate of a deceased partner was obligated to offer the decedent’s interest to the surviving partners and where the surviving partners were obligated to buy that interest at a predetermined price based solely on book value, the predetermined price was held to be the proper one for estate valuation purposes”); Fiorito, 33 T.C. at 444 (applying buy-sell restrictions in 1945 agreement and holding: “It now seems well established that the value of property may be limited for estate tax purposes by an enforceable agreement which fixes the price to be paid therefor, and where the seller if he desires to sell during his lifetime can receive only the price fixed by the contract and at his death his estate can receive only the price theretofore agreed upon.”). However, as the law has shifted to require additional scrutiny to whether the agreement fulfilled a bona fide business purpose and was also not some form of testamentary substitute, see Dorn, 828 F.2d at 182; St. Louis County Bank, 674 F.2d at 1210; Estate of Godley, 80 T.C.M. (CCH) at 164; Cameron W. Bommer Revocable Trust, T.C.M. (RIA) 97380 at 2423; Lauder II, T.C.M. (RIA) 92736 at 3730-31, citations to Brodrick have relegated it to supporting the general approach of regulation section 20.2031-2(h), or as a specific example of how an agreement can satisfy the second prong of the price term control test by being enforceable at both life and death. See Slocum, 256 F. Supp at 754 (Brodrick supports position that agreement be binding at life and death); Lauder II, T.C.M. (RIA) 92736 at 3729-30 (referencing Brodrick as supporting general proposition that property values may be limited for tax purposes by terms in buy-sell agreement, but more specifically relying on Brodrick for proposition that agreement must bind all parties at life and death); Estate of Lauder v. C.I.R., T.C.M. (P-H) 90530, 2595, 2600 (1990) (Lauder I) (noting evolution of law and citing Brodrick for proposition that agreement must be binding at life and death); Estate of Wildman v. C.I.R., T.C.M. (P-H) 89667, 3449, 3453 (1989) (citing Brodrick as one of many cases embodying portions of price term control test); Cobb, T.C.M. (P-H) 85208 at 915 (noting evolution of law and citing Brodrick for proposition that agreement must be binding at life and death); Estate of Bischoff, 69 T.C. at 41 (citing Brodrick as case requiring agreement to be binding during life and at death); Estate of Caplan v. C.I.R., 33 T.C.M. (CCH) 189, 192 (1974) (referencing Brodrick for proposition that agreement must be binding at life and death).
Treasury Regulation section 20.2031-2(h) also supports this shift. After making explicit that “[l]ittle weight will be accorded a price contained in an option or contract under which the decedent is free to dispose of the underlying securities at any price he chooses during his lifetime,” the regulation then provides that “[e]ven if the decedent is not free to dispose of the underlying securities at other than the option or contract price,” the price will be disregarded if the agreement does not represent a bona fide business agreement or is a testamentary substitute. Treas. Reg. section 20.2031-2(h) (emphasis added). Thus, although all parties may be equally bound to an agreement furthering legitimate business purposes, it must still be shown that the agreement is not serving as a testamentary device.
Finally, it is worth observing that when Congress passed section 2703 of the tax code, see Pub. L. 101-508, Nov. 5, 1990, 104 Stat. 1388-498, it essentially codified the rules laid out in section 20.2031-2(h). See I.R.C. section 2703; see also Estate of Gloeckner, 152 F.3d at 214 (“the 1990 Act for all intents and purposes codifie[d the] pre-existing regulatory language” of section 20.2031-2(h)). As we discussed earlier in this opin