Florida Tax Litigation Lawyer & Attorney : Fox Rothschild : Serving West Palm Beach, Jacksonville, Miami

The Fifth Circuit in Taylor v. United States, ___F.3d___, 2008 WL 57081 (5th Cir. 2008) faced the issue of how to value payments made pursuant to a structured settlement arising from tort claims, which payments could not be anticipated, sold, assigned or encumbered. The issue is whether the annuities should have been valued under the customary willing buyer-willing seller test (presumably at a discount because of the restrictions on transferability), or using the Section 7520 tables. The estate had argued that the provisions of Reg. Section 20.7520-3(b)(1)(i) of a “restricted beneficial intent” meant that the Section 7520 approach should not be used. The cited regulations preclude the use of section 7520 tables for “an annuity…that is subject to any contingency power, or restriction…” The court explained that the use of the tables did not produce a result so unrealistic that the table should be ignored. As the Tax Court noted:

the enactment of a statutory mandate in section 7520 reflects a strong policy in favor of standardized actuarial valuation of these interests which would be largely vitiated by the estate’s advocated approach. A necessity to probe in each instance the nuances of a payee’s contractual rights, when those rights neither alter or jeopardize the essential entitlement to a stream of fixed payments, would unjustifiably weaken the law.” Gribauskas, 116 T.C. at 163-64.

The Fifth Circuit relied on its earlier opinion in Cook v. United States, 349 F.3d 850 (5th Cir. 2003) affirming T. C. Memo 2001-170 which valued lottery payments as suitable for valuation by using the Section 7520 approach rather than general valuation principles which remains the Fifth Circuit’s view.

The Ninth Circuit (Estate of Shackleford v. United States, 262 F.3d 1028 (9th Cir. 2001)), and the Second Circuit (Estate of Gribauskas, 342 F.3d 85 (2nd Circuit, 2003) are to the contrary. The result in Taylor does not seem unreasonable because the factor accounting for the disparity between the expert valuation testimony and the table valuation is not properly applied to the lottery winnings. After all, non-marketability of a private annuity is an assumption underlying the section 7520 table.

From a planning point of view, until the Supreme Court resolves the conflict in the circuits, any private annuity arrangement should have strong non-assignability clauses.

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Once again the Internal Revenue Service in AOD 2008-1 announced its nonacquiescence in Herbert V. Kohler, Jr., v. Commissioner, T.C. Memo 2006-152(2006), but did not appeal the adverse result in the Tax Court.

In Kohler, a shareholder died and two months later the corporation reorganized tax-free under § 368 and the new stock received by the shareholder’s estate was subject to transfer restrictions, and a purchase option designed to insure that family members would continue to own all of the stock.

Pursuant to § 2032, the Tax Court held that the new stock received within six months after death, is the stock to be valued. In other words, the court accepted the estate’s argument that (i) the stock should be valued at six months post-death and (ii) that the stock to be valued has the restrictions which depress the value. As the court noted, the regulations (Reg Sec. 20.2032-1(c)(1)) provide that a tax-free organization is not a disposition. 

If the Service disagrees with a decision, it has a simple remedy: Appeal. Sound tax policy is not found here. 

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The Supreme Court first approved an application of the doctrine of equitable recoupment in Bull v. United States, 295 U.S. 247 (1935). In a case of first impression, the Tax Court (Menard, Inc. v. Commissioner, 130 T.C. No. 4 (2008)) held that under the doctrine of equitable recoupment, it had jurisdiction to offset an income tax deficiency with a tax paid even if the court lacks subject matter jurisdiction over the tax so paid.

Section 6214(b) was amended by the Pension Protection Act of 2006 by adding the last sentence to subsection (b) authorizing the Tax Court to apply the doctrine of equitable recoupment to the same extent as it is available in the district courts and Claims Court. (This amendment confirms the jurisdiction of the court to apply equitable recoupment which had split the courts of appeal. See conflict between the Sixth and Ninth Circuits). The Commissioner had argued that the Tax Court cannot apply the doctrine unless it has jurisdiction over the tax, i.e. income, estate and gifts, and excise tax. The Commissioner argued that this group does not include the “hospital tax” imposed by sections 3101 and 31111, 

Rejecting this argument, the Tax Court stated as a matter of policy, that the 2006 Amendment should be read in such a manner so as to eliminate confusion and to provide “simplification benefits to both taxpayers and the IRS.”

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In a fully reviewed opinion, the United States Tax Court in the Estate of Christiansen v. Commissioner, 130 TC No.1 (2008) rendered what may become a landmark case dealing with “formula disclaimers.”

The decedent’s daughter made a formula disclaimer of everything in the estate in excess of $6,350,000.00. The excess passed to a charitable lead trust and a foundation. (As to the part passing to the trust, the charitable deduction was disallowed by the court on the ground that the disclaimant had an interest in the trust which itself was not disclaimed, violating Reg. § 25.2518-2(c) and  §25.2518-3(a)(b)).

The specific formula disclaimer clause provided “intending to disclaim a fraction or portion of the Gift, … hereby disclaims that portion of the Gift determined by reference to a fraction, the numerator of which is the Fair Market Value of the Gift … less $6,350,000.00, and the denominator of which is the Fair Market Value of the Gift….” Fair Market Value was defined as the value as finally determined for Federal Estate Tax purposes. The disclaimer clause also had a savings clause in which the disclaimant “…hereby takes such actions to the extent necessary to make the disclaimer…a qualified disclaimer.”

The Commissioner challenged the disclaimer as not being effective to pass the property to the foundation on two grounds: (1) The amount was subject to a contingency - as a conditioned subsequent and (2) the clause was void as contrary to public policy. As to the condition subsequent argument, the court held that the regulation (§ 20.2055-2(b)(1) which disallows a charitable deduction if the Gift is dependent upon the performance of an act precedent) does not apply. As the court noted, the transfer to the foundation occurred at the time of the disclaimer and was not contingent upon any event that occurred after the decedent’s death. 

As to the public policy discussion, the Commissioner cited the often-cited case of Commmissioner. V. Procter, 142 F.2d 824 (4^th Cir. 1944). In Procter, the court voided a clause as contrary to public policy in that the clause would discourage collection of tax, would render the court’s own decision as moot by undoing the gift, and would upset a final judgment. Here, the Tax Court stated “This case is not Procter. The contested phrase would not undo a transfer, but only reallocate the value of the property transferred…” The court concluded that an increase in the charitable deduction to reflect the increase of the property passing to the charity “violates no public policy.”

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On January 25, 2008 the Justice Department submitted a brief for the First Circuit, arguing that a district court erred in U.S. v. Textron Inc. and Subsidiaries, 507 F. Supp. 2d 138 (D.R.I. 2007) by refusing to enforce an IRS summons and in holding that tax accrual workpapers prepared by a public corporation for a regular financial audit required by federal securities laws are protected by the work product doctrine. The District Court in Textron was able to conclude that the IRS was not entitled to the tax-accrual workpapers because the court ruled that those workpapers had “little to do” with the determination of Textron’s tax liability and that disclosure “would put Textron at an unfair disadvantage” in disputes regarding its tax liability. 

In its brief the United States argues that the District Court’s determination that Textron’s tax accrual workpapers are protected work product (i) misapplies the Supreme Court’s Arthur Young, 465 U.S. 805 (1984) (holding that accountants’ tax-accrual workpapers were “highly relevant” to an IRS audit and were not protected by an accountant’s work-paper doctrine) decision, (ii) conflicts with the First Circuit’s work-product test set out in Maine, 298 F.3d 60 (1^st Cir. 2002)(“documents should be deemed prepared for litigation and within the scope of the [work product rule] if, ‘in light of the nature of the document and the factual situation in the particular case, the document can be fairly said to have been prepared or obtained because of the prospect of litigation’”), and (iii) unnecessarily creates a conflict with the Fifth Circuit’s El Paso, 682 F.2d 530 (5^th Cir. 1982), cert. denied, 466 U.S. 944 (1984) (no work-product protection for documents “assembled in the ordinary course of business, or pursuant to public requirements unrelated to litigation”) decision which has held that a company’s tax-accrual workpapers are not protected work product.

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On February 4, 2008 as part of President Bush's proposed fiscal 2009 budget, Treasury suggested that Congress give tax return preparers a break.  Realizing the potential conflict between the client taxpayer and the preparer the Treasury made the following proposal: “The standard applicable to preparers when taking a position not disclosed on a return would be the substantial authority standard. Because the determination as to whether a transaction has a significant purpose of tax avoidance or evasion is inherently subjective to the taxpayer, the preparer standard applicable to tax shelters would also be substantial authority. However, a preparer would be required to have a reasonable belief that the position would more likely than not be sustained on the merits when taking a position with respect to a transaction determined to have a potential for tax avoidance or evasion to which section 6662A applies. The standard applicable to preparers for disclosed positions would remain at reasonable basis. No penalty would be asserted against a preparer if the preparer has reasonable cause and good faith. The proposal would be effective for returns prepared after January 1, 2008.”

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       The most recent appellate case involving family limited partnerships, Estate of Bigelow v. Commissioner, 503 F.3d 955, 2007 WL 2684526 (9th Cir. 2007) deserves careful study for the discussion of the "bona-fide sale for adequate and full consideration," exception to section 2036.

       The Ninth Circuit held that if the consideration exception applies, section 2036 does not apply.  In determining the applicability of the exception, the inherent reduction (such as arises when an investor transfers a stock portfolio to a hedge fund in exchange for an interest therein) of the value of the property transferred cannot per se disqualify the property from failing the 2036(a) exception.  But, the court continues on to state:

"The validity of the adequate and full consideration prong cannot be gauged independently of the non-tax-related business purposes involved in making the bona fide transfer inquiry."

         Estate planners should not assume that the inquiry of subjective motive is necessarily required in measuring the adequacy of the consideration.  In Bongard, 124 T.C. 95 (2005), Judge Halpern, in a concurring opinion, expressed his disagreement with the majority's interpretation of the bona-fide sale exception, as the Judge stated:"

"Therefore, to establish that the transfers were for full consideration, petitioner must, for each transfer, establish that the value of the property transferred by decedent did not exceed the cash value of the property received by him. Id. By the explicit terms of section 25, 2512-8, Gift Tax Regs., the resulting inquiry is limited to an economic calculus, and there is no room for any inquiry as to the transferor's (decedent's) state of mind.  Yet the majority makes his state of mind critical..."

         A more recent Tax Court decision, Estate of Rector, T.C. Memo 2007 367 (2007) involved the creation of an FLP, by a 92-year old woman who was living in a nursing home.  She was the only general partner and her revocable trust held the remaining 98% interest as a limited partner.  Before death, the decedent transferred by a gift a 30% interest of FLP.  Judge Laro had no difficulty in concluding that section 2036 applied and no discount was available.  See also, Estate of Hilde E. Erickson, 2007 T.C. Memo 107 (2007).

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That’s the question currently being considered in the Tax Court in what most likely will be a fully reviewed opinion. The facts of the case are as follows, the taxpayer applied to the IRS for innocent spouse relief in August of 2002. The IRS made a final determination denying the requested relief in a letter dated April 27, 2006. This letter gave the taxpayer ninety (90) days in which to file a petition in the ninety-day time frame. Then the decision from the tax court, Billings v. Commissioner, 127 T.C. 7 (2006), which came out in July of 2006 held that the tax court had no jurisdiction over innocent spouse reviews pursuant to § 6015(f). Not until after taxpayer’s ninety-day window closed, did Congress amend § 6015 to specifically grant the tax court jurisdiction over such claims. Prior to that amendment, however, various federal courts had held that the tax court did not have jurisdiction over §6015(f) petitions. See Comm’r v. Ewing, 439 F.3d 1009, 1013 (9th Cir. 2006)(court held that 6015(e) did not grant jurisdiction over 6015(f) petitons); see also Barman v. Commissioner, 446 F.3d 785 (8th Cir. 2006)(same). Taxpayer was thus faced with a situation where the IRS told her that she had to seek review of its decision in the tax court, but federal case law stated that the tax court had no jurisdiction over her claim. The United States District Court for the Southern District of Florida held that the taxpayer’s failure to file a petition in the ninety-day window was excusable, given the uncertainty in the law over this issue. Finding that the ninety-day review period for 6015(f) petition is analogous to the ninety day window for filing a complaint with the EEOC in Title VII cases. In that situation, the Supreme Court has held that the filing window is a “requirement subject to waiver, estoppel, and equitable tolling.” Zipes v. TWA, 455 U.S. 385, 393 (U.S. 1982). Waiver and equitable tolling should also be available to those seeking review of a denial of innocent spouse relief, although like the Title VII cases, it should be granted sparingly. See Baldwin County Welcome Center v. Brown, 466 U.S. 147, 151 (1984).
The Southern District held that the Taxpayer’s situation merited either a waiver of tolling of the ninety-day time period for filing a petition or for review with the tax court. Finding that the uncertain state of the law on the jurisdiction of the tax court at the time taxpayer would have had to file the petition excused her failure to file. Therefore, the Court granted taxpayer thirty days from the date of the order to file a petition for review of her denial of innocent spouse relief under § 6015(f) with the tax court.

The taxpayer then filed a petition in the Tax Court in which the IRS responded with a motion to dismiss for lack of jurisdiction. In December of 2007 the Tax Court in Miami heard oral arguments as to why equitable tolling should apply to the 90 day window in this particular § 6015(f) innocent spouse case. Tax Court Judge Holmes indicated that the issue is a complicated one that his colleagues might want to take to conference.

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Estate of Jelke III v. Comm'r 2007 WL 3378539 (11th Cir. 2007) involves the proper valuation for estate tax purposes of a 6.44% stock interest, or 3,000 shares, owned by the decedent, Jelke, in a closely-held, investment holding company, owning appreciated, marketable securities. In a case of first impression in the Eleventh Circuit (11th Cir. agreed with the 2002 5th Cir. case Estate of Dunn, 301 F. 3d 339 (5th Cir. 2002) the court vacated the Tax Court’s valuation for estate tax purposes, holding that the Tax Court used an inappropriate valuation method, and remanded with instructions that the Tax Court recalculate the net asset value of the company using a dollar-for-dollar reduction of the entire potential $51 million in built-in capital gains tax liability, under the assumption that the company was liquidated on the date of death and all assets sold. The Court reached this conclusion on the theory that a willing buyer would have insisted on reducing the closely held company value to reflect that built-in capital gains tax liability.

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